The Green Climate Fund (GCF) Board hosted its 7th meeting in Songdo, Korea from 18-21 May 2014. This Insight is an introduction and update on the current design of the GCF, providing observations on the critical role the GCF can play in making marginally uneconomic mitigation projects commercially viable. Mr John Scowcroft, EMEA Executive Adviser is at the meeting, representing the Institute as an accredited observer to the Fund and will follow-up this Insight with his personal observations and findings from the meeting.
The GCF was established in 2010 by the United Nations Framework Convention on Climate Change (UNFCCC) Conference of the Parties (COP) as an operating entity of the financial mechanism. The objective of the GCF, as agreed to by the COP, is to be transformational and bring about a “paradigm shift” towards low-emission and climate-resilient development pathways.
The GCF explained
The GCF aims to provide funds for public and private sector projects and programmes. Private sector programmes will be provided through a special entity termed the Private Sector Facility (PSF). The PSF has an especially important role to play in advising the Board on how the GCF might help mitigate the investment barriers currently faced by the private sector, in an effort to encourage and mobilise deeper levels of global private sector capital. The barriers to private sector investment in mitigation activities typically include:
- higher up-front project costs relative to current alternatives over the life of a project,
- greater technological risks, especially in developing countries,
- limited relevant expertise/capacity among core actors in every element of the value chain of investments,
- nascent stage of climate-related technologies including a lack of scale and capacity of players along all relevant segments of the value chain of investments,
- increases in transaction costs and low levels of confidence in potential private investors,
- lack of awareness of mitigation options among key stakeholders (including municipal and local bodies, financial and regulatory bodies, local governance institutions, industry, consumers and communities),
- underdeveloped capital market and/or a lack of financial instruments to correctly price risk (leading to high risk premiums),
- 3rd party risks in the form of foreign exchange availability, regulatory uncertainty and the risk of contractual default by local institutions, and
- absence of local technical and finance capacity.
The Board discussed at its 3rd meeting last year that PSF investment priorities should include (among others) enabling a reduction in the emission intensity of industrial production and support for the development, transfer and deployment at scale of low-carbon power generation (clearly CCS mitigation falls within the scope of both these sectors).
The GCF can play a critical role in making marginally uneconomic mitigation projects commercially viable. The following hypothetical illustration shows how ‘blending’ or structuring different sources of finance including GCF resources, can help lift internal rates of return (IRR) above their hurdle rates.
The Institute considers that the Board is operationalising the GCF in an efficient manner, especially in light of its prospective complexity, scale and scrutiny of future operations. Additional funding will clearly be required to make the GCF functional and consistent with the annual US$100 billion funding target in 2020. All subsequent funding pledges and commitments from this point onwards will of course be linked to the pace of the Board’s implementation of appropriate administrative arrangements, future commitments that may arise from the upcoming UN Secretary General’s Climate Summit in New York, and the UNFCCC’s negotiations. These negotiations will reflect the relative positions of both developed and developing countries as to the desired shape and make-up of any future funding ‘roadmap’.
There are some interesting areas in the Board’s current discussions where the CCS community might perhaps offer to play a more engaged role. For example, the Logical Model (LM) for mitigation will assess the performance of GCF funded mitigation projects and programmes. It has been developed in close reference to a number of existing programmes that mostly service energy efficiency and renewable energy activities such as the Clean Technology Fund (CTF), Scaling Up Renewable Energy Programme (SREP) and the Global Environment Facility (GEF). In stark contrast no existing programmes that support clean fossil energy technologies or specifically CCS have been referenced when developing the LM.
As such, the Board has given the Secretariat approval to solicit advice from an Advisory Panel that will undertake independent technical advice. The CCS community could consider reaching out to the Secretariat and offer such a service to help it assess the transformational impact claims of CCS proposals. This matter is due for a draft decision by the Board at its October 2014 meeting.
Furthermore the CCS community should keep an eye on the GCF Investment Committee’s discussions with regard to any CCS-specific decision criteria. This criteria will be used by the Secretariat to assess CCS relevant funding applications.
Finally, it is clear that initial proposals can come from unsolicited submissions made by sub-national, national, regional or international IEs or intermediaries. As such the CCS community could consider organising itself to develop such a "concept note" for funding and prepare to submit soon after the GCF is announced operational.
