Submission
Ensuring Accountability in the Protocol's ‘Flexibility Mechanisms’ I. Introduction The Alliance of Small Island States (AOSIS) welcomes this opportunity to present its initial views on preparatory work needed for the fourth session of the Conference of the Parties to the UN Framework Convention on Climate Change (COP-4). From the outset of these negotiations, AOSIS has promoted the design of a Convention and a Protocol with legally binding commitments, that followed the basic design principles of certainty, effectiveness and equity. These commitments, and the mechanisms employed to implement them, must be stated clearly, in manner understandable to regulators and those they regulate, comprehensible to the media and the public, and capable of sending strong signals to the market place. Among other things, this submission, seeks to highlight the many scientific and regulatory uncertainties which the Kyoto Protocol has left unresolved. By scientific uncertainty, we mean, for example, methodologies for calculating and comparing emissions and uptake by sinks of various GHGs from a variety of sources and sectors. These methodologies, even if applied with best possible information will always involve some range of uncertainty. Regulatory uncertainty, on the other hand, refers to weaknesses in the rules and institutions put in place to monitor, verify and to enforce compliance with commitments. For example, assuming that the IPCC and other bodies are able to reduce scientific uncertainties with regard to methodologies for calculating net emissions, it remains uncertain whether the Protocol's institutions will be capable of confirming that these methodologies have been properly applied. The task is further complicated by the Protocol's flexibility mechanisms, which will allow Parties to meet their commitments, through emissions trading or joint implementation, and that will require the Protocol's institutions to track rights and obligations as they are exchanged between Parties and, potentially, with the private sector. The extremely innovative and untested character of these mechanisms raises uncertainties as to whether they will increase or undermine the Protocol's effectiveness. It also remains to be decided whether it is the buyer or the seller who must beware in the operation of these new flexibility mechanisms. A. Techniques for reducing or accounting for uncertainty We are supportive of the use of a range of techniques available to the Parties for reducing or accounting for scientific and regulatory uncertainty, through the use of caution, experimentation, and discounting. More specifically, the Convention and the Protocol processes should allow opportunities for Parties to: • increase the use and reliance upon objective and science-based processes and institutions, such as the IPCC and ad hoc technical advisory panels; • restrict the scope of the Protocol's activities to only those with a higher degree of certainty; • postpone or condition the authorisation of activities until uncertainties are resolved or reduced; • require the use of discounting to take risks associated with uncertainty into account, to create disincentives for the use of less certain activities and to promote further the reduction of uncertainties; • strengthen processes and institutions related to monitoring, verification and compliance in order to promote transparency and to expose those taking advantage of uncertainties; • ensure that, where there is an inconsistency of approach within the Protocol with regard to reducing scientific and regulatory uncertainty, that the highest possible standard is applied in each circumstance; and • encourage ‘learning by doing’ by piloting flexibility mechanisms. B. Internalising the costs of flexibility Our approach to flexibility mechanisms can be characterised as having the dual objective of ensuring that emissions reduced through these mechanisms are achieved in manner that is both cost effective and environmentally effective. Efforts to ensure environmental effectiveness, by reducing scientific and regulatory uncertainty may be criticised as raising the transaction costs of mechanisms that were designed to be cost-effective, thus defeating their purpose. While it is true that high transaction cost and an over-burdensome bureaucracy must be avoided, it is also true that some portion of the cost differential between emissions reduction activities in investor states and in those in host states results from lower regulatory capacity in host states. Furthermore, the complex nature of these flexibility mechanisms may require additional oversight at the international level that necessarily entails additional transaction costs. In these circumstances, raising transaction costs to ensure environmental effectiveness is entirely appropriate. II. Comments on specific issues The Secretariat has specifically requested comments on preparatory work needed for COP-4 on the 5 items indicated in 1/CP.3. A. Methodological work on sinks 1/CP.3, para 5(a): Determination of modalities, rules and guidelines as to how and which additional human-induced activities related to changes in greenhouse gas emissions and removals in the agricultural soil and land-use change and forestry categories shall be added to, or subtracted from, the assigned amount for Parties included in Annex I, as provided for under Article 3, paragraph 4, of the Protocol. Our concern with the request by some parties for the blanket inclusion of agriculture, land use change and forestry sectors and sources ("sinks") in the Kyoto Protocol are well known and need not be restated here. It is worth recalling, however, that our concern with sinks had to do with the fact that their use would