Market mechanisms in the Paris Agreement

December 2015 - A legally binding agreement. Global warming to be restricted to well below 2° C, preferably in the direction of 1.5° C. All Parties to participate in the global climate change effort. Significant progress in climate financing. And general agreement on the use of international cooperation mechanisms. The Paris Agreement is a turning point in the international climate change regime. However, as was the case after the signing of the Kyoto Protocol in 1997, there is considerable follow-up work to be done before the new agreement enters into force. This also applies to the market mechanisms. In Article 6 of the Paris Agreement, the mechanisms are defined as part of a more far-reaching cooperative approach which follows three specific paths to international-level cooperation. In terms of the carbon market, the new agreement provides for ‘cooperative approaches’ under Articles 6.2 and 6.3 and for a ‘sustainable development mechanism’ under Articles 6.4 and 6.7. A further form of cooperation defined under Articles 6.8 and 6.9 is explicitly not described as a market mechanism. These three very different approaches succeed in covering the needs of all Parties in engaging in international cooperation. The mechanisms are open to all Parties for use on a voluntary basis.

Paris creates reliable conditions

When it comes to the global carbon market, cross-border trading of certificates is a key prerequisite. The Paris Agreement speaks not of certificates, but of ‘international transfer of mitigation outcomes’ (ITMOs). International trading of certificates or ITMOs is only possible when the accounting rules for achieved emission reductions have been clearly observed and the risk of double counting of certificates has been avoided. The robust accounting system in turn requires that greenhouse gas inventories, both national and international registers and also the tracking, subtraction and addition of certified emission reductions, be based on reliable processes. This is stipulated in the new agreement and must be applied in the arrangements to follow and then implemented at national and international level. In practice, given the experience gained in drafting and adopting the Marrakesh Accords, this can take longer than expected or is perhaps necessary. Process issues such as how to manage certified reductions achieved with market mechanisms during the transition phase will no doubt soon come up in subsequent negotiations. The establishment of closed registration systems for all mitigation outcomes which at minimum ensure the avoidance of double counting of emission reductions will be a challenge during this phase, not least for individual Parties. A national greenhouse gas inventory would have to account for emission reductions from national policy, mitigation outcomes from climate financing and the international market mechanisms. This also applies to the voluntary market and especially in cases where certificates are to be used under Article 6.2 to meet reduction targets in specific countries or in emissions trading schemes. The earlier individual Parties introduce appropriate rules, the earlier pilot projects can commence.

The Paris Agreement also cites environmental integrity as a prerequisite for use. It is expressly referred to alongside the avoidance of double counting with the aim of establishing quality attributes for market mechanisms at project, programme and sectoral/emissions trading scheme level. This will play an important role in subsequent climate change negotiations. Under Article 6.1, which lists the requirements for all cooperation mechanisms under Article 6, cooperation mechanisms are expected to contribute to increased ambition in the implementation and promotion of nationally determined contributions (NDCs). The exact definition of the relationship between market mechanisms and NDCs will play a key role in the environmental integrity debate and must result in a new definition or enhancement of the additionality rules relative to the CDM rules.

National mitigation efforts and ambition

Article 6.1 provides a broad framework for cooperation activities and the roof for subsequent provisions. It mentions mitigation and adaptation activities. Sustainable development and environmental integrity are defined as targets to promote and pursue. There is no restriction to market-based approaches. It does, however, state that these voluntary mechanisms should lead to higher ambition in the implementation of nationally determined contributions. The NDCs are based on intended nationally determined contributions (INDCs). These can be made more ambitious through the use of market mechanisms and other forms of international support. This calls, however, for greater efforts on the part of host Parties in respect of the conditional part of their NDCs. Article 6 thus increases the NDCs for host Parties. Reductions achieved in excess of the NDC result in a net emission reduction which could not be achieved without international cooperation of this type. Net emission reductions and nationally determined contributions by host Parties, which Germany and the EU cited as essential reform requirements, can now be achieved. In distinguishing the nationally determined contributions of the host Parties (non-conditional NDCs) from conditional mitigation outcomes achieved using market mechanisms or climate financing, the wording in most of the INDCs submitted is too vague. To enable better use of the market mechanisms, their additionality in relation to the NDC must be better defined. This can involve a process which not only enables clarification of the use of the market mechanisms in an ongoing cycle, but could also play an important role in achieving increased ambition in the NDC stocktake years 2018 and 2023. This would also shed light on the extent to which actual NDCs and net emission reductions can be achieved through use of the market mechanisms. The additionality of all the activities listed under Article 6 as addressed in the clarification processes differs from the assessment of the additionality of individual CDM projects. Against this backdrop, it is easy to imagine that in the future, assessing the additionality of a mitigation activity will take place at two levels – at individual project level and also at policy level, meaning with a supplementary assessment to see how the activity fits with the host Party’s national policy. This gives rise to two closely linked additionality issues. Provided that, in those areas in which they intend to use international market mechanism, the host Parties determine the conditions in relation to their NDCs, assessment of the additionality of individual activities can be made easier and faster. Better definition of the NDCs is thus a prerequisite for higher ambition, including with regard to the market mechanisms.

