1999 June 8 - The Kyoto Mechanisms: A Business Perspective

The Kyoto Mechanisms: A Business Perspective

8 June 1999

Business Principles for the Kyoto Mechanisms

· The Kyoto mechanisms should be market-based, designed and implemented to minimize transaction costs, use existing institutions, including private sector entities to the greatest extent possible, and promote voluntary industry participation.

· The use of the Kyoto mechanisms should not impair a company’s ability to compete globally and to serve the growing needs of its markets. In this regard, absolute emissions caps should not be imposed upon industry or companies.

· Trading units and credits from projects should be "fungible" for all three mechanisms and be recognized by all Parties to honor whatever commitments a private sector entity or

· Party may have at the national or international level.

· Any restrictions - particularly with regard to "supplementarity" – can only serve as a disincentive to active business involvement because the resulting increased costs could reduce the amount of financial resources available to address the climate challenge.

· The Kyoto mechanisms are not the only market-driven policy options. Business-led market-based voluntary initiatives to address climate change stimulate innovation and commitment, complement existing regulations and can be more cost-effective than command-and-control options.

· Governments are encouraged to substantively and broadly involve the business community in the design and policy development of the Kyoto mechanisms.

Introduction

The Kyoto Protocol authorizes the development of a number of mechanisms to help governments meet their obligations through actions undertaken jointly with other parties. If developed and implemented effectively through efficient, market-based approaches, the Kyoto mechanisms could offer countries an opportunity to meet the treaty’s obligations more cost-effectively than would be possible through domestic actions alone.

Clearly, the emissions targets of the Kyoto Protocol will impact and change business practice and conditions, whether through potential negotiated voluntary agreements, business-led voluntary initiatives or, least desirably, through regulatory measures. In all cases, governments should assess and take into account the impact of policy choices on economic growth -- particularly investment, employment, trade competitiveness and technology development and dissemination, and of the implications for all companies, and in particular for small and medium sized enterprises.

Moreover, the Kyoto mechanisms are not the only market-driven policy options. Business-led market-based voluntary initiatives to address climate change stimulate innovation and commitment, complement existing regulations and are more cost-effective than command-and-control options. The Kyoto mechanisms should accommodate, complement and encourage the wide range of voluntary initiatives, including those pertaining to baseline establishment, voluntary goal-setting and registration of carbon offset generation and transactions.

Notwithstanding the benefits, the costs to business and industry and to society as a whole of reducing greenhouse gas (GHG) emissions will be significant. Industry is concerned that the legally binding national emissions obligations (caps and schedules) required by the Kyoto Protocol will negatively affect economic development and social welfare, particularly if they are imposed at the industry or company level. Therefore, absolute emissions caps should not be imposed upon business sectors or companies.

Industry, particularly energy intensive consuming companies in ratifying countries, would be faced with a significant increase in production costs relative to competitors in other countries. Great care should be taken to ensure climate policies do not result in unfair international competition that damages global growth and jobs in these and other sectors.

As governments consider how best to devise effective national climate policy programs, they should consult regularly with business. The business sector has extensive experience in: project identification and development; research and development of new technology, and its commercialization and dissemination; the funding and management of investments and joint ventures; transactions including trading in commodities and financial instruments on market exchanges; capacity building within companies, with joint venture partners and with the public sectors; benchmarking and sharing of best practice; and environmental management, protection and enhancement. The private sector’s knowledge and experience in these crucial areas can provide important expertise relevant to the Kyoto mechanisms.

Business seeks to play a constructive role in addressing climate change. Governments are encouraged to substantively and broadly involve the business community in the early design and policy development of the Kyoto mechanisms.

Background

The Kyoto Protocol's mechanisms include:

· Joint Implementation (JI) - addressed in the Protocol's Article 6

· Clean Development Mechanism (CDM) - Article 12

· Emissions Trading - Article 17

Sinks, as defined in Article 3, are linked to these three mechanisms as a means of achieving emissions reduction credits. But specifically how "human-induced land-use change and forestry activities, limited to afforestation, reforestation and deforestation" will be measured and then qualify to "be used to meet the commitments under" Article 3 remain to be considered in light of the IPCC Special Report.

Who Should Participate?

The Protocol permits Annex I government Parties to "authorize legal entities" to participate in JI projects (Art.6) and "involve private and/or public entities" in CDM activities (Art.12). The Protocol, however, is silent on legal or private entities' participation in Emissions Trading (Art.17). Procedures for emissions trading should explicitly allow for participation by business and industry.

"Legal entities" and "private entities" include the private business sector. This terminology supports the view that business enterprises and existing market mechanisms can play a major role in implementing the Kyoto mechanisms. The discussion that follows offers a business perspective on features of the mechanisms that the ICC believes are important in constructing effective and efficient mechanisms. These in turn, will facilitate and encourage private sector participation in the Kyoto Mechanisms.