increase regulatory options, introduce uncertainties, and distract the Protocol from focusing on its main policy task of shifting the global economy away from its excessive dependence on fossil fuels. We continue to believe that there are a number of unresolved scientific uncertainties and methodological inadequacies associated with both Article 3.3 and Article 3.4 of the Protocol. In this regard, we wish to again underline the view that methodological weaknesses and scientific uncertainties associated with sinks has lead to gaps in data, and a lack of comparability between information already reported by Annex I Parties. These shortcomings will make the credible assessment of compliance with Article 3 commitments extremely difficult. This challenge will only be compounded by the introduction of flexibility mechanisms that will depend heavily upon common and verifiable methodologies to ensure the comparability of data and the demonstration of compliance. Recognising that Article 3.3 and 3.4 allow for a staged approach for the treatment of emissions from sources and removals by sinks in the agriculture, land use change and forestry sectors, we feel that it is even more critical that the Parties adopt a 2-track approach to resolving and accounting for uncertainties in these areas by: 1) accelerating efforts to improve and harmonise methodologies for calculating emissions and removals from these sectors; and 2) capping or discounting the use of removals from those sectors where significant uncertainties remain. We recognise that some Parties attach great importance to the early completion of the decision making process on the issue of sinks. These Parties must also recognise that other Parties like the AOSIS members are extremely concerned with the need to avoid unnecessary loopholes and the creation of perverse incentives. Therefore, to facilitate the adoption by the COP and the COP/MOP of methodologies for the accounting of sinks, we suggest that SBSTA-8 should request that the IPCC prepare, as a matter of urgency, a special report on the scientific and technical issues surrounding sinks. The IPCC should address the issues that are unresolved from a scientific and technical perspective as well as those that cannot be resolved by the IPCC without further guidance from the COP/MOP. Based on this request, the IPCC could examine various methodological tools and approaches for the treatment of sinks with a view to providing an analysis of short and long term consequences that could be expected from each approach, in particular the impact on emissions. The IPCC should also be requested, in particular to study methodologies for "discounting" credits from sinks associated with higher levels of uncertainty that would specify a discount for each sink category that would be applied to any credits generated by that category towards a Parties assigned amount. The discount values, and modalities for gaining credits in excess of the default values would then be agreed by Parties. The development of these methodologies may progress in the interim period from now until the entry into force of the Protocol through the work of the COP, under Article 12 of the Convention; and after the entry into force of the Protocol, by the COP/MOP through work on inventory methodologies under Articles 5 and 7 of the Protocol. B. Systems of accountability for the Protocol's flexibility mechanism Decision 1/CP.3 identifies 2 overlapping issues specifically directed at 2 of the Protocol's flexibility mechanisms (Article 17 and Article 6). These are dealt with here together, and the discussions extend to the Protocol's other 2 closely-related flexibility mechanisms in Articles 4 and 12. (b) Definition of relevant principles, modalities, rules and guidelines, in particular for verification, reporting and accountability of emissions trading, pursuant to Article 17 of the Protocol; (c) Elaboration of guidelines for any Party included in Annex I to transfer to, or acquire from, any other such Party any emission reduction units resulting from projects aimed at reducing anthropogenic emissions by sources or enhancing anthropogenic removals by sinks of greenhouse gases in any sector of the economy, as provided for under Article 6 of the Protocol; The most innovative and untested aspects of the Kyoto Protocol can be grouped together as the Protocol's 4 "flexibility mechanisms". Although they have important, distinguishing features, each is based on the principle that the Protocol will operate most efficiently if Parties and/or private entities are allowed to invest in emissions reduction opportunities where they are cheapest to achieve. In effect this will allow Annex I Parties and, in some cases, private entities, to purchase, or invest in the creation of "emissions reduction units" outside their territories, which can then be used to offset their obligations under the Protocol. 