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  <br />Dr. Pierre Alexandre DELAGARDELLE<br />Partner / Ph.D. / Avocat à la Cour<br />An introduction to <br />CARBON FUN...
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
Investment Funds - Carbon Funds
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Investment Funds - Carbon Funds

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Climate change has become one of the highest preoccupations of the post-industrial period. Mitigation of climate change, by reduction of greenhouse gases ("GHG") emissions and stabilisation of the carbon dioxide concentrations in the atmosphere has entered the agenda of most government policies. The Kyoto protocol aims to encourage this trend through allocation of a credit system. Carbon investments funds are a key player when implementing such system in green developments.

Published in: Economy & Finance
  • This innovative Fund is the first of its kind and will exclusively purchase and trade carbon credits generated in the post Kyoto period, potentially up to 2022. By assuming the inherent regulatory risk, the Fund will give a clear signal to the market of the EIB and its partners’ confidence in the development of a post Kyoto regime while directly supporting environmental projects.
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  • Dr. Pierre Alexandre DELAGARDELLE
    Partner / Ph.D. / Avocat à la Cour



    AN INTRODUCTION TO
    CARBON FUNDS
    April 2010



























    Climate change has become one of the highest preoccupations of the post-industrial period. Mitigation of climate change, by reduction of greenhouse gases ('GHG') emissions and stabilisation of the carbon dioxide concentrations in the atmosphere has entered the agenda of most government policies. The Kyoto protocol aims to encourage this trend through allocation of a credit system. Carbon investments funds are a key player when implementing such system in green developments.




    CARBON INVESTMENTS

    1. THE KYOTO PROTOCOL
    The Kyoto protocol (the 'Kyoto Protocol') is a protocol to the United Nations Framework Convention on Climate Change ('UNFCCC' or 'FCCC'), an international environmental treaty aiming to stabilize greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous interference with the climate system.
    The Kyoto Protocol was negotiated in December 1997 at the city of Kyoto, Japan and came into force on 16th February 2005. 184 (hundred eighty four) parties of the UNFCCC have ratified its protocol to date. The detailed rules for the implementation of the Kyoto Protocol were adopted at the 7th conference of the parties to the UNFCCC in Marrakesh in 2001 ('COP7'), and are called the 'Marrakesh Accords.'
    1.1 Reducing GHG emissions
    The Kyoto Protocol is a legally binding agreement under which industrialized countries will reduce their collective emissions of GHG by 5.2% compared to the year 1990 (compared to the emissions levels that would be expected by 2010 without the Protocol, this target represents a 29% cut). The goal is to lower overall emissions from six GHGs:
    (1) Carbon dioxide ('CO2');
    (2) Methane;
    (3) Nitrous oxide;
    (4) Sulfur hexafluoride;
    (5) Hydrofluorocarbon ('HFC'); and
    (6) perfluorocarbon ('PFC');
    Out of these six, the CO2 is the principal GHG. Hence it has become common to refer to CO2 emissions as to GHG emissions.
    The major distinction between the Kyoto Protocol and the UNFCCC is that while the UNFCCC only encouraged industrialised countries to stabilize GHG emissions, the Kyoto Protocol commits them to do so. Recognizing that developed countries are principally responsible for the current high levels of GHG emissions in the atmosphere as a result of more than 150 years of industrial activity, the Protocol places a heavier burden on developed nations under the principle of 'common but differentiated responsibilities.'
    What emerged from the Kyoto meeting is that as each country produces CO2, it must be able to contain that CO2 by tree-planting or other processes that can absorb it, such as sequestration and changing farming methods. Or it can reduce the CO2 it produces in the first place. If that country produces more CO2 than it can absorb, it must purchase 'absorption ability' from another country.

    1.2 Carbon credits
    Carbon credits ('Carbon Credits') create a market for reducing GHG emissions by giving a monetary value to the cost of polluting the air. As such, carbon credits may be regarded as a 'currency' under the Kyoto Protocol.
    One Carbon Credit is equal to one Ton of CO2 (a Ton of Co2 is the equivalent of emissions produced during a return jet flight from Paris to New York). A country might have difficulties in absorbing 500,000T of CO2 and according to the Kyoto Protocol it must seek to purchase those from another country that has largely absorbed its quota. The funds used to purchases carbon credits will ultimately be used to give grants to further carbon.
    Carbon credit trading is a mean aiming to push countries exceeding their quotas to subsidise green developments to countries that maintain low GHG emissions. Provided that this GHG mitigation projects generates credits, this approach can be used to finance carbon reduction schemes between trading partners and around the world.
    There are many companies that sell carbon credits to commercial and individual customers who are interested in lowering carbon emissions on a voluntary basis. These customers purchase the credits from an investment fund or a carbon development company that has aggregated the credits from individual projects.
    The quality of the credits is based in part on the validation process and sophistication of the fund or development company that acted as the sponsor to the carbon project. This is reflected in their price; voluntary units typically have less value than the units sold through the rigorously-validated Clean Development Mechanism ('CDM').
    Emissions become an internal cost of doing business and are visible on the balance sheet alongside raw materials and other liabilities or assets.

    1.3 The Kyoto mechanisms:
    The Kytoto protoctol proposes three flexiblemechanism to assist its parties reduce the emissions of GHG:
    - Joint development (article 6);
    - Clean development (article 12); and
    - Emission trading (article 17).

