Implementing a new robust market for climate mitigation outcomes: Are we getting closer?

Jargon at international climate talks often acts as a barrier to quick understanding of the nature and status of key issues – Article 6, ITMOs, ‘corresponding adjustments’ and (my personal favorite) A6,4ERs are just a few of the phrases used. Many readers not focused on the climate talks associated with the Paris Agreement may have heard talk of Article 6 but little of the detail. In this blog we give a quick overview of what is being discussed and how close (or far) the key issues are from being resolved.

Article 6 is the key remaining issue in resolving the rulebook under the Paris Agreement. It covers the manner in which the emission reduction achievements by country parties may be transferred. It also covers the replacement of the Clean Development Mechanism. It is an area fraught with deeply held and often opposed perspectives. Much of that revolves around views on whether market based systems can be used to fight climate change more quickly or more cost effectively. Many countries and observers are vocal in views that market solutions come at great risk. This resolves down to arguments about the robustness of any Article 6 trading system. Will units traded represent strong environmental outcomes? For example, will it be clear that there is no risk of double counting such that two countries are effectively claiming credit for the same outcome?

The overall lead of the working group responsible for negotiating Article 6 has flagged that the COP25 talks in Madrid need not solve everything. It needs to solve key issues on Article 6.2, 6.4 and 6.8 in order to allow Article 6 to be operationalized.

Broadly, Article 6.2 relates to country-to-country transfers of mitigation outcomes (referred to as internationally transferred mitigation outcomes or ITMOs); Article 6.4 relates to the establishment of a Sustainable Development Mechanism (SDM) as a replacement for the Clean Development Mechanism under the Kyoto Protocol) and Article 6.8, which relates to non-market approaches.

The relevance for the private sector of these discussions are many. As climate risks become more evident, the scale and pace of investments in the 2020s are key. That in turn requires parties to the Paris Agreement delivering on their Nationally Determined Contributions (the heart of the Paris Agreement, being the commitments each party has made to reducing emissions). A robust and efficient country-to-country trading system relating to ITMOs will likely act as a means to transfer financial flows to developing countries, in turn supporting climate mitigation investments in recipient countries requiring private sector support and finance. It is also likely that countries will develop mechanisms by which public/private initiatives for a sector can directly access a share of the benefits arising from ITMO transfers that come from successful implementation. Similarly, the SDM (like the CDM before it) specifically recognizes the ability for private sector involvement in projects authorized under it. Absent a functional ITMO structure there is concern on the investor side that they will be unable to properly monetize their investments and, as such, they may abstain from investment.

We cover some of the core elements and issues on Article 6.2 and 6.4 below. These reflect text as it stands on Dec 8, 2019.

Article 6.2

Article 6.2 concerns how country parties under the Paris agreement can transfer credit for mitigation outcomes under their NDCs. Article 6.2 in the original Paris Agreement did not provide the rules for this. Rather, it set guideposts for future discussions by calling on countries when voluntarily making ITMO transfers; calling for that to occur with robust environmental integrity and transparency, including avoiding double-counting (i.e. the same mitigation outcome being claimed by different parties).

The text relating to guidance on Article 6.2 sets out the core elements of skeleton for an operational system, covering:

• Core characteristics of ITMOs, such as being measured in carbon dioxide equivalent (tons of CO2), trackable in a registry, bearing a serial number and relating to a mitigation outcome that can be used against an NDC.
• Eligibility requirements, such as being a party to the Paris Agreement, having complied with obligations regarding its NDC and has arrangements in place to authorize the use of ITMOs and the tracking of them.
• Rules around ‘corresponding adjustments’ (one of the most fraught negotiation issues), which seek to prevent double-counting by providing mechanisms by which a country that authorizes transfer of ITMOs to another country will then adjust its NDC performance to reflect that.
• Sectors and greenhouse gases, regarding what are eligible to be the basis of an ITMO (both from the country first transferring and the country that uses it), particularly whether ITMOs could be created from a sector outside a country NDC.
• Limits of use regarding whether to clarify that ITMOs can only be used under the Paris Agreement and not for other international mitigation purposes and other matters such as whether to exclude emission reductions achieved before the period of the NDC (as well as whether Kyoto units should be allowed be used against NDCs).
• Reporting, covering an initial report in order to show eligibility to generate and transfer ITMOs and then annual reporting on relevant matters such as tracking and how a number of issues relating to environmental integrity are adequately addressed (the scope of which are subject to intense discussions).
• Review mechanisms using technical expert reviews to recommend improvements by participating countries.
• Information through an Article 6 database which will compile information submitted by parties regarding ITMO matters and a centralised accounting and reporting platform

Article 6.4 – The Sustainable Development Mechanism

Many of the elements being developed in respect of Article 6.4 would be familiar to those aware of the history of the Clean Development Mechanism. That has the advantage of assisting movement of some elements forward but some are of the view that the structure of the SDM is at risk of repeating past errors, not just in terms of environmental integrity (vis-à-vis the robustness of additionality claims) but also in terms of designing a mechanism that can drive significant investment efficiently and at scale. The carbon unit that will be issued under the SDM are referred to as A6,4ERs (perhaps the high water mark for obscure COP terminology).

Elements in the current text would form the basis of an operational system (which was the case with the CDM, with further detail being developed as the mechanism was implemented). The text elements are discussed below but the nature of the issues between the parties is such that it is difficult to see how a break-through is possible. Those issues are many but are centred around certain principle maters, including accounting (tons of carbon dioxide equivalent or allowing for other measures under NDCs), avoidance of double-counting and additionality (e.g. if all emission reductions need to be additional to what would have been achieved under an NDC, why should there also be a corresponding adjustment to the host country NDC).

• Establishing a supervisory board that will supervise the SDM, including high level rules of procedure regarding governance of that board.
• Host party responsibilities, covering eligibility requirements before a country can host activities under the SDM, including being a party to the Paris Agreement, having complied with obligations regarding its NDC and designated a national authority. Open issues relate to the interface with wider accounting under the Parties’ NDC (such as whether issuance of units authorized by the host country would lead to a ‘corresponding adjustment’ to its NDC).
• Additional design limits, covering matters that seek to address concerns with markets by requesting host parties to report on efforts to address matters such as price fluctuations, speculative transfers, secondary trading limits, making use of credits supplemental to domestic action and restrictions on carry-over.
• Activity design, covering core elements such as use of a baseline, demonstrative additionality and cover monitoring and verification.
• Approaches to methodology design.
• Approval requirements by country parties for private or public parties to participate.
• Validation requirements involving use of an independent entity to assess against the rules and procedures.
• Registration of activities that have been validated.
• Monitoring and verification of activities.
• Issuance of A6,4ERs on the basis of successful verification.
• Registry requirements including allowing for various required accounts.
• Whether A6,4ERs can be used only against NDC requirements.
• Whether or not CDM and JI projects under the Kyoto Protocol can transition to the SDM, including whether previously issued units under those can be used.

We will be updating over week 2 of COP-25 on Article 6, during which many key issues are likely to be escalated for senior political discussions.