The CDM should be re-engineered to ensure it or any new market mechanism can be a climate finance tool to provide upfront finance to carbon-cutting projects, UN agency UNEP DTU found in a paper published on Thursday.
The paper aimed to guide governments, which this year at UN climate negotiations will craft rules on a new market mechanism and on how it and other schemes can work under the post-2020 Paris Agreement.
It proposed two models to turn the CDM into a climate finance tool for use by the 80+ countries intending to use markets in their NDCs, or as “one of the easiest and immediately realizable instruments” for the Green Climate Fund.
The paper found that the CDM hadn’t been able to function as properly intended up to now because banks viewed projects as too risky to provide finance upfront.
It said this undermined the system because the cash flow from resulting carbon credits generated by verified emission reductions “arrived at a time when project financial barriers were long since overcome.”
The CDM channelled over $315 billion towards carbon-cutting projects in developing countries over the past ten years, but investment dried up due to the collapse of carbon credit prices as countries delayed agreeing a global successor to the 1997 Kyoto Protocol until last year.
The UNEP report warned that the development of a new market mechanism under the Paris Agreement would face the same risks “unless the bitter sweetness of the CDM experience is heeded”.
The paper proposed two models to counter this, both of which could be applied together:
1) The regulator guarantees issuance for all projects but only agrees to deliver a fixed number of credits, using criteria based on issuance rates of project types over the past 10 years of the CDM minus a ‘conservativeness premium’ that would form a reserve pool to cover against any carbon credits lost through defaulting projects.
“With absolute certainty of issuance, all that remains for the lender to assess is the fiduciary quality of the buyer. This is a process that banks are familiar with” so that ERPAs “might become AAA-rated collateral”.
2) Banks absorb risk by offering the developer to repay part of their loan with carbon credits, which are then cancelled.
“This is obviously not viable for private sector banks seeking sound return-to-risk-ratios, but it would be a useful delivery mechanism for finance provided through, for example, the Green Climate Fund Private Sector facility,” the report said
By Ben Garside – ben@carbon-pulse.com
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