    1.3.1 Joint implementation ('JI'): green energy investments in other countries
    According to Article 6 of the Kyoto Protocol, a country with an emission reduction or limitation commitment under the Kyoto Protocol (Annex B Party) may earn ERUs from an emission-reduction or emission removal project in another Annex B Party, each equivalent to one tonne of CO2, which can be counted towards meeting its Kyoto target.
    Concept
    A JI project must provide a reduction in emissions of GHG by sources, or an enhancement of removals by sinks, that is additional to what would otherwise have occurred. Projects must have approval of the host Party and participants have to be authorized to participate by a Party involved in the project.
    The mechanisms help stimulate green investment and help Parties meet their emission targets in a cost-effective way.
    Track 1 and Track 2 procedures
    If a host Party meets all of the eligibility requirements to transfer and/or acquire ERUs, it may verify emission reductions or enhancements of removals from a JI project as being additional to any that would otherwise occur. Upon such verification, the host Party may issue the appropriate quantity of ERUs. This procedure is commonly referred to as the 'Track 1' procedure.'
    If a host Party does not meet all, but only a limited set of eligibility requirements, verification of emission reductions or enhancements of removals as being additional has to be done through the verification procedure under the Joint Implementation Supervisory Committee ('JISC'). Under this so-called 'Track 2' procedure, an independent entity accredited by the JISC has to determine whether the relevant requirements have been met before the host Party can issue and transfer ERUs.
    A host Party which meets all the eligibility requirements may at any time choose to use the verification procedure under the JISC (Track 2 procedure).
    Countries including Japan, Canada, Italy, the Netherlands, Germany, France, Spain and others are actively promoting government carbon funds, supporting multilateral carbon funds intent on purchasing carbon credits from non-Annex I countries, and are working closely with their major utility, energy, oil and gas and chemicals conglomerates to acquire greenhouse gas certificates as cheaply as possible. Virtually all of the non-Annex I countries have also established a designated national authority to manage its Kyoto obligations, specifically the 'CDM process' that determines which GHG projects they wish to propose for accreditation by the CDM Executive Board.
    1.3.2 The 'clean development mechanism'
    According to article 12 of the Kyoto Protocol, the Clean Development Mechanism ('CDM') allows a country with an emission-reduction or emission-limitation commitment under the Kyoto Protocol (Annex B Party) to implement an emission-reduction project in developing countries.
    These projects qualify to earn CER credits, each equivalent to one Ton of CO2 that can be counted towards meeting the targets of the Kyoto Protocol. This corresponds to an environmental investment and credit scheme, providing a standardised emission offset instrument, CERs.
    CDM scheme projects may be based on any energy saving project such as implementation of solar panels, windfarms etc. A CDM scheme project must provide emission reductions that are additional to what would otherwise have occurred. The projects must qualify through a rigorous and public registration and issuance process. Approval is given by the designated national authorities. Public funding for CDM project activities must not result in the diversion of official development assistance.
    1.3.3 Emissions trading' or 'carbon market'
    The carbon credit system according to the Kyoto protocol is based principally upon the trade emissions allowed divided into 'assigned amount units' ('AAUs'). However during this process other units may be acquired or transferred.
    Assigned amount units
    Under the Kyoto Protocol, the 'caps' or 'quotas' for GHG for the developed Annex 1 countries (the 'Annex I Parties') are known as assigned mounts ('Assigned Amounts') over the 2008-2012 commitment period and are listed in Annex B.
    In turn, these countries set quotas on the emissions of installations run by local business and other organizations ('Operators'). Each Operator has an allowance of credits, where each unit gives the owner the right to emit one metric tonne of carbon dioxide or other equivalent GHG. Operators that have not used up their quotas can sell their unused allowances as carbon credits, while businesses that are about to exceed their quotas can buy the extra allowances as credits, privately or on the open market.
    An Annex I Party may hence transfer some of the emissions under its Assigned Amounts to another Annex I Party that finds it relatively more difficult to meet its emissions target.
    According to article 17 of the Kyoto Protocol, 'the parties included in Annex B may participate in emissions trading for the purposes of fulfilling their commitments under Article 3. Any such trading shall be supplemental to domestic actions for the purpose of meeting quantified emission limitation and reduction commitments under that Article'.
    Naturally, Luxembourg is among the numerous countries (parties) included the Annex B.
    According to the 'emissions trading', countries that have emission units to spare are allowed to sell this excess capacity to countries that are over their targets. As CO2 is the most common GHG, people speak simply of 'trading in carbon'. Hence, carbon may be tracked and traded like any other commodity.
    In order to prevent Parties 'overselling' units, and as consequence being unable to meet their own emissions targets, each Party is required to maintain a reserve of ERUs, CERs, AAUs and/or RMUs in its national registry.
    This is known as the 'commitment period reserve', and must always be at least at level of 90 per cent of the Party's assigned amount or at least five times its most recently reviewed inventory.
    Other trading units in the carbon market
    Further units that can be acquired or transferred (each equal to one Ton of CO2), may be in the form of:
    i. A 'removal unit' ('RMU') on the basis of land use, land-use change and forestry ('LULUCF') activities such as reforestation;
    ii. A 'certified emission reduction' ('CER') generated from a clean development mechanism project activity.
    iii. An 'emission reduction unit' ('ERU') generated by a 'joint implementation project';
    The acquisition or the transfer of these above units is tracked and recorded through the registry systems under the Kyoto Protocol.
    An international transaction log ('ITL') verifies transactions proposed by registries to ensure they are consistent with rules agreed under the Kyoto Protocol.

    2. CARBON INVESTMENT VEHICLES
    A carbon investment vehicle ('CIV') is a collective investment scheme which receives money from investors and uses this money in:
    1. Buying carbon credits; or
    2. Investing into GHG emissions reduction projects.
    Investments are generally made through the Kyoto Protocol’s CDM; and JI schemes.
    After a certain defined period, the CIV will then give investors carbon credits and/or cash in return. The emission reduction projects can be sourced from different developers, countries, and technologies. Over the last decade CIV have evolved to become important participants in the global carbon market.

    2.1 Investment approach
    Originally, most of the CIVs were sourcing carbon credits through Emission Reduction Purchase Agreements ('ERPAs') with payment on delivery.
    ERPAs started as contractual arrangements where a party (the buyer) pays the other party (the seller) cash in exchange for carbon credits, thereby 'allowing' the purchaser to emit more carbon dioxide into the atmosphere
    However these types of contracts were considered as bearing a certain risk upon each of the parties: Seller must deliver credits upon anticipation and the buyer must block cash in anticipation of payments until credit delivery.
    In the last few years, CIVs have moved towards the direct financing of projects (e.g., through equity investments, loans). Thus, the buyer can obtain carbon credits at the lowest price possible.
    The contractual arrangements put in place vary case-by-case and are determined in the investment term sheets. For example, a CIV that provides equity together with other investors will become the owner of only a portion of the carbon credits and can purchase additional carbon credits at a discounted price.

    2.2 Investment target
    CIVs are focusing in sourcing credits from both CDM and JI projects. Generally, vehicles investing only in either CDM or JI are relatively not common.
    Project development paths for CDM and JI present different risk/reward profiles. Usually, investors are better accustomed to the CDM process for which clear rules and procedures have been established. However JI is likely to attract more carbon market investors once the registration processes are stabilised.
    Some CIVs have additional investment objectives, such as fuel switching, fugitive methane including landfill gas and coal bed methane, land use and land use change, water resource and infrastructure, and biofuels development.
    One tenth of these new funds do not provide specific information on the sectors they target but use general terms, for example 'climate change mitigation and adaptation projects,' or 'reduction of negative ecological impact.' Behind these general areas, a wide range of project types can be found. These range from the often criticised efficient coal-fired plants through debated Reducing Emission from Deforestation in Developing Countries ('REDD') to relatively problematic emission reduction programmes (so-called 'Programmes of Activities' or 'PoA') .
    REDD and PoA still require many clarifications before they become mainstream CDM activities. So far, development banks and governments have played a major role in promoting these types of projects.
    Finally, funds that did not specify investment goals are usually those interested only in carbon credits. They seek pools of carbon assets often without following their origin (i.e., project type).
    Interestingly, taking into account all 2008 funds, there is less capital targeted at off-take ERPAs than the capital dedicated to upfront project financing.

