Networked Carbon Markets Networking Carbon Markets— Key Elements of the Process July 2016 Networked Carbon Markets Networking Carbon Markets— Key Elements of the Process July 2016 Justin Macinante ii  This Discussion Paper was prepared by the author for the World Bank Group’s Networked Carbon Markets (NCM) initiative. It describes the rationale, objectives and key elements of the NCM initiative. It is expected that the proposed concepts and components outlined in this Paper will evolve based on discussions with stakeholders, further technical work, and negotiations under the United Nations Framework Convention on Climate Change. This is the second iteration of the Paper, which is ‘live’ and will continue to be updated to capture the evolution of the NCM initiative. Contents 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2 Situation on the Ground Post the 21st Conference of the Parties (COP21)— The Requirements and Opportunities of a Heterogeneous Environment . . . . . . . . . . . . . . . 4 2.1. The Decision as It Relates to Mitigation Actions, Especially Markets . . . . . . . . . . . . . . 4 2.2. Existing Heterogeneous Mitigation Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 3 The Foundations—Background Framework Concepts Post-COP21 . . . . . . . . . . . . . . . . . . 8 4 A Common Language . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 4.1. Mitigation Outcomes and Their Values . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 4.2. Mitigation Value—Development and Refinement of the Concept . . . . . . . . . . . . . . . . 16 4.3. Mitigation Value Assessment—Developing a Process . . . . . . . . . . . . . . . . . . . . . . . 18 5 Trading between Jurisdictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 5.1. Effect on the Form of the Mitigation Outcome Asset Transferred . . . . . . . . . . . . . . . 20 5.2. Transaction Mechanisms, Including ITU/Index ‘Transaction Currency’ Basis . . . . . . . . . 21 5.3. Relationship between Mitigation Value, Settlement Platform, and ITUs and the Index . . 24 5.4. International Settlement Platform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 5.5. Avoiding Perverse Outcomes: Trading Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 6 Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32 6.1. Suitable Institutions to Perform MV Assessments . . . . . . . . . . . . . . . . . . . . . . . . 33 6.2. Regulatory Supervision of MV Assessments . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 6.3. Exchange Rate Setting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 6.4. Registries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 6.5. ISP—International Settlement Platform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 iv  Contents 6.6. ICAR—International Carbon Asset Reserve . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 6.7. Overriding Regulatory Supervision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 7 Market Design + Market Information Technology Architecture; the Plumbing . . . . . . . . . . . 45 7.1. International Emissions Trading to Date . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 7.2. NCM Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 7.3. New Approaches: Distributed Ledger Technology . . . . . . . . . . . . . . . . . . . . . . . . . 49 8 What Is the Market? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 8.1. Who Will Trade? Why? How Will Networking Begin? . . . . . . . . . . . . . . . . . . . . . . . 50 8.2. Market Development: Phased Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 8.3. Simulating the Market, Trading Rules, Testing for Perverse Outcomes, Results, Direction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 9 Recommended Next Steps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 Glossary of Selected Acronyms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 Annex A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 Annex B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 Annex C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 Annex D . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 Figures 1 Types of Linking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2 How MV Protects the Environmental Integrity of Trade of Mitigation Outcomes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 3 Some of the Actions That Countries Are Designing and Implementing under the Cooperative Measures Mechanism . . . . . . . . . . . . . . . . . . . . . . . . 5 4 Evidence of the Heterogeneity of Responses Occurring in Jurisdictions around the World . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Contents  v 5 Administrative Complexity Where Units Transferred but Not Converted and There Are Multiple Trading Partners—Holding Accounts in Country B Registry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 6 Converting Units for Export . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 7 Schematic of Possible NCM Market Structure . . . . . . . . . . . . . . . . . . . . . . 32 8 Transaction Flow at Present . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 9 Detail of ITL Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Tables 1 Summary of Transaction Mechanisms . . . . . . . . . . . . . . . . . . . . . . . . . . 24 2 Summary of Transaction/Exchange Rate Outcomes . . . . . . . . . . . . . . . . . . 25 3 Range of Scenarios for Modelling Trading Rules . . . . . . . . . . . . . . . . . . . . . 31 4 Overview NCM Institutions and Parties . . . . . . . . . . . . . . . . . . . . . . . . . . 32 5 UNFCCC Institutions’ Roles and Functions . . . . . . . . . . . . . . . . . . . . . . . . 42 6 Kyoto Units Enabled by the Data Exchange Standards (Table copied from the UNFCCC website) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 7 Types of UNFCCC Transactions Enabled (Table copied from the UNFCCC website) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 1. Introduction The World Bank’s Networked Carbon Markets (NCM) transactions; and thirdly, that governments should retain initiative is collaboratively exploring the post-2020 the sovereignty to act on the information about those tools, services and institutions needed to enhance other mitigation actions and assets as they see fit. the transparency, comparability, and fungibility of Generally, the form of any linking arrangement will range heterogeneous climate actions, for a connected from a very loose alignment (soft link) to a very tight international carbon market. The cost and efficiency alignment of key elements (a hard link)—see Figure 1 benefits of linking will be important for engendering more below. Hard linking requires aligning the design features climate action and supporting the global developmental of mitigation actions—some of these design features goal to limit global warming to 2°C and aim to limit it to may be easily reconcilable among the linking partners, 1.5°C. The NCM initiative aims to enable comparison while others may not. Recognizing that aligning mitigation of different mitigation actions and trade across different actions can be a lengthy and costly process, especially mitigation outcomes in a way that is: inclusive; once a mitigation action has already been implemented, transparent; efficient; and has environmental integrity. It “networking” is one form of ‘soft’ linking that can offer an is founded on the assumptions that firstly, the linking of alternative solution. Rather than seeking to align mitigation diverse and heterogeneous mitigation actions is desirable; actions, networking is about facilitating trade of the secondly, that governments and market participants need outcomes of those actions by recognizing differences and information about the schemes with which they enter placing a value on these differences. transactions and the assets they acquire through those Figure 1: Types of Linking Direct Linking Unilateral Multilateral Units Units System A System B System A System B Bi-lateral Units Units Units System A System B System C Indirect Linking Units Units System A System C System B Networking Units System A System B Source: International Bank for Reconstruction and Development/The World Bank (2016). 1 2  Introduction The effectiveness of any type of linking arrangement Differentiating actions based on their MV was less (direct linking, indirect linking, networking) is contingent important under the Kyoto Protocol since most tradable upon the transparency of the process and accountability actions followed similar rules and procedures, as of relevant institutions and governance frameworks. If prescribed and verified under the Clean Development countries and market participants lack information about Mechanism (CDM) or Joint Implementation (JI) the environmental integrity of the actions that they are mechanism. The Paris Agreement, reached in December linked to, there will be very little interest in linking and little 2015, is much less prescriptive and leaves the rules open interest in trading. The services and institutions developed to the discretion of national governments. Assessing MV through the NCM initiative are intended to provide responds to the demands of a new Paris Agreement governments and market participants with the information regime to better understand the bespoke rules and that they might need in order to link. procedures that different domestic mitigation actions rest upon, and the resulting mitigation impact of the outcomes The services and institutions developed through the NCM that they produce. MV seeks to provide assurance of the initiative might be introduced in a phased manner, initially environmental integrity of the asset, in accordance with supporting countries to design robust mitigation actions rules and procedures that are recognized by regulations, and facilitating comparability and linkage within countries. a regulatory body and/or participating jurisdictions, as It is intended that these services and institutions could illustrated in Figure 2. help to facilitate linkage bilaterally, before being extended to markets on a regional basis—perhaps through ‘carbon In preparing this paper, informal discussions have clubs’—and in the long term helping markets to link on a occurred and feedback has been obtained from a series global basis. of partners also working on various elements of the NCM initiative or who have expressed interest in it. In particular, A key element of the NCM initiative is a risk-based account has been taken of the concepts and ideas set out approach to assessing climate change mitigation value by Andrei Marcu in the paper ‘NCM and the Post-2020 of heterogeneous mitigation actions. The need to assess Global Climate Change Regime’, the relevant sections mitigation value (MV) rests upon the assumption that of which are copied in Annex A, and also a paper on many different actions have mitigation outcomes, but Article 6, Paris Agreement. Others include: Jennifer Austin, that they don’t necessarily have the same mitigation consultant on NCM; Clayton Munnings, consultant on outcomes. MV is intended to provide a way to differentiate NCM; Climate Markets & Investment Association (CMIA— between assets that are generated from mitigation actions Adrian Rimmer, Fenella Aouane); European Energy that vary in their design, implementation and impact. Figure 2: How MV Protects the Environmental Integrity of Trade of Mitigation Outcomes Scene: 10 million 3 ‘Country A’ carbon allowances are purchased by Country B. The actual mitigation value of each ‘Country A’ asset is 0.5 tonnes. Scenario 1: The actual mitigation of Country A’s Scenario 2: The actual mitigation of Country A’s carbon assets are not accounted for in the trade carbon assets are accounted for in the trade This scenario This scenario does not overstate actual 10 overstates actual 10 emission reductions and the carbon 10 emission reductions integrity of the trade is preserved. 8 by 50 million tonnes. 8 6 6 5 5 5 4 4 2 2 0 0 Units Purchased Actual Emission Reductions    Units Purchased Actual Emission Reductions Mitigation Value is intended to preserve the environmental integrity of the trade. Source: World Bank. Introduction  3 Exchange: EEX/Eurex (Manuel Möller, Steffen Löbner); initiative may be considered. Section 4 and Section 5 London Stock Exchange Group, FTSE Group (Kevin elaborate on these elements and Annex C provides Bourne, Gordon Morrison) and Mike Wilkins of S&P. a glossary of terms. These sections consider how a commonality that facilitates fungibility might be achieved Account has been taken also of papers by: International and how trading might result. The role of a generic Institute for Sustainable Development (IISD)/New ‘international transaction unit’ and supporting infrastructure Climate Institute (Frédéric Gagnon-Lebrun, Seton is also introduced in these sections. Stiebert) ‘Scorecard to Assess Carbon Integrity Risks’; Grantham Research Institute on Climate Change and the Section 6 turns attention to the types of institutions that Environment (Luca Taschini and Corina Comendant): might be required, including ones suitable to participate in ‘A Comparative Assessment of Design Options for the MV assessment process, providing practical examples, an International Carbon Asset Reserve’; Climate and considering the types of expertise and tools those Transparency Initiative: ‘A Guide to Climate Performance institutions might leverage. It also considers options for Assessments for the G20’; INFRAS (Fuessler and regulatory supervision of the MV assessment process. Wunderlich) and GRI (Taschini): ‘International Carbon Other institutions involved will include those participating Asset Reserve—Prototyping for instruments reducing in any exchange rate or trading coefficient setting risks and linking carbon markets’; Reed Smith (Peter processes, registries, the ISP (international settlement Zaman and Adam Hedley) ‘The regulatory framework platform), and ICAR (international carbon asset reserve). to support carbon market linkage—a concept paper’; This section also examines the approach that might be and concepts developed in the World Bank (Mitigation taken to determining an appropriate institution to exercise Action Assessment Protocol (MAAP) and the assessment overarching regulatory supervision, noting that under approach proposed by Johannes Heister). Article 6 (the Cooperative Approaches mechanism) of the Paris Agreement, the Conference of the Parties (CMA) will This paper builds on the findings of an earlier version provide guidance and not governance. published on the World Bank website (link: http://www .worldbank.org/en/topic/climatechange/brief/globally- Section 7 looks at questions of market design and the networked-carbon-markets) in 2015, the objective of essential infrastructural elements that might be necessary: which was to describe key elements of the mitigation hardware and software. Consideration is given to possible value assessment process. This paper, updating the earlier market architecture—the institutions and their relationships version based on stakeholder feedback received, will to each other; and this section also briefly touches upon inform a model for the NCM initiative, to be prepared at a the information technology ‘plumbing’—the ways in which later date. institutions are actually linked, that is, the mechanics of how information passes between them, including the Section 2 looks at the situation on the ground in the wake potential application of new concepts such as distributed of the 21st Conference of Parties to the United Nations ledger technology. Framework Convention on Climate Change (UNFCCC COP21) and the Paris Agreement. It provides a brief Section 8 asks the critical question: what is the market? analysis of the Paris Agreement as it relates to markets, Where will demand come from, how and why will it taking account of work by Marcu.1 It also acknowledges grow? Section 9 concludes the paper by putting forward the subject matter of the NCM initiative, that relates to recommendations for next steps, noting that the emphasis the diverse and heterogeneous mitigation actions that are is on the institutions within potentially interested being put in place by jurisdictions around the globe, both jurisdictions, including China, India, Chile, Mexico and those included in the Nationally Determined Contributions others through the World Bank Group’s Program for (NDCs) lodged by Parties to the UNFCCC and those that Market Readiness, to develop the model as it stands as operate outside the scope of NDCs. it might suit their domestic circumstances and to engage relevant stakeholders locally. The NCM work plan for Section 3 considers the conceptual framework of the 2016 has a country focus, exploring opportunities and NCM initiative, post-COP21, with the aim of providing conducting stakeholder consultations. a background against which key elements of the NCM 1 Marcu, Andréi (2016): Mitigation value, networked carbon markets and the Paris climate change agreement. 2. Situation on the Ground Post the 21st Conference of the Parties (COP21)—The Requirements and Opportunities of a Heterogeneous Environment 2.1.  The Decision as It Relates to Mitigation • specific scopes of activities; Actions, Especially Markets • emission reductions that are additional to what would otherwise occur; The Paris Agreement, reached in December 2015, • verification and certification of emission reductions by includes provisions that recognize transfers of mitigation designated operational entities (DOEs); outcomes, resulting from mitigation actions, between jurisdictions. Parties may engage on a voluntary • experience gained from existing mechanisms under basis in cooperative approaches that involve the use the UNFCCC and its related legal instruments.7 of ‘internationally transferred mitigation outcomes’ The internationally transferred mitigation outcomes towards nationally determined contributions.2 These (ITMOs) introduced under Article 6 can be used towards should promote sustainable development and ensure NDCs, if they follow the guidance of the CMA. Similarly, environmental integrity and transparency, including in the ‘mechanism’ introduced under Article 6 is for the governance, and apply robust accounting to ensure, inter purpose of contributing to mitigation of GHGs and alia, avoidance of double counting consistent with the sustainable development. The guidance in the case of guidance developed and recommended by the Subsidiary ITMOs is expressed only in terms of accounting and the Body for Scientific and Technological Advice (SBSTA) rules, modalities and procedures for the mechanism pursuant to the decision in paragraph 36.3 are to be in the terms listed above in the preceding The use of internationally transferred mitigation outcomes paragraph. It can be concluded that the ITMOs and to achieve NDCs under the Paris Agreement shall be mechanism contributions are to be taken into account voluntary and authorised by the participating Parties.4 only for inclusion in domestic calculations of NDCs. A mechanism to contribute to mitigation of greenhouse It is noted that (at the time of writing) discussions gases (GHGs) and support sustainable development is and negotiations continue between the Parties as to also established for use by Parties on a voluntary basis.5 interpretation and implementation of these and other Again, the SBSTA is charged with the task of developing provisions of the Paris Agreement. As such, and as the and recommending rules, modalities and procedures focus of this paper is on the networking of mitigation for this mechanism.6 These are to be adopted by the actions, especially markets, discussion will be confined for Conference of Parties serving as the Meeting of the Parties the most part in this paper to the ITMO element of the to the Paris Agreement (CMA) on the basis of: Cooperative Approaches mechanism.8 • voluntary participation authorised by each Party Importantly, under the Cooperative Approaches involved; mechanism, ITMOs can be generated from any mechanism, procedure or protocol: the Paris Agreement • real, measurable and long-term mitigation benefits; does not specify that ITMOs need to be generated 2 Paris Agreement, Article 6, paragraph 2. 3 Ibid. 4 Paris Agreement, Article 6, paragraph 3. 5 Paris Agreement, Article 6, paragraphs 4–7. 6 Decision 1/21, paragraph 38. 7 Decision/21, paragraph 37. 8 The mitigation mechanism supporting sustainable development elaborated in Article 6, paragraphs 4–7, will be picked up in a later version of this paper, once there is greater clarity around its rules, procedures and modalities. 4 Situation on the Ground Post the 21st Conference of the Parties (COP21)  5 Figure 3: Some of the Actions That Countries Are Designing and Implementing under the Cooperative Measures Mechanism QUANTITY INSTRUMENTS: PRICE INSTRUMENTS: REGULATORY EMISSION/CERTIFICATE TAXES, INCENTIVE TRADING Multi-Sector Single Sector Multi-Sector Single Sector • GHG Performance • Cap and Trade • Credit and • Carbon Tax • Feed-in Tariffs Standards • Offsets Baseline • Capital • Energy • Technology Standards • Clean Energy Subsidies Efficiency • Fuel Standards Standard Tariffs • RECs only from emissions trading schemes (ETSs) and/or 2.2.  Existing Heterogeneous Mitigation carbon taxes. This breadth in scope of the Cooperative Actions Approaches mechanism means that it will accommodate a patchwork of different mitigation actions. Figure 3 It is important not to lose sight of the reason for, and illustrates some possible mitigation actions and outcomes subject of, the NCM initiative, namely the diverse and that could be delivered under this new Paris Agreement heterogeneous mitigation actions that are being put in regime. place by jurisdictions around the globe, as is illustrated in Figure 4. Furthermore, the Paris Agreement indicates that the CMA will provide guidance (not governance) in relation to It can be seen that mitigation actions being implemented the Cooperative Approaches mechanism. In the overall in diverse jurisdictions around the world are not limited context of voluntary commitments by Parties through their simply to carbon pricing mechanisms. Nevertheless, NDCs, and the greater emphasis placed on transparency as of 2015, there were nearly 40 countries and 23 in the Paris Agreement, it is logical that governance sub-national jurisdictions designing or implementing frameworks will need to be established outside of this different carbon pricing policies such as emissions trading mechanism. These governance frameworks will ensure systems or carbon taxes.9 These included in Canada, that mitigation outcomes are transferred in a way that schemes in Alberta and Québec; in the United States, is transparent and efficient. In the absence of top-down the California Cap-and-Trade Program and the Regional governance, it seems clear also that countries will need Greenhouse Gas Initiative amongst nine north-eastern to establish independent processes to provide assurance states; planned or existing emission trading schemes, at of the environmental integrity of ITMOs, in accordance a national level, in New Zealand, Switzerland, Korea and with rules and procedures that are recognized by all Kazakhstan; and, at a sub-national level, in seven city- participating jurisdictions and stakeholders. regions of China; in Japan, three regional ETS, as well as various other voluntary crediting or offsetting instruments, 9 World Bank, 2015, State and Trends of Carbon Pricing 2015, Washington, DC: World Bank, chapter 4. 