Further background and structure of the GCF
The GCF is governed and supervised by a board (comprised of two co-chairs) which has full responsibility for its funding decisions. It is also formally accountable to the COP as prescribed in an overarching 'governing instrument' – indeed, the Fund can only be terminated subject to a COP decision.
As at 31 March 2014, the GCF had some US$54.89 million in pledges and contributions, of which US36.68 million has already been deposited by twelve national governments. The Board has approved US$54.82 million funding (including about $27 million for the Secretariat). Its target is US$100 billion per annum in 2020, as adopted by the COP.
Under the supervision of the Board is:
- The Secretariat, which itself contains two working groups; Decision and Risk Management.
- The Trustee, which manages the financial assets of the Fund. In 2011 the COP designated the World Bank as interim Trustee for three years after it becomes operational, after which the Board will select a permanent Trustee through a competitive bidding process.
- An Independent Evaluation Unit (IEU),
- an Independent Integrity Unit (IIU), and
- an Independent Redress Mechanism (IRM).
Furthermore, the Board has established 4 committees;
- an Investment Committee which has responsibility for policy, strategy and guidance
- a Risk Management Committee
- an Ethics and Audit Committee and
- a Private Sector Advisory Group (PSAG), a panel providing advice on GCF engagement with the private sector.
The PSAG is specifically structured to support private sector project finance, guarantees and insurance, and financial institutions and intermediation.
The GCF will eventually offer two types of financial instruments with three offerings:
- Grants - no repayment required.
- Concessional loans (deeply concessional) at zero per cent interest over 15 to 40 years.
- Concessional loans 2 (moderately concessional) at interest rates to be determined but likely to be equivalent to European Central Bank rate or US Treasury bond rate over 8 - 15 years.
The Board has adopted the following suite of guiding principles to underpin the nature of the financial instruments offerings:
- Grants should be tailored to incremental cost or the risk premium required to make the investment viable, or to cover specific activities such as technical assistance.
- Loans should seek the right level of concessionality, so as not to displace investments that would otherwise have occurred, including for private sector investment.
- Levels of indebtedness capacity of the recipient should be taken into account so as not to encourage excessive indebtedness.
- Terms should be structured on a case-by-case basis to address specific barriers.
- The GCF should avoid crowding out commercial financing.
- GCF finance should leverage other financing, both public and private, and seek to maximise leverage in the case of private financing.
- Promote long-term financial sustainability.
- Apply due diligence to assess risk.
The GCF is structured into two themes (mitigation and adaptation) and one modality (PSF). It will initially embrace a two-tier allocation system in addition to broader considerations of geographic balance and gender equity issues. The first tier will aim for a 50:50 split in funds between the mitigation and adaptation themes. The second tier will be activity-based with an element of competitive funding between the PSF and public sector proposals (it has notionally proposed a 20 per cent tranche of total cumulative commitments be initially set aside for the PSF).
In addition to the above, the approval processes for funding will likely be split between two categories to generate administrative efficiencies. Projects or programmes requiring limited funding amounts will be handled through a streamlined approval process, while those requiring large funding amounts or are highly innovative will be referred to the Board for consideration and approval.
In relation to mitigation activities, a "mitigation logical model" (LM) has been developed to track the performance of 4 key sectoral/cross-sectoral themes, including;
- urban and built environment emission reduction,
- low-carbon power generation,
- reduced emissions from agriculture and forests,
- mainstreaming low-emission development into governments.
Funding is to be allocated on the ability of a proposed activity to demonstrate its potential to limit and reduce emissions in the context of promoting a "paradigm" shift. This essentially means satisfying the following 3 core ‘impact’ and ‘transformational’ performance indicators:
- tonnes of greenhouse emissions produced, with the intention of reducing emissions relative to a 'without project' baseline,
- cost per tonne of CO2-equivalence reduced (the intention is to reduce costs of mitigation), and
- volume of public and private funds catalysed (the intention is to maximize the impact of GCF funds).
A potential 4th key indicator is the delivery of at least one co-benefit as a result of GCF funding, which for example may include enhanced economic growth, enhanced livelihoods and better access to electricity. It is plausible that CCS is to be considered under the first two LM themes. Indeed, CCS is specifically cited in two separate Board papers, in both Annex II of GCF/B.05/23 (which was considered at its 5th meeting in late 2013) and Annex III of GCF/B.07/06 (yet to be considered at its 7th meeting). It is recommended that a criterion to assess “Impact/result potential performance indicator” should include "Support to development of negative emission technologies (Number of carbon capture and storage projects, tCO2 sequestered)".