    3. LUXEMBOURG’S ATTRACTIVENESS FOR CARBON INVESTMENT VEHICLES
    Luxembourg’s attractiveness in CIVs results from its adequate legal, regulatory and fiscal framework for the incorporation of CIVs. The flexibility of the available legal vehicles, combined with a recognized regulatory framework and favourable tax environment shape the Luxembourg financial sector’s attractiveness.
    This section aims at giving its readers an overview of the common Luxembourg investment vehicles.
    3.1 LUXEMBOURG CARBON Investment Funds
    Luxembourg has a long experience with the fund industry and other investment vehicles.
    CIVS which may be set up as:
     Undertakings for collective investment ('UCIs') governed by Part II of the Law of 20 December 2002 relating to undertakings for collective investment, as amended (the '2002 Law') (the 'Part II Funds'); as well as
     Investment companies in risk capital ('SICARs'), governed by the law of 15 June 2004 relating to the investment company in risk capital, as amended from time to time (the '2004 Law'); as well as
     Specialised investment funds ('SIFs') governed by the law of 13 February 2007 on specialised investments funds, as amended (the '2007 Law'); or
    The table hereinbelow summarises the main differences between Luxembourg investment vehicles.

    SIFs SICARs Part II Funds
    Promoter A SIF’s promoter is not supervised by the CSSF, nor does the 2007 Law require CSSF authorisation of the promoter.
    The creation of a SICAR does not require the services of a promoter.

    Neither a promoter, nor an investment manager/adviser of a SICAR needs the CSSFs approval. The CSSF will check whether the promoter disposes of the required professional qualification and relevant experience for the exercise of his/her functions.

    With the FCP, the CSSF will check that the management company complies with the applicable legal requirements, as provided for specifically in the 2002 Law.
    Eligible investors
    The shares in a SIF can only be subscribed by:
    - Institutional investors; or
    - Professional investors; or
    - Well-informed investors. The shares in a SICAR can only be subscribed by:
    - Institutional investors ; or
    - Professional investors ; or
    - Well-informed investors.
    The derogation providing that the general partners of limited partnerships do not need to qualify as 'well informed investors', should they which to subscribe to shares in the SICAR has been extended by the law of 24 October 2008 improving the legal framework of the Luxembourg financial sector, modifying, inter alia, the 2004 Law and published in Luxembourg’s official journal (the 'Memorial') on 29 October 2008 (the '2008 Law') to the directors and all persons who operate the management of the SICAR regardless of its legal structure. Unrestricted.

    Entity type SICAV/F (S. A., S.C.A., S.à r.l., SCoSA); FCP; or Other (e.g., fiduciary structure). Corporate entity (S.A., S.C.A., S.à r.l., SCoSA, S.C.S.. (i) SICAV (S.A.) ; SICAF (S.A., S.C.A., S.à r.l.); or FCP.
    Eligible assets / Strategies
    The purpose of SIFs is to invest their funds in 'values'. The use of the term 'value' seems to indicate that almost any type of investment is accepted. The SIF may hence invest in a broad range of assets, including carbon assets, but also de¬rivatives, real estate, hedge funds and private equity.
    The policy and limits are to be set out in the offering document. All types of private equity / venture capital investments (including carbon assets, real estate private equity).
    Temporary investments in other assets pending investments in private equity / venture capital are possible.
    Part II of the 2002 Law does not provide any specific provisions regarding investment policies for Part II Funds. There are however a many applicable CSSF circulars and interpretations regarding such.
    The CSSF has issued circulars regarding investments by Part II Funds in transferable securities, alternative investments, venture capital, future contracts and options and real estate.
    Risk diversification requirements
    No investment or borrowing restrictions are defined in the SIF Law, with the exception of the principle of risk-spreading:
    - A SIF may not invest more than 30% of its assets or commitments to subscribe in securities of the same nature issued by the same issuer.
    - Short sales may not result in the SIF holding an open position on securities of the same nature issued by the same issuer representing more than 30% of its assets.
    - When using derivative financial instruments, a SIF must ensure risk-spreading comparable to the above via an appropriate diversification of such derivatives’ underlying assets. The 2004 Law does not impose any investment diversification rules. A SICAR may therefore invest in just one or two companies or MFIs, for example in particularly narrow sectors such as carbon, biotechnology or geological prospecting.
    A SICAR invests its assets in securities representing risk capital. By risk capital is understood the direct or indirect contribution of assets to entities in view of their launch, their development or their listing on a stock exchange.

    Except during a transitional period, investment in any target company may not exceed 20% of the NAV.

    Segregated sub-funds
    The 2007 Law provides for compartments or sub-funds in a SIF. Each compartment can have its own specific investment policy and, as applicable, with securities of a different par value or no nominal value.
    The constitutional documents of the SIF must expressly provide for the creation of compartments or sub-funds. A multiple compartment SIF, by itself, is an individual legal entity. However, in contrast to the Luxembourg Civil Code, the assets and liabilities of each compartment are segregated and are only subject to the liabilities of that specific compartment, unless otherwise provided for in the constitutional documents. The 2008 Law provides for the introduction of compartments in a SICAR. Each compartment can have its own specific investment policy and each company may offer securities of a different par value or no nominal value.
    The constitutional documents must expressly provide for the creation of multiple compartments or sub-funds within a SICAR. The 2002 Law provides for the possibility to create several compartments with strict segregation of assets and liabilities between compartments.

    Required service providers in Luxembourg Depositary (credit institution);
    Administrative agent;
    Independent auditors. Idem. Idem.
    Minimum capital / net assets requirements For FCPs
    Net assets must reach EUR 1.25 Mio within 12 months from authorisation.
    For SICAV/Fs
    Upon incorporation:
    - S.A./S.C.A.: EUR 31.000,-;
    - S.à r.l.: EUR 12.500,-.
    Subscribed share capital and share premium must reach EUR 1,25 Mio within 12 months of authorisation. Upon incorporation:
    - For an S.A./S.C.A.: EUR 31,000,-;
    - For an S.à r.l.: EUR 12,500,-.
    Subscribed share capital must reach EUR 1 Mio within 12 months of authorisation. For FCPs
    Net assets must reach EUR 1,25 Mio within 6 months from authorisation.
    For SICAV/Fs
    Upon incorporation:
    - SA/SCA: EUR 31,000 ;
    - S.à r.l.: EUR 12,500.
    a) Share capital must reach EUR 1,25 Mio within 6 months of authorisation.
    Structuring of capital calls and issue of shares / units Capital calls may be organized either by way of capital commitments or through the issue of partly paid shares (to be paid up to 5% at least) or units.
    The issue of shares of a SICAV does not require an amendment of the articles of incorporation before a public notary.
    The issue price may be freely determined in accordance with the principles laid down in the articles of incorporation / management regulations.
    For SICAVs
    Existing shareholders have no pre-emptive right of subscription, unless otherwise provided for in the articles of incorporation.
    Capital calls may be organized either by way of capital commitments or through the issue of partly paid shares (to be paid up to 5% at least) or units.
    Investors' subscriptions for shares can also be done on an ongoing basis (i.e. without specific commitment or contractual undertaking of the investors to subscribe for shares/units of the SICAR upon request of the SICAR).
    For FCPs
    Capital calls may be organized either by way of capital commitments or through the issue of partly paid units. Existing unitholders do not have a pre-emptive right of subscription in case of issue of units, unless otherwise provided for in the management regulations.
    Units must be issued at a price based on the NAV (plus costs and actualization interests, if appropriate).
    For SICAVs
    Capital calls must be organised by way of capital commitments (shares must be fully paid-up).
    Existing shareholders do not have a pre-emptive right of subscription in case of issue of shares, except if otherwise provided for in the articles of incorporation. Issues of shares do not require an amendment of the articles of incorporation before a public notary.
    Distribution of Dividends For SIF-FCPs and SIF-SICAVs
    There are no statutory restrictions on payments of (interim) dividends (except for compliance with minimum net assets / capital requirement).
    For SICAFs
    Distributions may not reduce the SICAF’s assets, as reported in the last annual reports, to an amount less than one-and-a-half times the total amount of the SICAF’s liabilities to its creditors.
    Interim dividends are subject to statutory conditions. There are no statutory restrictions on payments of (interim) dividends (except for compliance with minimum capital requirement).
    The distribution of dividends is not limited to accrued income but also includes, for example, interests, dividends and other income from investments made by the FCP or the SICAV as well as capital gains registered in relation to the FCP's or the SICAV's portfolio of assets (even when these capital gains are not realised yet). However, the payment of distributions must not result in the net assets of the FCP or the SICAV falling below the minimum required by the 2002 Law (i.e. EUR 1.250.000,-).
    Calculation of NAV The NAV must be determined in accordance with the rules laid down in the articles of incorporation or management regulations of the SIF. As a matter of principle, it will be determined at least once a year, namely at the end of the financial year.
    Assets are to be valued at fair value.
    The NAV must be determined at least once a year. The requirement for investors to be informed at least once every six month about the NAV has been abolished by the 2008 Law.
    Assets are to be valued at fair value. Part II UCIs must calculate the net asset value of their shares or units at least once per month.
    Exceptions may be granted by the CSSF (for example for real estate funds).