6  Situation on the Ground Post the 21st Conference of the Parties (COP21) Figure 4: Evidence of the Heterogeneity of Responses Occurring in Jurisdictions around the World Situation on the Ground Post the 21st Conference of the Parties (COP21)  7 with a national ETS under consideration; and a carbon These schemes are mentioned here solely to help keep price mechanism in Australia.10 In addition, there were them in mind while consideration is given to the issues at least a dozen national and sub-national jurisdictions and proposals described in this paper. It is noted that in where a carbon tax applied, with others considering the the lead up to COP 21, 119 NDCs, covering 147 Parties introduction of such instruments.11 to the UNFCCC, had been communicated by 1 October 2015. Of these, nearly half of the Parties indicated an Equally importantly, in the case of the emissions trading intention to use market-based mechanisms. Some schemes, they differ in many key design aspects, including Parties identified those instruments as a condition for in areas such as: the implementation of their NDCs. While almost no • the nature of the asset traded, and base unit of its quantitative data was included on the degree of use measurement; expected, some Parties did indicate that the use of market-based mechanisms would be to achieve only • jurisdictional level of implementation; part of their mitigation targets.12 Nevertheless, this • number of compliance entities under the scheme; does give an indication of the level of support for such mechanisms.13 • banking and borrowing rights of compliance entities; • distribution of assets—grandfathering, auctioning; • lifespan of asset, surrender obligations of compliance entities; • use of offsets/credits within the scheme, permitted sources of those credits/offsets. 10 Ibid. 11 Note 9 supra, chapter 5. 12 UNFCCC Synthesis Report on the aggregate effect of the intended nationally determined contributions, FCCC/CP/2015/7, unfccc.int/ resource/docs/2015/cop21/eng/07.pdf, accessed 14 April 2016, p. 38, paragraphs 180–182. 13 See also Section 8. 3. The Foundations—Background Framework Concepts Post-COP21 This section aims to provide a framework within which the year period (First Commitment Period 2008– mitigation value assessment process might be considered. 2012), with the intention that there would be In so doing, the aim is not only to reach some level of subsequent commitment periods. consistency of understanding of the concepts and terms, (iii) Some states and the European Union (EU) gave but also to flag some of the areas that could benefit from further application to the market concept by further investigation. creating corresponding obligations on domestic A. Carbon markets as a creation of policy—compliance economic actors and establishing schemes drives demand for trading between these entities (e.g., as in the European Union Emission Trading Scheme (i) The UNFCCC and Intergovernmental Panel on (EUETS)). Climate Change (IPCC) position, that is, the generally accepted position of most governments (iv) While the EUETS has had success in reducing globally, based on scientific research, is that GHG emissions of the entities on which it places emissions must be reduced to avoid dangerous compliance obligations, the top down model has anthropogenic climate change. shortcomings, inter alia, because: (ii) To achieve these reductions requires a. the idea of a top down, compliance- fundamental changes in the structure of the way driven model is limited due to the inability in which economies are organised, away from to impose and enforce compliance activities that generate such emissions or in the commitments on sovereign states (in a way those activities are carried out. regulatory command and control sense), keeping in mind that compliance is the (iii) Pricing mechanisms and, in particular, markets, underlying driver of demand in this market; were introduced to facilitate an economically and efficient transition to a low carbon emission economy—carbon trading is only a tool for b. politically and economically, national achieving the policy objective of reduced governments of sovereign states will always emissions. act to protect the national self-interest, hence voluntary commitment is not an (iv) There is no natural market for avoided/reduced/ adequate substitute for the ability to enforce sequestered GHG emissions, that is, no compliance. natural demand. Demand is generated by the imposition of obligations on the economic actors C. Bottom-up model responsible for the emissions—these obligations (i) A response to the shortcomings of the top down take the form of requirements on emitters to model has been the growth of implementation reduce their emissions profile over time. or development by individual jurisdictions, both (v) Hence demand in the carbon market is primarily at the sovereign state and sub-national levels, compliance driven. of their own mitigation actions, including trading mechanisms. B. Top-down model (ii) Differences in the design and other elements (i) The Kyoto Protocol includes an attempt by of these mechanisms, while reflecting local the signatory Parties—national governments preferences and circumstances, have resulted in of sovereign states—to put in place such a fragmentation and heterogeneity. compliance driven market. (iii) In order to improve the liquidity and depth of (ii) Parties listed in Annex B made quantified these markets, and help them leverage new low emission limitation and reduction commitments carbon financing and investment, ways are being (QELRCs) to reduce their emissions by the stated percentage amounts over a fixed five 8 The Foundations—Background Framework Concepts Post-COP21  9 explored to facilitate fungibility of the diverse asked what, if any, significance this has for assets traded in these heterogeneous markets. the definition of an ITMO, or of a ‘mitigation contribution’ in the Article 6 mechanism?15 (iv) Fungibility of the assets being traded presumes either (i) the assets are all the same, which (iv) The Paris Agreement emphasis is on the public cannot be the case here unless all the availability of NDCs and the five-year cycles of heterogeneous trading schemes are made the review and resetting of NDCs. Each cycle is to same; or (ii) that there is a way of evaluating be more ambitious than the last and through and comparing the relative values of the diverse these cycles, Parties are to ‘ratchet up’ efforts to assets being traded, for example, by applying keep global temperature increase well below 2°C exchange rates or ratios. above pre-industrial levels and pursue efforts to limit the increase to 1.5°C above pre-industrial (v) An evaluation and comparison of the various levels.16 diverse assets might be made by assessing the MV of the jurisdictional environments within (v) Greater emphasis is also placed on transparency. which the assets are being generated: the MV Article 13 provides that “an enhanced assessment process might then inform trading transparency framework for action and support, coefficients, or rates of exchange, or ratios, at with built-in flexibility which takes into account which assets can be traded between schemes, Parties’ different capacities and builds upon whether that trading is between schemes in collective experience, is hereby established.”17 a single jurisdiction, or across two or more (vi) These elements accord with fundamental jurisdictions. underlying assumptions of the NCM, namely, D. Bottom-up framework in the context of the Paris that: Agreement, post-COP21 • governments will likely need information (i) The Paris Agreement offers a hybrid framework, about the jurisdictions and mitigation actions drawing on the strengths of the top-down with which they link and the mitigation approach by providing guidance to support outcomes, which may be purchased; bottom-up mitigation actions. In a number • the effectiveness of mitigation actions and of ways, the Paris Agreement can be seen as the assets generated may change over providing a hook for markets and linking.14 time, as might the economic or emissions (ii) The emphasis is on how mitigation actions profile of a jurisdiction and, therefore, this contribute to Parties’ NDCs in mitigating GHGs. information would need to be collected and However, the Parties’ NDCs themselves are non- monitored on an ongoing basis; binding commitments. Hence, compliance as the • similarly, market participants will also driver of demand in carbon markets applies up need access to such information to make to the national level of a sovereign state, but no informed investment decisions; higher, that is, not at an international level. • some governments and market participants (iii) Under the Paris Agreement regime, there is will have the resources to do their own due no compliance obligation on a Party, such as diligence on an ongoing basis, others may there was under the Kyoto Protocol to surrender not: for those governments and market Assigned Amount Units (AAUs) against its participants that do not have access to quantified emission limitation and reduction these resources, an independent source of commitment (QELRC). While procedural aspects information would be important. Imagining of the Paris Agreement are legally binding, a linked international carbon market that substantive aspects—such as the undertakings accommodates over sixty national and by Parties in their NDCs—are not. It might be 14 For example, Decision 1/21, paragraphs 31, 36–38, 107, 133–136 and Paris Agreement, Article 6. 15 This question is considered further in Section 4. 16 Earth Negotiations Bulletin, Vol. 12, No. 663, “Summary of the Paris Climate Change Conference: 29 November–13 December 2015, International Institute for Sustainable Development (IISD), 15 December 2015, at p. 43. 17 Paris Agreement, Article 13, paragraph 1. 10  The Foundations—Background Framework Concepts Post-COP21 sub-national jurisdictions, would suggest that their specific national and regional development not relying on an independent due diligence priorities, objectives and circumstances” and process would impose an immense in terms of (Article 4.2) “the differences . . . resource burden, particularly if due diligence in starting points and approaches, economic were needed to be conducted on an structures and resource bases, the need to ongoing basis; and maintain strong and sustainable economic growth, available technologies and other • further, it is implicit that governments individual circumstances.” The Paris Agreement is retain the sovereignty to act on this to be implemented to reflect equity and reframes information however they please—as long Parties’ commitments in terms of three elements as it is responsible and in accordance with as “the principle of common but differentiated transparent rules that are made available to responsibilities and respective capabilities, in the other market participants. light of different national circumstances.”19 (vii) By assessing the MV of the jurisdictional (v) Hence, mitigation relates to the actions (in environments within which assets are generated, the context of the UNFCCC, taken by a Party not only will it be possible to derive trading (sovereign state), but in broader terms, taken by coefficients, or ratios, between schemes or any economic actor), to limit or reduce its GHG with other participating jurisdictions, but also emissions by sources to the atmosphere or to a valuable informational tool will be available enhance removals of GHG emissions by sinks to enhance market transparency and facilitate from the atmosphere. benchmarking by governments both internally and externally. F. Mitigation information that might be useful for enabling comparability and linkage E. What is ‘mitigation’ and how is a value attached to it? (i) In developing technical and analytical foundations for a framework to assess and (i) Mitigation means stabilising GHG concentrations compare different climate change mitigation in the atmosphere at a level that would prevent efforts (the aim of the NCM initiative), it dangerous anthropogenic interference with the is important to consider what mitigation climate system, which is the ultimate objective of information might be useful for policymakers and the UNFCCC (Article 2). market participants. (ii) According to the IPCC, this means keeping (ii) For the purposes of this paper, MV is defined average global temperature increase to less as a measure of the effectiveness of mitigation than 2°C above pre-industrial levels. The Paris efforts, or put another way, the mitigation Agreement aims to strengthen the global impact—intended to provide necessary third response to the threat of climate change by not party due diligence information about different only holding the temperature increase to well mitigation outcomes, in accordance with below that level but also by pursuing efforts to recognized rules and procedures. limit that increase to 1.5°C above pre-industrial levels.18 (iii) In the context of the Paris Agreement, this information would need to be framed to take (iii) Mitigation can be achieved in two ways: account of the common but differentiated (i) limiting or reducing anthropogenic GHG responsibilities and respective capabilities, in emissions by sources to the atmosphere, or the light of different national circumstances,20 (ii) preserving or enhancing sinks or reservoirs of in which the mitigation efforts are made, in GHGs. considering those efforts relative to each other. (iv) The commitments of Parties under the UNFCCC Furthermore, successive NDCs will represent a to mitigate are qualified in terms of (Article 4.1) progression beyond the then current NDC and “common but differentiated responsibilities and reflect the Party’s highest possible ambition, 18 Paris Agreement, Article 2, paragraph 1. 19 Paris Agreement, Article 2, paragraph 2. 20 Article 2, paragraph 2, Paris Agreement. The Foundations—Background Framework Concepts Post-COP21  11 again reflecting its common but differentiated its views might be very difficult to determine responsibilities and respective capabilities, in the consensually. light of different national circumstances.21 (vii) The process of operationalizing a framework (iv) Hence it could be envisaged that information to assess relative GHG contribution is beyond useful to policymakers and market participants the scope of this paper. Nevertheless having, might include not only a scheme’s impact, or the as part of the MV assessment, an estimate of impact of a jurisdiction’s collective low-carbon the jurisdiction’s relative contribution to the policies—but also the impact of a scheme’s global emission reduction target, could tie a target, or what that jurisdiction has stated it jurisdiction’s MV back to the ultimate objective of would achieve in that respect: that is, its relative the UNFCCC. While theoretically any jurisdictional contribution to the global emission reduction level (i.e., national, provincial, local) can state a target. level of ambition for its mitigation actions, it is unlikely that all jurisdictions will have done so. (v) In the case of Parties to the Paris Agreement, Furthermore, it is impracticable to consider trying this relative contribution would be as expressed to gather all the data necessary to make valid through their NDCs and it is conceivable that assessments of whether a jurisdiction’s level of it might provide a focal point around which ambition is adequate, in global terms, for sub- countries with similar levels of ambition coalesce, national jurisdictions (i.e., for provincial, city or in much the same way trading blocs develop local level jurisdictions).22 around shared, common goals and objectives in commerce more generally. Relative GHG All the same, in developing an MV assessment (viii) contribution might become a principle by process, the relationship between a jurisdiction’s which Parties organise themselves for linking or MV relative to other jurisdictions, and its MV networking, and consequently information as to when compared to (a) its level of ambition and levels of ambition would constitute an important (b) the level of expectation as to its ambition, component in their decision making processes. will need to be explored and considered, as well as the level of jurisdiction at which (a) and (vi) In theory, a jurisdiction’s ‘relative contribution’ (b) should be taken into account.23 might be compared, also, against a ‘view’ as to what the relative contribution for that G. How is mitigation value measured? jurisdiction should be (taking account of its (i) The most common standard unit for circumstances) in the context of achieving measurement of GHG emissions is a metric the ultimate objective of the UNFCCC (that is, tonne of CO2-equivalent gas, pursuant to the keeping average global temperature increase conventions adopted under the UNFCCC and to less than 2° above pre-industrial levels) or IPCC Guidelines. Paris Agreement (e.g., not only holding the temperature increase to well below that level (ii) While the heterogeneous mitigation actions that but also by pursuing efforts to limit that increase are springing up in jurisdictions may vary in the to 1.5° above pre-industrial levels). However, basic unit of measurement they provide for, while this might be valuable information to have, most of the differences (at least between the how this ‘level of expectation’ could be derived trading schemes) seem to be between metric would not be without controversy. For example, tonnes or US short tons, or as to the types of it might be made by an independent, unbiased, gas emissions, e.g., CO2 only, or a number of expert group, but how such a group could be GHGs. As such, there should not be any difficulty constituted and the basis on which it formed in reducing all of these to a common unit of 21 Article 4, paragraph 3, Paris Agreement. 22 Furthermore, it is noted that for transfers of carbon assets between schemes across the boundaries of national jurisdictions, those jurisdictions will need to be Parties to the Paris Agreement and have authorized the transaction for the assets to come within the terms that apply to ITMOs. 23 NB: if comparing one jurisdiction with another, they need to be assessed in the same way: so if one is a city or province (i.e., sub-national), and the other is a sovereign state (i.e., national), the same criteria must be applied to each in arriving at their respective MVs; cannot look at the level of ambition for the sovereign state, but not for the province, especially if they both operate a trading scheme generating mitigation outcome assets they wish to be fungible. 12  The Foundations—Background Framework Concepts Post-COP21 measurement. Similarly, mitigation by schemes process for determining the effectiveness of a based on energy intensity, fuel substitution, particular mitigation action depends on whether or ratios per unit of production (or similar), or the units are allocated: other such measures, should (in most cases) a. In anticipation of mitigation outcomes also be capable of being reduced to a unit of happening (e.g., in the case of an ETS where measurement common to other schemes, e.g., the number of allowances are announced at metric tonnes CO2-equivalent gas. the start of a commitment period). As with (iii) However, physical measurement of GHG any forecast, there is likely to be a difference emissions, reductions, avoidance or removals between expected and actual mitigation is impractical at best, and possible for only a outcomes. The difference explains why caps limited suite of point sources: for example, tend to achieve less (and, perhaps, in more the USEPA Acid Rain program, in providing for rare circumstances, more) abatement than trading in SO2 emission allowances, benefitted intended via its objective. This would usually from continuous monitoring of stack emissions involve measurements/estimations with of regulated sources: this sort of approach is respect to a forecasted business-as-usual simply not possible across the board in the case (“BAU”) scenario. of broader, economy-wide schemes that provide b. After mitigation outcomes have been for GHG emissions and reductions, etc., from achieved (e.g., in the case of an offset diverse sources, more generally. scheme, where credits are issued after (iv) Hence both volume of emissions and the extent emissions have been reduced below a of their mitigation often will need to be derived baseline). In this case, the effectiveness as estimates, or indirectly through measurement of the action will be a function of whether of proxies. There are well-developed the mitigation outcomes that have been methodologies and a considerable body of data claimed, are real. This would usually and experience in making such estimations: for involve measurements/estimations of the example, since 1996, UNFCCC Annex I Parties emissions below a stated baseline. There have been required to submit to the secretariat are also other considerations, for instance, an annual inventory of their emissions by sources how well the mitigation action has been and removals by sinks of all GHGs not controlled set up: see the IISD risk categories such as: by the Montreal Protocol (non-Annex I Parties program boundaries/leakage; funding to also have to submit National Communications); fully implement; enforcement; accounting, both the IPCC and the UNFCCC have issued monitoring, reporting, etc.25 guidelines; methodologies have been approved Mitigation actions where units are allocated in also by the Clean Development Mechanism anticipation of mitigation outcomes (e.g., for an ETS) (CDM) Executive Board; and there is also the GHG Protocol (World Resources Institute (vi) This process involves understanding why there is (WRI)/World Business Council for Sustainable likely to be a difference between expected and Development (WBCSD)) and International actual mitigation outcomes. There could be a Standards Organisation standard ISO 14064, for number of reasons for this including: GHG accounting and reporting principles and a. Endogenous or exogenous reasons. methodologies.24 Endogenous reasons are those that are (v) A jurisdiction’s collective mitigation effort will be related to the impact of the mitigation a function of the programs, policies and pledges action. Exogenous reasons are those that (‘mitigation actions’) that it has in place to limit arise from actions or events outside of the or reduce its GHG emissions by sources to the mitigation action (e.g., economic factors, or atmosphere or to enhance removals of GHG decline in production of carbon intensive emissions by sinks from the atmosphere. The goods due to lower demand). 24 Seealso, for example, Climate Action Tracker methodology: http://climateactiontracker.org/. 