UNFCCC Workshop March Assessment of Additionality  New Guidelines  Lessons learned  Future challenges By Luis de la Torre

UNFCCC Workshop March Assessment of Additionality Challenges for an old topic  Financial benchmarking and its standardization is a common issue in most multinationals and financial institutions to accelerate the decisions and assure a minimum level of quality (risk)  The financial target is not the only value that is commonly treated as default values, all the parameters of capital budgeting are normally treated in this way as policy.  The values can change significantly or stay static for long term according to the context where they are used.  For CDM projects, this is a critical issue that affects the registration process as delays or rejection

UNFCCC Workshop March Assessment of Additionality The new Guidelines on the assessment of investment analysis  After two years of discussions and global consultations, the Meth Panel could recommend EB a set of default values for cost of equity and rules for computation of WACC (e.g. 0.5/0.5 rule for Greenfield project, use of taxes among others).  This approach is optional and covers all countries signatories of Kyoto Protocol.  International accounting regulations such as IFRS and USGAAP currently covers WACC calculations but the approach for the CDM market is truly pioneer and gives the message of feasibility of more standardization of other parameters to improve the registration process and monitoring (reduction in time and cost of resources).

UNFCCC Workshop March Assessment of Additionality The whole picture in capital budgeting Macroeconomic parameters Microeconomic parameters Capital budgeting Inflation GDP growth and demand Exchange rates Fiscal issues Capital composition Books and investee positions Financial target Risk acceptance

UNFCCC Workshop March Assessment of Additionality Example of some issues affecting macro/micro indicators standardization  The concern of recent meltdown in 2008 and future return of the market, not very linear  The concept of “strong currency” as benchmark due to the crisis for USD or Euros  The accounting rules seen as very complex and different in many context, specially the discussion on rules for SMEs and large Corporations.  The complexity of validating inflation and currency adjustment in prices in time (e.g. energy delivery contracts as electricity or fuels)

UNFCCC Workshop March Assessment of Additionality Some answers: long term view  Long term analysis of economic parameters have been definitely key to get consensus on default values for cost of equity. Source: Elroy Dimson, Paul Marsh, and Mike Staunton, LBS 2006

UNFCCC Workshop March Assessment of Additionality Some answers: Accounting  All CDM projects are based on legal entities with accounting Books and following market regulations to avoid discussions on investee positions if the financing is structured from a headquarters, basically using the risk exposure as general rule. Hosting only CDM ProjectHosting many assets Assets 500 MM Debt 300 MM Equity 200 MM K e =20% CDM Assets 20 MM CDM Debt 10 MM CDM Equity K e = 14%

UNFCCC Workshop March Assessment of Additionality Some answers: Country risk/risk free rate  There are many companies with reputation and tradition in calculating Country Risk and years of data. All are good but a decision was made to facilitate the construction of default values.  The use of US T-bond indexed to inflation was another decision of a paper with excellent tradition in the largest market, even in times of severe crisis such as 1929, WW1-2 or 2008 Meltdown.

UNFCCC Workshop March Assessment of Additionality Future challenges (1) : business plan guidelines  Most CDM project financing define sales based on PLF, no ramp up with strong rationale and weak proposals of demand.  Prices are also presented as flat all over the crediting period with no consideration of effect of exchange rate for raw materials or price in final consumers.  The depreciation of assets is another point considered flat in most analysis even there are specific rules according to the type of asset and this affects the tax shield position.  Fiscal rules also changes in most countries and this is difficult to asses by DoEs

UNFCCC Workshop March Assessment of Additionality Future challenges (2) : business plan guidelines  The answer to this is more standard guidance and now there are conditions to create better rules to give clear and fair values to all countries without exception.  Thinking in a systemic approach, a universal template in a spreadsheet running macros and updated to a official UNFCCC database of parameters is possible and will help to increase the flow of projects and reduce the controversies with DoEs and timing for registration.  Moving forward, it is possible to open a discussion to incorporate risk assessment

11 Assessment of Additionality Decisions based only on IRR UNFCCC Workshop March Example: financial return of Power generation Projects

12 Minimum risk Highest value generation Best choice Assessment of Additionality Decisions based on Risk and Value generation UNFCCC Workshop March 24-25

13 Assessment of Additionality Final Remarks  Today the level of financial data for most countries and industrial sectors is enough to develop more standard approaches in the analysis of risk and return.  A long run analysis is mandatory to assure the consistency of the values  NAMAs should be developed in parallel with the financial information of the countries related to the carbon market.  No doubt this approach will have a very significant impact in the fairness and transparency of business related to CDM plus the advantage of a higher flow of better projects.