    Financial reports / Consolidation Audited annual report (within 6 months from end of relevant period).
    Explicit exemption from consolidation requirements. Audited annual report (within 6 months from end of relevant period).
    Explicit exemption from consolidation requirements Part II Funds must publish:
    - an annual report for each financial year; and
    - a half-yearly report covering the first six months of each financial year.
    Tax regime
    SIF level
    Any SIF is exempt from corporate income tax, municipal business tax and net wealth tax.
    In addition to a specific registration tax of EUR 75, the only tax payable by a SIF is the annual subscription tax which amounts to 0,01%, levied on the net asset value of the SIF as per the last day of each quarter.
    Investor level
    No withholding tax is levied on income distributed by the SIF to investors unless the 'European Savings Directive' is applicable.
    A VAT exemption is applicable to management services rendered to a SIF.
    For corporate SIF’s, the benefits of some of the double tax treaties concluded by Luxembourg may be available. The income tax treatment of the SICAR depends upon the legal form under which it has been incorporated.
    - Incorporation of the SICAR;
    - Capital duty: EUR 75,- flat;
    - General tax features:
    - EU directives and tax treaties are in principle compatible, a SICAR should be considered as a 'fully taxable' company;
    - VAT: Management services rendered to a SICAR are VAT exempted;
    - Annual Subscription Tax: Exempted.
    - Net Worth Tax ('ISF'): Exempted. Part II funds are subject to an annual subscription tax (taxe d’abonnement) of 0.05% p.a. of their NAV. Classes of shares which are reserved for institutional investors are subject to a subscription tax at a reduced rate of 0.01%.
    Unlike FCPs, SICAV/Fs benefit from certain double tax treaties. Investments may be made through fully taxable subsidiaries benefiting from double tax treaties and the EU parent-subsidiary directive.
    No capital duty is due upon incorporation of Part II UCIs. However, a fixed registration duty of EUR 75 has been introduced.




    FUTURE EVOLUTION OF CARBON FUNDS
    The future performance and evolution of CIVs is shaped by multiple factors that can be grouped into the following components:
    3.2 Global market environment
    3.2.1 Post-2012 climate change policy
    The lack of agreement on a long-term international climate policy framework renders new CDM/JI project opportunities less and less attractive to potential carbon investors.
    However, some expect that the carbon market will continue to thrive thanks to an increase in the number of regional, sub-national, and national mandatory and voluntary schemes expanding the demand for emission reductions, irrespective of developments within the UNFCCC.
    Over the next two years, the international climate policy framework and domestic regulations are expected to take shape, with carbon markets playing a central role. This should provide a clearer idea of the longer-term demand for international carbon credits, and how the revised supply structure (see Development of CDM/JI markets) could meet it.
    3.2.2 European policy
    On 12 December 2008, the European Council decided to allow Member States to use UN credits up to 3 (three) percent of their 2005 verified emissions annually through 2020. This is in agreement with the initial EC proposal and less stringent than the amendment proposed by the Environment Committee (i.e., 8 percent of 2005 emissions for 2013-2020). Some EU countries will be allowed to use additional credits amounting to 1 percent of their 2005 emissions. Overall, Member States will be able to source almost 800 million credits in total between 2013 and 2020, if no international agreement is reached, otherwise the limit will double .
    3.2.3 Development of CDM/JI markets
    Experience has highlighted the fact that the buyers’ demand in carbon markets has been outpacing the supply. Indeed, in 2007 Caisse des Dépôts (2007) had already reported estimates that less than 50 percent of the capital raised by carbon funds had been invested .
    Markets have also demonstrated recently a preference to smaller projects.
    In the midst of negotiating a post-Kyoto agreement, there have been discussions on improving existing CDM and JI project mechanisms. The CDM scheme needs to find a way of dealing with several problems inter alia uneven geographical distribution, long and complex administration, and potential scope expansion. JI is also expected to undergo some alterations. So far it has been in the shadow of the CDM, having only a tiny number of projects registered compared to the CDM project pipeline.
    Unfortunately, all of these issues have not been resolved in the Copenhagen climate conference and in the Copenhagen Accord. The summit did not result in a legally binding deal or any commitment to reach one in future. The accord calls on countries to state what they will do to curb GHG emissions, but these will not be legally binding commitments.

    3.3 Carbon funds are starting to diversify their investment portfolio
    In the face of the uncertainties around the future CDM/JI market, existing carbon vehicles are expected to evolve from the traditional carbon fund models to a more diversified risk strategy that offers a large range of credit options.
    Some funds already include other types of credits such as EUAs or VERs in their portfolio, thereby opening themselves up to a wider range of sectors and potential investors.
    In general, such an extension of carbon investing strategies allows funds to reduce their exposure to uncertainties around the future of CDM/JI markets.
    Funds have also started to invest part of their capital in non-CDM/JI projects such as clean coal and renewable energy companies. In particular, funds investing ready cash in clean technology vehicles are well positioned to win good deals.
    Recently, the sector has struggled to get financing for wind farms, solar parks, and biofuel plants. Therefore, carbon funds could fill the gap by providing capital for project completion to developers of these types of projects that have power purchase agreements or other means of providing stable cash flow.
    Carbon funds that originally concentrated only on carbon credits from CDM/JI projects will look for other options to secure their existence and ensure continuous capital flow.