Features Common to the Three Mechanisms

The Protocol refers to principles, modalities, procedures and guidelines for implementation, monitoring, reporting, etc., with respect to all three mechanisms. International guidelines will be needed, as the Protocol prescribes.

At the national level, governments will also have to establish the specific policies and programmes that they, individually, may use to achieve their commitments. The ability of business to participate in the international Kyoto mechanisms may depend on the domestic framework that defines the role of business in meeting national obligations and that authorizes and encourages business to participate in international emissions trading and project activities.

Supplementarity

The Protocol's phrase, "supplemental to domestic actions" (also known as "supplementarity") should be applied by Parties in a way that enables society to capture the full benefit of lower-cost options to reduce GHG emissions and to encourage the widest participation of the private sector. Any restrictions - particularly with regard to "supplementarity" – can only serve as a disincentive to active business involvement because they will increase costs and reduce the amount of financial resources available to address the climate challenge.

Trading Units

Recognizing that JI and CDM projects will generate "emission reduction units" and "certified emission reductions" (CERs), respectively, and that emissions trading requires an emissions unit of some kind to trade, the optimal "trading unit" should be one that is identical and fungible for all three mechanisms (e.g., one metric ton of CO2 equivalent). Under no circumstances should Parties discriminate among categories of CERs. For example, CERs realized through reduced emissions from power plants, whether from substitution by nuclear, hydro, solar, or more efficient fossil fuel systems should have equal value and not be treated differently. Units acquired by business firms through their involvement under JI or CDM (or from domestic obligations, actions or voluntary actions) should be exchangeable through emissions trading.

A trading unit should have an intrinsic market value that will accrue to the holder. Moreover, the trading unit should be recognized by all Parties as valid to honor whatever emissions commitments a private sector entity or Party may have.

National governments very well may choose different policies and programmes to achieve their commitments under the Protocol. In order for the business sector to play an active role in these programmes, governments will need to establish a procedure whereby "credits" obtained internationally can be utilized as "credits" under whatever domestic programmes are established.

Institutions

A number of institutional challenges are raised by the prospect of the Kyoto mechanisms. According to the Protocol, the CDM is to be "supervised by an executive board," suggesting that it is to be an institution. Private sector entities should be used to the greatest extent possible. The establishment of new institutions should be discouraged. Foreign direct investment and joint venture operation - both of which are features of JI and the CDM - are areas in which the international business community is well experienced and actively engaged. Moreover, there are already well-established exchanges engaged in commodities trading and financial transactions.

Hence, the use of existing market institutions and established, recognized financial institutions, such as regional development banks for the CDM, with procedural guidelines as appropriate, will minimize bureaucracy and transaction costs, as well as encourage development of innovative project and trading options.

Compliance

Issues of non-compliance by Parties with their emissions commitments should be resolved in a way that does not jeopardize a company's ability to participate in the Kyoto Mechanisms.

The ability of companies to participate in good faith in the Kyoto Mechanisms will depend on how non-compliance provisions will affect companies. Ex-post-facto non-compliance by a Party should not prejudice the validity of trades made in good faith by companies. Companies’ willingness to acquire credits through project activities or to exchange credits through emissions trading will be limited if, as a result of non-compliance by the governments, otherwise legitimate trades can be declared invalid after the fact, or if credits or trading units become frozen with respect to future transactions. Since trading units acquired through trading and credits from project activities have economic value, they should not be subject to confiscation or other government interference which would diminish their value in the market.

Confidential Business Information

In tracking transfers under the Kyoto Mechanisms, Parties should record only the minimum essential information (e.g., countries involved, date, number of tons, serial number). They should avoid more extensive reporting requirements that would jeopardize confidential business information.

Suggested Features Applicable to the Clean Development Mechanism

As the First and Second Dakar Government/Industry Workshops on Investment and the CDM showed, the CDM will promote its environmental and sustainable development goals only if it is seen as beneficial to, and is widely used by, both developing countries and companies.

Activities contemplated under the CDM provide opportunities for developing countries (i.e., non-Annex I Parties) to link national development objectives to emissions reduction and offset projects. CDM projects may also provide access to new sources of funding for domestic investment, capacity building and technology partnerships and to emissions trading markets. The attractiveness and success of the CDM is linked to establishing an environment which will stimulate direct investment and environmental protection.

Additionally, funding will be generated by contribution of "a share of the proceeds" from projects for "adaptation" investments in developing countries that may be "particularly vulnerable" to potential climate change impacts (Art.12.10).

Business participation in and funding of CDM projects will only be possible if projects are commercially viable. The CDM is designed to provide financial incentives in the form of certified emissions reduction credits (CERs). To ensure that these credits create the necessary financial incentive, modalities and procedures should be established which are:

· credible

· simple and efficient

· inclusive

· encouragement of early action

· flexible

· cost-effective

Development of Guidelines

"Modalities and procedures" for the operation of the CDM are yet to be elaborated at the international levels. Parties should develop national guidelines that facilitate and encourage the widest possible participation by private business.

