Carbon Pricing and Green Financing

Carbon pricing is an instrument that captures the external costs of greenhouse gas (GHG) emissions. This is levied on the Carbon emitters and is used as a relief against the loss that occurred due to Climate Change. It is based on the Polluter Pays principle.

The problem of accounting for loss due to Climate Change:

There are huge costs of emissions that the public pays for, such as damage to crops, health care costs from heat waves and droughts, and loss of property from flooding and sea level rise – and ties them to their sources through a price, usually in the form of a price on CO2 emitted.

Carbon Pricing Mechanisms

There are two major types of Carbon Pricing:

1. Emissions Trading Systems (ETS) or cap-and-trade system – It caps the total level of GHG emissions that an industry can do. Those industries with low emissions can sell their extra allowances to larger emitters. This establishes a market price for GHG emissions.
   • For Example, Carbon Emission reduction Certificates or Carbon Credits (For example, Ci Dev)
2. Carbon tax: Defining a tax rate on GHG emissions or – more commonly – on the carbon content of fossil fuels. Unlike ETS, there is no cap on the amount of emissions.
   • For example, in India, the clean energy cess (or Coal Cess) is levied on coal, lignite and peat as well as on imported coal. It was introduced in the 2010-11 union Budget. It is now renamed as “Clean Environment Cess”.

Other mechanisms to price the carbon emission

Results-Based Climate Finance (RBCF) is a funding approach where payments are made after pre-defined outputs or outcomes related to managing climate change, such as emission reductions, are delivered and verified. Internal carbon pricing is a tool an organization uses internally to guide its decision-making process in relation to climate change impacts, risks and opportunities.

Carbon Credit

Carbon credits are tradable permits that allow countries to emit a specific amount of carbon dioxide (CO₂) or equivalent greenhouse gases.

Mechanism of Carbon Credit

One credit equals one ton of CO₂ reduced or removed. Companies buy credits to offset emissions, promoting carbon neutrality and funding green projects like reforestation and renewable energy.

For example, a coal-fired power plant emits more CO₂ than the permissible limit. To comply with regulations, it buys carbon credits from a solar energy project that has reduced emissions by producing clean energy.

By purchasing these credits, the power plant offsets its excess emissions while funding renewable energy expansion. This system encourages high-emission industries to either reduce emissions or buy credits, promoting global carbon neutrality and supporting sustainable environmental projects.

Clean Development Mechanism

Under the rules of the Kyoto Protocol, a Clean Development Mechanism was institutionalised, according to which Certified carbon emission reductions (CERs)/Carbon credits are issued.

It aims to influence future carbon market mechanisms so that low-income countries, and especially least developed ones, receive a greater and fairer share of carbon finance.

For Example, Delhi Metro became the first Metro rail system in the world in 2011 to get Carbon credit. It has earned ₹19.5 Cr between 2012-2018 by selling these carbon credits. Gujarat launched India’s first emissions trading scheme in Surat.

Limitations: Its market collapsed in 2012, as too many carbon credits were issued to developing countries. This meant that to ensure more buyers of the carbon credit, more countries and companies were required to participate in taking a greater number of targets.

Carbon Market under the Paris Agreement

Carbon markets under the Paris Agreement (Article 6) for “voluntary cooperation” towards climate goals:

1. Market Mechanism 1 (Article 6.2) – It allows countries to sell any extra emission reductions {called as Internationally Transferred Mitigation Outcomes (ITMO)} they have achieved compared to their NDCs. [Government Sector]
   • This is a voluntary direct bilateral cooperation, while ensuring environmental integrity and transparency (the reporting requirements under the Paris regime), which means no COP Supervision is required.
2. Market Mechanism 2 (Article 6.4) – It would create a new international carbon market for the trading of emissions reductions created anywhere in the world by the public or private sector.
   • This new market referred to as the “Sustainable Development Mechanism” (SDM) seeks to replace Kyoto Protocol’s “Clean Development Mechanism” (CDM). It allows CDM carbon credits to be used even under the Paris Agreement.
   • Unlike Market Mechanism 1, It will be supervised by COP and allow Private participation. It does not automatically imply that emission reductions transferred from a host country be adjusted against its NDC targets. The private and public targets are separate from each other and cannot be offset against each other.
   • These reductions represent additional efforts of the private sector or public entities to mitigate GHG emissions, and in fact, it must be appreciated that they raise global climate ambition.
   • Overall Mitigation in Global Emissions (OMGE), which is a new voluntary element of the Paris Agreement, is a key requirement of the SDM.

