How will host countries (and their partners) finance the ambitious emissions reductions underpinning a CAT agreement?

A host country in a CAT agreement will go through three phases to achieve ambitious emissions reductions beyond their NDC (as described in Lujan and Silva-Chavez, 2018 for REDD+):

  1. Readiness. Host countries model a plausible mitigation scenario beyond their NDC, based on realistic policy instruments and volume of mitigation actions mobilized by these instruments beyond those already underpinning the NDC, after inclusive stakeholder consultations.
  2. Implementation. Host countries introduce the policy instruments that financially incentivize or mandate mitigation action by private companies and households envisaged in the scenario developed previously. Governments adjust the policy instruments based on monitoring of the actually achieved mitigation.
  3. Results-based finance. Host countries are paid the agreed price for emission reductions and carbon stocks enhancement beyond their NDC achieved as per the monitoring.

Partners in a CAT will commit funding for the purchase of a specific volume of mitigation units at a pre-determined price (or price range). Ideally, the price is specified for the entire period. Their commitment could be placed in an escrow account and disbursed when emissions reductions take place.  Given that payments for the credits will only accrue ex post, pre-financing instruments need to be implemented. These can include:

  • Loans from partner countries or development banks to the host country government or private entities securitized by the revenue flow from ITMO sales.
  • Partners’ partial disbursement of committed funds as milestones set in the CAT Agreement are achieved. For example, with implementation of particular policies and measures; or approval of large infrastructure investments, the partners would disburse a share of the funds committed for results-based finance.
  • Host countries issuance of sustainability-linked bonds, whose coupon and repayment is linked to the level of mitigation achieved by the country. The first bond of this type has been issued by Italian utility ENEL in 2020. A related instrument is the sustainable sovereign bond proposed to reduce deforestation in Brazil (Elwin, Robins, Willis and Cozzolino, 2021)[1]. Such an innovative financial instrument would link interest payments of a sovereign bond to Brazil’s success in reducing deforestation.
  • Private (green) bonds by companies making real investments in mitigation in the host country to support their low carbon investment, at a lower coupon than comparable bonds.

[1] Lujan, B. and Silva-Chavez, G. (2018) Mapping Forest Finance: A Landscape of Available Sources of Finance for REDD+ and Climate Action in Forests. Environmental Defence Fund, Forest Trends.