25 FrédéricGagnon-Lebrun, Seton Stiebert: ‘Carbon Integrity Assessment at the Program Level—Scorecard to Assess Carbon Integrity Risks, Supplementary Note’, IISD/New Climate Institute, July 2015. The Foundations—Background Framework Concepts Post-COP21  13 b. Continuous or discrete reasons. Continuous (ix) If a jurisdiction has a number of mitigation reasons are regular events that cause actions in place, it is worth also considering outcomes to differ from forecasts. These how the mitigation actions fit and work together can be readily incorporated into the cap (Do they complement each other? Are there setting process by adopting conservative gaps? Overlaps? Inconsistencies? Conflicting assumptions at the outset. Discrete risks, elements?). on the other hand, are those that occur (x) The extent to which estimates, indirect irregularly (e.g., tsunami destroying nuclear measurement through proxies, or direct power plants in Japan). Discrete risks can measurement, are applicable, will vary be further categorized into those that are depending on the size and nature of emissions, probable and those that are possible (that is, the mitigation action and the jurisdiction. in terms of likelihood). (xi) Account will also need to be taken of the level (vii) Given the number of factors that can affect of government: is the jurisdiction regional (e.g., whether expected mitigation outcomes actually EU), national, sub-national, provincial, local—are eventuate, it would seem impossible to achieve the emissions and their mitigation particular to anticipated outcomes equal to actual outcomes. the jurisdiction; what degree of independence is As such, it would seem equally the responsibility there from the next higher level of government of policymakers not to attempt the impossibility (principle of subsidiarity)26—this may dictate of forecasting the future, but rather to: the applicability of any of the factors listed in a. be transparent about how actual mitigation the preceding point in the case of any particular outcomes are tracking relative to expected sub-national jurisdiction; and the operation outcomes; and of internationally binding commitments and principles (e.g., principle of supplementarity).27 b. adjust for differences between actual and expected mitigation outcomes, where there H. Additional import restrictions may be adverse environmental implications (i) While the concept of MV can provide a valuable (in this context, refer to Figure 2). informational tool to governments, policymakers Herein is evidenced the essential role of MV (viii) and other stakeholders for a range of purposes in reflecting the extent to which exported units from internal benchmarking through to are backed by actual mitigation outcomes. This international trading in mitigation outcomes, involves considering the extent to which: ultimately the administrator of the importing jurisdiction/scheme will decide whether to a. the BAU has a factual basis; place restrictions on different types of imports, b. actual emissions are tracking the BAU and what value will be placed on them when scenario; they are. c. emission reductions are a function of (ii) Such ‘import restrictions’ might take the form of exogenous or endogenous factors; and quotas, or technical specifications,28 or relate to the value that will be accorded to those imported d. there have been adjustments for differences assets—for example, the level of compliance between actual and expected mitigation obligation accepted as being acquitted by outcomes. surrender of the imported asset. The degree to 26 The general aim of the principle of subsidiarity is to guarantee a degree of independence for a lower authority in relation to a higher body or for a local authority in relation to central government. It therefore involves the sharing of powers between several levels of authority, a principle which forms the institutional basis for federal States: http://www.europarl.europa.eu/aboutparliament/en/displayFtu. html?ftuId=FTU_1.2.2.html, accessed 3 August 2015. 27 ‘. . . the use of the mechanisms [International Emissions Trading, CDM, JI] shall be supplemental to domestic action and that domestic action shall thus constitute a significant effort made by each Party included in Annex I to meet its quantified emission limitation and reduction commitments under Article 3, Paragraph 1.’ (Article 1 Draft Decision-/CMP.1 (Mechanisms) contained in Decision 15/CP.7, Marrakech Accords). 28 For instance, the EUETS specifications excluding or limiting certified emission reductions (CERs) from certain types of projects. 14  The Foundations—Background Framework Concepts Post-COP21 which these import restrictions are imposed and imposed by the administrator/regulator, market the levels at which they might be set will always factors such as demand and supply, liquidity, and be a matter for the prerogative of the receiving depth of the market, will remain important in or purchasing jurisdiction, or domestically the determining the FV of the carbon asset traded. administrator of the receiving scheme. It will always be up to the buyer to decide what price they are willing to pay, in the overall I. What determines financial value (‘FV’) of a traded circumstances. asset? It is important to note that there will be a range of ways (i) The financial value (‘FV’) of a mitigation outcome in which MV can be applied. Nevertheless, elements of is the price a buyer is willing to pay for it. As the concept, by whom the assessment process might such, FV will depend on a number of market be carried out and how they might be regulated can all factors, including demand and supply, market be considered and are, in this paper. In doing so, it is liquidity, and depth of the market, as well as important to keep in mind that for there to be any value marginal cost in a jurisdiction of mitigating in the process these elements seek to inform, the design emissions as opposed to buying mitigation must ensure that environmental integrity is maintained outcomes in order to acquit compliance and that it promotes the objectives of the UNFCCC, but obligations (marginal abatement cost). equally, that design should afford certainty, clarity and (ii) Whatever level of significance attaches to the MV operational efficiency such that the market can perform and additional regulatory restrictions on imports the role for which it is intended. 4. A Common Language This section begins to explore how heterogeneous • Credits/offsets: mitigation actions might be compared, to facilitate • are generated by projects which avoid or reduce trading between them. It looks in greater detail at the emissions that would otherwise occur, or which mitigation outcome asset, the application of additional sequester GHGs from the atmosphere, in both import restrictions to it, its financial value, and the cases, compared to a baseline; relationship between these elements. It looks into MV in more detail also, both the development and refinement • need to be real, measurable and verifiable, as of the concept itself and developing a process for its well as additional to BAU; assessment. A glossary of proposed key definitions is set • can be surrendered on a voluntary basis, by out at Annex C. entities that do not have compliance obligations; • depending on the rules of the relevant 4.1. Mitigation Outcomes and Their Values compliance scheme, may also be able to be What Is a Mitigation Outcome Asset? surrendered in respect of compliance obligations; A mitigation outcome asset is an instrument generated as • Other forms of asset might include any sort of units part of a scheme, project or program that has a mitigation issued pursuant to an NDC, for example, energy impact. In some jurisdictions, the legal system may intensity units, tax credits, etc., under other schemes classify such an asset as a ‘chose in action’, meaning that or pricing mechanisms. it confers a right enforceable at law. The nature of any property rights (i.e., the right to own, hold and sell) in the Design Differences and Fungibility assets and in whom those rights are vested may vary from Mitigation actions have differences in design aspects, one jurisdiction to another, depending on the legal system which mean that the mitigation outcome assets issued in place. The asset may be classified also as a ‘financial under them will differ from one jurisdiction (or scheme) instrument’, depending on the application of financial to another. There are also important similarities, such as regulations in any particular jurisdiction. the fact that the schemes under which the assets are While the measurement unit used might vary from one issued all have the same purpose, namely mitigation of scheme to another, mitigation outcome assets are usually GHG emissions; and that the assets are intended to be or measured in base units of a metric tonne of carbon are capable of being traded, and are surrendered against dioxide equivalent greenhouse gas (‘CO2-eq GHG’), compliance obligations, under the respective schemes. whereby Global Warming Potentials (GWP) of other GHGs The fact that these schemes have a common purpose, are used to give the equivalent number of tonnes of CO2, namely mitigation, provides the means to evaluate the and GWP CO2 = 1. differences between them and, thereby, to arrive at a Mitigation outcome assets can take a variety of forms: relative measure of their effectiveness in achieving that purpose. • Allowances: The NCM initiative aims to enable comparison of different • are usually issued (either free or by auction) mitigation actions and trade across different mitigation by a compliance scheme (ETS) administrator outcome assets by providing for their fungibility. To be to scheme participants (compliance entities)— ‘fungible’, means that a thing is mutually interchangeable entities emitting GHGs who have obligations with another thing that is, for all intents and purposes, under the scheme to mitigate their emissions; identical to it. The comparison of assets across schemes • compliance entities will be required to surrender and jurisdictions will be a function of the extent to which allowances equivalent to their GHG emissions for differences in the schemes can be reduced to relative the compliance periods determined under the values in terms of mitigation. The actual mitigation scheme (e.g., annually); outcome assets themselves will retain their differences (due to scheme designs) and, not being identical, will 15 16  A Common Language not be interchangeable with, or able to be substituted for, participants in the mitigation actions as might be the case each other, per se: that is, they are not ‘fungible’, in the with transactions between jurisdictions, but without the fullest meaning of that concept.29 Rather it will be their necessity of cross-jurisdictional comparison, simplifying the relative value—in mitigation terms—that will be capable of approach to MV and its assessment, matters which are being traded into another scheme. This will be achieved now picked up in the following sections. by deriving a trading coefficient, or exchange rate, or ratio, for the assets issued under the different schemes or in the different jurisdictions, based on the respective 4.2.  Mitigation Value—Development mitigation value assessment outcomes for those and Refinement of the Concept jurisdictions (or schemes). As noted earlier, a key element of the NCM initiative is a risk-based approach to assessing MV across Mitigation Outcomes Generating heterogeneous carbon asset classes: mitigation efforts a Financial Instrument will have an MV, which can be translated into a trading Another question about the nature of a mitigation coefficient between schemes, or a rate of exchange, outcome asset is whether it is a financial instrument. or price, or ratio at which an asset generated by the This will depend on the financial regulations of the mitigation action will be exchanged or purchased into particular jurisdiction. For example, in the EU, Directive another scheme or jurisdiction. In Section 3, MV is 2014/65/EU,30 defines ‘financial instrument’ to include defined as a measure of mitigation impact—intended to emission allowances, consisting of any units recognised provide necessary third party due diligence about different for compliance with requirements of Directive 2003/87/ mitigation outcomes, in accordance with recognized rules EC (Emissions Trading Scheme).31 This means that EUAs and procedures. The process of measuring mitigation and some, but not all, CERs will be financial instruments value is now described in further detail. for the purposes of European financial regulations (that is, under MiFID II).32 Measuring Mitigation Impact Hence, if the assets generated by mitigation actions in Exogenous factors relevant to level of mitigation. place in a jurisdiction are defined as a financial instrument A jurisdiction’s effectiveness in bringing about mitigation in that jurisdiction, but not in another acquiring jurisdiction, will be a function of the mitigation actions it has in or vice versa, a question arises as to how this will affect place to limit or reduce its GHG emissions by sources them as ITMOs, since that would mean some are financial to the atmosphere or to enhance removals of GHG instruments, while others are not, and that a particular emissions by sinks from the atmosphere. Reductions in a sort of asset might be regulated as a financial instrument jurisdiction’s emissions over any particular timeframe may in one jurisdiction, but then not be when subject to result also from exogenous factors, such as, for example, an international transfer to another jurisdiction, or vice reduced activity due to an economic downturn. While the versa. The treatment of ITMOs in this regard may have monitored, reported and verified reductions (including implications for investment and engagement by financial any due to such exogenous factors) will be a physical markets. How such issues are addressed may have a quantity—at least an estimate of such if unable to be bearing on the effectiveness of the role that carbon measured directly—how they are taken into account when markets can play. valuing a jurisdiction’s mitigation action, may depend on Discussion of the treatment of mitigation outcome how they came about.33 assets as ITMOs should not detract from the significance NCM broader purpose than just jurisdictional comparison. of transfers that might take place domestically, that is, between schemes within a jurisdiction. Such transactions Valuing mitigation efforts of jurisdictions holistically is may bring the same economic efficiencies and benefits to one approach to developing a framework to assess 29 Unless the schemes are harmonized to a sufficient degree to allow assets from one to be accepted in the other, as in the case of full linking—see discussion in following paragraphs. 30 Directive on Markets in Financial Instruments and amending Directives 2002/92/EC and 2011/61/EC (‘MiFID II’). 31 Directive on Markets in Financial Instruments and amending Directives 2002/92/EC and 2011/61/EC (‘MiFID II’), Annex I, Section C, paragraph (xi). 32 MiFID II to apply on 3 January 2018 under the currently applicable timeline: EC press release 10 February 2016. 33 That is, whether they are due to an effort on the part of the jurisdiction, or some exogenous factor. This point is noted also in following sections of the paper, in considering valuing of a mitigation outcome asset. A Common Language  17 and compare different mitigation actions. However, the Valuing Mitigation Outcome Assets NCM initiative seeks to achieve more than just broad Assets valued for various reasons—compliance, price. comparison of jurisdictions’ mitigation efforts; rather it seeks to enable comparison of different mitigation actions Economic actors will value mitigation outcome assets for and trade across different assets in a way that is inclusive; different reasons. For example, an ETS being a creation transparent; efficient; and has environmental integrity. of policy relies on the compliance obligations placed on compliance entities to drive demand for the allowances Mitigation actions and tradable assets. issued under the scheme. Hence, assets in such a market Mitigation actions may involve the creation of assets that will have a value for compliance purposes—their value are tradable, as in the case of an ETS that works on the on surrender. The administrator/regulator of a scheme basis of tradable allowances being held and surrendered will decide what value to accept in terms of the physical against emissions. The aim is to change behaviour by emissions offset—the compliance obligation acquitted—by providing a price signal to economic actors (i.e., the the asset surrendered at the end of the relevant period. emitters) as to when it is more cost effective to alter their The market, on the other hand, will attach a financial preference—that is, to spend on abatement, rather than value to the assets—the price—and although this might be buy allowances. For the price signal to work, the effect of influenced by a range of factors, it will be influenced also exogenous factors on emissions needs to be taken into by the scheme administrator’s view of what to accept in account. terms of the physical emissions offset.37 Paris Agreement acknowledgement of role. How to value traded assets? To recap briefly, the Paris Agreement includes provisions In any ETS it is likely that domestically issued units will be that acknowledge the role to be played by transfers issued with a par value. To do otherwise, the particular of mitigation outcome assets between jurisdictions. circumstances, or scheme design, would need to warrant Parties may engage on a voluntary basis in cooperative that they be issued at a discount or a premium. Questions approaches that involve the use of ‘internationally arising from this are: transferred mitigation outcomes’ towards nationally • Will third parties agree that those domestic determined contributions.34 These should promote allowances should have that value? Does this sustainable development and ensure environmental accord with the value those third parties place on integrity and transparency, including in governance, and the mitigation impact of that scheme or jurisdiction apply robust accounting to ensure, inter alia, avoidance of overall? double counting consistent with the guidance developed and recommended by the SBSTA pursuant to the decision • Secondly, what value will the scheme administrator in paragraph 36.35 The use of ITMOs to achieve NDCs will assign to, say, project generated credits/offsets be voluntary and authorised by the participating Parties.36 accepted under the scheme, or allowances from another scheme, or another jurisdiction? Need to value assets in terms of mitigation. Is the value for domestic assets realistic? While it is too early to know what guidance on robust accounting will be developed and recommended by the In relation to the first question, third parties that take a SBSTA, it is clear from the Paris Agreement that being different view of the value of allowances issued under able to put a value, in mitigation terms, on the mitigation that scheme have two options: elect not to trade with outcomes transferred between jurisdictions, which is that jurisdiction, or if they do, for allowances from that acceptable for the purposes of that accounting guidance jurisdiction traded into their scheme, assign a value that from the SBSTA, will be critical to these outcomes being reflects their view.38 There is currently a range of ideas on recognized as contributing to NDCs. how this can or should be approached (see below). What 34 Paris Agreement, Article 6, paragraph 2. 35 Ibid. 36 Paris Agreement, Article 6, paragraph 3. 37 Hence,in theory, price should be a function of value accorded to asset on surrender, which should be a function of mitigation value. 38 Assuming, for the moment, there are no bilateral or international rules determining how the traded asset is to be valued. 18  A Common Language will be more of an issue for the first jurisdiction is if, by emissions, can provide a mitigation value. This MV might assigning a par value for domestic units, the ETS achieves be operationalized through a discount factor in terms of less emission reductions than expected.39 the global temperature goal for mitigation outcome asset units and an exchange rate based on the relative ambition Assigning value to imported assets. of the transaction participants. The discount factor and In relation to the second question, in the case of the exchange rate would be applied to exported units, which credits, a risk-based assessment could provide guidance would need to be ‘budget compliant’. as to the MV and hence the value to assign on surrender. Also at this global level, Climate Transparency is seeking In the case of allowances from another scheme or to foster an independent, globally accepted source of jurisdiction, the question becomes one of measuring credible, comprehensive and comparable information and valuing the mitigation impact achieved in the other on climate action in countries. To do this it is bringing scheme or jurisdiction and converting it to a value for the together a composite picture of G20 country climate individual traded allowance.40 As noted, there is a range performance on an annual basis. Its work streams, apart of ideas on how this can or should be approached, which from the G20 annual report, include a Climate Change are canvassed briefly below. Performance Index for countries, advocacy at the G20, a UNFCCC climate transparency framework and capacity 4.3.  Mitigation Value Assessment—Developing building at the national level.43 a Process At a scheme level, the World Bank Mitigation Action This section does not deal comprehensively with all Assessment Protocol (MAAP) assesses the risks relating to the work that has been undertaken on this subject.41 the characteristics of a specific program.44 It focuses on the Rather, it simply aims to provide a flavour of the diversity mitigation value of carbon credits and while it is intended of approaches to the question of how to undertake to enable comparison of carbon assets from jurisdiction to mitigation value assessment. Amongst other things, it jurisdiction and inform linking decisions, in the short term flags the basic issue of the level at which value is being it can be used to facilitate prioritisation, benchmarking assessed—jurisdictional level, scheme level, or at the level and better program design within a jurisdiction. The MAAP of the carbon asset. consists of modules for assessing: the quality of the program’s design and robustness of its implementation; Beginning at the broadest level, one approach is to anchor the track record and capacity of the entity managing mitigation value to the policy objective of the UNFCCC design and implementation; the level of risk associated by valuing the ambition expressed by Parties to the Paris with the jurisdiction where the mitigation action is being Agreement through their NDCs.42 By starting from the implemented; and the sustainable development benefits level at which global emissions must be capped to enable contributed by the program. Where the carbon assets temperature increase to be limited to 1.5°C, a comparison generated by the program are traded, two additional areas can be made with the aggregate commitments of Parties are assessed, being: the jurisdiction’s credibility in terms as expressed through their NDCs. Consideration of of the likelihood of it achieving its stated targets; and the whether the collective ambition of the NDCs is consistent jurisdiction’s contribution to the global emission reduction with the 1.5°C limit; of what individual Parties’ fair burden effort. sharing contributions might be; and of whether those Parties will actually comply with their committed levels of 39 Where the jurisdiction is a Party to the Paris Agreement, this could mean performance does not match its NDC targets, however, as these are not binding and there is no obligation on Parties to, e.g., surrender AAUs against compliance, as was the case under the Kyoto Protocol, or anything similar, it is not clear at this stage how material a problem this would be. 40 Again assuming, for the moment, there are no bilateral or international rules determining how the traded asset is to be valued this will be done by the buyer’s scheme administrator. 