    List of Acronyms

    AAU Assigned Amount Unit
    CCS Carbon Capture and Storage
    CDM Clean Development Mechanism
    CDM EB CDM Executive Board
    CER Certified Emission Reduction
    DOE Designated Operational Entity
    EC European Commission
    ERPA Emission Reduction Purchase Agreement
    ERU Emission Reduction Units
    ETS Emission Trading Scheme
    EU European Union
    EUA European Union Allowance
    GHG Greenhouse Gas
    JI Joint Implementation
    MEP Member of the European Parliament
    PoA Programme of Activities
    REDD Reducing Emission from Deforestation in Developing Countries
    RGGI Regional Greenhouse Gas Initiative
    UN United Nations
    UNEP United Nations Environment Programme
    UNEP Risoe UNEP Centre on Energy, Climate and Sustainable Development
    UNFCCC United Nations Framework Convention on Climate Change
    WCI Western Climate Initiative
    VER Voluntary Emission Reduction
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Investment Funds - Carbon Funds

  1. 1.  <br />Dr. Pierre Alexandre DELAGARDELLE<br />Partner / Ph.D. / Avocat à la Cour<br />An introduction to <br />CARBON FUNDS<br />April 2010<br />Climate change has become one of the highest preoccupations of the post-industrial period. Mitigation of climate change, by reduction of greenhouse gases ("GHG") emissions and stabilisation of the carbon dioxide concentrations in the atmosphere has entered the agenda of most government policies. The Kyoto protocol aims to encourage this trend through allocation of a credit system. Carbon investments funds are a key player when implementing such system in green developments.<br />CARBON INVESTMENTS<br />The Kyoto Protocol<br />The Kyoto protocol (the "Kyoto Protocol") is a protocol to the United Nations Framework Convention on Climate Change ("UNFCCC" or "FCCC"), an international environmental treaty aiming to stabilize greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous interference with the climate system. <br />The Kyoto Protocol was negotiated in December 1997 at the city of Kyoto, Japan and came into force on 16th February 2005. 184 (hundred eighty four) parties of the UNFCCC have ratified its protocol to date. The detailed rules for the implementation of the Kyoto Protocol were adopted at the 7th conference of the parties to the UNFCCC in Marrakesh in 2001 ("COP7"), and are called the "Marrakesh Accords."<br />Reducing GHG emissions<br />The Kyoto Protocol is a legally binding agreement under which industrialized countries will reduce their collective emissions of GHG by 5.2% compared to the year 1990 (compared to the emissions levels that would be expected by 2010 without the Protocol, this target represents a 29% cut). The goal is to lower overall emissions from six GHGs: <br />Carbon dioxide ("CO2");<br />Methane;<br />Nitrous oxide;<br />Sulfur hexafluoride;<br />Hydrofluorocarbon ("HFC"); and <br />perfluorocarbon ("PFC");<br />Out of these six, the CO2 is the principal GHG. Hence it has become common to refer to CO2 emissions as to GHG emissions.<br />The major distinction between the Kyoto Protocol and the UNFCCC is that while the UNFCCC only encouraged industrialised countries to stabilize GHG emissions, the Kyoto Protocol commits them to do so. Recognizing that developed countries are principally responsible for the current high levels of GHG emissions in the atmosphere as a result of more than 150 years of industrial activity, the Protocol places a heavier burden on developed nations under the principle of "common but differentiated responsibilities." <br />What emerged from the Kyoto meeting is that as each country produces CO2, it must be able to contain that CO2 by tree-planting or other processes that can absorb it, such as sequestration and changing farming methods. Or it can reduce the CO2 it produces in the first place. If that country produces more CO2 than it can absorb, it must purchase "absorption ability" from another country. <br />Carbon credits<br />Carbon credits ("Carbon Credits") create a market for reducing GHG emissions by giving a monetary value to the cost of polluting the air. As such, carbon credits may be regarded as a "currency" under the Kyoto Protocol. <br />One Carbon Credit is equal to one Ton of CO2 (a Ton of Co2 is the equivalent of emissions produced during a return jet flight from Paris to New York). A country might have difficulties in absorbing 500,000T of CO2 and according to the Kyoto Protocol it must seek to purchase those from another country that has largely absorbed its quota. The funds used to purchases carbon credits will ultimately be used to give grants to further carbon. <br />Carbon credit trading is a mean aiming to push countries exceeding their quotas to subsidise green developments to countries that maintain low GHG emissions. Provided that this GHG mitigation projects generates credits, this approach can be used to finance carbon reduction schemes between trading partners and around the world.<br />There are many companies that sell carbon credits to commercial and individual customers who are interested in lowering carbon emissions on a voluntary basis. These customers purchase the credits from an investment fund or a carbon development company that has aggregated the credits from individual projects. <br />The quality of the credits is based in part on the validation process and sophistication of the fund or development company that acted as the sponsor to the carbon project. This is reflected in their price; voluntary units typically have less value than the units sold through the rigorously-validated Clean Development Mechanism ("CDM").<br />Emissions become an internal cost of doing business and are visible on the balance sheet alongside raw materials and other liabilities or assets.<br />The Kyoto mechanisms: <br />The Kytoto protoctol proposes three flexiblemechanism to assist its parties reduce the emissions of GHG: <br />Joint development (article 6);<br />Clean development (article 12); and <br />Emission trading (article 17).<br />Joint implementation ("JI"): green energy investments in other countries <br />According to Article 6 of the Kyoto Protocol, a country with an emission reduction or limitation commitment under the Kyoto Protocol (Annex B Party) may earn ERUs from an emission-reduction or emission removal project in another Annex B Party, each equivalent to one tonne of CO2, which can be counted towards meeting its Kyoto target. <br />Concept<br />A JI project must provide a reduction in emissions of GHG by sources, or an enhancement of removals by sinks, that is additional to what would otherwise have occurred. Projects must have approval of the host Party and participants have to be authorized to participate by a Party involved in the project. <br />The mechanisms help stimulate green investment and help Parties meet their emission targets in a cost-effective way.<br />Track 1 and Track 2 procedures <br />If a host Party meets all of the eligibility requirements to transfer and/or acquire ERUs, it may verify emission reductions or enhancements of removals from a JI project as being additional to any that would otherwise occur. Upon such verification, the host Party may issue the appropriate quantity of ERUs. This procedure is commonly referred to as the "Track 1" procedure." <br />If a host Party does not meet all, but only a limited set of eligibility requirements, verification of emission reductions or enhancements of removals as being additional has to be done through the verification procedure under the Joint Implementation Supervisory Committee ("JISC"). Under this so-called "Track 2" procedure, an independent entity accredited by the JISC has to determine whether the relevant requirements have been met before the host Party can issue and transfer ERUs. <br />A host Party which meets all the eligibility requirements may at any time choose to use the verification procedure under the JISC (Track 2 procedure). <br />Countries including Japan, Canada, Italy, the Netherlands, Germany, France, Spain and others are actively promoting government carbon funds, supporting multilateral carbon funds intent on purchasing carbon credits from non-Annex I countries, and are working closely with their major utility, energy, oil and gas and chemicals conglomerates to acquire greenhouse gas certificates as cheaply as possible. Virtually all of the non-Annex I countries have also established a designated national authority to manage its Kyoto obligations, specifically the "CDM process" that determines which GHG projects they wish to propose for accreditation by the CDM Executive Board.