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Carbon Finance from Compliance Markets

The United Nations Framework Convention on Climate Change (UNFCCC), signed in 1992, represents an international agreement to stabilise greenhouse gas concentrations in the atmosphere at 1990 levels. Parties to the Convention are divided into those countries that take on responsibility for achieving the convention’s goal, the Annex I countries (all developed countries and countries with economies in transition), and those that do not, the non-Annex I countries (developing countries). The UNFCCC specifically states that the Parties may implement measures to reduce GHG emissions jointly with other Parties. The Parties to the Convention meet once a year at the Conference of Parties (CoP) to discuss and negotiate measures against global climate change.

To further the goals of the UNFCCC, the Kyoto Protocol was adopted at CoP-3 in 1997. The Kyoto Protocol entered into force in February 16th, 2005, which binds the countries that have ratified it and that are listed in Annex B[1] to emission limitations and reduction commitments against 1990 levels. The first commitment period for Annex B countries to show compliance with their emission reduction and limitation targets under the Kyoto Protocol covers the years 2008 to 2012.

Based on the principle that the effect on the global environment is the same regardless of where the GHG emissions reductions are achieved, countries may meet their targets through a combination of domestic activities and the use of the Kyoto Mechanisms, which are designed to allow investor countries to meet their targets in a cost-effective manner and in the case of developing countries to assist achieve sustainable development. There are three Kyoto Mechanisms:

  • Joint Implementation – JI (Article 6);
  • Clean Development Mechanism – CDM (Article 12); and
  • International Emissions Trading – IET (Article 17).

Both JI and CDM are “project-based mechanisms” and involve developing and implementing projects that reduce GHG emissions overseas, thereby generating carbon credits that can be sold on the carbon market. JI is the mechanism that allows trades of credits between Annex I countries, whereas the CDM allows trades between an Annex I country and a non-Annex I country (i.e., a developing country). The main advantages for countries hosting projects are the attraction of foreign investment, the transfer of technology, and the contribution to the country’s sustainable development.

The JI and CDM mechanisms promote investment in greenhouse gas abatement technologies in, among others, the energy generation, energy usage, waste management, transportation, forestry and agriculture sectors, through providing an incentive for emission reductions in the form of awarding tradable credits. Yet projects need to fulfil a set of requirements set by the Kyoto Protocol and later Convention documents. For example, the achieved emission reductions need to be additional to “business as usual”, and be clearly accounted for and credited.

[1] Annex B to the Kyoto Protocol should not be confused with Annex I to the Convention. The former comprises of all Annex I countries with the exception of Belarus and Turkey.