41 All relevant references can be viewed at http://www.worldbank.org/en/topic/climatechange/brief/globally-networked-carbon-markets. 42 Johannes Heister, World Bank Group, Mitigation Value to Enable International Linkage of Domestic Programs, presentation to strategy workshop, Cologne, 28 May 2016. 43 See www.climate-transparency.org. 44 World Bank Group, The Mitigation Action Assessment Protocol, February 2016, link: http://pubdocs.worldbank.org/pubdocs/ publicdoc/2016/3/639271458579397657/Mitigation-Action-Assessment-Protocol-Feb-2016-CLEAN.pdf; developed by DNV GL, Rating of Emission integrity and Mitigation Value of Carbon Assets: Rating of Mitigation Actions; expert reviewed and more granular approach developed by IISD/New Climate Institute, Scorecard to Assess Carbon Integrity Risks, Supplementary Note, July 2015. A Common Language  19 At the mitigation outcome asset level, efforts have ratings are made of both the issuer (sovereign, corporate, focused on delineating the components of assets issued other public sector entity) and the instrument itself. Many and traded under an ETS that represent actual mitigation elements—such as who will undertake the assessments, effort from those that represent a surplus deriving from how will they be regulated, and how the assessments some exogenous factor.45 Work is continuing to examine might be applied—are yet to be clarified. What is apparent, these and other potential methodologies. Ultimately, there however, given the central importance of an independent may not be a single methodological approach settled assessment framework of mitigation actions to the overall upon, but rather there may be a suite of such approaches concept of networking markets, is the need for these that address different levels depending on the needs efforts to provide a workable outcome that is acceptable of any particular user. In this respect, an analogy can to stakeholders generally. be drawn with credit ratings in the debt markets, where 45 See for instance, unpublished draft by Clayton Munnings, Defining Mitigation Value for an Emissions Trading System, dated 18 February 2016. 5. Trading between Jurisdictions Using MV to Facilitate Trade may be a lot more administratively complex: Figure 5 of Mitigation Outcomes shows hypothetically all the different unit accounts that Country B might need to have in its registry. This is Scenario (ii) described in Section 5.2 and Annex D. It is clear from the preceding sections on development of the concept of MV and the process for MV Unit Converted on Transaction assessment, that it can be a powerful informational tool for governments and policymakers in evaluating Alternatively, MV could be applied to convert the domestic progress, both domestically and internationally, towards unit for export into any of a range of different types of UNFCCC objectives. This should assist also in fostering units. For example, at the point of trade: the transparency emphasized by the Paris Agreement. • the domestic unit might be converted into generic Governments may also see value in MV assessments ‘international transaction units’ (ITUs), the conversion in an introspective sense, as a yardstick for measuring factor would be based on the mitigation value: say, if the success of their own mitigation actions, as a tool 100 domestic units are sold and the MV assigned to for internal review, benchmarking and enhancement those units is 0.5, then a total of 50 ITUs would be of policies, or other non-trade related purposes. At the created, and 100 domestic units would be cancelled; or same time, for jurisdictions wishing to achieve greater efficiencies by promoting trade domestically between • the domestic unit might be converted into the unit of mitigation actions, or to access international markets the importing jurisdiction; by engaging in trade with other jurisdictions, the NCM These examples are elaborated in more detail in initiative is developing concepts to facilitate application of Section 5.2. MV assessments to foster trading of mitigation outcomes. 5.1. Effect on the Form of the Mitigation Figure 5: Administrative Complexity Where Units Outcome Asset Transferred Transferred but Not Converted and There Are The way in which MV is applied to the transaction process Multiple Trading Partners—Holding Accounts can take a range of different forms, leading to differing in Country B Registry results. The following examples in this Section 5.1 illustrate the point, which is then elaborated in Section 5.2 and Annex D. In the first example, the asset retains its original form of unit; in the second example, the asset is converted into another unit, either that of the importing scheme or jurisdiction, or some form of ‘transaction unit’. Unit Retains Original Domestic Form In the first example, when the mitigation outcome asset from Country A is transferred to Country B, the Country A unit ends up in the Country B registry, in the account of the Country B buyer. This approach may be simpler if the buyer and seller have only a small number of trading partners. Subject to any other import restrictions that might apply, MV might be applied to determine the value of the unit, thereby preserving the integrity of trade. The mitigation value would therefore be reflected in the discounted co-efficient of each mitigation outcome transferred. If the buyer/seller have a number of trading partners, retaining the original form of the domestic unit 20 Trading between Jurisdictions  21 Figure 6: Converting Units for Export Foreign Unit Converted Model Index Unit Model International International Domestic Domestic Transaction Transaction Unit/s Unit/s Unit Unit Imports are converted into a certain Imports are converted into a certain quantity of quantity of Country B’s units generic “International Transaction Units’ based on the MV of Country B’s units, relative to an Index.    5.2.  Transaction Mechanisms, Including ITU/ Buyer B with the relevant number of B units. This Index ‘Transaction Currency’ Basis contrasts with scenario (ii), in which A units are transferred into Buyer B’s account in the Jurisdiction B registry—it Different Unit Forms then becoming a matter for the Jurisdiction B scheme The forms that transactions take will have implications administrator to determine how to ascribe value to those for how the mitigation value is reflected. To illustrate this, A units in the Jurisdiction B scheme, bearing in mind that three scenarios are set out in Annex D. It is presumed there are differences between A units and B units (due to that each of these transactions will be via an intermediary, differing scheme design aspects). namely a settlement platform. Aspects of the form, role Further, under scenario (ii), compliance entities in and functions of the settlement platform are considered Jurisdiction B (as in all jurisdictions trading on this basis) in Section 5.3. However, all transactions will need to be would need to have accounts for units from all other settled and cleared, so it is reasonable to assume that trading jurisdictions from which they might possibly there will be such an intermediary in all transactions. The acquire units. If this applied across all transactions first two scenarios are: and all jurisdictions engaged in NCM, it would make (i) foreign unit converted model; administration more complex and may lead to inconsistencies and risks: for example, each jurisdiction’s (ii) foreign unit imported model. registry would look like that illustrated for Country B in In both these scenarios, units from the scheme in Figure 5—every account holder holding accounts for Jurisdiction A (A units) are being sold by Seller A to every other participating jurisdiction with which it might Buyer B, who has compliance obligations in Jurisdiction B, trade. which trades B units. In scenario (i), upon the transaction These transaction scenarios illustrate how MV, translated taking place, the A units purchased by Buyer B are into an exchange rate for the mitigation outcome assets, converted into the equivalent number of B units by the has implications for the process and, ultimately, for the Jurisdiction B scheme administrator, at the prevailing price. exchange rate, and the A units are cancelled. In scenario (ii), the A units are not cancelled but credited to Buyer B’s In scenario (i), as it is B units that are credited to registry account in Jurisdiction B as A units. Buyer B’s account in the Jurisdiction B registry, the value on surrender of the purchased units will be whatever the In scenario (i), the Buyer B account in the Jurisdiction B Jurisdiction B scheme administrator has set under that registry only ever receives B units. The Jurisdiction B scheme for B units. As such, the price of the traded assets scheme administrator cancels the A units and credits 22  Trading between Jurisdictions should be substantially influenced by the exchange rate (1) medium of exchange; on the transaction date. Hence the relative MVs of the (2) unit of account; and respective jurisdictions should be a factor in the price paid. (3) as a store of value. By contrast under scenario (ii), on the transaction date Buyer B will not know what value the Jurisdiction B An international currency serves the same functions for scheme administrator will place on the A units when financial transactions between jurisdictions. Domestically, surrendered. This decision may be influenced by a governments will usually determine what they accept as number of factors, including the way the Networking legal tender; internationally, choice is more a matter of is designed, for instance, whether exchange rates are market forces. As such, choice is dictated more by the ‘official’ or ‘unofficial’; the degree to which scheme first two functions, rather than the third. The medium of administrators agree to apply them; and also the period exchange and unit of account functions, as well as the role of time between the transaction and surrender of the of money in conveying information about relative prices, A units, by Buyer B, for compliance purposes under the underpin the dominant role of the US$ as an international Jurisdiction B scheme: the longer the time between the currency. two events, the greater the chance that the exchange A transaction vehicle unit for trading mitigation outcome rate will change, which may affect the decision of the assets across jurisdictions would perform similar functions Jurisdiction B scheme administrator. Under this scenario, to an international currency. It could serve: as the Buyer B carries this risk. It will be a powerful disincentive medium of exchange, that is, as a vehicle for carrying out to purchase from another scheme. indirect exchanges between two other types of mitigation outcome asset; as a unit of account, it might be used International Transaction Unit officially to define exchange rates; and as a transmitter The introduction of a ‘vehicle’ for transactions (an of information it could facilitate transactions by informing International Transaction Unit, or ‘ITU’) in the Networking counterparties, avoiding the need for them to undertake could greatly simplify the process. In foreign exchange time-consuming and expensive research of their own; transactions, use of a vehicle currency (e.g., $USD) greatly and also convey information about the performance of reduces the number of exchange rates that must be dealt the market in policy terms, more broadly. This is not to with in a multilateral system. For example, in a system of disregard the role it could also usefully perform as a store ten currencies, with one a vehicle, nine rates need to be of value in the Networked market. quoted; without the vehicle, forty-five rates need to be For a currency to be used internationally, as in the case quoted.46 of the US$, there must be confidence in its value (that is, Hence, using a vehicle currency can yield the advantage in the issuing country’s inflation performance). It should of fewer, larger and more liquid markets with fewer have a stable value: its price relative to other currencies currency balances, reduced informational needs and should provide sufficient information to interested parties. simpler operations. In theory, the same principles should There also needs to be confidence in the political stability hold for exchange rates in Networking. Such simplification of the issuing government; and the financial markets should allow the Networking transactions to flow more in that country should be substantially free of controls, rapidly and efficiently, reducing also the scope for error broad—containing a range of financial instruments, and and capacity for manipulation and fraud. deep—having well-developed secondary markets. If there is to be an International Transaction Unit, how The rationale for a transaction vehicle: analogies to the confidence in its value is gained and maintained, how international monetary system47 the stability of its value is supported and how price It is helpful here to consider how use of a transaction, or information is communicated to interested economic international, currency comes about in the international actors, are matters that require careful consideration. The monetary system. Money fulfils three basic functions, as a: body that issues the units will need to gain the confidence 46 See also Figure 5 in this respect. 47 Thissection is based on: George S. Tavlas, Finance & Development June 1998—The International Use of Currencies: The U.S. Dollar and the Euro, June 1998, Volume 35, Number 2, International Monetary Fund: http://www.imf.org/external/pubs/ft/fandd/1998/06/tavlas .htm, accessed 19/02/16. Trading between Jurisdictions  23 of the market in its stability, and the stability and reliability The purpose served by the Index in scenario (iii) is to of the process it operates. For instance, if ITUs are issued provide a way of comparing the relative MVs of the by an international treaty-based body, its constitution, jurisdictions. In this example, the MV of each jurisdiction operational rules, funding and functions will need to be is measured against the weighted average for all trading clear, transparent, independent and, above all, stable and jurisdictions. As noted above, in so doing it provides for consistent. ITUs to operate as a ‘vehicle currency’, analogous to the role of the $US in FX transactions. The ITUs might be just Index a notional transaction currency, facilitating the transaction as in the scenario, or they might also serve an investment The nature, characteristics and other aspects posited for purpose in their own right. There are many other possible an International Transaction Unit, such as how it could be mathematical configurations and variations on the idea of comprised and what it would represent, are considered an index. These depend on what information is sought to later in this paper. For the purpose of setting out here a be communicated, and to whom. transaction scenario involving an International Transaction Unit, it is proposed that its value derives from an index. Manner of Application of MV Influences Outcomes However, it might equally be based on a standard or emissions budget (or the index might be), which refers The difference between scenarios (i) and (iii), versus back to a globally agreed emissions target (e.g., such scenario (ii), demonstrates that the form of the as the UNFCCC objective of keeping average global transaction, in relation to when and how the traded asset temperature increase to less than 2°C above pre-industrial is ascribed a surrender value in the buyer’s scheme, will levels). These alternatives are explored later in this section. impact on the risk and certainty of the trade. Scenario (iii) centralises the administrative aspect (conversion of A to B An index can be defined as a statistical composite units), which would enhance the certainty and efficiency that measures changes in the economy or a financial of the process. market, often expressed as changes from a base year or a preceding month. Each index has its own method of However, in all three scenarios, the application of the calculation;48 components may be weighted according exchange rate is translated into the number of units to certain characteristics, e.g., stock index weighted for converted, which might have implications for the market cap. environmental integrity of the overall scheme, since it could potentially result in more units (which are rights In scenario (iii) in Annex D, there is an index (the to emit) being created in the scheme. While this risk ‘Index’).49 Again, as in the previous two scenarios, units might be addressed through design aspects,51 it raises from the scheme in Jurisdiction A (A units) are being sold a fundamental question: should the scheme design be by Seller A to Buyer B, who has compliance obligations such that the MV assessment process can translate into in Jurisdiction B, which trades B units. In this scenario, differentials between jurisdictions both in terms of (a) the Seller A converts the A units being sold into International environmental integrity (manifested as the value accorded Transaction Units (“ITUs”) at the applicable exchange rate; to traded assets when surrendered) and (b) the price of Buyer B then buys the number of B units into which those the traded assets? Or should there be ‘only one moving ITUs convert, at the applicable exchange rate. The B units part’, so to speak? are transferred to Buyer B’s account in the Jurisdiction B registry, relieving the Jurisdiction B scheme administrator An alternative approach to that outlined in the above of the need to make the conversion by issuing B units and scenarios would be if the exchange rate were to be cancelling A units. The exchange rate for A units converted reflected only in the price. However, this would mean that to ITUs50 would be derived from the MV of Jurisdiction A each jurisdiction could only ever buy its own units. This relative to the Index. Similarly, the exchange rate for the is because if lower value units were to be bought from conversion of ITUs to B units, would be derived from the another jurisdiction, the environmental integrity of the value of the Index relative to the MV of Jurisdiction B. 48 This might include an index based on reference to a global emissions budget, or similar concept, discussed later in this Section. 49 For illustration, the Index could be based on a basket of, say, the average of MV assessment outcomes for all the jurisdictions engaged in Networking, weighted according to their respective GHG emissions. Note however, that indices all have their own method of calculation and the Index could be constructed in any one of many different ways. 50 Whether these ITUs themselves would be tradable, or simply notional units for the purposes of facilitating transactions, is another issue that is touched on briefly in Section 5.3. 51 This issue considered by Jennifer Austin, in ‘Networked Carbon Markets—Concept Development—Using Mitigation Value to Guide Design of Trading Rules’ and being addressed through modelling exercise, described in in Sections 5.5 and 8.3 of this paper. 24  Trading between Jurisdictions overall system might again be impaired. Overvaluing low account by the scheme administrator/regulator in the MV units has the same effect as converting high MV units buyer’s jurisdiction, such as: into a bigger number of low MV units (which still equate • If the unit is transferred into the buyer’s registry to emission rights). But, as noted, this situation would be account in the buyer’s jurisdiction: avoided if each jurisdiction could only ever buy its own units. Market participants might be more receptive to such • If the exchange rate is not binding, for instance, a mechanism, as it would be simpler to understand and because participating jurisdictions have not interpret movements in the market. The drawback is that agreed to be bound by it, then the scheme jurisdictions could not trade with each other directly, but administrator/regulator in the buyer’s jurisdiction rather might only do so indirectly through a market maker. may or may not take account of the relative MVs This alternative is further elaborated later in this section. at the time the unit is surrendered under that scheme; To summarise the transaction mechanisms floated above, see Table 1. • If, on the other hand the jurisdictions have given the exchange rate binding, or official status, then the scheme administrator/regulator in the 5.3.  Relationship between Mitigation Value, buyer’s jurisdiction may be bound to reflect it, Settlement Platform, and ITUs and the Index and hence relative MVs, in the value accorded This section, firstly, revisits MV in more detail and, in so to the unit on surrender. However, this may doing, considers the role and function of the settlement be affected by any time delay between the platform; and secondly, examines the concept of ITUs in transaction date and the date when the unit is more detail, and the feasibility and potential benefits of an surrendered; index. • If the transaction mechanism provides for conversion into units under the buyer’s jurisdiction at the time of Relationship between MV and Role of Exchange Rate the trade, then the units received will all be treated When units of a mitigation outcome from one jurisdiction the same and so the decision is taken out of the are traded into another, comparison of the MVs is one hands of the scheme administrator/regulator in the way to provide an exchange rate. There are a number of buyer’s jurisdiction. The relative MVs, through the options for how the exchange rate might be taken into exchange rate, will determine the number of those units received—hence determining the total value on the transaction date. Table 1: Summary of Transaction Mechanisms Scenario Price No. of Units on Trade Occurring Administration 1. Foreign unit Depends on market, but Depends on exchange rate Decentralized converted exchange rate relevant 2. Foreign unit Depends on market, Depends on exchange rate Decentralized and more imported exchange rate possibly less complex relevant due to surrender value uncertainty 3. International Depends on market, but Depends on exchange rate Centralized Transaction Unit exchange rate relevant transaction currency 4. Via market Depends on market, Will be whatever number buyer Centralized maker, no direct exchange rate very relevant contracts to purchase trade between counterparties Trading between Jurisdictions  25 Table 2 summarises these possibilities. need to be clearinghouse member firms that would act for counterparties to transactions. Under this structure, just It can be seen that a critical link between the MV and the as with the exchange traded segment of the FX market, surrender value is the exchange rate, which is derived there would be daily marking to market and settlement, from the MV assessment process outcomes. How the MVs and margin calls, thus frequent payments to and from translate into the exchange rate, by whom the process is brokers and clearers, reducing counterparty default risk as carried out and the supervisory regulation exercised over well as the risk of fraud. that process, and the nature of the exchange rate, itself, once it has been derived, for instance, how dynamic it is, For such an arrangement to be viable, however, it would are all fundamental issues, considered by other papers need to be supported by an adequate volume of trading. commissioned under the NCM initiative.52 If all transactions needed to take place via a single centralised settlement platform, this would be more Nature and Role of the Intermediary— likely.53 It is probable also that, with such an arrangement, The Settlement Platform the risk of double counting (as well as fraud) could be more easily controlled. Whatever the transaction structure, there will need to be a way to effect the physical and financial settlement of The settlement platform would need to be linked to the transactions. This will be the case irrespective of whether scheme registries of the participating jurisdictions. As such, the transactions are over-the-counter (OTC) or exchanged it would make sense for the settlement platform to either traded. Hence, for the purpose of the transaction incorporate or be linked also to a central registry tracking scenarios set out above, it was assumed that there would the movement of carbon assets between jurisdictions be an intermediary—the settlement platform (referred to across all Networking markets.54 This would provide as the “International Settlement Platform”) through which a means to ensure double counting was avoided.55 A trading would take place. central registry could also facilitate an audit mechanism for cross-checking the individual scheme registry holdings. The settlement platform would probably also provide central counterparty clearing, since settlement and clearing Apart from a settlement platform, central clearing are frequently handled together. For clearing, there would counterparty and registry, the other type of institutional Table 2: Summary of Transaction/Exchange Rate Outcomes Transaction Mechanism Exchange Rate Outcome Asset unit transferred to buyer’s account Not official for scheme administrators Value determined by buyer’s scheme administrator Asset unit transferred to buyer’s account Official as between scheme MV informs exchange rate, buyer’s administrators scheme administrator takes into account in determining value on surrender—but note, also may be affected by time delay between transaction and surrender Asset unit converted into buyer’s units Exchange rate applied in transaction MV informs exchange rate, which at transaction to determine number of buyer’s units determines number credited 52 E.g.,Jennifer Austin, Networked Carbon Markets—Concept Development—Using Mitigation Value to Guide Design of Trading Rules. 