Criteria for project qualification should be transparent and non-discriminatory. "National treatment" should be accorded potential investors and qualifying projects, and there should be no discrimination based upon the source of the investment.

Additionality

Similarly, the Protocol's concept of "additionality" (i.e., emissions reductions "additional to any that would otherwise occur," with regard to the CDM and JI), should be defined in a way that will encourage private sector participation in project development. Specific funding and technology criteria should be avoided. Additionality should be defined solely in terms of avoided greenhouse gas emissions.

Certification

Certification of emissions reductions by "operational entities" (Art.12.5) and "independent auditing and verification of project activities" (Art.12.7) should be executed ex post by independent, professional, private sector testing and auditing enterprises.

Institutions

The CDM should be a mechanism and enabling concept, not an institution within the UN or under the UNFCCC. Existing institutions, such as Regional Development Banks, commercial banks and commodities exchanges, should be used, within general guidelines established by "the Conference of the Parties (to the UNFCCC) serving as the meeting of the Parties" to the Protocol (known as the COP/MOP) and with oversight responsibility of a professional "executive board" of the CDM (Art.12.4).

Proceeds and Adaptation

The Protocol provides that "a share of the proceeds from certified project activities" is to cover CDM "administrative expenses" and "assist developing country Parties … particularly vulnerable … to meet the costs of adaptation." (Art.12.8). The "share of the proceeds" should be credited to the CDM in the form of a small portion of the emissions reductions that accrue from the project, and transferred only after credits have been awarded to participants. The portion awarded should be determined in a transparent fashion, be non-discriminatory and reflect structural differences between non-Annex I Parties’ economies.

Equally important, Parties should recognize that a "share of the proceeds" represents an incremental transaction cost that will affect the overall economic attractiveness of the CDM projects to participating companies. Every effort should be made to minimize that cost in order to help ensure full business participation.

The time and effort required to qualify projects under the CDM also imposes a transaction cost that will act to limit business participation. To minimize these costs, procedures should be transparent and efficient. In particular, authorization to qualify CDM projects should reside with the nation that hosts the project, subject to agreed international guidelines. Authorization to qualify CDM projects should not involve multiple layers of bureaucratic approval.

Early Action

Early action and banking, with retroactive qualification by Parties of projects during the period 2000 to 2008, should be encouraged (Art.12.10).

Suggested Features Applicable to Joint Implementation

Procedures established by Parties should encourage broad participation by the private business sector in JI projects.

Project Approval

Criteria for approval of projects should facilitate project development and be transparent and non-discriminatory. Approved projects should be accorded "national treatment" under investment, tax and other regulatory legislation.

Verification and Reporting

Verification and reporting requirements should be limited to those necessary to transfer tradable units (i.e., "emission reduction units") between project participants and between Parties and, also, to comply with national and international compliance procedures.

Additionality

Suggested Features Applicable to Emissions Trading

"Principles, modalities, rules and guidelines" for emissions trading under the Protocol remain to be elaborated by the Conference of the Parties. As with the other Kyoto mechanisms, rules and guidelines for emissions trading not only should allow but, also, facilitate and encourage private sector participation.

Existing commodities and financial exchanges, including market facilitators, should be utilized for trades, offering both services and market price transparency to those buyers and sellers who trade directly with each other (i.e., "primary market") and those who deal through the exchange facilities (i.e., "secondary market"). Existing regulatory and oversight mechanisms and compliance features in existing standard trade practice will help ensure integrity of the emission trading system.

Transferability

Emissions trading, per the Protocol, is to be limited to Annex I Parties under rules established by the COP. These rules should authorize private and public entities to engage in trading, as is allowed under JI and the CDM. Parties themselves will have to both monitor and confirm trades, since they will represent transfers between Parties of an "assigned amount" under Article 3 of the Protocol. Procedures to capture and record these data should reflect practical and reasonable time periods so that institutions and companies are not unduly burdened.

As with the other two mechanisms, early action and banking should be encouraged.

Conclusions

In conclusion, the ICC and its members, in offering these views on the Kyoto Mechanisms, believe that if these proposed instruments are designed and operated according to market principles, they can contribute significantly to lowering the cost greenhouse gas emissions reductions as part of a mix of instruments, including negotiated voluntary agreements and business led voluntary initiatives.

Clearly, business and industry participation in CDM and JI projects can also play a positive role in capacity building. However, even with well designed mechanisms, business continues to be concerned that the legally binding national emissions obligations required by the Kyoto Protocol will have significant negative economic and social consequences, including impacts that affect competitiveness and employment in businesses around the world.

Business and industry are ready to play a constructive role in the design of the Kyoto Mechanisms, in an effort to help devise and advance pragmatic and effective solutions.