<br />The "clean development mechanism"<br />According to article 12 of the Kyoto Protocol, the Clean Development Mechanism ("CDM") allows a country with an emission-reduction or emission-limitation commitment under the Kyoto Protocol (Annex B Party) to implement an emission-reduction project in developing countries.<br />These projects qualify to earn CER credits, each equivalent to one Ton of CO2 that can be counted towards meeting the targets of the Kyoto Protocol. This corresponds to an environmental investment and credit scheme, providing a standardised emission offset instrument, CERs. <br />CDM scheme projects may be based on any energy saving project such as implementation of solar panels, windfarms etc. A CDM scheme project must provide emission reductions that are additional to what would otherwise have occurred. The projects must qualify through a rigorous and public registration and issuance process. Approval is given by the designated national authorities. Public funding for CDM project activities must not result in the diversion of official development assistance. <br />Emissions trading" or "carbon market"<br />The carbon credit system according to the Kyoto protocol is based principally upon the trade emissions allowed divided into "assigned amount units" ("AAUs"). However during this process other units may be acquired or transferred.<br />Assigned amount units<br />Under the Kyoto Protocol, the "caps" or "quotas" for GHG for the developed Annex 1 countries (the "Annex I Parties") are known as assigned mounts ("Assigned Amounts") over the 2008-2012 commitment period and are listed in Annex B.<br />In turn, these countries set quotas on the emissions of installations run by local business and other organizations ("Operators"). Each Operator has an allowance of credits, where each unit gives the owner the right to emit one metric tonne of carbon dioxide or other equivalent GHG. Operators that have not used up their quotas can sell their unused allowances as carbon credits, while businesses that are about to exceed their quotas can buy the extra allowances as credits, privately or on the open market. <br />An Annex I Party may hence transfer some of the emissions under its Assigned Amounts to another Annex I Party that finds it relatively more difficult to meet its emissions target. <br />According to article 17 of the Kyoto Protocol, "the parties included in Annex B may participate in emissions trading for the purposes of fulfilling their commitments under Article 3. Any such trading shall be supplemental to domestic actions for the purpose of meeting quantified emission limitation and reduction commitments under that Article".<br />Naturally, Luxembourg is among the numerous countries (parties) included the Annex B.<br />According to the "emissions trading", countries that have emission units to spare are allowed to sell this excess capacity to countries that are over their targets. As CO2 is the most common GHG, people speak simply of "trading in carbon". Hence, carbon may be tracked and traded like any other commodity. <br />In order to prevent Parties "overselling" units, and as consequence being unable to meet their own emissions targets, each Party is required to maintain a reserve of ERUs, CERs, AAUs and/or RMUs in its national registry. <br />This is known as the "commitment period reserve", and must always be at least at level of 90 per cent of the Party's assigned amount or at least five times its most recently reviewed inventory.<br />Other trading units in the carbon market<br />Further units that can be acquired or transferred (each equal to one Ton of CO2), may be in the form of:<br />A "removal unit" ("RMU") on the basis of land use, land-use change and forestry ("LULUCF") activities such as reforestation;<br />A "certified emission reduction" ("CER") generated from a clean development mechanism project activity. <br />An "emission reduction unit" ("ERU") generated by a "joint implementation project";<br />The acquisition or the transfer of these above units is tracked and recorded through the registry systems under the Kyoto Protocol.<br />An international transaction log ("ITL") verifies transactions proposed by registries to ensure they are consistent with rules agreed under the Kyoto Protocol.<br />Carbon Investment Vehicles<br />A carbon investment vehicle ("CIV") is a collective investment scheme which receives money from investors and uses this money in:<br />Buying carbon credits; or <br />Investing into GHG emissions reduction projects.<br />Investments are generally made through the Kyoto Protocol’s CDM; and JI schemes. <br />After a certain defined period, the CIV will then give investors carbon credits and/or cash in return. The emission reduction projects can be sourced from different developers, countries, and technologies. Over the last decade CIV have evolved to become important participants in the global carbon market. <br />Investment approach <br />Originally, most of the CIVs were sourcing carbon credits through Emission Reduction Purchase Agreements ("ERPAs") with payment on delivery. <br />ERPAs started as contractual arrangements where a party (the buyer) pays the other party (the seller) cash in exchange for carbon credits, thereby "allowing" the purchaser to emit more carbon dioxide into the atmosphere<br />However these types of contracts were considered as bearing a certain risk upon each of the parties: Seller must deliver credits upon anticipation and the buyer must block cash in anticipation of payments until credit delivery.<br />In the last few years, CIVs have moved towards the direct financing of projects (e.g., through equity investments, loans). Thus, the buyer can obtain carbon credits at the lowest price possible. <br />The contractual arrangements put in place vary case-by-case and are determined in the investment term sheets. For example, a CIV that provides equity together with other investors will become the owner of only a portion of the carbon credits and can purchase additional carbon credits at a discounted price. <br />Investment target <br />CIVs are focusing in sourcing credits from both CDM and JI projects. Generally, vehicles investing only in either CDM or JI are relatively not common. <br />Project development paths for CDM and JI present different risk/reward profiles. Usually, investors are better accustomed to the CDM process for which clear rules and procedures have been established. However JI is likely to attract more carbon market investors once the registration processes are stabilised. <br />Some CIVs have additional investment objectives, such as fuel switching, fugitive methane including landfill gas and coal bed methane, land use and land use change, water resource and infrastructure, and biofuels development. <br />One tenth of these new funds do not provide specific information on the sectors they target but use general terms, for example "climate change mitigation and adaptation projects," or "reduction of negative ecological impact." Behind these general areas, a wide range of project types can be found. These range from the often criticised efficient coal-fired plants through debated Reducing Emission from Deforestation in Developing Countries ("REDD") to relatively problematic emission reduction programmes (so-called "Programmes of Activities" or "PoA"). <br />REDD and PoA still require many clarifications before they become mainstream CDM activities. So far, development banks and governments have played a major role in promoting these types of projects. <br />Finally, funds that did not specify investment goals are usually those interested only in carbon credits. They seek pools of carbon assets often without following their origin (i.e., project type). <br />Interestingly, taking into account all 2008 funds, there is less capital targeted at off-take ERPAs than the capital dedicated to upfront project financing.<br />Luxembourg’s attractiveness for Carbon Investment Vehicles <br />Luxembourg’s attractiveness in CIVs results from its adequate legal, regulatory and fiscal framework for the incorporation of CIVs. The flexibility of the available legal vehicles, combined with a recognized regulatory framework and favourable tax environment shape the Luxembourg financial sector’s attractiveness. <br />This section aims at giving its readers an overview of the common Luxembourg investment vehicles.