53 This is envisaged under the NCM proposals—the International Settlement Platform. 54 The International Transaction Log (ITL) under the Kyoto Protocol and the European Union Transaction Log (EUTL) under the EUETS provide models for centralised checking of transactions and holdings. For example, the EUTL automatically checks, records, and authorizes all transactions that take place between accounts in the Union registry. This verification ensures that any transfer of allowances from one account to another is consistent with EUETS rules. The Union registry centralised the national registries of the 31 participating states in 2009. 55 Although, if the transaction mechanism was index-based with ITUs, conversion into and out of ITUs should ensure that this is the case. 26  Trading between Jurisdictions entity that may be involved in the transaction is the ICAR for the role, since ICAR may probably need to be international carbon asset reserve (ICAR). The settlement active in the markets engaging in Networking anyway. platform/central clearing and registry functions could be A drawback of this proposal is that jurisdictions would fulfilled without needing also to include the ICAR function. not actually be trading with each other, but just with It is beyond the scope of this paper to look at the purpose the market maker, so it would be a more indirect form and role of the ICAR (mentioned briefly at Section 6.6).56 of Networking. However, if there is a limited trading However, the ICAR role would be to support environment when networking begins, the introduction administrators of the schemes participating in Networking of a single market maker might be useful for generating to maintain domestic prices in the target ranges envisaged liquidity. Such an arrangement may prove helpful in by the policies of their respective jurisdictions. If so, this fostering initial trading and promote familiarity with would seem to be more policy related and fundamentally concepts such as MV, MV assessment and the exchange different to the transactional management nature of the rates based on it. settlement platform/central clearing/registry functions. Irrespective of the transaction mechanism which is applied Sole Market Maker Function in Networking, there will be scope for MV assessments and the exchange rate to be based around a ‘transaction As an alternative way to remove the risk to the currency’ and an index. Consideration is now given to the environmental integrity of the scheme, where traded units feasibility and potential benefits of doing so. convert to a greater number of domestic units, hence more emissions, it is worth considering the possibility International Transaction Unit that the intermediary/settlement platform, or ICAR, or the two in conjunction, might also act as sole market Mention has been made in Section 5.2 of the benefit to maker, quoting both bids and offers and standing ready be derived by introducing a transaction ‘vehicle currency’, to make a two-sided market for compliance entities in in the form of International Transaction Units (ITUs). As any participating jurisdictions who wish to trade mitigation noted, the introduction of the ITU, would be analogous outcome units, for whatever reason, externally to their to the use of the US$ as a “vehicle” currency in FX domestic situation. The idea would be that both the transactions. However, the fact that the US$ is the most offer/bid prices and the buy/sell spread would reflect the widely transacted currency reflects not only its use as a exchange rate in the case of any jurisdiction. vehicle currency in FX transactions, but also its roles57 as: If the market structure were such that a single market • investment currency in many capital markets; maker was counterparty to all transactions, where an • reserve currency held by many central banks; entity sought to buy units from a seller outside their jurisdiction, or wished to sell excess units to a buyer • transaction currency in many international commodity outside their jurisdiction, application of the exchange rate markets; would affect only the price. Hence the exchange rate • invoice currency in many contracts; and would not determine the number of mitigation outcome units transacted. The scheme administrator or each • intervention currency used by monetary authorities. participating jurisdiction would still only ever deal with its The reasons for this have been touched on briefly above. own domestic units. It is unlikely the ITU would perform similar roles (except Whatever entity were to perform such a role as the sole possibly as an asset for investment in its own right). In market maker, whether the intermediary/settlement fact, it is conceivable that ITUs might only exist in pending platform, or ICAR, the two acting in conjunction, or some accounts on the International Settlement Platform, for the other entity, it would need to be capitalized with units purpose of facilitating Networking transactions. If so, the from the participating jurisdictions. This may recommend extent of the ITU role would be that entities wishing to 56 See, for example, ‘Design Options for an International Carbon Asset Reserve’ prepared by Juerg Fuessler and Martin Herren, INFRAS Consulting Group, July 2015, Networked Carbon Markets, A Knowledge Series, World Bank Group. 57 Query the extent to which these other roles for the US$ underpin its role as a vehicle currency in FX trading? Trading between Jurisdictions  27 sell mitigation outcome assets would convert those assets of the KP.58 Other considerations that would need to be into ITUs (at the applicable exchange rate) and entities addressed include definition of its delivery mechanism, wishing to buy assets would need to hold ITUs in their how further definition or limitation might be made, how pending account for conversion into the desired asset legal restrictions on the use of an ITU might be made denomination (at the applicable exchange rate). However, and communicated, what facility an ITU would have as an if ITUs were to be introduced it is expected their role investment vehicle and how a price could be placed on it. would comprise more functions than just as a medium of exchange. Feasibility of an Index In summary, the benefits of introducing a ‘transaction As noted earlier, an index is a statistical composite vehicle’ unit such as the ITU include the following: that measures changes in the economy or a financial market, often expressed as changes from a base year or • reduces the number of exchange rates that must be a preceding month. Each index has its own method of dealt with in a multilateral system; calculation. Components may be weighted according to • can yield the advantage of fewer, larger and more certain characteristics, as in for example, a shares index liquid markets with fewer mitigation outcome asset weighted for market capitalisation. balances; The first question, then, might be what will the index • reduces informational needs, thereby fostering be a composite of? If it is an MV Index, then it could be simpler, less cost-intensive operations; formed by a basket of MV assessment outcomes for all jurisdictions involved in Networking, as in the transaction • should allow the Networking transactions to flow scenario in Annex D. Another possibility is a composite more rapidly and efficiently, reducing also the scope formed by a basket of MV assessment outcomes for all for error and capacity for manipulation and fraud; and sovereign (national) jurisdictions (irrespective of whether • ultimately, should result in less administration and they engage in Networking). There are many other lower transaction costs across the system. possible variations on this theme. In any case, however, the MV assessment outcomes for individual jurisdictions Irrespective of whether the ITU were to be notional or a would be compared against the composite. Which of tangible asset for investment, its purpose, how its value is these methodologies would be more appropriate for the derived, how and by whom it is created and issued and purposes of Networking and why that would be the case, pursuant to what authority, are characteristics that need are questions to be considered. to be considered and defined. Much further work will be required to elaborate and define this instrument. Components of the composite may be weighted, and there is any number of possible different weightings that For example, the ITU might be defined as a transaction might be applied to a basket of MV assessment outcomes unit for the purposes of facilitating trading between including, for example: Networking markets, its value being a function of the Index: this might be a composite average of the MV • weighting according to annual emissions; assessment values of all jurisdictions that have opted • weighting by some measure of economic size, such into Networking, weighted according to their respective as GDP; emissions budgets, which might be derived from the global level of emissions necessary for keeping average • weighting according to population size. global temperature increase to less than 2°C (or 1.5°C) If the Index is a composite of MV assessment outcomes above pre-industrial levels. Governments might agree by for all jurisdictions involved in Networking only, then treaty that ITUs be created and issued by an overriding the weighting might take account of factors such as the supervisory body established to ensure proper governance percent of the jurisdiction’s economy covered by the in globally Networking markets. trading scheme, or the percent of the jurisdiction’s overall Continuing this example, the environmental value of an emissions covered by the trading scheme. On the other ITU might be set at one metric tonne CO2-equivalent hand, from the perspective of traders, the most important gas, calculated using GWP as defined by decision 2 of weighting of the Index might be according to price. Again, the third meeting of the COP/MOP (Decision 2/CP.3) which of these methodologies would be more appropriate or as subsequently revised in accordance with Article 5 for the purposes of Networking and why that would 58 Cf. definition of a CER—Decision 17/CP.7 (Marrakesh Accords). 28  Trading between Jurisdictions be the case, are questions that need further detailed serve as a proxy for how effective the Networking market consideration. is performing to bring about mitigation. Ultimately, the questions to be answered are what information is the While it would be possible to have the Index as a Index communicating, and who wants it? Commercial composite in these terms, the question is what purpose exchanges offer index products to their clients after would it serve? An index of the MV assessment outcomes conducting thorough market research to ascertain what of all sovereign (national) jurisdictions (irrespective would be of most value to those clients. This may be a of whether they engage in Networking), whichever good approach to follow. way it is weighted, might serve to provide an indicator tracking the progress of countries generally towards the Benefits of an Index UNFCCC objective. Comparing an individual jurisdiction’s performance against such an index would provide a Direct comparison between jurisdictions may be exactly valuable independent marker on how well or poorly that what is better avoided, pointing to a clear benefit served jurisdiction’s mitigation actions were addressing emissions, by having the Index: no direct jurisdictional comparisons. relative to the weighted average. This would be of benefit As can be seen in transaction scenario (iii) in Annex D, to governments, as well as interested third parties. But interposing the Index avoids direct comparison of MV its application to Networking is not clearly apparent, as assessment between jurisdictions. All jurisdictions’ the comparison would not be like-with-like if some of the assessments are considered only against the Index, the jurisdictions included in the composite were not trading.59 weighted average of all such assessments. Similarly there would not be an exchange rate directly between Another possibility is for the Index to be a composite the mitigation outcomes of two jurisdictions, as all of a limited number of Networking jurisdictions’ MV mitigation outcome asset units are only ever exchanged assessments, based on pre-determined criteria for for transaction vehicle units (in the case of transaction inclusion in the basket. A model for such an index is the scenario (iii), ITUs, where exchange rates measure composition and valuation of the IMF’s Special Drawing jurisdictions’ mitigation outcome assets against ITUs). Rights (SDR) basket. In the case of SDRs, the basket comprises the five currencies60 issued by member states Another clear purpose served by the Index is that, by that had the largest exports of goods and services over the introducing the ITUs, there is a transaction mechanism to preceding five year period, and have been determined by provide for physical settlement not by the movement of the IMF to be ‘freely usable’, that is, widely used to make mitigation outcome asset units from one jurisdiction to payments in international transactions and widely traded another, but by movement of the value—the mitigation on exchange markets. value—that they embody. Hence each jurisdiction will only ever need to deal with its own mitigation outcome units.61 What the pre-determined criteria for inclusion in a limited Networking basket might be, to ensure validity Another benefit of this mechanism is that investors of application of such an Index, requires careful and market makers might need only to hold ITUs in a consideration. The criteria for inclusion could, for example, pending account on the international settlement platform, be derived so as to ensure the basket provided a more rather than maintaining accounts in denominations of stable yardstick, rather than one for which the basket all participating jurisdictions in which they might wish to composition changed regularly. Stability would foster trade. This would significantly reduce transaction costs and greater confidence in the Index. However, it would also be administration, making participation in the market a more important that the basket covered a substantial part of the attractive option.62 overall market in mitigation outcome assets, for the Index to be relevant for traders. Other Benefits? A further possibility would be for the Index to be based Can the use of the Index bring other benefits, such as on a basket of the MV assessment outcomes of all greater liquidity, to the NCM? As a statistical composite, jurisdictions engaged in Networking. Such an Index could there is no capacity to invest in the Index itself. An investor 59 Query whether this would be a technical problem with the Index? 60 China’s renminbi added 2015. 61 Note that in the case of the sole market maker proposal, this would be implicit, so the Index would not add anything in this respect. 62 Although with the sole market maker proposal, if the carbon assets were converted into and held as ITUs, their electronic certificates would need to have identifiers to show from which jurisdiction they originated; since they would just be converted back to the mitigation outcome assets of that same jurisdiction, query what benefit would be gained from holding them as ITUs. Trading between Jurisdictions  29 or market maker that wished to trade speculatively might participating jurisdictions may accept project credits hold ITUs, just as they might hold units of the mitigation under the terms of their scheme: introduction of project outcome assets under any of the individual schemes, or credits to Networking cannot be assumed as automatic. hold project generated credits if these are tradable under An index-based transaction mechanism might help Networking. As proposed in scenario (iii) in Annex D, overcome this difficulty, as the risk-assessed project the ITUs would only come into existence as a result of credits would be converted to ITUs, which in turn would a jurisdiction’s mitigation outcome asset units, or project be converted at the applicable exchange rate to the asset credits (if included), being converted into ITUs. In order denomination of a buyer’s jurisdiction, eliminating the risk to hold ITUs, the investor would need either to have of non-acceptance of the project credits by the scheme purchased them as ITUs, or to have converted units administrator.64 Participating jurisdictions would need to from one of the participating trading schemes, or project be in agreement over the methodology for inclusion of credits, into ITUs. As envisaged, the ITUs would exist in risk-assessed project credits, in the first place. pending accounts on the settlement platform and of An index can form the basis for an investment fund, themselves would not be able to be surrendered against as in the case of some exchange-traded funds (ETFs). the compliance obligations of any participating scheme, However, whether investment funds based on the Index but might also be capable of being traded on other would add to liquidity in the Networking would depend exchanges. Thus the ITUs might serve two purposes: on how actively those funds were traded, rather than the firstly, as the ‘transaction currency’—a simple pass through fact that there is an index on which they are based. ETFs to facilitate transactions; and secondly, as an investment themselves have a widely varying range of liquidity. The vehicle, a store of value. popularity and hence degree of trading in a fund would The degree of liquidity in the Networking will depend on be more a function of how it is set up, its overall structure, the number of buyers and sellers there are willing to trade rather than just the fact that it is based on an index. across jurisdictions. This in turn, will be a function of the It is noted also that an investment fund based on an MV potential arbitrage opportunities from one participating index may be holding carbon assets, but investors will jurisdiction to another. The ability of investors to hold ITUs be trading shares in the fund.65 The mechanism for how would increase their ability to find those opportunities, such a structure may generate liquidity in Networking not least because it would facilitate price disclosure across is yet to be explored, as are other possible structures the entire market at a glance. However, it also raises the and indices. Other products such as forward contracts question of whether, in maintaining holdings of ITUs, the based on the Index, or spreads between future prices of investors wouldn’t at the same time be draining supply, the Index and the mitigation outcome assets of various hence liquidity, from the market. jurisdictions, could also generate liquidity and depth in the This is a relevant consideration in a market based on market. It is likely that commercial exchanges such as the a number of ETSs, since by definition, in an ETS there LSE, EEX and ICE would develop derivative products along is a limited, finite number of asset units available, with these lines. that number, in theory, reducing over time. Networking addresses this by facilitating compliance entities from one ETS accessing assets from another ETS. But as all 5.4.  International Settlement Platform participating schemes are based on the same premise, An international settlement platform is one of the three namely that a limited, finite number of mitigation outcome key elements of the NCM concept and numerous assets is available, and is reducing over time, this benefit references to its role are made in the preceding is, to a degree, nugatory.63 paragraphs of Section 5.3. The presumption is that The limited supply issue would, of course, be countered transactions between Networking markets will need to be by project credits being available. However, not all on an exchange traded basis, rather than over-the-counter 63 This issue of satisfactory balancing of supply and demand to ensure that the Networking, as well as its constituent trading schemes, continues to provide a price signal in keeping with the overall UNFCCC policy objective is principally addressed by the NCM proposal for an International Carbon Asset Reserve (ICAR). While this is the subject of research by other parties for the World Bank, it is noted that ICAR may have a significant role through the Index by acquisition and disposal of ITUs. 64 NB: the inclusion of project credits will have a bearing on how the index is devised: needs further consideration as introduces potentially invalid comparisons. 65 Exact mechanism will depend on fund structure. 30  Trading between Jurisdictions (OTC). Detailed consideration will need to be given to NCM work plan is reviewing seven design options for MV- how this might operate and work on this undertaken by based trading rules. Networking partners will be referenced or included in Table 3 is taken from the terms of reference for phase further iterations of this paper in due course. 