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Environmental Funds as instrument of environmental policy The economic and political restructuring underway in transition countries aims to change

the role of the state, re-establish the private sector in the economy, decentralize political power and in this process, develop a new division of tasks and responsibilities between the government, the private sector and households. Part of this movement will involve the creation of a new system of financing for environmental expenditures. Financing for environmental investments increasingly should be based on private sources, and follow the guidelines of the Polluter Pays Principle. n that context establishing and functioning of !nvironmental Funds is fully "ustified. Environmental Funds are institutions designed to channel earmarked revenues for environmental protection purposes. #evenues generally derive from environmental charges and taxes. They are set aside $%earmarked%& for environmental purposes rather than transferred to the general government budget. Funds use these revenues to provide financial assistance, usually on favorable terms, for investments and other pro"ects to achieve environmental ob"ectives. Different types of Environmental Funds - !nvironmental Funds take a number of different forms. 'ne key distinction is between comprehensive $or general& funds and specific funds. Comprehensive Funds provide finance for a broad range of environmental protection activities $air, water, soil, noise&. (ost !nvironmental Funds in )entral and !astern !urope are comprehensive funds. This type of Fund also exists in some developing countries. To a great extent, comprehensive funds can be viewed as supplementing the general budget for environmental protection. Specific Funds, on the other hand, provide finance for an identified environmental problem or program. There are a few examples of this type of fund in the region, such as the water management fund in *ungary. !xamples of specific funds in '!)+ countries include the water agencies in France and the ,etherlands and the %-uperfund% for the cleanup of abandoned hazardous waste sites in the .-. ndependently of their structure, !nvironmental Funds can take at least three fundamentally deferent forms/ cash fund, endowment fund, revolving fund. Cash Fund: This form is the simplest one. The cash fund receives money from donors, fines, royalties or any other source, either in one instalment or in several tranches and spend it according to the availability of money and approval of pro"ects. 0ll spending is done on a grant basis. Pro"ect monitoring can be carried out by the fund administration. 1hen funds are exhausted, either the fund is replenished or if it was designed as a sinking fund, it ends its operations. This is often the case with debt counterpart funds. Endowment Fund: The endowment fund invest the funds received in an interest bearing form such as bonds, private bank accounts, real estate, etc. and spend only interest earned on those investments. This form trades cash availability, which of course, is considerably smaller than in the case of the cash fund, against the establishment of a long-term financial investment for environmental conservation.. (oreover, the establishment of administrative 2

bodies is also a more long-term affair. *owever, this kind of funds re3uires a minimal financial critical mass to be worth it. f the capital invested is too small, the interests earned will be insignificant and not worth it. Revolving Fund/ The revolving fund disburses the cash in the same way as the cash fund but it does so on a loan basis. 0 long-term financial mechanism is therefore established in the same way as the endowment fund. *ere again, there is a trade-off, this time between investment security and immediate outreach to target groups. 0ssuming that loans made in the context of the fund4s environmental aims are not as secure an investment as government bonds or real estate, the funds trade greater availability of cash for its pro"ects against a higher degree of insecurity. Funds also vary by their territorial scope. (ost !nvironmental Funds in )entral and !astern !urope are national funds, though in some countries, such as Poland and the #ussian Federation, there are Funds at the municipal and local levels. Funds can also be organised by ecological regions/ the water agencies in France, for example, are organised by ma"or river basins. !nvironmental Funds can also be organised on an international scale, such as the 5lobal !nvironmental Facility. !nvironmental Funds vary in their institutional arrangements. The term %!nvironmental Funds% is sometimes used to refer "ust to the revenue earmarked for environmental protection. !armarked revenues are not necessarily lodged in a specific institution. These revenues can be held for redistribution in several different ways, such as a simple addition to the general budget6 a separate account in the general budget6 or as money assigned to a dedicated organisation. Therefore, structural arrangements for !nvironmental Funds can range from legal re3uirements directing the use of earmarked revenue by existing ministries and agencies to a %full-fledged% independent organisation. The main functions of comprehensive Environmental Funds - -everal functions are necessary for the operation of comprehensive !nvironmental Funds in !conomies in Transition. These include/ -- revenue collection6 -- cash management6 -- preparing a yearly implementation program $budget&6 -- drafting the eligibility criteria for pro"ects6 -- identifying potential pro"ects6 soliciting application from potential recipients6 -- pro"ect appraisal/ evaluating pro"ect applications6 -- final evaluation and award by decision-making group6 -- disbursement of funding6 -- administration/ personnel, accounting, research6 and -- monitoring and evaluating pro"ects and programs.