1 . Accountability and compliance The acceptance of this "extraterritorial" achievement of sovereign obligations is based on the assumption that emissions reduction efforts are equally valuable contributions to the achievement of Article 3, regardless of where they take place. For this assumption to be confirmed with confidence, "principles, modalities, rules and guidelines" must be designed that deliver a level of regulatory and scientific confidence equivalent to the highest common denominator of national circumstances among the Protocol's parties. In other words, before an emissions reduction unit generated in Party A can be offset against any part of an amount assigned to Party B, the rules adopted under Articles 4, 6, 12 or 17 for verification, reporting and accountability must be able to demonstrate that the regulatory mechanisms in place in Party A are as effective as those in Party B. This requires either a harmonisation of rules for verification, reporting and accountability between participating Parties at the domestic level or the intervention of regional or international rules with equivalent "bite". Furthermore, because there will be a shared, global interest of all Parties to ensure that arrangements between two or more Parties are jointly achieving the relevant part of an assigned amount, the Protocol must provide multilateral oversight to ensure verification, reporting and accountability. The proponents of the Protocol's flexibility mechanisms have consistently emphasised the great need for strong compliance mechanisms at both the domestic and international level for joint implementation and emissions trading operate in a way that both sovereign and private investors find credible. For these reasons, AOSIS would support requiring Parties wishing to participate in these mechanisms to demonstrate that, through domestic, regional or international arrangements, the selling Party has put in place systems of verification, reporting and accountability that are of at least as high a standard as those in place for the "buying" Party. Furthermore, at the international level, AOSIS strongly supports the establishment, under Article 18, of "appropriate and effective procedures and mechanisms to determine and to address cases of non-compliance with the provisions of this Protocol, including through the development of an indicative list of consequences, taking into account the cause, type, degree and frequency of non-compliance." It would, furthermore, wish to see, prior to the operation of any emissions trading regime adopted under Article 17, the adoption, by means of an amendment to the Protocol, a list of binding consequences that could be associated with noncompliance. Any Party wishing to participate in an Article 17 trading regime would be required first to have accepted such an amendment under Article 20 of the Protocol. 2. Coverage of sinks Given its concerns, outlined above, about the inclusion of sinks in the Protocol as a whole, AOSIS appreciates the restraint exercised by the negotiators in making no reference to "removals by sinks" in Articles 4, 12, 17. AOSIS believes this provides Parties with an opportunity to reduce, resolve or account for the inclusion of sinks within each of these mechanisms, in light of the particular regulatory challenges that each mechanism may present. For example, emissions reduction units generated by sinks projects may only be properly offset against parts of an assigned amount emitted from a source of an equivalent life-span. 3. Environmental and financial additionality Relevant primarily to project-based transfers in Articles 6 and 12, additionality requires project proponents to establish that the investment is yielding genuine net reductions in emissions that are additional to what would otherwise have occurred. The concept of additionality can be broken down into the closely related concepts of environmental and financial additionality. Environmental additionality requires the project proponent to establish that the net result of the investment will be a reduction in global emissions as compared to a baseline of emissions that assumes the investment had not been made. Common methodologies for establishing baselines will be required of projects in both Annex I and non-Annex I Parties. Furthermore, the issue of the life-span of the emission reduction units must be taken into account for the purpose of estimating environmental additionality. Financial additionality requires an assessment of whether the investment would have taken place in the absence of the regulatory incentive provided by the Convention or the Protocol. Financial additionality is important to regulators because it can provide important evidence for environmental additionality -- i.e., the fact that additional financial resources are flowing towards climate friendly projects may provide important evidence that the emissions reductions produced by that investment might not otherwise have occurred. Proof of financial additionality is important to developing countries in particular, because it helps reassure them that GEF resources, "regular" flows of Official Development Assistance, or Foreign Direct Investment, are not being redirected to CDM-related investments from investments that would otherwise have received a higher national priority. There are explicit references to financial additionality in the AIJ guidelines and AOSIS believes that financial additionality, and in particular, the results of the GEF replenishment should form part of the context of the further development of Article 12. However, should the "financial additionality" of the GEF replenishment be brought to bear on the evolution of Article 12, then Parties will need to examine what role, if any, the GEF will play in the implementation of the provisions of this Article. 