Solution: Not all mitigation actions fall within the purview of its NDC. Therefore, India can significantly gain from the market mechanism under Article 6.4 by selling emission reductions that lie outside its NDC.

 Note: The Dotted Arrows indicate that the LDCF and SCCF are administered by GEF

Non-Market Approach

The non-market approach under the Paris Agreement (Article 6.8) aims to boost “mitigation, adaptation, finance, technology transfer and capacity-building”, in situations where no trade is involved, such as government institutions.

Under the Kyoto Protocol, developing countries had no targets to achieve, they only sold carbon credits. But now, under the Paris Agreement, even developing countries are required to have mitigation targets. This is based on a Common but differentiated responsibility approach, that all countries must participate in the fight against climate change.

Importance of Carbon market for India:

• Developing countries gain from selling carbon credits: particularly India, China and Brazil, gained significantly from the carbon market under the Clean Development Mechanism (CDM) of the Kyoto Protocol. India gained around S.$2.55 billion from this.
• Therefore, logically, India has a lot to gain from a thriving carbon market. However, with the ratification of the Paris Agreement, the rules of the game have changed.

Current status of carbon Pricing:

• Currently, there are more than 50 carbon pricing initiatives implemented or scheduled for implementation, consisting of 28 ETSs in regional, national, and subnational jurisdictions, and 29 carbon taxes, primarily applied on a national level.
• In total, these carbon pricing initiatives cover 11 Gigatons of carbon dioxide equivalent (GtCO2e), or about 20% of global GHG emissions, compared to 15% in 2017. For example, China’s ETS is expected to begin by 2020.

Carbon Pricing Leadership Coalition (CPLC)

CPLC is a voluntary initiative of 34 national & sub-national governments, 163 businesses, and over 82 strategic partners representing civil society organizations, NGOs & academic institutions. Aim: to support carbon pricing, share experiences and enhance the global, regional, national and sub-national understanding of carbon pricing implementation. The CPLC Secretariat is administered by the World Bank Group. India, Delhi Metro Rail Corporation and Indian Railways are the government-level partners.

Challenges Faced by Carbon Pricing Mechanisms

1. Limitation of Accounting the Loss of Climate Change: There is a time lag between cause and effect. Greenhouse gases emitted today affect the global temperatures in 50 years or so. But people are not inclined to pay for the future damages in the present.

Social Discount Rate

Taxing the present generation to fund the estimated losses of the future.  This is based on the amount which would be required by us to avoid the damages in the future. For Example, if climate change were on track to cause $5tn damages by the end of the century we should fix an annuity in the form of Carbon pricing mechanisms to cover that amount by the end of the century. This can be done by Incorporating the environmental impact into commercial lending decisions while simultaneously balancing the needs of economic growth and social development. Editor’s Note: For UPSC Mains point of view, you need not understand all these concepts and must try to form your own summary of core points that can help you answer the long answer.

2. Buying Carbon credits instead of completing targets: Countries are always faced with the dilemma of either selling their carbon credits like before or using these credits to achieve their own mitigation targets. After the Paris Agreement, over half of the countries have communicated their intention of using market mechanisms to achieve NDC targets. India is not one of them as it aims to rely on domestic mitigation efforts to meet its NDC goals.
3. Issues with Carbon credits issued under CDM (Kyoto): Some countries have cast doubts on the environmental integrity of these credits. These might have been issued without completing the necessary checks. The carbon credits issued under the SDM would be under the supervision of UNFCCC CoP, ensuring their integrity.

Still, it would be better if the Carbon credits issued under the CDM mechanism, should be utilised as early as possible and markets must be free from such tainted certificates.

1. The problem of double counting: The developed countries view that private participation under Article 6.4 of the Paris Agreement may lead to double counting. The Private sector may buy carbon credits awarded for the public sector NDC targets.  
2. Share of Proceeds (SOP) to Adaptation Fund: For developing countries, adaptation is a necessity. However, it remains severely underfunded compared to financing for mitigation activities. Both Articles 6.2 and 6.4 are related to mitigation measures. As per the agreement under Glasgow CoP, 5% of proceeds under traditional market mechanisms (Article 6.4) will now mandatorily go toward funding adaptation.

Green finance

It refers to financial investments flowing into sustainable development projects and initiatives, environmental products, and policies that encourage the development of a more sustainable economy.