n addition to the current roles of environmental funds, it is worth considering the following options/ mobilising private capital from commercial banks, and the co-financing of loans by commercial banks for environmental infrastructure measures6 serving as a financial intermediary for F s6 administering other state subsidy schemes6 utilising the !. -tructural Funds and )ohesion Fund6 supporting soft measures to strengthen absorption capacity6 providing technical assistance to central and regional authorities6 and human resources and 3uality assurance as a critical factor for success. ,ot all these functions should to be carried out by the Funds themselves. #evenue-raising, for example, could be undertaken by other environmental authorities or by tax authorities. The core Fund activities revolve around the pro"ect cycle, including pro"ect appraisal and pro"ect finance. !nvironmental Funds need a management structure to undertake these main functions and tasks. 'ther important management activities may include budget preparation and financial management, monitoring ongoing pro"ects, and post-pro"ect evaluations. n addition, a decision-making authority is needed to oversee Fund operations, approve budgets, programs and large expenditures, as well as to ensure that the Fund follows national environmental policy and government financial re3uirements. This power is usually vested in a board of directors, which in many countries is chaired by the (inister of !nvironment. *owever, the Fund should be ultimately accountable to government and Parliament, which should approve its budgets. Funds may benefit from advisory mechanisms, such as an advisory board of independent experts.-uch mechanisms can contribute substantively to the Fund4s operations and enhance Fund credibility and acceptability. 0n advisory Forum to discuss ma"or issues with different stakeholders $industry, environmental groups, and regional and local government representatives& may also be useful.

The legislation for Funds in )!! countries establishes a general and comprehensive set of objectives. The stated ob"ectives vary, but can include/ -- promoting activities and investments to protect and improve air 3uality and water 3uality, to minimise waste generation, or to preserve soil6 -- encouraging the development of an environmentally more benign economic structure6 -- sponsoring research and development activities and pro"ects6 -- promoting activities to protect natural values and natural habitats and preserve biodiversity6 -- encouraging environmental education and training6 and -- improving environmental monitoring systems. 8

n practice, the main role of Funds in )!! countries has been to provide financial assistance for environmental protection investments and environment-related infrastructure development. n some countries, Funds also play an important role in financing state administrative tasks such as monitoring and enforcement, as well as some state environmental research and development activities. !nvironmental Funds provide a means for overcoming the institutional and market failures encountered in the transition period. 9y reducing the financial burden of environmental investments on enterprises and households, Funds can accelerate the pace of environmental improvement. 5enerally, Funds will contribute less than the full costs of an investment so they can be a valuable mechanism for leveraging resources from domestic and foreign sources. Funds can also perform important institutional strengthening functions/ they can help develop the expertise which is fre3uently lacking in the region for the effective preparation, evaluation and financing of environmental pro"ects. 9y working with commercial banks, they can help transfer these skills to the private sector. 0s an environmental policy tool, the Funds can help channel much needed resources to environmental problems which impose real and significant costs on society, and ensure that these resources are used in a cost-effective manner. The subsidy element provided by Funds can be used as an incentive to reinforce the effectiveness of other policy tools such as regulations and economic instruments. 9y providing resources for environmental expenditures, particularly in the industry or energy sectors, Funds can help to breakdown the barriers to cooperation that fre3uently exist between environmental and sectoral ministries in !conomies in Transition. Funds can play a pivotal role in supporting the development and implementation of ,ational !nvironmental 0ction Programmes $,!0Ps&. Funds could provide both analytical skills and financial resources needed in the development and implementation of ,!0Ps. !nvironmental Funds financed by environmental charges, taxes and fines, may also be "ustified under extended definitions of the Polluter Pays Principle. 9y making polluters responsible as a group, earmarking of environmental taxes and charges overcomes the difficulty of linking individual polluters to damage and provides an alternative to making the general taxpayer foot the bill for cleanup. Thus, !nvironmental Funds can function as mechanisms for recycling funds from polluters in general to address the environmental problems most in need of remedial action.