1 of the modelling and simulation exercise. The exercise requires modelling of inter-jurisdictional trading and inter- 5.5.  Avoiding Perverse Outcomes: sectoral trading within a jurisdiction using each of the Trading Rules seven types of trading rules set out. Insights derived from modelling and analysis work As evident from the descriptions of the options, the done for the NCM initiative as well as in other contexts, exercise aims to cover the range of possible approaches highlights the risks that trade flows based on exchange that governments might take with a view to protecting rates, under certain market conditions, may give rise to the environmental integrity of schemes and avoid trading perverse outcomes such as an increase in emissions.66 giving rise to perverse outcomes such as an increase To examine this risk more thoroughly, the modelling and in emissions. The modelling and simulation exercise is simulation exercise being conducted as part of the 2016 elaborated in more detail in Section 8.3 of this paper. 66 Stockholm Environment Institute (Michael Lazarus, Lambert Schneider, Carrie Lee, Harro van Asselt) for the International Carbon Action Partnership (ICAP), Options and Issues for Restricted Linking of Emissions Trading Schemes, May 2015; Jennifer Austin, Networked Carbon Markets Concept Development—Using Mitigation Value to Guide Design of Trading Rules, September 2015 (prepared as part of NCM initiative, unpublished). Trading between Jurisdictions  31 Table 3: Range of Scenarios for Modelling Trading Rules Type Option Description Binding 1A: Governments adjust both The regulator discounts all allowances (both domestic and domestic and imported allowances imported) in order to allow all units to reflect the true mitigation to reflect the true MV value. Binding 1B: Governments assign premiums A government might choose to ‘invite’ foreign units by assigning and discounts to imported units a premium to imported units from jurisdictions with a higher mitigation value. At the same time, governments may also choose to discount imported units from jurisdictions with a lower mitigation value. The premiums and discounts are based on the relative mitigation values. Binding 2a: Governments restrict imports A government might choose to discount imports from (based on relative mitigation value) jurisdictions with a low mitigation value to preserve the environmental integrity of their own scheme. At the same time, the regulator may choose to not assign a premium to imports that have a higher mitigation value, in order to avoid the increase in overall emissions that is depicted in Scenario 1B. Binding 2b: Governments restrict imports Similar to Scenario 2a but discounting reflects the actual (based on actual mitigation value) mitigation value of imports, rather than relative mitigation value. Guidance 3: Actual MV as the minimum Similar to Scenario 2a but further discounting could be applied discount factor based on other considerations (e.g., political/economic factors). Guidance 4: Discounts on import fluctuate in Similar to Scenario 2b, but governments may wish to discount accordance with an actual MV range foreign allowances—within a set MV range—to ensure a balance between regulatory flexibility and certainty. Binding Constant ambition factor Tradable units are capped at a certain level in order to adjust for relative ambition. The ‘constant ambition factor’ will be applied in addition to the trading rules in Scenarios 1 to 4. 6. Institutions Building on analysis of existing financial markets, this to put them in an overall context by quickly reviewing all section considers the types of institutions that might be the institutions and parties that might be involved (see suitable to participate in the mitigation value assessment Table 4). process, providing practical examples, and considering Diagrammatically, the institutions, parties and their the types of expertise and tools those institutions might relationships might possibly look something like Figure 7. leverage. However, before proceeding, it may be helpful Table 4: Overview NCM Institutions and Parties Institutions and Parties Comment Individual jurisdictions opting into NCM Each maintains their own scheme registry Compliance entities from individual jurisdictions Engage in trading across jurisdictions Other market participants Brokers, dealers, market makers: private sector entities Suitable entity/entities to perform MV assessments Considered in Section 6.1 of this paper Regulatory supervisory body for MV assessments Considered in Section 6.2 of this paper Exchange rate determination and regulatory supervision Considered in a separate paper commissioned by NCM Settlement platform and clearing Considered in a separate paper commissioned by NCM and see Section 5 in general Central registry Could be linked to settlement platform, see Sections 5 and 7 ICAR Considered in a separate paper commissioned by NCM Overriding governance structure for NCM Considered in Section 6.7 of this paper and in a separate paper commissioned by NCM Figure 7: Schematic of Possible NCM Market Structure Overarching Supervisory Body Central Settlement Regulatory Regulatory Supervisory ICAR? Supervision of Registry Platform/Clearing Body for MV Assessment Rate Setting Trading Exchange Suitable Entities Rate Setting Performing MV Assessments Jurisdiction A Jurisdiction B Jurisdiction C A1 A2 A3 B1 B2 B3 C1 C2 C3 32 Institutions  33 This section begins by examining what the mitigation statistical analysis and mathematical modelling, critical value assessment process requires of a ‘suitable weighting of factors, detailed and extensive research, institution’, including in terms of tools and expertise. and the exercise of experienced, expert judgment; Without disregarding the possibility of other options, • as a relative measure as between jurisdictions, it two specific examples of types of institutions that, at would involve a process similar to rating processes, least in part, already may meet the requirements of the that is, design of a process to score the mitigation process are considered. It also considers options for effectiveness of jurisdictions’ mitigation actions. regulatory supervision of the MV assessment process. Other institutions involved will include those participating These technical requirements presuppose: in the exchange rate setting process, registries, the ISP • financial resources necessary to ensure in-house (or (international settlement platform), ICAR (international access to) research materials; carbon asset reserve) and the approach that might be taken to determining an appropriate institution to exercise • not only the ability to access and obtain databases overarching regulatory supervision, such as the UNFCCC. and datasets, but also: • the ability to store the information, 6.1.  Suitable Institutions to Perform • to assess, analyse and interpret the information, MV Assessments • the capacity to evaluate and form opinions based What Does the Process Require on that information, and of a ‘Suitable Institution’? • the capacity to communicate the outcomes of What are practical examples of the types of suitable these deliberations in meaningful ways that are institutions that would participate in the mitigation value readily accessible to stakeholders; assessment process? What tools and expertise would they • mathematical analytics; need to leverage? To answer these questions, the logical starting point is to consider what that process is, what it • skilled and experienced personnel, premises in entails: which to house those personnel in suitable locations (probably needing to be near a financial centre), • ‘assessment’ requires suitably qualified analysts, appropriate organisational IT and communications access to relevant information and the hardware for infrastructure; the analysts to evaluate that information; • these personnel requirements presuppose not only • it is posited that ‘mitigation value’ means a measure financial resources, but the appropriate support of mitigation impact—the effectiveness of their systems such as an effective management structure, mitigation actions—emission reduction programs—in operational and administrative systems, training and ‘mitigating’, which takes account of their respective governance systems. jurisdictional ‘circumstances’, so on this basis, analysts need to be qualified in: Bearing these requirements in mind, a minimum size of organisation would appear to be necessary, needing to be • assessing emission reduction programs and capitalised to a minimum extent. In view of the need to other mitigation actions, avoid conflicts of interest or perceptions of bias, it is unlikely • evaluating mitigation action effectiveness, that national or sub-national public sector bodies would be suitable. It is possible that a multilateral agency might be • evaluating mitigation action ambition, or pledges, considered suitable, however, this might also be viewed as • evaluating jurisdictional circumstances and all ‘putting all the eggs in one basket’, limiting the scope for a that entails,67 and diversity of views and methodological approaches, and also increasing the potential for bureaucratic hurdles. So, focusing apart from being able to review and evaluate large on private sector entities, a certain type of organisation amounts of factual information, the analysis needs would more readily have the personnel profile and internal to be able to account for large data sets, complex infrastructure to undertake the process elements described 67 See, for instance, jurisdictional elements listed in Section 3, Sub-section G, preceding. 34  Institutions above. These considerations point initially towards: (a) Historically, sovereign debt has been zero risk rated when credit rating agencies; and (b) organisations that have been determining the capital holding requirements for banks (at accredited as Designated Operational Entities (DOEs), under least in the eurozone). However, in the wake of the Greek, the Kyoto Protocol. Spanish, Irish and other credit crises, this policy has been raised for discussion by governments.68 This is not to exclude other organisations that might equally undertake such operations, such as: Points to Be Drawn from Consideration of Credit • large international (ex-accountancy) consultancies Ratings and Credit Rating Agencies (PwC, KPMG, EY, etc.); A number of important points can be drawn from the • investment banks; experience of credit ratings and credit ratings agencies: • large global accounting firms or other large global • Just as is the case with credit rating agencies, suitable multi-disciplinary consultancies (e.g., non-DOE institutions for performing the MV assessment environmental consultancies); process should be independent, private sector and, preferably, for-profit organisations. The aim would • organisations like Climate Action Tracker (a be to avoid any potential risk of national, or sub- consortium of consultancies and NGOs); or even national jurisdictional bias, or even the perception of • large global law firms (now that they can have multi- such bias, on the part of the entities carrying out the disciplinary teams), or assessments. For-profit organisations are preferred, as most not-for-profit organisations derive some • consortia, made up from combinations of any of form of governmental benefit—even if only in the these types of organisations. form of non-taxable status, and this could leave open suggestions of partiality, no matter how unfounded; Credit Rating Process Similar to MV Assessment Process • Suitable institutions should be subject to regulatory supervision: To the extent that this exercise is to look for suitable institutions to participate in the ‘mitigation value • This is now the case with credit rating agencies assessment process’, it is worth considering that the under, for example: closest comparable business process would be that • the EU Regulation on Credit Rating carried out by credit rating agencies in rating public sector Agencies—Regulation (EC) 1060/2009, and debt and public sector issuers of debt, including sovereign governments. • in the US, the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act; It is in the context of the bond market, and in relation to debt and borrowings generally, that the concept of ratings • Under the EU Regulation, for instance, credit is most often used. When borrowing, sovereigns, all levels rating agencies must fulfil certain obligations, of government, corporate borrowers, even individuals, are such as: rated on their creditworthiness, that is, their willingness • avoiding conflicts of interest; and capacity to meet their commitments: to pay interest and repay their capital borrowing. Continuing the analogy • ensuring the quality of their ratings and for Networking, the jurisdiction issuing the carbon asset rating methodologies; and would be evaluated as a whole, in terms of the MV of the • ensuring transparency; mitigation actions in place to achieve mitigation outcomes from within its boundaries. An ETS would be evaluated • Under the EU regulation, credit ratings agencies as a part of this MV assessment process. The MV of the will be subject to a high level of supervision, jurisdiction could be considered relative to that of other including investigatory powers, centralised under jurisdictions (or against a composite weighted average European Securities & Markets Authority (ESMA); thereof), to give an ordinal ranking similar to that of • What might be appropriate in this respect is sovereign or other governmental issuer credit ratings. considered more in Section 6.2; Additionally, it is noted that the risk weighting of sovereign debt has arisen in the context of bank capital adequacy. 68 Financial Times, 2 May 2016, ‘Sovereign risk system needs reforming’ Patrick Jenkins. Institutions  35 • There should be encouragement for a multiplicity of • knowledge-base; organisations to become MV assessment agencies: • management systems and personnel; the greater the number of suitable organisations there is, independently performing MV assessments, • training; and in theory, the greater the reliability of the MV • any other matters pertinent to the assessment process should be. In light of some of requirements mentioned above; the criticism levelled at the credit ratings sector in the wake of the global financial crisis,69 it would • The methodologies for carrying out the MV be preferable to avoid a small number of large assessment process should either be: organisations dominating the market, for example, (i) specified by the supervisory body; or it has been reported that just three organisations, Moodys, S&P and Fitch, have about 95% of the (ii) accredited by the supervisory body and global credit ratings market;70 transparent, for example, by being made publicly available: the opacity of ratings • Remuneration of MV assessment agencies should be methodologies was another criticism structured so as to avoid potential conflicts of interest levelled at the credit ratings sector in the or the perception of such and, if possible, so as to wake of the global financial crisis;71 foster desired policy outcomes: • While suitable institutions for conducting MV • The ‘issuer pays’ model, (versus subscriber pays) assessments should be afforded regulatory which is the usual method of remuneration in recognition, this should not be allowed to credit ratings at the very least gives rise to a become a hurdle for potential new entrants; perception of possible conflicts of interest risk; • In considering the types of organisations that • One possible alternative approach to might be suitable institutions for conducting remuneration for MV assessment agencies might MV assessments, it is important to remember be to have a small levy on transactions arising that, from the perspective of both their core from Networking (as in the example of Share business and their regulatory obligations, credit of Proceeds (SOP-Admin) in CDM) to create rating agencies are solely focused on rating a pool from which MV assessment agencies their subjects’ creditworthiness, that is, the would be remunerated. This and other possible willingness and capacity to meet commitments: approaches need to be explored; to pay interest and repay capital. Hence, while • The type of organisation and the number will there are useful principals to be drawn from the ultimately be up to the relevant supervisory body; experience of credit rating agencies, per se, they however, it is suggested that: may not be suitable institutions to conduct MV assessments. • Organisations should be required to satisfy minimum criteria in order to be considered DOE Roles and Functions Comparable suitable to become an MV assessor, including for to MV Assessment Process example: The other types of organisations that have experience • technical and financial capacity; conducting similar types of assessments to those • access to resources; envisaged in the MV assessment process are Designated Operational Entities (DOEs), accredited under the Kyoto • governance; 69 World Bank Group, Financial and Private Sector Development Vice Presidency, ‘Credit Rating Agencies, No Easy Regulatory Solutions’, Crisis Response, Public Policy for the Private Sector, Note Number 8, October 2009, http://siteresources.worldbank.org/ EXTFINANCIALSECTOR/Resources/282884-1303327122200/Note8.pdf, accessed 15 April 2015. 70 European Commission, Memo/ 13/571, 18 June 2013, New Rules on Credit Rating Agencies (CRAs) enter into force http://europa.eu/ rapid/press-release_MEMO-13-571_en.htm, accessed 15 April 2015; note that this was in part due to the quasi-regulatory status they were afforded as “nationally recognised statistical rating organisations” per 1975 US SEC Regulations. 71 Note 70 supra. 36  Institutions Protocol. DOEs will have already had a taste of the type activities relating to the consideration of project activities of assessments described, albeit in the context of CDM as follows: projects, and Programmes of Activities (POAs). • list of project activities; DOEs are accredited by the CDM Executive Board and • status of project activities; designated by the COP/MOP72 to undertake usually either validation, or verification and certification, of CDM • regional distribution of project activities; projects and POAs. They are independent auditors that • sectoral distribution of project activities; assess whether a potential project meets all the eligibility requirements of the CDM (validation) and whether • list of project activities declined, if any, including the the project has achieved greenhouse gas emission reasons for doing so; reductions (verification and certification). In one sense, • list of the project activities undertaken in countries the experience of DOEs is more pertinent, since it having less than 10 registered project activities; involves risk-based evaluations of processes designed to mitigate GHG emissions. However, in another sense • number of project activities under validation or it is more limited, since it might be characterised as a verification per qualified auditor; rule-based audit process of mitigation activities, based to • average timeframes for the validation and verification some degree more on box ticking for past activities and of project activities (from the signing of contract to to a lesser extent on judgment of future outcomes and submission of the request to the CDM EB), divided directions. by region; The roles and functions of DOEs include: • average fees for the validation and verification of • validating proposed CDM project activities; CDM project activities, divided by region. • verifying and certifying reductions in anthropogenic DOE functions are to independently audit the project emissions by sources of greenhouse gases; methodologies, including baselines and to assess whether the project has achieved the intended mitigation. • complying with applicable laws of the Parties hosting In this sense their roles are very much aligned with the CDM project activities when carrying out functions; types of activities that suitable institutions participating • demonstrating an absence of real or potential conflict in the mitigation value assessment process would be of interest with the participants in the CDM project expected to carry out, that is, in relation to the subject activities for which validation or verification and matter. However, as noted above, the actual activity certification functions are being carried out; performed being more a rule-based audit process of mitigation activities, would probably be less aligned than • maintaining a publicly available list of all CDM project the activities carried out by, say, credit ratings analysts. activities validated, verified and certified; The analysts employed by DOEs would clearly satisfy at • submitting an annual activity report to the Executive least the first two requirements outlined above, that firstly, Board; they need to be qualified in assessing emission reduction • making information obtained from CDM project programs; and secondly, they need to be qualified in participants publicly available, as required by the evaluating mitigation effectiveness. On the other hand, Executive Board. Information marked as proprietary or analysts from credit ratings agencies would be more likely confidential shall not be disclosed without the written to satisfy the third requirement, that they need to be consent of the provider of the information, except as qualified in evaluating jurisdictional circumstances and all required by national law. that entails. It can be seen that the DOE roles and functions are Points to Be Drawn from a Consideration of DOEs quite closely prescribed. The CDM Executive Board is prescriptive in its approach to supervising performance Guidance and regulatory supervision of the MV by the DOEs of their roles and functions. For example, assessment process is considered in more detail in the annual activity report must include information on Section 6.2, however, to summarise the preceding 72 Conference of Parties to the Convention serving as the meeting of Parties to the Protocol. Institutions  37 points, it is noted in relation to DOEs under the Kyoto 6.2.  