Importance for India: Need to Finance our Green Projects:

• India’s NDCs & SDGs are estimated to cost $2.5 trillion and $8.9 trillion, respectively, by 2030.
• For the $200 billion needed to attain a target of 100 GW of solar power and 60 GW of wind power installation by 2022.

Mobilizing this enormous finance would require the development of new and innovative financial mechanisms. In Asia, the proportion of sustainable investing relative to total managed assets was small in 2014— at about 0.8%, as compared to 50% in Europe and Australia and 17-31% in the USA and Canada collectively.

• With the rise in renewable energy in India and increasing environmental, social and governance (ESG) risk assessment, the proportion of sustainable investing has risen since then considerably.

Funding Mechanism for Green Finance in India:

Budgetary allocation:

• Tax concession and market interventions in Green projects to attract private players. For example, low-cost LEDs. Concession for Solar Power plants.
• India is among the few countries in the world to have introduced a carbon tax.
• Clean energy cess imposed on coal mines in India or imported into India is collected into the ‘National Clean Energy Fund’ set up for funding research and innovative projects in clean energy technologies. ₹400/Tonne

Other Obligatory Mechanisms:

• Renewable Purchase obligation (RPO)
• RBI has included renewable energy project financing as a part of PSL in July 2015.
• Companies Act, 2013 mandates that larger companies should contribute at least 2% of their average net profits annually towards Corporate Social Responsibility (CSR) activities, which contributes to green financing.

Green Infra Bonds

These are issued by Banks and development financial institutions (DFIs), to fund projects with a positive environmental impact.

• 2015 saw a record of $38.4 billion of green bonds issued globally, in order to finance low-carbon transport and eco-friendly projects, leading to many pension funds and money managers in developed countries looking towards investing in socially responsible and environment-friendly projects. They can assess environmental, social and governance (ESG) risks while appraising projects for financing.
• Sovereign Blue Bonds: It is issued to finance certain programs of marine activities, that have positive environmental, economic and climate benefits.
  • It has been developed with the support of the World Bank and GEF.
  • It is part of the project under the World Bank’s South West Indian Ocean Fisheries Governance and Shared Growth Program (SWIOFish).

Funds Available via International Organizations

Clean Technology Fund (CTF)

The CTF is managed by the WTO. It focuses on making renewable energy cost-competitive with coal-fired power as quickly as possible.

WWF-India’s Small Grants Innovation Program (SGIP):

It offers eligible individuals a one-time grant of up to INR 4L over a maximum period of 2 years for undertaking conservation research/ action research that addresses issues and offers solutions or insights towards:

1. Species and habitat-related problems and concerns – with a focus on immediate threats and issues Enabling communities and other stakeholders to address local environmental concerns
2. Improving local livelihoods through conservation and natural resource management or promoting livelihoods that reduce impacts on biodiversity
3. Aspects of trade involving wildlife species.

Carbon Initiative for Development (Ci-Dev), 2001:

Initiative by World Bank: To build capacity & develop tools and methodologies to help the world’s poorest countries access carbon finance, mainly in the area of energy access. It is set up to use performance payments based on reduced emissions to support projects that use clean and efficient technologies in low-income countries. Other Objectives:

• To demonstrate that performance-based payments for the purchase of certified carbon emission reductions (CERs) can lead to a successful and viable business model that promotes increased private sector participation.
  • Clean Development Mechanism (CDM) issues Certified carbon emission reductions (CERs)/Carbon credits according to the rules of the Kyoto Protocol.
  • For example, Delhi Metro became the first Metro rail system in the world in 2011 to get Carbon credit.
  • Its market collapsed in 2012. The issue was discussed at COP 25 in Madrid in 2019.
• To influence future carbon market mechanisms so that low-income countries, and especially least developed ones, receive a greater and fairer share of carbon finance.
• To contribute proposals to further improve and extend the scope of the Clean Development Mechanism (CDM) for use by LDCs, in particular for Programmes of Activities (POA).
• Remember:
  • Clean Development Mechanism: Under Kyoto Protocol.
  • Sustainable Development Mechanism: Under the Paris Agreement

UNFCCC Funds

Adaptation fund

It was launched in 2001 to finance concrete adaptation projects and programmes in developing countries Parties to the Kyoto Protocol that are particularly vulnerable to the adverse effects of climate change.

• It is financed with a share of proceeds from the Clean Development Mechanism (CDM) project activities and other sources of funding. The share of proceeds amounts to 2% of certified emission reductions (CERs) issued for a CDM project activity, later enhanced to 5%.
• Adaptation Fund Board (AFB): To manage & supervise the fund. The AFB is composed of 16 members and 16 alternates and meets at least twice a year (Membership of the AFB).