<br />LUXEMBOURG CARBON Investment Funds <br />Luxembourg has a long experience with the fund industry and other investment vehicles. <br />CIVS which may be set up as:<br />Undertakings for collective investment ("UCIs") governed by Part II of the Law of 20 December 2002 relating to undertakings for collective investment, as amended (the "2002 Law") (the "Part II Funds"); as well as<br />Investment companies in risk capital ("SICARs"), governed by the law of 15 June 2004 relating to the investment company in risk capital, as amended from time to time (the "2004 Law"); as well as<br />Specialised investment funds ("SIFs") governed by the law of 13 February 2007 on specialised investments funds, as amended (the "2007 Law"); or <br />The table hereinbelow summarises the main differences between Luxembourg investment vehicles.<br />SIFsSICARsPart II FundsPromoterA SIF’s promoter is not supervised by the CSSF, nor does the 2007 Law require CSSF authorisation of the promoter.The creation of a SICAR does not require the services of a promoter. Neither a promoter, nor an investment manager/adviser of a SICAR needs the CSSFs approval.The CSSF will check whether the promoter disposes of the required professional qualification and relevant experience for the exercise of his/her functions. With the FCP, the CSSF will check that the management company complies with the applicable legal requirements, as provided for specifically in the 2002 Law.Eligible investorsThe shares in a SIF can only be subscribed by:Institutional investors; orProfessional investors; orWell-informed investors.The shares in a SICAR can only be subscribed by:Institutional investors ; or Professional investors ; orWell-informed investors.The derogation providing that the general partners of limited partnerships do not need to qualify as "well informed investors", should they which to subscribe to shares in the SICAR has been extended by the law of 24 October 2008 improving the legal framework of the Luxembourg financial sector, modifying, inter alia, the 2004 Law and published in Luxembourg’s official journal (the "Memorial") on 29 October 2008 (the "2008 Law") to the directors and all persons who operate the management of the SICAR regardless of its legal structure.Unrestricted.Entity typeSICAV/F (S. A., S.C.A., S.à r.l., SCoSA); FCP; or Other (e.g., fiduciary structure).Corporate entity (S.A., S.C.A., S.à r.l., SCoSA, S.C.S..SICAV (S.A.) ; SICAF (S.A., S.C.A., S.à r.l.); or FCP.Eligible assets / StrategiesThe purpose of SIFs is to invest their funds in "values". The use of the term "value" seems to indicate that almost any type of investment is accepted. The SIF may hence invest in a broad range of assets, including carbon assets, but also derivatives, real estate, hedge funds and private equity. The policy and limits are to be set out in the offering document. All types of private equity / venture capital investments (including carbon assets, real estate private equity). Temporary investments in other assets pending investments in private equity / venture capital are possible.Part II of the 2002 Law does not provide any specific provisions regarding investment policies for Part II Funds. There are however a many applicable CSSF circulars and interpretations regarding such. The CSSF has issued circulars regarding investments by Part II Funds in transferable securities, alternative investments, venture capital, future contracts and options and real estate.Risk diversification requirementsNo investment or borrowing restrictions are defined in the SIF Law, with the exception of the principle of risk-spreading: A SIF may not invest more than 30% of its assets or commitments to subscribe in securities of the same nature issued by the same issuer. Short sales may not result in the SIF holding an open position on securities of the same nature issued by the same issuer representing more than 30% of its assets.When using derivative financial instruments, a SIF must ensure risk-spreading comparable to the above via an appropriate diversification of such derivatives’ underlying assets. The 2004 Law does not impose any investment diversification rules. A SICAR may therefore invest in just one or two companies or MFIs, for example in particularly narrow sectors such as carbon, biotechnology or geological prospecting.A SICAR invests its assets in securities representing risk capital. By risk capital is understood the direct or indirect contribution of assets to entities in view of their launch, their development or their listing on a stock exchange.Except during a transitional period, investment in any target company may not exceed 20% of the NAV.Segregated sub-fundsThe 2007 Law provides for compartments or sub-funds in a SIF. Each compartment can have its own specific investment policy and, as applicable, with securities of a different par value or no nominal value. The constitutional documents of the SIF must expressly provide for the creation of compartments or sub-funds. A multiple compartment SIF, by itself, is an individual legal entity. However, in contrast to the Luxembourg Civil Code, the assets and liabilities of each compartment are segregated and are only subject to the liabilities of that specific compartment, unless otherwise provided for in the constitutional documents.The 2008 Law provides for the introduction of compartments in a SICAR. Each compartment can have its own specific investment policy and each company may offer securities of a different par value or no nominal value. The constitutional documents must expressly provide for the creation of multiple compartments or sub-funds within a SICAR. The 2002 Law provides for the possibility to create several compartments with strict segregation of assets and liabilities between compartments.Required service providers in LuxembourgDepositary (credit institution);Administrative agent;Independent auditors.Idem.Idem.Minimum capital / net assets requirementsFor FCPsNet assets must reach EUR 1.25 Mio within 12 months from authorisation.For SICAV/Fs Upon incorporation:S.A./S.C.A.: EUR 31.000,-;S.à r.l.: EUR 12.500,-.Subscribed share capital and share premium must reach EUR 1,25 Mio within 12 months of authorisation.Upon incorporation:For an S.A./S.C.A.: EUR 31,000,-;For an S.à r.l.: EUR 12,500,-.Subscribed share capital must reach EUR 1 Mio within 12 months of authorisation.For FCPsNet assets must reach EUR 1,25 Mio within 6 months from authorisation.For SICAV/FsUpon incorporation:SA/SCA: EUR 31,000 ;S.à r.l.: EUR 12,500.Share capital must reach EUR 1,25 Mio within 6 months of authorisation.Structuring of capital calls and issue of shares / unitsCapital calls may be organized either by way of capital commitments or through the issue of partly paid shares (to be paid up to 5% at least) or units.The issue of shares of a SICAV does not require an amendment of the articles of incorporation before a public notary.The issue price may be freely determined in accordance with the principles laid down in the articles of incorporation / management regulations.For SICAVsExisting shareholders have no pre-emptive right of subscription, unless otherwise provided for in the articles of incorporation.Capital calls may be organized either by way of capital commitments or through the issue of partly paid shares (to be paid up to 5% at least) or units.Investors' subscriptions for shares can also be done on an ongoing basis (i.e. without specific commitment or contractual undertaking of the investors to subscribe for shares/units of the SICAR upon request of the SICAR).For FCPsCapital calls may be organized either by way of capital commitments or through the issue of partly paid units. Existing unitholders do not have a pre-emptive right of subscription in case of issue of units, unless otherwise provided for in the management regulations.Units must be issued at a price based on the NAV (plus costs and actualization interests, if appropriate).For SICAVsCapital calls must be organised by way of capital commitments (shares must be fully paid-up).Existing shareholders do not have a pre-emptive right of subscription in case of issue of shares, except if otherwise provided for in the articles of incorporation. Issues of shares do not require an amendment of the articles of incorporation before a public notary. Distribution of DividendsFor SIF-FCPs and SIF-SICAVsThere are no statutory restrictions on payments of (interim) dividends (except for compliance with minimum net assets / capital requirement).For SICAFsDistributions may not reduce the SICAF’s assets, as reported in the last annual reports, to an amount less than one-and-a-half times the total amount of the SICAF’s liabilities to its creditors.Interim dividends are subject to statutory conditions.There are no statutory restrictions on payments of (interim) dividends (except