The market mechanisms under Article 6

Article 6.2f: Cooperative Approaches – Various forms of cooperation possible

The term cooperative approaches is largely open to interpretation. The Parties are free to conduct mitigation activities on a bilateral basis or in groups and to transfer the mitigation outcomes as agreed. Although cooperative approaches are cited as playing a role in achieving NDCs, that role is not defined.

Article 6.2 allows the use of market and non-market approaches. However, the transfer of mitigation outcomes is not permitted for non-market approaches. Under the Paris Agreement, the cooperative approaches are not subject to any specific UNFCCC monitoring process.

That said, as expressly stated in Article 6.2, the transactions take place within the accounting system. In addition, importance is also placed on transparency in both the activity and the transfer. The necessity of the cooperative approaches arose from the call from several Parties which have either developed or would like to develop their own approaches independent of the UN to use them in meeting their obligations under the Paris Agreement. Nonetheless, guidance is to be drafted and adopted by the Conference of the Parties serving as the meeting of the Parties to the Paris Agreement. With regard to the central requirements for a robust accounting system, key objectives under Article 6.2 will include looking at how mitigation activities can be made transparent and how the cooperative approaches can contribute to higher ambition.

Article 6.4ff Sustainable Development Mechanism (SDM) – Central UNFCCC market mechanism to promote sustainable development

One clear difference between Articles 6.2f and 6.4ff will be the differing degrees of regulation for the two mechanisms. Article 6.4 provides for governance under the UN, while Article 6.2 merely provides for guidance and transparency. Both mechanisms are to contribute to higher ambition by providing for robust accounting and environmental integrity.

The Sustainable Development Mechanism (SDM) is placed under UN supervision. A comprehensive set of rules, modalities and procedures is to be developed. This is strongly reminiscent of the requirements and implementation rules developed for the CDM – as is the intention to again allow private and public enterprises to participate in the SDM. Nonetheless, the SDM is essentially a new market mechanism. This can be seen in the nationally determined contributions for host Parties and the contributions to net emission reductions. The host Party NDCs are found in the additional mobilisation of national resources to facilitate international cooperation. Host Party contributions to net emission reductions occur, by way of contrast, either by means of explicit agreement or via the actual mitigation outcome of an activity which does not result in the issuance of tradable certificates. While under the CDM, the additional share of emission reductions was an outcome which was not accounted for, such mitigation outcomes will in future be visible in host Party inventories. The question of net emission reductions is defined as ‘overall mitigation in global emissions’. Net emission reductions arise, however, from the decision to use the market mechanisms rather than via the host Party’s current NDC. Thus, the wording used for the contribution which is to result in ‘overall mitigation in global emissions’ also addresses the buyer Parties. This means that it is left to the buyer Parties to ensure that host Parties’ additional mitigation outcomes are not used in full to meet buyer Parties’ national emission reduction targets. At the moment, there is no way of knowing how net emission reductions achieved by host Parties can be secured. The requirement for higher ambition is, however, clearly stated in several sections of the Paris Agreement, not least in Article 6.4 (d).

With the so-called Share of Proceeds (SoP), the SDM receives an additional provision which was also used for the CDM. The Sustainable Development Mechanism is to set aside a yet-to-be defined share of the proceeds from mitigation activities to co-finance adaptation costs in countries most vulnerable to the adverse effects of climate change. This amount will also be used to cover SDM-related administration expenses. The certificates used in providing the SoP will be sold on the market, but they will not be a reliable source of financing in periods involving low use of the SDM.

Article 6.8f Mechanism for non-market approaches

In contrast to the cooperative approaches of the Sustainable Development Mechanism, the non-market approaches do not allow transfer of ITMOs. What this means and how it might affect international cooperation is a topic for further analysis and consultation. While it would appear that transfers aimed at meeting targets and for use in emissions trading are excluded, the extent to which the service functions of the market mechanisms are excluded requires further debate. This applies both to measurement, reporting and verification (MRV) and the accounting system. These are useful in identifying the mitigation contributions of specific activities and also serve as transparency tools.

In addition, many terms introduced in the two paragraphs have no international definition. This applies in particular to the term ‘integrated, holistic and balanced non-market approaches’. For some time now, supporters of market and non-market approaches have had considerable problems of misunderstanding. This did not stand in the way of an agreement being reached in Paris. The cooperative approaches under Article 6 must be developed in relation to the NDC and thus to national strategies, policies and measures, providing a basis for dialogue on common ground.

Initial consideration of the additionality aspect of the ‘Paris Mechanisms’

The various provisions contained in Article 6 were negotiated with a view to their potential uses. Recommendations and methodologies for their use will have to be developed and adopted in follow-up negotiations. Against this backdrop, it would make sense for the Article’s potential uses and scope to be further investigated and defined in order to better understand its requirements and also to maintain the momentum achieved regarding the cooperative approach. The task now at hand – even before the next meeting of the subsidiary bodies at the climate change conference in Bonn next May – is to develop practical ways of using these provisions and initiate dialogue between potential buyers and sellers.