Green Climate Fund (GCF):

GCF is a fund functioning within the framework of the UNFCCC through the common direction of 194 members. It is founded as a mechanism to redistribute money from the developed to the developing world, to assist the adaptation and mitigation practices to counter climate change.

1. To promote low-emission and climate-resilient development pathways by providing support to developing countries to limit or reduce their greenhouse gas emissions
2. To adapt to the impacts of climate change, considering the needs of those developing countries particularly vulnerable to the adverse effects of climate change.
3. It supports countries in fulfilling their NDC
4. Intended to be the centrepiece of efforts to raise Climate Finance by $100 billion / year by 2020.
5. It will support projects, programmes, policies and other activities in developing country Parties using thematic funding windows.

India would push for developed countries to make good on their prior commitments on finance and technology. So far, India has received only $2 million of the $10 million committed in 2018.

Developed countries were to raise $100bn/year for capacity building in developing countries by 2020 according to the Paris Agreement, But India has received negligible amounts till now.

• Transformative Carbon Asset Facility (TCAF): $500mn fund under World Bank. It helps developing countries pay for emission reductions and combat climate change; It is a market-based scheme; that helps implement INDCs.
• India is stressing the issue as these funds will help nations work on fulfilling their INDCs which aim to reduce carbon emissions through a host of solutions.
• National Implementing Entity (NIE): NABARD

Global Environment Facility (GEF)

GEF is a financial organization founded in 1991 to fund environmental projects. GEF is the largest public funder of projects to improve the global environment. It has 183 countries, International institutions, civil society organizations (CSOs), and the private sector. India is one of its founding members.

The grants for projects under GEF are related to five core areas:

1. biodiversity,
2. climate change,
3. international waters,
4. land degradation, and
5. Chemicals & Wastes: such as persistent organic pollutants (POP), but also for the ozone layer

GEF mandate is decided as per guidance provided by the COP of the multilateral environmental conventions namely:

1. CBD
2. UNFCCC
3. UN Convention to Combat Desertification (UNCCD)
4. Stockholm Convention on Persistent Organic Pollutants (POPs)
5. Minamata Convention on Mercury:
   1. Minamata City went through devastating incidents of mercury poisoning.
   2. It is expected that over the next few decades, this international agreement will enhance the reduction of mercury pollution from the targeted activities responsible for the major release of mercury to the immediate environment.

It additionally takes projects under:

1. Montreal Convention (Ozone)
2. Integrated Management of Wetland Biodiversity and Ecosystems Services (IMWBES), i.e. It undertakes projects on Ramsar Sites.

GEF Assembly is its main governing body. It is not held regularly. The 6th GEF assembly was hosted in Vancouver, Canada in 2023. The funding budget in the 5^th GEF assembly was cut a bit, as the US pledge was slashed to half. As a result, funding of environmentally sustainable projects was reduced.

GEF Funds

GEF has achieved a strong track record with developing countries and countries with economies in transition, providing $12.5 billion in grants and leveraging $58 billion in co-financing for over 3,690 projects in over 165 countries.

1. Least Developed Country Fund (LDCF): to support a work programme to assist LDCs, in carrying out, inter alia, the preparation & implementation of national adaptation programmes of action. COPs provide guidance with regard to priority areas and provisions on full-cost funding and a co-financing scale for LDCs NAPAs.
2. Small Grants Programme (SGP): grants directly to civil society and community-based organizations, totalling $653.2 million. More than 20,000 grants have been given so far under it.
3. Special Climate Change Fund (SCCF), 2001: Open to all countries.
   • Adaptation; technology transfer and capacity building; energy, transport, industry, agriculture, forestry and waste management; and economic diversification.
   • This fund should complement other funding mechanisms for the implementation of the Convention.

The National Adaptation Fund for Climate Change (NAFCC)

Operationalised in 2015-16, the fund is meant to assist national and state-level activities to meet the cost of adaptation measures in areas that are particularly vulnerable to the adverse effects of climate change.

• This scheme has been taken as CSS with the NABARD as the National Implementing Entity (NIE). 100% central grant is given to the State Governments for implementing climate change adaptation projects; [Volume: ₹350Cr currently]
• Aim: to support concrete adaptation activities that are not covered under ongoing schemes of State and National Governments that reduce the adverse effects.