Other more ‘administrative’ assessment criteria likely to be applied to mitigation proposals may include:
- needs of beneficiary country/region,
- institutional capacity of beneficiary,
- economic efficiency of activity, and
- financial viability of activity.
The Investment Committee may task the Secretariat with additional decision criteria depending on the activity.
Project submission and approval processes
The core actors in the GCF processes include: Implementing Entities (IEs), Executing Entities (EEs) and Intermediaries. The relationship between these entities are illustrated below.
An IE can be a public or private entity that the GCF 'accredits' as being competent. It is then able to submit funding proposals for specific projects or programmes and is tasked, on a fee for service basis on behalf of the GCF the management to oversee the approved activity from its preparation to conclusion. Intermediaries essentially perform similar functions as IEs, but are responsible for transferring funds from the GCF to all relevant and necessary EEs. As such, EEs are either the project owners or have delegated operational responsibility and receive funds, manage and administer the day-to-day activities.
If an IE performs the functions of an EE (which is plausible) it would need to transfer its oversight role to another independent entity such as an accredited external auditor, the Nationally Determined Authority (NDA) or the Board. There needs to be a separation of duties between the IEs/Intermediaries and the EEs because EEs are fully accountable to IEs/Intermediaries for the integrity of project execution.
The GCF will formally commence operations once it has been ‘capitalized’ and the Board has implemented 8 key operational modality requirements. Three of these modalities have already been adopted by the Board at its last meeting in February (6th meeting) and include:
- Initial Modalities for the "Operation of the GCF’s Mitigation and Adaptation Windows and the Private Sector Facility".
- Terms of Reference of the Independent Evaluation Unit, the Independent Integrity Unit, and the Independent Redress Mechanism (GCF/B.06/06).
- Policies and Procedures for the Initial Allocation of GCF Resources (GCF/B.06/05).
The Institute expects that substantial progress can be made at the Board’s 7th meeting towards the completion of the other 5 modalities, including:
- Initial Results Management Framework of the GCF (GCF/B.06/04).
- Initial Proposal Approval Process, Including the Criteria for Programme and Project funding (GCF/B.06/08).
- Guiding Framework and Procedures for Accrediting National, Regional and International Implementing Entities and Intermediaries, including the GCF’s Environmental and Social Safeguards, and Fiduciary Principles and Standards (GCF/B.06/09).
- Financial Risk Management and Investment Frameworks (GCF/B.06/10 and GCF/B.06/11).
- The Structure of the GCF, including the structure of the PSF.
Details are yet to be finalised with regard to the initial modalities and how they accommodate the needs of the beneficiary country and any alternative funding sources. The Board is due to consider this matter at its 7th meeting, noting that the GCF is required to finance agreed full and agreed incremental costs for activities to enable and support enhanced action on technology development and transfer, specifically including CCS (GCF/B.07/08, page 8 para. 53).
Activity approval processes
All proposals for funding will essentially need to satisfy 8 approval steps:
- Concept step: IE, or intermediary, or the executing entity (EE) submits a ‘brief’ concept note to the Secretariat validating alignment with GCF objectives and criteria.
- Preparation and appraisal: EE prepares feasibility studies, financial and economic analyses, environmental and social impact assessments and submits to Secretariat to determine eligibility and confirm activity is consistent with the country’s climate change strategy.
- Decision to proceed: If there is no objection by national governments (as solicited by NDAs) then the Board will decide to proceed, not proceed, or impose conditional modifications. Funding terms and conditions will be finalised by the IE, intermediary or EE.
- Implementation: Funds to be disbursed by the Trustee in accordance with the criteria contained in the grant or loan agreement.
- Commissioning/launch of the activity: Project or programme comes into effect and triggers monitoring and evaluation requirements for associated outcomes by the IE or intermediary.
- Impact period: Period in which the activity will make an impact.
- Debt servicing: If funding is in the form of a concessional loan the intermediary would service the debt to the GCF via the Trustee.
- Close: This is the date from which the activity impact will no longer be measured.