After meetings between senior Lebanese officials and UN legal counsel, Nicolas Michel, the UN secretary-general said in a report on Tuesday it was clear that a mixed tribunal was needed to ensure that justice was done.
Rafik al-Hariri and 22 others were killed in a bomb attack on 14 February, 2005, an event that shook the nation and led to the departure of Syrian forces from Lebanon.
Annan said the attack on al-Hariri and other similar bombings "have contributed to creating a climate of insecurity and intimidation which seriously affects the functioning of the country's political institutions as well as economic and social life".
A UN investigating team has spent nearly 10 months looking for al-Hariri's killers. Last week, the new chief investigator, Serge Brammertz, told the UN Security Council that he was cautiously optimistic that new promises by Syria to co-operate after months of refusals and delays could lead to progress in the probe.
His predecessor had implicated senior Syrian and Lebanese officials in the explosion in Beirut that killed al-Hariri.
Annan said in the report that UN consultations with Lebanese authorities highlighted the "urgent need" to find the truth behind the assassination, which could contribute to restoring stability and durable peace to the country.
The report was a response to a Security Council resolution adopted on December 15 which asked the secretary-general to help the Lebanese government to identify the nature and scope of international assistance needed to try anyone charged in the terrorist attack that killed al-Hariri.
Annan said: "It appears that the establishment of a mixed tribunal would best balance the need for Lebanese and international involvement in the work of the tribunal.
"That balance would be determined by such important characteristics as the tribunal's founding instrument, jurisdiction, applicable law, location, composition, and financial arrangements."
As a result of the recent discussions, Annan said, "there is a common understanding that it would be most appropriate to establish the tribunal through an agreement concluded between Lebanon and the United Nations".
He said Lebanese authorities made it clear that using Lebanese criminal law "would play an important role in ensuring that the tribunal would have a national dimension".
The Lebanese also expressed "a preference for the tribunal to have personal jurisdiction over all those responsible for the crime in which Mr Hariri and others were killed".
Annan said the issue of where to locate the tribunal must be carefully considered, balancing the objective of having judicial proceedings in Lebanon with the security of the judges, prosecutor, witnesses and those accused. Logistical and financial implications must also be taken into account, he said.
"At this stage, it is clear that there is a belief, based on security concerns, among the Lebanese authorities that the tribunal might not be able to operate effectively in Lebanon," he said.
As for the composition of the tribunal, Annan said: "The Lebanese authorities emphasised that significant international participation would be essential for the tribunal to fulfill its purpose effectively."
The secretary-general stressed the importance of ensuring that the judges, prosecutor and court personnel are selected "in a way that ensures the independence, objectivity and impartiality of the judicial process".
Annan said if "the common understanding" between the UN and Lebanese authorities was acceptable to the Security Council, it should adopt a resolution asking him to initiate negotiations with the Lebanese government directed at establishing a mixed tribunal.
He said he would present recommendations on expanding the mandate of the investigating commission to cover other attacks in Lebanon since October 1, 2004.