The UN’s role in carbon markets past, present, and future

1 December 2015

Carbon markets are gaining traction across the globe. What governance role for the multilateral system in this area?

Carbon markets have been one of the bright spots in climate change mitigation efforts for the last 10-15 years. While climate talks at the multilateral level have stalled, or searched for new ideas after the entry into force of the Kyoto Protocol (KP), markets have delivered. Delivery may have been imperfect, but any policy instrument is invariably so. Moreover, searching for perfection may be genuine, but it could ultimately be detrimental to a real solution.

Carbon markets, and especially any international component, owe a significant part of their development and functioning to the multilateral system and arrangements put in place under the Kyoto Protocol. Whether the KP is a top-down or bottom-up approach is something that can be debated but is not the primary subject of this article. It is nevertheless important to remember that the KP arrangements on emissions trading are restricted to addressing international transfers and not to delving into the role of national governments.

Countries are now in the process of negotiating a new climate agreement due to be signed off by the end of the Twenty-first Conference of the Parties to the UN Framework Convention on Climate Change (UNFCCC COP21) in early December in Paris, France. The deal should replace the Kyoto Protocol as the world’s primary multilateral climate governance instrument when it expires at the end of the decade.

In contrast to the KP, which mandated emissions cuts from a specific group of developed countries listed on the Convention’s “Annex I,” the new climate pact will be universal. Parties have agreed that each nation should outline a climate plan, dubbed “Intended Nationally Determined Contribution (INDC),” containing at least a mitigation element.

This chosen format for the new agreement implies a much wider coverage on the one hand, and on the other, a likely greater diversity in self-determined greenhouse gas (GHG) emissions abatement. In sum, international efforts should add up to enough to keep the world below a two degree Celsius warming from pre-industrial levels, although whether the INDC approach will be able to deliver this remains to be seen in the outcome of the negotiations in the French capital.  

Carbon market 1.0

It can be said that the multilateral system has contributed considerably to the creation and function of the carbon market 1.0. The KP is effectively a giant cap-and-trade scheme. Annex I parties were the covered parts of the system and could only emit a certain amount GHG emissions, expressed as “assigned amounts” in UN speak, while non-Annex I parties were not covered but could a participate through baseline and credit mechanisms. The KP also provided Annex I countries with abatement cooperation through “joint implementation,” a way to generate project-based credits among those covered by the cap.

Article 17 of the Kyoto Protocol provided countries with the opportunity to trade spare “assigned amount units” (AAUs), in other words, to sell AAUs to other countries that may have exceeded their assigned amount emissions threshold. This option was used by a few parties but not widely. The importance of the AAUs as an accounting tool and tradable commodity, moreover, has not always been fully understood.

It must be emphasised that the KP has provided through the presence of AAUs as a standard unit the means to ensure the environmental integrity of any international transfer of domestic units for compliance. Thus the KP under Article 17 has played a pivotal role in efforts to link domestic markets and emissions trading schemes. For example, the EU had sought to link its Emissions Trading System (ETS) with Australia’s planned carbon market – before the instrument was culled by Canberra – and Brussels is currently pursuing technical talks with Switzerland for eventual linking.

The KP therefore in many respects generated the impulse for the creation of an international carbon market, as well as provided the legitimacy, credibility, infrastructure, and regulator for some of the instruments. The KP has also influenced the structure of the market. The world's current main carbon market, the EU ETS, was created in order to help meet the bloc’s commitment under the KP. EU resistance to market approaches was replaced with enthusiasm, especially as other domestic approaches to GHG mitigation had proved elusive and un-implementable in the context of bloc’s governance arrangements. Japan’s deployment of markets, the second largest demand centre, also took place through the use of Clean Development Mechanism (CDM), JI, and the KP infrastructure.