Regulatory Supervision of MV Protocol that: Assessments • the subject matter of their activities is directly relevant MV and the MV assessment process are integral to as it relates to risk-based evaluations of processes the NCM initiative. Given the need to avoid, and to be designed to mitigate GHG emissions; perceived to avoid, conflicts of interest in undertaking the • consequently, DOE analysts need to be qualified MV assessment process, it is unlikely that state entities or in assessing emission reduction programs and in even intergovernmental organisations could be involved evaluating mitigation effectiveness; in performing this role. This section has proceeded on the basis that the MV assessment process would be • however, the process they carry out might be best carried out by independent, private sector, for-profit characterised more as a rule-based audit process of organisations, to the extent feasible, without connections mitigation activities; and to the government of (a) their domicile, or (b) their • the CDM Executive Board exercises a tight rein on the location of residence for tax purposes, or (c) their main scope of their activities. operational location. In spite of the current lower level of demand for certified On the other hand, it is likely that an intergovernmental emission reductions produced by CDM registered project organisation, or organisations, will have an important activities and programmes of activities, there were still role to play in providing regulatory supervision of both fifty-one entities accredited and provisionally designated the entities that carry out the MV assessments and to carry out various ranges of sectoral scopes by the of the process itself. In view of the importance of the Executive Board in the period October 2013 to September MV assessment process and the proposition that it be 2014, as reported to the COP/MOP in December 2014.73 conducted by the private sector, regulatory supervision This suggests there is a large potential pool of suitably of the MV assessment agencies and the MV assessment qualified professionals available from this source. Whether process is a critical part of the model. But what level of this potential might be borne out, depends to a degree on regulatory supervision will be required and why? the processes carried out by these entities and the quality of the training provided to their analysts. Financial Regulation In considering these questions, it is noted as a broader Suitable Institutions to Participate in the Mitigation point, that mitigation outcomes will be regulated as Value Assessment Process financial instruments in some jurisdictions. This may A conclusion that might be drawn from the foregoing is not be the case in all jurisdictions that potentially may that the type of institution most suitable for participating in participate in Networking. Furthermore, where they the mitigation value assessment process may be one that do apply, the financial regulations may apply to some combines the skills, knowledge, experience and resources carbon assets, but not to others. For example, in the EU, of a credit rating agency with that of an organisation that Directive 2014/65/EU,74 defines ‘financial instrument’ has been accredited as a DOE. to include emission allowances, consisting of any units recognised for compliance with requirements of Directive It is suggested that suitable institutions should be 2003/87/EC (Emissions Trading Scheme).75 This means independent, private sector organisations. They would that EUAs and some, but not all, CERs are financial need to be well resourced technically and financially, and instruments. Other mitigation outcomes that may come should be subject to regulatory oversight. Encouragement under Networking do not fall within that definition. In time, should be provided for a reasonable number of these financial regulations may need to be modified to organisations to participate in the MV assessment process take account of mitigation outcomes under Networking and consideration should be given, in particular, to how more uniformly. However, the basic point is that there they are remunerated to avoid the potential conflict of already exist bodies of rules that will need to be taken interest, inherent in ‘issuer pays’ arrangements. 73 Annual report of the Executive Board of the clean development mechanism to the Conference of the Parties serving as the meeting of the Parties to the Kyoto Protocol. Lima, Peru. December 2014. http://unfccc.int/resource/docs/2014/cmp10/eng/05.pdf, accessed 17 August 2015. 74 Directive on Markets in Financial Instruments and Amending Directives 2002/92/EC and 2011/61/EC (‘MiFID II’). 75 Directive on Markets in Financial Instruments and Amending Directives 2002/92/EC and 2011/61/EC (‘MiFID II’), Annex I, Section C, paragraph (xi). 38  Institutions into account in developing Networking and, once the such ratings can be made per year, the timing of Networking is functioning, observed by participants. publication of outcomes, and for six-monthly (as opposed to annual) reviews; Regulation of CRAs • make CRAs accountable for their ratings, which are Returning to regulatory supervision of the MV assessment no longer considered ‘mere opinions’; process in particular, reference has been made to US and • require publication of all ratings on a European EU rules above in the context of credit ratings. These rules Rating Platform (established by ESMA) to improve of themselves would not directly apply to MV assessment, comparability and visibility of all ratings; since they deal specifically with credit rating agencies (‘CRAs’). Hence, irrespective of whether mitigation • address conflicts of interest by imposing restrictions outcomes in Networking are characterised as financial on shareholdings covering CRAs and rated entities instruments and Networking as a financial market, it will and requiring rotations of CRAs at least every four still be necessary to provide specifically for regulatory years where the ‘issuer pays’ model applies; supervision of the MV assessment process and the • encourage issuers to use smaller CRAs with less institutions considered suitable to undertake that process. market share to encourage broadening of the market. To illustrate an approach that might be taken for regulatory The CRAs still devise and apply their own ratings supervision of institutions undertaking MV assessments, it methodologies. However, process timing requirements is useful to consider the CRA regulations more closely. For mean issuers have more time to respond before they are example, the EU Regulation on Credit Rating Agencies— made public, so at least there is time for factual errors to Regulation (EC) 1060/200976 includes provisions that: be rectified and publication is less distortive of markets. • to perform ratings for regulatory purposes, a CRA If CRAs intend to change materially existing or use new must be registered and in order to be registered, methodologies, models or key rating assumptions that must fulfil certain obligations (i) on the conduct of may impact rating outcomes, they must first publish the their business, (ii) intended to ensure the integrity intended changes and invite comment for a fixed period, and independence of the rating process and (iii) to together with detailed explanation of the reasons and enhance the quality of the ratings issued; implications. • the European Securities and Markets Authority DOEs and the CDM Executive Board (ESMA) is responsible for registering and directly supervising CRAs; The other specific example considered in relation to suitable institutions for undertaking the MV assessment • CRAs must avoid conflicts of interest (e.g., to ensure process was that of DOEs accredited under the Kyoto an employed analyst does not rate an entity in Protocol. These entities are accredited (‘provisionally which they have a financial interest); must ensure designated’) by the CDM Executive Board upon a the quality of the ratings (e.g., carry out on-going recommendation by the CDM Accreditation Panel, which monitoring of credit ratings); must ensure the quality is advised by a specially constituted CDM Accreditation of the methodologies (e.g., methodologies must Team.77 They are then designated by the COP/MOP be rigorous and systematic); and must have a high and are required to submit annual activity reports to the level of transparency (e.g., by publishing an annual CDM Executive Board. Annual reports must satisfy CDM transparency report); Executive Board guidance to ensure consistency and • ESMA is endowed with comprehensive investigatory completeness of reporting with respect to the key CDM powers, including the power to demand documents activities of a DOE. or data; to summon persons to hearings; to conduct DOEs are accountable to the COP/MOP through the on-site inspections; to impose administrative CDM Executive Board and are required to comply with sanctions, fines and penalties; the decisions and instructions of the Board, which have • places requirements on CRAs as to when ratings of been many and frequent. Problems have arisen due to sovereign debt are undertaken, how many unsolicited the fact that DOEs are under contractual arrangements 76 As amended by Regulation 462/2013 and Directive 2013/14/EC. 77 Membershipis open to both external experts and secretariat staff: see ‘Procedure: Selection and performance evaluation of experts on the CDM accreditation roster of experts’, version 01.0, document CDM-EB79-A02-PROC, UNFCCC. Institutions  39 with client project developers, while at the same • Developing, maintaining and making publicly time being obliged to satisfy CDM Executive Board available a repository of approved rules, procedures, requirements. DOEs are fully responsible to the CDM methodologies and standards; Executive Board for the quality of their work, and therefore • Developing and maintaining the CDM registry; cannot include disclaimers, but the same is not true for client relationships. Client contracts routinely disclaim • Developing and maintaining a publicly available liability other than in situations of gross negligence database of CDM project activities containing and even then, often limit commercial liability. This is information on registered project design documents, understandable, given that DOEs do not want to carry comments received, verification reports, its decisions the risk of liability to the client stemming from a third as well as information on all CERs issued; and party intervention, namely that of the CDM Executive • Addressing issues relating to observance of modalities Board. The inevitable result is that clients suffer the and procedures for the CDM by project participants consequences, such as delays, due to DOEs not meeting and/or operational entities, and report on them to the the CDM Executive Board’s prescriptive requirements, COP/MOP. a situation exacerbated by the market for DOE services being a seller’s market. In spite of this seemingly broad mandate, in a number of respects the COP/MOP, not the CDM Executive Board, The roles and functions of the CDM Executive Board, is the final decision maker. Additionally, the level of include: transparency with regard to the performance of DOEs • Making recommendations to the COP/MOP on and actual issues arising from registration and issuance further modalities and procedures for the CDM; has been found to be generally low. A 2010 report commissioned by WWF,78 found that meeting reports and • Approving new methodologies relating to, inter alia, case-specific recommendations information were kept baselines, monitoring plans and project boundaries; confidential in the case of accreditation, and registration • Being responsible for the accreditation of operational and issuance. entities, in accordance with accreditation standards, and making recommendations to the COP/MOP Regulatory Conclusions for the designation of operational entities. This While the illustrations outlined above evidence significant responsibility includes: levels of regulatory supervision of the respective activities, • decisions on re-accreditation, suspension and they offer different approaches to how regulatory withdrawal of accreditation; supervision might be applied to the MV assessment process. In both cases, the entities need to satisfy the • operationalization of accreditation procedures requirements to become registered or accredited/ and standards; designated. However, the CRAs devise and apply their • review the accreditation standards; own ratings methodologies, whereas DOEs must conform to the methodologies, modalities and procedures laid • Making publicly available relevant information, down for the CDM by the Executive Board. In the case submitted to it for this purpose, on proposed CDM of CRAs, there is a shift towards greater accountability project activities in need of funding and on investors for their decision-making. In the case of DOEs, the CDM seeking opportunities, in order to assist in arranging Executive Board performs its role in relation to the DOEs, funding of CDM project activities, as necessary; but largely leaves the DOE and its project developer client • Making any technical reports commissioned to sort out liability and risk issues as between themselves. available to the public and provide a period for In a similar vein, regulation of CRAs is moving towards public comments on draft methodologies and greater transparency, whereas the evidence suggests guidance before documents are finalized and any regulation of DOEs has been treated as confidential, recommendations are submitted to the COP/MOP for hence less transparent. their consideration; 78 Öko-Institut e.V., Berlin June 2010. ‘2010 rating of Designated Operational Entities (DOEs) accredited under the Clean Development Mechanism (CDM),’ report for WWF. 40  Institutions Bearing these points in mind, and taking account of the the intended changes and invite comment for a fixed fact that the process of MV assessment is closer to that period, together with detailed explanation of the performed by the CRAs in making credit ratings, but reasons and implications; noting also that the process of credit rating has been • registered institutions would be required to publish around for over one hundred years and so is developed, a schedule of the MV assessments (solicited and refined and, within boundaries, a settled process, whereas unsolicited) proposed to be undertaken over specified MV assessment is an entirely new concept, an approach forthcoming (e.g., next six months, annual) periods; to the level of regulatory supervision appropriate might be along the following lines: • all MV assessment outcomes would be published, along with reasons, key assumptions, etc, in • institutions considered suitable to undertake MV accordance with the accredited methodology applied; assessments should be registered and maintain their registration with the supervisory body at all material • registered institutions would be accountable for the times; MV assessment outcomes they publish; and • to be eligible for registration, institutions would need to • the supervisory body might be vested with satisfy criteria, such as those outlined in Section 6.1; investigatory and regulatory powers and functions similar to those vested in ESMA, under the EU • registered suitable institutions would also need to Regulation on Credit Rating Agencies (as amended). submit their proposed methodologies for undertaking MV assessments, which would need to be accredited There are many models for how the supervisory body by the supervisory body; might be constituted. For example, the CDM Executive Board is established by the Kyoto Protocol and various • it would be important for the supervisory body to decisions of the UNFCCC COP have determined its role exercise close oversight of the methodologies for and functions. Its rules of procedure have been adopted MV assessments: referring again to the illustration of by the COP and cover matters such as its composition; CRAs, one of the main points of criticism of credit nominations and appointments; terms of service of ratings agencies’ roles in the 2008 financial crisis, was members; qualifications and conduct; officers; meetings, that they created complex but unreliable models to voting rules and so on. On the other hand, it is noted that calculate probability of default for mortgages as well the supervisory body would be performing a role similar as securitised mortgage-backed products;79 in many respects to that performed by ESMA in relation to • the supervisory body might publish guidelines on CRAs, so ESMA might provide another pertinent model, as the factors and criteria on which it would accredit a financial market regulator. methodologies, then it would be up to the registered institutions to submit their proposed methodologies, criteria, factors to be taken into account in making 6.3.  Exchange Rate Setting MV assessments, to the supervisory body for Detailed consideration will need to be given to how accreditation. In determining these guidelines, the regulatory supervision of any exchange rate setting supervisory body might obtain useful guidance from mechanism or process operates. Work on this carried out expert bodies such as the International Standards by NCM partners will be referenced or included in further Organisation (ISO); iterations of this paper in due course. • MV assessment methodologies would be publicly available, either on the supervisory body’s website 6.4.  Registries and/or the relevant institution’s website; Detailed consideration will need to be given also to how • if a registered institution intended to change regulatory supervision of the operation of a central registry materially existing or use new methodologies, models might be provided. Work on this undertaken by NCM or key assumptions that may impact MV assessment partners will be referenced or included in further iterations outcomes, they would be required first to publish of this paper in due course. 79 Forexample, in 2007 as US housing prices began to fall, Moody’s downgraded 83% of the US$869 billion in mortgaged-backed securities it had rated AAA in 2006. Institutions  41 6.5.  ISP—International Settlement Platform identify three stages in the evolution of the ICAR, the initial stage accommodating the platform and gateway An international settlement platform is one of the three and insurance options; the second stage would see the key elements of the NCM concept and there will need to emergence of the universal mitigation value system and be an appropriate body ensuring proper governance and introduction of the central hub option to mitigate the risks exercising supervisory oversight of its activities. Detailed associated with transfers of allowances; and the final stage consideration will need to be given to how any such body would see the drawing in of existing networks and linking might be constituted. Work on this carried out by NCM agreements.82 partners will be referenced or included in further iterations of this paper in due course. 6.7.  Overriding Regulatory Supervision 6.6.  ICAR—International Carbon Asset Reserve Whichever way the supervisory bodies are constituted, the question arises of to what higher authority should One of the three elements of the NCM initiative is they be accountable? This is the case for all regulatory exploring the possibility of an institutional structure in the bodies formed under NCM, so for example, relates not form of a pooled reserve of carbon assets, to support a just to the body supervising MV assessments, but also network of carbon markets by addressing market risks and to the one that might be needed to supervise exchange failures. Such an international carbon asset reserve (ICAR) rate determination, setting and adjustments. Bearing in could provide a source of liquidity or perform the role of mind the ultimate objective of mitigation, and the purpose market maker, mentioned in Section 5. The form, scope of the NCM initiative, one answer would appear to be and functions of an ICAR are still being explored; however, that oversight should be exercised by the UNFCCC COP, it is intended that any such institution would support, possibly by making the overriding supervisory body a rather than replace, jurisdictional level market stabilisation Constituted Body under a new protocol. instruments. Presently, none of the institutions that exist within the Three options for the ICAR representing a range of UNFCCC framework address the role and functions of possibilities have been presented in a paper by INFRAS the market, how to achieve and maintain market stability, and GRI.80 They encompass at one end of the range, or how to manage a disorderly market. Nor do they the ‘hands off’ approach with ICAR a platform (or appear functionally capable of doing it. As the table on marketplace) to facilitate trading between ETSs for page 42 shows, they are not engaged in the markets accessing low-cost abatement opportunities, but not and, as currently constituted, would appear unsuited to providing a reserve; and at the other end, the ‘hands on’ engagement in the markets. approach of a central hub that would also provide a tool for mitigating carbon risk via centralised intermediation Table 5 shows a cross-section of the existing UNFCCC services and buy/sell services—thus it would hold a pool institutions and their roles and functions. of internationally-fungible allowances. The third option is In the roles and functions set out for these bodies, there for a more specialised ‘gateway and insurance’ ICAR to is no consideration given to the role of the market in facilitate creation and transfer of units from a developing furthering the ultimate objective of the climate change country with a carbon instrument such as a project based regime. There appears to be no consideration of the credit scheme to participating ETSs, thus it would also interaction of the market activities with other measures need to hold a pool of internationally-fungible allowances. in the suite of policies aimed at achieving that ultimate The authors note also that establishment of a mechanism objective. that will determine the mitigation values of carbon units In the context of the Kyoto Protocol, there is no mention will be very important to how the ICAR develops, as of Article 17 or emission trading markets, in relation to any this will enable comparability and hence fungibility of of the institutions. Furthermore, the bodies themselves mitigation outcomes from different jurisdictions.81 Given would not appear suited to addressing questions the importance and difficulty that this might entail, they 80 INFRAS (Fuessler and Wunderlich) and GRI (Taschini): ‘International Carbon Asset Reserve—Prototyping for instruments reducing risks and linking carbon markets’, 16 February 2016, draft paper presented in Zurich. 81 Ibid at p.19. 