Applying results-based finance to the Paris Agreement
Results-based finance is a mechanism that enables an “off-taker” to pay a “project developer” for the delivery of specific results. For a results-based payment mechanism to work, four key elements are required:
- A clear definition of the deliverable that one party can supply and that other wishes to pay for;
- A credible and transparent means of monitoring and reporting on the deliverable, ideally cost effectively;
- Certainty that the deliverable is unique and has not been sold to another party; and
- A contract that enables both parties to rely on the other, agree a price and terms of delivery and to seek compensation if one party fails to fulfil their obligations.
The promise of payment for the results, if negotiated to be sufficiently attractive, enables the project developer to overcome one or more barriers that would otherwise prevent the investment. Furthermore, payments for results are ex post so they are risk free for the off-taker, with the investor taking the risk and the rewards if they deliver.
A results-based payment mechanism can be used as a way to pay a project developer for a “benefit” which can be additional to other sources of cash flow. It can be viewed as a qualitative or quantitative element of a product or good, or a “co-benefit” of a service. It can be sold with the goods or services or it can be sold separately to a different off-taker.
Enough of the theory. What does this mean in practice?
The carbon markets and specifically the Clean Development Mechanism (CDM) and voluntary emission reduction markets are an excellent example of a results-based payment mechanism demonstrating all four of the criteria above. The Kyoto Protocol and EU ETS created demand for emission reductions that could be generated by investing in (more expensive / higher risk) low emission technologies. The international community set about defining methodologies to calculate, monitor and report on the number of emission reductions. Third party auditors were accredited and hired to verify the results and facilitate the issuance of unique certificates; and the Emission Reduction Purchase Agreement (ERPA) was created which enabled project developers to raise the additional finance they needed to build the (more expensive / higher risk) projects.
Unfortunately, the carbon markets were so successful that they created a number of problems. These were not necessarily related to the concept or results-based finance but more to the commoditization of the asset, the existence of a benchmark price but highly variable costs of producing the underlying asset and the asset’s fungibility under an international treaty.
We are proposing that the Paris Agreement, the Sustainable Development Goals and the world of Corporate Social Responsibility (CSR) actually create demand for many different types of results that could be delivered through a range of results-based instruments.
Here are two examples which we hope to talk more about during some of the Banks side events at CoP24:
Reneum is a blockchain technology platform which enables CSR actors and donors to purchase renewable energy certificates from renewable energy project developers operating in jurisdictions where there are currently no regulations to create Renewable Energy Certificates. The core product is electricity sold to a grid / captive user at an agreed tariff (which may or may not take account of the renewable nature of the energy). Reneum enables the project developer to monetize the renewable energy aspect of the electricity, selling it to, for example, CSR off-takers who have made commitments to purchase renewable energy but are unable to do so on their own grids. Reneum tokens (representing 1 MWh of renewable energy uploaded to the grid) cannot be generated in jurisdictions with Renewable Energy crediting legislation or to projects which claim carbon emission reductions as these mechanisms are already monetizing the co-benefit.
In practice, Reneum will provide a new source of revenues to encourage faster uptake of renewable energy in developing countries. Renewable energy lowers the emission intensity of an economy; providing more energy in a developing country helps to make households and communities less vulnerable to climate change; purchasing Reneum tokens contributes to the goals of the Paris Agreement, the SDGs and potentially CSR commitments.
The Adaptation Benefit Mechanism is designed to enable donors and CSR actors to “purchase” a wide range of “adaptation benefits” from private or public sector project developers. The ABM uses the modalities and procedures of the CDM to help:
- Define an adaptation benefit and establish the project-specific level of additional finance which the project developer needs to create the benefit;
- Define a methodology to monitor and report on the generation of the benefits;
- Deploy simple and cost-effective means of verifying outputs to ensure benefits exist and are correctly accounted for; and
- Provide an “Adaptation Benefit Offtake Agreement” as a basis for doing business.
The key to these non-market / results-based payments however, is why an off-taker would want to pay for “Adaptation Benefits” in the first place? There are two parts to this answer:
- Donors and CSR actors have an altruistic desire to help households and communities in developing countries adapt to climate change and adopt low carbon development pathways.
- There is a pressing need to mobilize private sector finance for climate action and these kinds of mechanisms can report not only on the “grant” based element of the off-take agreement (i.e. what the off-taker contributes to the project) but also on how much private sector finance the grant component has leveraged.
We will be discussing the ABM in the context of Article 6 at a side event “Market and results-based finance for climate investment” at the African Development Bank’s Pavilion from 0900-10.30 on Thursday 13th December.