Important factors for establishing an Environmental Fund: The environmental issue to be addressed is significant, and appropriate actions to respond are long term and can be met with the resource flows an !F could produce. There is active and broad based 5overnment support for creating a mixed, publicprivate sector mechanism that will function beyond direct government control. There is a critical mass of people from diverse sectors - government, ,5's, academic and private sectors, donor agencies ; who can work together despite different approaches to nature conservation and sustainable development. There is a basic fabric of legal and financial practices and supporting institutions $including banking, auditing and contracting& in which the ma"ority of people have confidence. There is a legal framework that permits establishing the fund, and tax laws that allow it to be exempt from taxes. There are mechanisms to involve a broad set of stakeholders in the design process, and willingness by these stakeholders to use them. 'ne or more mentors $e.g. another more experienced fund or an experienced international ,5'& are available to provide technical support to the new fund. There are realistic prospects for attracting a level of capital sufficient for the fund to support a significant programme while keeping operating costs to a reasonable percentage. There is an effective demand for the fund4s products, i.e. a client community interested in and capable of carrying out environmental activities on the scale envisioned. onditions for an efficient operation of an environmental fund - !stablishing a !nvironmental Fund is one thing. !ffective operations of this fund in another thing and according to the 5!F review of all existing !Fs re3uire specific conditions/ )lear and measurable goals and ob"ectives, and a results-oriented management culture that learns from experience and is open to changes in approach based on feedback. 0 governance structure with appropriate checks and balances, conflict of interest provisions, and succession procedures. (embers of governing bodies who are prepared to commit their time, engage in fund policy-making and leadership, and build support with varied constituencies. <inkages between the fund and any national environmental strategy or action plan. 0n ability to attract dedicated competent staff, especially a strong executive director. 9asic technical and other capabilities that permit the fund to become a respected and independent actor in the community. 0ccess to, and effective use of training mentoring and technical assistance resources to build capacity. *armonious and productive board-staff relationship. )onstructive relationship with relevant government agencies, intermediary organisations that provide services to clients, and other organisations in the environment community. The fund should avoid becoming an executing agency itself.

Financial and administrative discipline, combined with programme flexibility and transparency, and procedures that support this and are consistently applied. 0s of allocation of environmental fund resources! !nvironmental Funds need to have/ an overall financing strategy6 regular, usually yearly, implementation programs $or budgets&6 an ade3uate pro"ect cycle for all pro"ects6 and monitoring and evaluation of program implementation against its stated ob"ectives.

The starting point should be the priorities of national environmental policy. These need to be specific enough to provide clear guidance for the Fund4s financing strategy. The development of ,ational !nvironmental 0ction Programs can provide specific guidance and priorities. >ust as in all public spending programs, the Fund4s financing strategy should be determined by government and approved by Parliament. f possible, the overall themes of Fund strategy should be indicated in the Fund4s charter and, if necessary, in more detailed multi-year strategies. 'ne key 3uality of a Fund4s financing strategy is that it should provide clear guidance for developing the Fund4s spending programs and for pro"ect implementation choices. The procedures for identifying, preparing, and deciding on pro"ects can be described as the project cycle. The procedures of the pro"ect cycle and the criteria used for pro"ect appraisal should be transparent and should not change erratically. 1ritten operational procedures for the pro"ect cycle are usually necessary6 these should give a detailed description of each step in the cycle. The procedures should be available to all potential recipients and to the public. The se"uence of a project cycle is/ $i& identification6 $ii& preparation and design6 $iii& appraisal6 $iv& negotiations and financial award6 $v& monitoring of implementation and operation of the pro"ect6 and $vi& evaluation.

Disbursing Fund resources - !nvironmental Funds can use different approaches for disbursing resources, including/ direct grants, direct loans, grants on interest payments, loan guarantees, loans provided through financial intermediaries, and e3uity investments. n evaluating these different mechanisms, it is important to keep in mind that !nvironmental Funds provide, first of all, a subsidy for environmental activities. This should be distinguished from financing. 0 subsidy can be defined as a transfer of money on terms that are more favorable then those prevailing on the market. n general, when public agencies subsidize environmental activities, they do so in order to stimulate the recipients to undertake efforts and to spend more of their own resources on environmental improvement than they would have been willing to do otherwise. 0 subsidy usually increases recipients4 spending. The lower the re3uired resources that recipients must provide, the stronger the economic incentive provided by the subsidy. The Fund should seek to stimulate, and not to replace the recipient4s spending. n addition, re3uiring a contribution from the recipient can help reduce the financial risk, as it should help ensure that the recipient has a vested interest in the pro"ect4s success. n choosing disbursement mechanisms, Funds need to take into account/ the different incentive effects, administrative costs, and financial risks associated with their use. The main sources of revenue for Environmental Funds in transition countries have been/ environmental charges and fines, and specifically charges and fines on pollutant emissions. foreign sources of revenue, such as grants from foreign assistance programs. direct transfers from the government budget, revenues from the privatization of the state companies . !nvironmental taxes are considered payments for using environmental goods and services, introduced with incentive or revenue raising purpose in mind, but which are used for general government revenue. !nvironmental charges, in turn, are used to refer to those payments that are used to finance the provision of collective services, as well as those earmarked to an extra budgetary fund. #hich are the most appropriate charges for Environmental Funds$ Emission charges !ser charges. "nput product charges Consumption product charges