4. Certification provisions Each of the Protocol's flexibility mechanisms requires some form of "government approval" either at the point of transfer, or under Article 3, at the point that the part of the assigned amount or emissions reduction unit is added to or deducted from the Annex I Parties' assigned amount. However, only Article 12 provides for a process of auditing and certification that would provide for an objective assessment of whether the transfer was likely to result in net emissions reduction. The additional guidelines and rules that will be developed for Article 6, 17 and, should seek to take the precedent set by Article 12 into account by requiring that certification procedures be established for emissions reduction units generated and traded through these mechanisms, as well. 5. Compliance conditionality The rush of the Kyoto negotiations led to an inconsistency in the Protocol's approach to flexibility is its strong rules on compliance conditionality under Article 6 transfers while it is silent for other mechanisms. Under Article 6.1(d), an Annex I Party is prohibited from acquiring emissions reduction units unless it is in compliance with its inventory and reporting obligations under Articles 5 and 7. Furthermore, should a question arise through the Protocol's In Depth Review procedures with regard to a Party's compliance with Article 6, its may not apply its emission reduction units until the question is resolved. Regulatory risk associated with project-based flexibility mechanisms could be further reduced by allowing emissions reductions units to be certified and transferred only after the activity has been completed. The text of Article 6 and 12, which refer to emissions reductions "resulting from" project activities provides the basis for this "ex post" approach . AOSIS believes that there are strong arguments for extending compliance conditionality to emissions reduction units under Article 12, and under Article 17, and for providing for "ex post" certification for emissions reduced through activities under Articles 6 and 12. 6. Liability provisions As an instrument of public international law, negotiated, signed and ratified by states, the Kyoto Protocol will represent an exchange of sovereign obligations, and be subject to classical international rules of state responsibility. However, the flexibility mechanisms outlined above anticipate that the static obligations reflected in the allocation of commitments in Annex B, will be made fluid, allowing for a potentially infinite series of transactions through which emissions reduction units representing the Annex B commitments are bought, sold and reallocated.
Article 4.5 contains the only clear liability provision related to the Protocol's flexibility mechanisms. It operates on the principle that the seller or the transferor of the emissions credit bears the full risk of the bargain. However, transition and developing countries wishing to participate in Article 6, or in CDM projects should be aware Article 4.5 could provide a precedent for any liability rules that emerge under that mechanism, that may seek to hold host countries liable should the projects they are hosting fail to generate the promised emissions reductions. In these transactions, a potentially far wider range of actors may be responsible for the success or failure of the project, including in the design, funding and in the certification of the project. This complicates considerably the legal relationships and the chain of liability associated with an "emissions reduction unit". Disputes could arise between and among states, private entities, and intergovernmental organisations, each of which may share an interest in and a responsibility for the success or failure of a project. AOSIS believes that liability rules developed for the Protocol's flexibility mechanisms, particularly those involving developing countries and the private sector need to designed to ensure that, responsibility is spread equitably with regard to which participants are enjoying the "benefit of the bargain." 7. Maintaining the bargained-for allocations Finally, the bargain struck in Kyoto, however imperfect, represents allocation of obligations based, to some extent on an appropriate allocation of burdens among Annex I countries and between Annex I and developing countries. Each of the Protocol's flexibility mechanisms provides an opportunity for market and other disciplines to redistribute these burdens through a principles of cost-effectiveness. In order to generally maintain a sense of equity, and more specifically, to ensure that Annex I countries take action domestically, Articles 6 and 17 require that JI and emissions trading are supplemental to domestic action. Article 12 requires that the CDM can "contribute to compliance with a part of" Article 3 commitments, as determined by the COP/MOP. AOSIS believes that, in preparation for COP-4 Parties should explore how each of these provisions should appropriately limit the use of flexibility mechanisms to preserve aspects of the allocation reflected in Annex B. 8. Administration and adaptation fees At present only the CDM under Article 12 makes express provision for the assessment of administrative fees for the application of an adaptation surcharge. There are strong policy reasons for both of these fiscal instruments, to ensure the mechanism is self-supporting and to establish a reliable source of funds for a long neglected aspect of the climate change regime. The exclusive application of these fees to Article 12, raises questions as to how Article 6 and Article 17 mechanisms will pay their way, and may provide disincentive for investments in the CDM vis a vis the Protocol's other flexibility mechanisms. AOSIS therefore proposes that administrative and adaptation surcharges should be applied equally to all transactions certified under the Protocol's other flexibility mechanisms. C. Single project impact assessment (d) Consideration of and, as appropriate, action on suitable methodologies to address the situation of Parties listed in Annex B of the Protocol for whom single projects would have a significant proportional impact on emissions in the commitment period. AOSIS is concerned generally that, unless very narrowly defined, single project exceptions could provide substantial loopholes in Article 3 commitments, and reserves its comments until presented with specific proposals from the proponents of such methodologies.