for compliance with minimum capital requirement).The distribution of dividends is not limited to accrued income but also includes, for example, interests, dividends and other income from investments made by the FCP or the SICAV as well as capital gains registered in relation to the FCP's or the SICAV's portfolio of assets (even when these capital gains are not realised yet). However, the payment of distributions must not result in the net assets of the FCP or the SICAV falling below the minimum required by the 2002 Law (i.e. EUR 1.250.000,-). Calculation of NAVThe NAV must be determined in accordance with the rules laid down in the articles of incorporation or management regulations of the SIF. As a matter of principle, it will be determined at least once a year, namely at the end of the financial year.Assets are to be valued at fair value.The NAV must be determined at least once a year. The requirement for investors to be informed at least once every six month about the NAV has been abolished by the 2008 Law.Assets are to be valued at fair value.Part II UCIs must calculate the net asset value of their shares or units at least once per month. Exceptions may be granted by the CSSF (for example for real estate funds).Financial reports / ConsolidationAudited annual report (within 6 months from end of relevant period).Explicit exemption from consolidation requirements.Audited annual report (within 6 months from end of relevant period).Explicit exemption from consolidation requirementsPart II Funds must publish:an annual report for each financial year; anda half-yearly report covering the first six months of each financial year.Tax regimeSIF levelAny SIF is exempt from corporate income tax, municipal business tax and net wealth tax.In addition to a specific registration tax of EUR 75, the only tax payable by a SIF is the annual subscription tax which amounts to 0,01%, levied on the net asset value of the SIF as per the last day of each quarter. Investor levelNo withholding tax is levied on income distributed by the SIF to investors unless the "European Savings Directive" is applicable.A VAT exemption is applicable to management services rendered to a SIF.For corporate SIF’s, the benefits of some of the double tax treaties concluded by Luxembourg may be available.The income tax treatment of the SICAR depends upon the legal form under which it has been incorporated. Incorporation of the SICAR;Capital duty: EUR 75,- flat;General tax features:EU directives and tax treaties are in principle compatible, a SICAR should be considered as a "fully taxable" company;VAT: Management services rendered to a SICAR are VAT exempted;Annual Subscription Tax: Exempted.Net Worth Tax ("ISF"): Exempted.Part II funds are subject to an annual subscription tax (taxe d’abonnement) of 0.05% p.a. of their NAV. Classes of shares which are reserved for institutional investors are subject to a subscription tax at a reduced rate of 0.01%.Unlike FCPs, SICAV/Fs benefit from certain double tax treaties. Investments may be made through fully taxable subsidiaries benefiting from double tax treaties and the EU parent-subsidiary directive.No capital duty is due upon incorporation of Part II UCIs. However, a fixed registration duty of EUR 75 has been introduced.<br />FUTURE EVOLUTION OF CARBON FUNDS<br />The future performance and evolution of CIVs is shaped by multiple factors that can be grouped into the following components:<br />Global market environment <br />Post-2012 climate change policy<br />The lack of agreement on a long-term international climate policy framework renders new CDM/JI project opportunities less and less attractive to potential carbon investors. <br />However, some expect that the carbon market will continue to thrive thanks to an increase in the number of regional, sub-national, and national mandatory and voluntary schemes expanding the demand for emission reductions, irrespective of developments within the UNFCCC. <br />Over the next two years, the international climate policy framework and domestic regulations are expected to take shape, with carbon markets playing a central role. This should provide a clearer idea of the longer-term demand for international carbon credits, and how the revised supply structure (see Development of CDM/JI markets) could meet it. <br />European policy <br />On 12 December 2008, the European Council decided to allow Member States to use UN credits up to 3 (three) percent of their 2005 verified emissions annually through 2020. This is in agreement with the initial EC proposal and less stringent than the amendment proposed by the Environment Committee (i.e., 8 percent of 2005 emissions for 2013-2020). Some EU countries will be allowed to use additional credits amounting to 1 percent of their 2005 emissions. Overall, Member States will be able to source almost 800 million credits in total between 2013 and 2020, if no international agreement is reached, otherwise the limit will double. <br />Development of CDM/JI markets <br />Experience has highlighted the fact that the buyers’ demand in carbon markets has been outpacing the supply. Indeed, in 2007 Caisse des Dépôts (2007) had already reported estimates that less than 50 percent of the capital raised by carbon funds had been invested. <br />Markets have also demonstrated recently a preference to smaller projects. <br />In the midst of negotiating a post-Kyoto agreement, there have been discussions on improving existing CDM and JI project mechanisms. The CDM scheme needs to find a way of dealing with several problems inter alia uneven geographical distribution, long and complex administration, and potential scope expansion. JI is also expected to undergo some alterations. So far it has been in the shadow of the CDM, having only a tiny number of projects registered compared to the CDM project pipeline. <br />Unfortunately, all of these issues have not been resolved in the Copenhagen climate conference and in the Copenhagen Accord. The summit did not result in a legally binding deal or any commitment to reach one in future. The accord calls on countries to state what they will do to curb GHG emissions, but these will not be legally binding commitments.<br />Carbon funds are starting to diversify their investment portfolio <br />In the face of the uncertainties around the future CDM/JI market, existing carbon vehicles are expected to evolve from the traditional carbon fund models to a more diversified risk strategy that offers a large range of credit options. <br />Some funds already include other types of credits such as EUAs or VERs in their portfolio, thereby opening themselves up to a wider range of sectors and potential investors. <br />In general, such an extension of carbon investing strategies allows funds to reduce their exposure to uncertainties around the future of CDM/JI markets. <br />Funds have also started to invest part of their capital in non-CDM/JI projects such as clean coal and renewable energy companies. In particular, funds investing ready cash in clean technology vehicles are well positioned to win good deals. <br />Recently, the sector has struggled to get financing for wind farms, solar parks, and biofuel plants. Therefore, carbon funds could fill the gap by providing capital for project completion to developers of these types of projects that have power purchase agreements or other means of providing stable cash flow. <br />Carbon funds that originally concentrated only on carbon credits from CDM/JI projects will look for other options to secure their existence and ensure continuous capital flow.<br />List of Acronyms<br />AAU Assigned Amount Unit <br />CCS Carbon Capture and Storage <br />CDM Clean Development Mechanism <br />CDM EBCDM Executive Board <br />CER Certified Emission Reduction <br />DOE Designated Operational Entity <br />EC European Commission <br />ERPA Emission Reduction Purchase Agreement <br />ERU Emission Reduction Units <br />ETS Emission Trading Scheme <br />EU European Union <br />EUA European Union Allowance <br />GHG Greenhouse Gas <br />JI Joint Implementation <br />MEP Member of the European Parliament <br />PoA Programme of Activities <br />REDD Reducing Emission from Deforestation in Developing Countries <br />RGGI Regional Greenhouse Gas Initiative <br />UN United Nations <br />UNEP United Nations Environment Programme <br />UNEP Risoe UNEP Centre on Energy, Climate and Sustainable Development <br />UNFCCC United Nations Framework Convention on Climate Change <br />WCI Western Climate Initiative <br />VER Voluntary Emission Reduction <br />

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