#enalties and fines for noncompliance$

The '!)+ guidelines suggest several basic criteria to be considered for both incentive or revenue instruments/ environmental effectiveness6 economic efficiency, administrative efficiency $minimizing compliance costs and administrative costs&6 e3uity, and acceptability. These imply several elements that should be part of a revenue raising system/ -- a clear framework and ob"ectives6 -- a well-defined field of operations6 -- a simple mode of operation6 -- integration with sectoral policies6 -- low costs of implementation6 -- assessment of economic and distributive conse3uences6 and -- conformity with general principles for national and international trade $including the Polluter Pays Principle&, with fiscal policy, and with environmental policy. Foreign sources of finance - !xternal resources may be channelled through Funds in the form of/ grants concessional $soft& loans from bilateral donors, market rate loans from international financial institutions, debt for environment swaps$ 9ilateral donors and international financial institutions may find that using the !nvironmental Funds as intermediaries for financing environmental investments can provide a number of advantages/ -- !nvironmental Funds have often accumulated expertise in identifying promising environmental pro"ects, some of which may fit the priorities of foreign donors. -- -ome bilateral donors and international financial institutions face problems finding local counterpart funding. n many cases, these donors and institutions re3uire such funding, since local financial commitment assures the sustainability of the pro"ects. !nvironmental Funds can provide resources to co-finance environmental investments. -- !nvironmental Funds may be better able to undertake innovative financing arrangements than government ministries. Their pro"ect portfolio is usually flexible and may include pro"ects that meet special conditions re3uired by the donors. -- !nvironmental Funds may provide a cost-effective way for bilateral donors or international financial institutions to channel their money to small pro"ects and recipients.


The role of the Environment %inistry - n many )entral and !astern !uropean countries, the !nvironment (inistry provides the institutional base for Fund operations. The main advantage is/ that the public finance nature of Fund spending is directly underlined. it is easier to ensure this spending supports national environmental policy goals and are in line with overall economic policy. the responsibility for oversight is clearly assigned. The danger, however, is/ that the (inistry may become guided by short term political interests. administrative rules, including civil service pay scales, can make it difficult to attract and retain a sufficient number of ade3uately trained staff inside the (inistry. The main conclusions of the St. Petersburg Guidelines on Environmental Funds: D To avoid or minimize the long-term economic inefficiencies inherent in earmarking of funds, expenditure should be targeted to meet environmental priorities and promote pro"ects with large environmental benefits relative to their costs. D !nvironmental funds should play a catalytic role in financing, ideally offering no more support for pro"ect than is necessary, adapt to changing economic conditions, and support, not compete with, emerging capital markets. D !nvironmental funds should be used in con"unction with, and reinforce, other environmental policy instruments, such as compliance schedules, environmental auditing programs and voluntary agreements. D !nvironmental funds should develop an overall financing strategy, follow clear and explicit operating procedures for evaluating and selecting pro"ects, adopt effective monitoring and evaluation practices, and make effective use of internal and external expertise to enhance administrative efficiency. D For investment pro"ects, funds should have well-designed program and pro"ect cycles to ensure cost-effective use of resources. D !nvironmental funds should leverage increased private sector resources and capital market financing for environmental investments. D n defining and evaluating fund revenue mechanisms, environmental authorities should try to ensure environmental effectiveness, economic and administrative efficiency, e3uity and acceptability. -ystems should provide a stable base of revenues, be simple in structure, and be easy to monitor and enforce. D !nvironmental funds should ensure transparency and should be accountable to government, parliaments, and the public for their actions.


urrent problems - t is possible to identify the following issues currently faced by many of the funds, which will doubtless have an impact on the future/ D unstable andEor decreasing revenue stream6 D unclear or vague long-term strategy6 D low level of mobilisation of other capital $private, in particular&6 D vulnerability to political influences6 and D pressure to change their extra-budgetary character. &e' challenges for Environmental funds in the conte(t of E) accession - ssues that shape the future operation of the funds are/ D drastically increased need for investment financing of public environmental infrastructure development in order to meet !. re3uirements6 D pressure for pro"ect selection that might be directed to maximize and capture !. subsidies6 D increased need for financing in order to strengthen institutional capacity for enforcement and monitoring6 and D strong lobbying for subsidizing private sector environmental expenditures undertaken to meet tightened environmental legislative re3uirements. Environmental funds can play an important role in the E) accession process via their role in financing investment programs and strengthening monitoring and enforcement activities. *owever, they should focus not so much on reducing the financial costs of any environmental investment, but rather on concentrating their resources on supporting investments that will help to achieve clearly stated priorities and ob"ectives. Furthermore, the funds should place the goals related to !uropean integration on their priority lists. t is noteworthy to consider how the process of !. accession and the accompanying measures, in terms of additional funding sources available for candidate countries in the coming years $i.e. before and also after the accession&, will have implications for the work of environmental funds

Prepared by/ 0ss Prof Fasim TatiG, Ph.+. Faculty of !conomics -ara"evo