Diminished activity

The KP will likely cease to play any formal role in the post-2020 period and, in any case, it has only been playing a marginal one after the completion of the first commitment period from 2008-2012. This is evinced by the increasing decoupling of the EU from the UNFCCC infrastructure for carbon markets, the virtual elimination of CDM and JI credits from the EU ETS, and the effort by Japan to create a Joint Crediting Mechanism to replace the CDM in satisfying the country’s demand for international mitigation outcomes. Carbon market activity has also been greatly diminished primarily due to the lack of demand in the EU ETS, and with it the role of the UNFCCC, the KP, its market mechanisms, and infrastructure.

As parties to the UNFCCC move closer to securing a new climate regime climate observers and policymakers alike are currently speculating on the role of the multilateral system with respect to any international carbon market. This question can be seen as having three components: the remaining second commitment period (SCP) of the KP from 2013-2020; the pre-2020 period; and activity beyond the end of the decade that will be covered by the Paris deal.

Near term forecasts

For the remaining time of the SCP, the KP will continue to play the same role, as a mechanism that generates credits – through the CDM and JI – provides the infrastructure for transfers between KP parties, and the accounting framework for compliance, tracking, and avoidance of double counting, whereby the same emissions reduction is counted twice both by the host country and an eventual buyer of the abated emissions. However, there does not seem to be much activity given the reduced coverage of the SCP of the KP, and limited demand that is driven by low emissions and new regulation that effectively bars KP credits from the EU ETS.

Furthermore, for those countries that are not part of the KP but have commitments or pledges under the Copenhagen and Cancun agreements, the situation is even less clear. Some parties may intend to use the international transfer of mitigation outcomes to meet their Copenhagen pledges. And while many countries do not feel an obligation to obtain approval from the UN to transfer internationally, there seems to be a general unease with respect to the lack of any multilateral protocol to provide assurance that double counting is avoided.

The discussion under the UN’s Subsidiary Body for Scientific and Technology Advice (SBTSA) that covers the Framework for Various Approaches (FVA) is seen as a way to create such a system. SBSTA, a UNFCCC technical negotiating track, was in 2012 given a mandate to conduct three work programmes to elaborate on a “framework for various approaches,” (FVA) “non-market-based approaches,” and a “new market-based mechanism” as a way of coordinating various market and non-market based efforts related to mitigation commitments under the UNFCCC. Once created for the pre-2020 period it could be envisaged that such a system may prove useful for climate governance arrangements beyond the end of the decade as well.

The association of the FVA with a new market mechanism and non-market approaches nevertheless complicated the discussion under SBSTA. Many parties saw no need for any other pre – and maybe now post-2020 – provisions related to markets and transfers and the discussions subsequently stalled. A number of interesting concepts have been discussed, but there has been no outcome in these talks to date. It is as yet unclear what the fate of the SBSTA talks post-Paris will be, as some would like to see it discontinued, and the discussions on the post-2020 period placed under the ADP and whatever process emerges for implementing the Paris agreement.

There is nonetheless a lack of any pre-2020 provisions to avoid double counting. At minimum this makes it unlikely that the SBSTA process will be discontinued in Paris. Many developed countries have been reluctant to let go of existing talks on markets before the outcomes in this area are clear under the new climate regime along with the supportive process. Although seemingly a trivial point, it must also be recalled that the SBSTA discussions at COP21 should normally be wrapped up in the first week, before parties move to gavel the Paris agreement in the second half of the meet.

The role the multilateral agreement might play in creating and catalysing carbon markets, as well as linking and price convergence, may be handicapped by the lack of a standard unit similar in function to AAUs.

New regime, new markets?

The new climate regime is emerging as a much less centralised agreement through the submission of INDCs whereby countries will choose a range of measures to achieve climate goals. The lack of centralisation is also apparent through what can be foreseen as provisions for reporting and compliance. Many domestic carbon markets and mechanisms are currently in the pipeline. The role the multilateral agreement might play in creating and catalysing carbon markets, as well as linking and price convergence, may be handicapped by the lack of a standard unit similar in function to AAUs.

It is likely that some parties will want to transfer emissions reduction units or outcomes that can then be used for meeting other parties’ stated abatement ambitions under the INDCs. A provision in the agreement that would recognise parties’ ability to count units transferred internationally as part of domestic reduction efforts in a transparent manner may be all that is needed from the Paris deal. The need for a multilateral emissions accounting framework to ensure that there is no double counting seems obvious and is also accepted by almost all parties at this stage. 

There are other services that the new regime could provide around markets, however, these are more contested by different groupings. One of these is to track emissions unit flow. The “International Transaction Log” (ITL) currently connects registries that are involved in emissions trading as defined under the KP. A key mandate of the ITL is to ensure accurate accounting and verification of transactions proposed by registries in order to support the review and compliance processes of the KP. Moving forward some parties have suggested that this kind of information sharing could instead be ensured bilaterally.

While this is certainly possible, lessons learned from the EU ETS show that these functions are better off being centralised, so much so that they often end up this way but sometimes a crisis is needed before reaching this conclusion. Therefore, as no one needs another crisis around carbon markets again, such tracking would be better off done centrally from the beginning of the new regime.

“Net decrease or avoidance of emissions” is another concept currently referred to in the draft text for the Paris talks. However, it is not defined precisely, and the argument can be made that this should be a voluntary function that each party can do on its own, and that the multilateral system has no real role beyond accounting for the decisions of individual parties.

There is also a significant amount of divergence around the role of the international agreement to ensure environmental integrity through standards the transferred units should observe. This debate and search for a solution is hampered by the lack of a standard unit such as the KP’s AAUs. Moreover, while the desire to ensure the environmental integrity of the new climate regime would dictate that the Paris agreement should have relevant quality provisions for domestically issued units designed for international transfer for UNFCCC compliance, this may require a complex and potentially controversial system.  

Changing climate governance models

The role of the UN agreement in ensuring that countries move towards a linked, networked, or connected carbon market, where carbon prices will converge, is likely to be very reduced when compared to what the KP provided.  This is important as it affects competiveness and will become increasingly pertinent.

The linking of carbon markets may now gravitate towards groups of countries pursuing a “club approach” that may create standards that could eventually become accepted as universal. Whether this approach is legitimate or not is a valid question. Any answer will have to take into account a significantly changed state of global governance since the days of the KP, which now gives multilateral agreements a much more modulated responsibility.  

Another function that the new Paris regime may seek to provide in relation to markets, and one that is demanded by many countries, is a centrally operated baseline and credit mechanism under the control of the governing body of the new agreement. Some parties see the benefit in the re-assurance that a UN operated mechanism provides to stakeholders. Meanwhile, others simply do not have the means to elaborate and operate such a mechanism, but see the benefit in having the option available under the UN umbrella.

A final function that the new agreement could provide around carbon markets is on infrastructure. The UN has provided a good infrastructure under the KP in spite of all its imperfections and criticism. While the peril of its politicisation is real, that needs to also be compared with the ability and desire, of many countries to operate registries separately, especially if they are to record and execute transfers in the marketplace. 

Discussions under the ADP have evolved and what is needed for carbon markets from the UN system, as well as what is possible, are now much better understood as a result of efforts within and beyond the multilateral process.  The current draft text is complicated but now provides options for those market-relevant items that can and should be in the Paris agreement. This includes the ability to transfer and account for the transfers in fulfilling the INDCs, as well as the creation of a centrally operated baseline and credit mechanism, although couched in more general language at this stage (Article 3ter). The accounting framework is key and provisions for it are generally accepted.

The rest of the items discussed are not really found in the existing options on the table and they should not be. While more detail is always welcome to avoid deep fights over interpretation in the years ahead – and to start from a more advanced point in 2016 from an implementation perspective – attempts to include them will inevitably lead to more “fights” in Paris that are unnecessary and unhelpful at this stage given the sizeable task at hand.

Andrei Marcu, Senior Advisor, Head of the Centre for European Policy Studies (CEPS) Carbon Market Forum

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