82 Ibid. 42  Institutions concerning the market: the COP and MOP are negotiating While there may be no single body responsible for fora and inter-governmental decision-making bodies. The overseeing the entire global financial system, there are Secretariat is an administrative and regulatory body, as treaty-based bodies whose functions encompass global are the CDM EB, JISC and Compliance Committee. These roles: for example, the Bank for International Settlements bodies are made up of government representatives, (BIS), the International Monetary Fund (IMF), International administrators and technocrats. It would be interesting to Organisation of Securities Commissions (IOSCO), while ascertain how many, if any, come from a market, trading in Europe, there is the European Central Bank (ECB) or financial governance background. and now the European Securities and Markets Authority (ESMA). The World Trade Organisation (WTO) might Bearing in mind also that if trading takes place between also provide a useful comparative example for such a carbon markets it will be, in essence, a new global supervisory body. If the NCM initiative develops and financial market, other possibilities need to be considered. Table 5: UNFCCC Institutions’ Roles and Functions Institution Role and Functions COP • The supreme policy making, decision making body, and negotiating forum, of the UNFCCC • Made up of representatives of all the signatories to the UNFCCC • Meets annually COP/MOP • As for the COP, the main body for the KP, which for efficiency meets conjointly with the COP Secretariat The functions of the Secretariat are set out in Article 8 UNFCCC in general terms: • To make arrangements for sessions of the Conference of the Parties and its subsidiary bodies established under the Convention and to provide them with services as required; • To compile and transmit reports submitted to it; • To facilitate assistance to the Parties, particularly developing country Parties, on request, in the compilation and communication of information required in accordance with the provisions of the Convention; • To prepare reports on its activities and present them to the Conference of the Parties; • To ensure the necessary coordination with the secretariats of other relevant international bodies; • To enter, under the overall guidance of the Conference of the Parties, into such administrative and contractual arrangements as may be required for the effective discharge of its functions; and • To perform the other secretariat functions specified in the Convention and in any of its protocols and such other functions as may be determined by the COP. IPCC • Surveys world-wide scientific literature and publishes assessment reports that are recognized as the most credible existing sources of information on climate change • Works on methodologies, e.g., within the National greenhouse Gas Inventories Programme, it assesses and develops methods and practices for inventories and disseminates related information • Responds to specific requests from the COP, SBI and SBSTA or other environmental Conventions Subsidiary Bodies: SBI: (Article 10 UNFCCC) • SBI • Consider the information communicated in accordance with Article 12, paragraph 1, to assess • SBSTA the overall aggregated effect of the steps taken by the Parties in the light of the latest scientific assessments concerning climate change; • Consider the information communicated in accordance with Article 12, paragraph 2, in order to assist the Conference of the Parties in carrying out the reviews required by Article 4, paragraph 2(d); and • Assist the Conference of the Parties, as appropriate, in the preparation and implementation of its decisions. Institutions  43 Institution Role and Functions SBSTA: (Article 9 UNFCCC) • To provide the Conference of the Parties and, as appropriate, its other subsidiary bodies with timely information and advice on scientific and technological matters relating to the Convention; • Provide assessments of the state of scientific knowledge relating to climate change and its effects; • Prepare scientific assessments on the effects of measures taken in the implementation of the Convention; • Identify innovative, efficient and state-of-the-art technologies and know-how and advise on the ways and means of promoting development and/or transferring such technologies; • Provide advice on scientific programmes, international cooperation in research and development related to climate change, as well as on ways and means of supporting endogenous capacity- building in developing countries; and • Respond to scientific, technological and methodological questions that the Conference of the Parties and its subsidiary bodies may put to the body. CDM Executive The executive board supervises the CDM, under the authority and guidance of the COP/MOP, and is Board (EB) fully accountable to the COP/MOP.83 In this context, the executive board: • Makes recommendations to the COP/MOP on further modalities and procedures for the CDM, as appropriate; • Makes recommendations to the COP/MOP on any amendments or additions to rules of procedure for the executive board, as appropriate; • Reports on its activities to each session of the COP/MOP; • Approves new methodologies related to, inter alia, baselines, monitoring plans and project boundaries; • Reviews provisions with regard to simplified modalities, procedures and the definitions of small scale project activities and makes recommendations to the COP/MOP; • Is responsible for the accreditation of operational entities, in accordance with accreditation standards, and makes recommendations to the COP/MOP for the designation of operational entities. This responsibility includes: (i) Decisions on re-accreditation, suspension and withdrawal of accreditation; (ii) Operationalization of accreditation procedures and standards; • Reviews the accreditation standards and makes recommendations to the COP/MOP for consideration, as appropriate; • Reports to the COP/MOP on the regional and subregional distribution of CDM project activities with a view to identifying systematic or systemic barriers to their equitable distribution; • Makes publicly available relevant information, submitted to it for this purpose, on proposed CDM project activities in need of funding and on investors seeking opportunities, in order to assist in arranging funding of CDM project activities, as necessary; • Makes any technical reports commissioned available to the public and provides a period of at least eight weeks for public comments on draft methodologies and guidance before documents are finalized and any recommendations are submitted to the COP/MOP for their consideration; • Develops, maintains and makes publicly available a repository of approved rules, procedures, methodologies and standards; • Develops and maintains the CDM registry; • Develops and maintains a publicly available database of CDM project activities containing information on registered project design documents, comments received, verification reports, its decisions as well as information on all CERs issued; • Addresses issues relating to observance of modalities and procedures for the CDM by project participants and/or operational entities, and reports on them to the COP/MOP. (continued) 83 Decision 17/CP.7, Annex paragraph 5. 44  Institutions Table 5: UNFCCC Institutions’ Roles and Functions (Continued) Institution Role and Functions JI Supervisory C’ee • Provides international oversight of JI projects to ensure they meet requirements for the JI program (JISC) Compliance • Committee focusing on compliance with the KP Committee • Functions through a plenary, a bureau, a facilitative branch and an enforcement branch Registries: • ITL established and maintained by the Secretariat • International • ITL will verify transactions involving ERUs, CERs, AAUs and RMUs under the KP Transaction • ITL required to refuse registration of any transaction where the pre-requisites have not been Log (ITL) satisfied • CDM Registry • CDM registry will maintain accounts of CERs on behalf of non-Annex I Parties to the KP • National participating in CDM projects Registries • CDM registry maintained by the CDM EB and will operate in conjunction with the ITL in relation to transactions involving CERs • National registries established by Annex I Parties • National registries contain accounts for all legal entities authorised by the Party to hold allowances or credits carbon markets continue as instruments of policy for as considered under different models such as under mitigating anthropogenic GHG emissions, it may be multilateral environmental agreements, or trade appropriate to consider the need for a treaty-based agreements such as the Trans-Pacific Partnership organisation to ensure both environmental and financial Agreement and the World Trade Organisation market regulatory coordination and governance going agreements.86 However, the paper concludes that in the forward. This is an area for further research. absence of a more tangible idea of how linking might occur, it is difficult to consider options for a regulatory Some of these issues have been considered in a recent framework other than at the high level of institutional paper.84 The authors survey existing frameworks for regulatory frameworks canvassed by the paper. bilateral, regional and multilateral linkages85 before analysing the particular requirements of networking 84 Reed Smith (Peter Zaman and Adam Hedley) ‘The regulatory framework to support carbon market linkage—a concept paper’. 27 April 2016. 85 Ibid, section 6, pp. 13 et seq. 86 Ibid, section 7, pp. 19 et seq. 7. Market Design + Market Information Technology Architecture; the Plumbing This section looks at questions of market design transaction; infringement of Commitment Period and the essential infrastructural elements that might Reserve by transferring Party; be necessary: hardware and software. It begins by • ITL responds to the transferring registry’s proposal by reviewing the architecture and plumbing currently in clearing it for further processing; place for international emission trading under the Kyoto Protocol and EUETS, before considering what different • If approved, the transferring registry completes the requirements might be necessary for trading under a transaction; if rejected, the ITL sends an error code to future Networking structure. It concludes by considering the transferring registry; the potential application of new developments and • For transactions under EU trading legislation, EU concepts in information technology, such as the registries send proposals to the ITL, which conducts ‘blockchain’. its ‘Kyoto checks’, then forwards the information to the Community Independent Transaction Log (CITL) 7.1. International Emissions Trading to Date for it to conduct supplementary checks defined under the EU scheme. This would also be the process in the International emissions trading has taken place pursuant case of other supplementary transaction logs. to the Kyoto Protocol through the International Transaction Log (ITL) and registries. Decision 19/CP.7 contains general Hence, as well as recording the holdings of units in requirements for the ITL and registries and modalities for registry accounts, the registries allow for settlement of an the accounting for assigned amounts under the Kyoto emissions trading transaction to occur by delivering units Protocol. The registries are the national registries of the from the seller’s account to the buyer’s account. Figure 8 38 Annex B Parties containing accounts within which units shows the process. are held in the name of the government, or legal entities Financial settlement depends on completion of the authorised by the government to hold and trade units; and physical settlement process which takes place through the the CDM registry implemented by the UNFCCC secretariat registries and ITL/CITL, as shown in Figure 9 taken from under the authority of the CDM Executive Board. the UNFCCC website (shows in more detail, the right- The process for a transaction involves: hand side of Figure 8 on the following page). • The seller and buyer agreeing to conclude the Technical Requirements under the Existing System transaction either over-the-counter (OTC) or through an exchange (either way, their contract will need to The full specifications for the ITL and registry system provide for settlement to be subject to or based on are set out in the Data Exchange Standards (most completion of the transfer to the buyer’s account in recent version sighted: Data Exchange Standards for the transferee registry); Registry Systems under the Kyoto Protocol, Technical Specifications (Version 1.1.11) 24 November 2013), • Seller directs its registry (transferring registry) to which describes the technical requirements for electronic transfer units to the buyer’s account in another communications between the ITL and registries—how registry; the data exchange standards are to be implemented, • The transferring registry sends a transaction proposal based on functional specifications for data exchange, to the ITL; that define what data are exchanged and by whom (the basic ‘plumbing’ for the system). The Data Exchange • The ITL assesses the proposal against a set of Standards define how data are exchanged between defined checks, for example: units previously national registries, the CDM registry and the ITL, as well as retired or cancelled; units existing in more than one any supplementary transaction logs (STLs). The CITL is the registry; units improperly carried over or improperly only STL at present. issued; legal entities authorised to participate in the 45 46  Market Design + Market Information Technology Architecture; the Plumbing Figure 8: Transaction Flow at Present Seller A National Registry A ITL OTC Contract T&C CITL/Other or Supplementary Logs Exchange T&C Buyer B National Registry B Figure 9: Detail of ITL Process Supplementary Checks European Union Community Other Supplementary Independent Transaction Log Transaction Logs International Transaction Log Kyoto Checks Communications Hub CDM National National National National Registry Registry Registry Registry Registry Market Design + Market Information Technology Architecture; the Plumbing  47 Under the Data Exchange Standards, communications Web services enable applications running on different between registries and the ITL must be secure and machines to easily exchange information with one processed as real-time transactions, using encrypted another without requiring additional proprietary software messages over the Internet. The technical specifications or hardware. Web services depend on standard require: extensible mark-up language (XML) messaging systems and SOAP, and are not tied to one operating system or • Web services using Simple Object Access Protocol programming language. Any information exchanged to (SOAP) and from registries and the ITL is through the use of XML • Hardware-based Virtual Private Network (VPN) exchanged via SOAP. All communications are encrypted using Secure Socket Layer (SSL). • XML87 formats adhering the prescribed standards The types of Kyoto units enabled by the Data Exchange • Digital signature authentication Standards are shown in Table 6. • Network time protocols The types of transactions enabled are shown in Table 7. Table 6: Kyoto Units Enabled by the Data Exchange Standards (Table copied from the UNFCCC website) Kyoto Units Unit Unit Name Issuer Description Kyoto Protocol AAU Assigned Amount Units National Units representing the initial assigned amount of each Article 3.7 registry Annex B Party RMU Removal Units National Units given for net removals from land use, land-use Articles 3.3, 3.4 registry change and forestry activities ERU Emission Reduction National Units converted from AAUs or RMUs on the basis of Article 6 Units registry JI projects CER Certified Emissions CDM Credits given for emission reductions certified for a CDM Article 12 Reductions registry project tCER Temporary CERs CDM Credits given for emission removals certified for an Article 12 registry afforestation or reforestation CDM project (to be replaced upon expiry at end of the second commitment period) lCER Long-Term CERs CDM Credits given for emission removals certified for an A&R Article 12 registry CDM project (to be replaced upon expiry at end of the project’s crediting period or in event of storage reversal or non-submission of a certification report) 87 Extensible Mark-up Language (XML) defines a set of rules for encoding documents in a format that is machine-readable and human- readable. The design of XML focuses on documents, but it is widely used for other purposes and hundreds of documents formats using XML have been developed, as XML is commonly used for the interchange of data over the Internet. Briefly by way of background, XML is an application of Standard Generalised Markup Language (SGML). SGML is an ISO standard—ISO8879:1986 Information Processing—Text and Office Systems—Standard Generalised Markup Language, which was derived from IBM’s Generalised Markup Language (GML). SGML was originally designed to enable sharing of machine-readable large project documents in government, law and various industries. With growth in the World Wide Web, SGML was seen as offering solutions to some development problems. 48  Market Design + Market Information Technology Architecture; the Plumbing Table 7: Types of UNFCCC Transactions Enabled (Table copied from the UNFCCC website) Kyoto Transaction Types Issuance Initial creation of an AAU, RMU, CER, tCER or lCER Conversion Transformation of an AAU or RMU into an ERU based on a JI project External Transfer External transfer of a unit from one registry to another registry Cancellation Internal transfer of a unit to a cancellation account, in order that it may not be used for compliance with an emission target Replacement Internal transfer of a unit to a replacement account, in order to replace tCERs or lCERs when required Retirement Internal transfer of a unit to a retirement account, in order that it can be used by the Annex B Party for compliance with its emission target Carry-Over Change of validity an AAU, ERU (only those converted from AAUs) or CER from one commitment period to the next Expiry Date Change Change in the expiry date of a tCER or lCER Internal Transfer between Internal transfer of a unit between holding accounts within the same registry (the ITL Holding Accounts does not verify such transactions but forwards them to the CITL to allow their verification under the EU trading scheme) 7.2.  NCM Transactions • Transactions under Networking presumably will need to account for exchange rates/price Will the existing architecture be adequate for NCM differentials/ratios between the respective transactions? Perhaps not, taking account of the following mitigation outcomes. The question arises considerations: whether the basic electronic ‘plumbing’ of these • The types of Kyoto units enabled by the Data transactions should be able to account for the Exchange Standards can all be measured in a trading side of the transaction also, as well as the common currency, the basic unit being one tonne transaction log-type checks? Or should it remain CO2-eq GHG. However, this may not necessarily be separate, as under the existing arrangements? the case under Networking; • Transaction log-type checks will need to be • Each heterogeneous trading scheme, presumably, performed on mitigation outcome assets traded will have its own registry already, and these may or under Networking, since presumably they may not be capable of satisfying the Data Exchange will need to be compliant for the purposes of Standards; counting towards NDCs. In this case, relevant checks against the requirements for that • The transaction types may also differ from those compliance will need to be conducted, but these enabled by the Data Exchange Standards: will be done by the STLs, presumably, not by the • The actions carried out by the ITL/STLs are ITL: this begs the question what will the ITL role (i) performing checks (all binary in nature); and include: will it just be account keeping? Auditing (ii) updating account records: there is no trading checks on STLs? Other? component, but rather the process the ITL/STLs • The advent of new technologies such as the perform is just a condition precedent to financial distributed ledger technology canvassed below. settlement of the transaction which takes place independently. Consideration should be given What might these considerations mean for design for this to whether this needs to change for trading and market? settlement under Networking. Market Design + Market Information Technology Architecture; the Plumbing  49 7.3.  New Approaches: Distributed stored in the ledger are maintained cryptographically Ledger Technology through the use of ‘keys’ and signatures to control who can do what within the shared ledger. Entries The accuracy and reliability of transaction record-keeping can also be updated by one, some or all of the and accounting will be paramount to the operation, let participants, according to rules agreed by the alone the success of any networking of carbon markets. network.” The importance of robust accounting for international transfers has been underscored in the words of Article 6, The two main advantages of distributed ledger technology Paris Agreement, Parties may engage: are firstly, its accuracy, since it offers a traceable record “. . . on a voluntary basis in cooperative of every transaction in the history of the asset; and approaches that involve the use of internationally secondly, security, since the ledger is extremely difficult to transferred mitigation outcomes towards nationally tamper with or make unauthorised changes to, as there determined contributions, promote sustainable are multiple copies of the database which are shared development and ensure environmental integrity publicly.89 and transparency, including in governance, and Because it is based on a distributed ledger, this technology shall apply robust accounting to ensure, may also render centralised clearing the settlement (for inter alia, avoidance of double counting example, in the case of the proposed ISP) unnecessary consistent with the guidance [developed and and so it is important that it is considered as part of the recommended by the Subsidiary Body for Scientific NCM development process. It has been reported that and Technological Advice (SBSTA) pursuant to the already banks and financial institutions see the threat decision in paragraph 37].” (emphasis added) it poses to their traditional roles, so they are investing In this respect, the advent and development of blockchain, large sums in developing and testing the technology for or distributed ledger technology, may prove timely. In incorporation into their e-commerce and crypto-currency January 2016, the United Kingdom Government’s Chief strategies. One illustration given is that of the Australian Scientific Adviser published a report88 recommending Stock Exchange, which in January 2016 announced that it the widespread application of this technology by the was developing a distributed ledger solution to replace its government. He begins: existing platform for clearing and settling trades.90 “Ledgers have been at the heart of commerce since The applications for international carbon trading extend ancient times and are used to record many things, beyond the application to incorruptible registries and most commonly assets such as money and property. databases. Technology companies are developing They have moved from being recorded on clay self-executing smart contract programmes whereby tablets to papyrus, vellum and paper. However, in a blockchain database hosts a secure smart contract all this time the only notable innovation has been along with an algorithm specifying the execution rules. computerisation, which initially was simply a transfer Once those rules are met, the contract is automatically from paper to bytes. Now, for the first time algorithms executed.91 This offers lower costs, scalability and a higher enable the collaborative creation of digital distributed level of trustworthiness that may well find an application ledgers with properties and capabilities that go far in networked carbon market transactions. beyond traditional paper-based ledgers. “A distributed ledger is essentially an asset database With clear applications in and interest from the financial that can be shared across a network of multiple sector, it is unsurprising that financial regulators are sites, geographies or institutions. All participants already taking an interest in getting to better understand within a network can have their own identical the technology and its applications. Parties interested in copy of the ledger. Any changes to the ledger are developing linked or networked carbon markets to achieve reflected in all copies in minutes, or in some cases, a more globally uniform carbon price would do well to seconds. The assets can be financial, legal, physical follow their example. or electronic. The security and accuracy of the assets 88 Mark Walport, UK Government Chief Scientific Adviser, Distributed Ledger Technology: beyond block chain, https://www.gov.uk/ government/uploads/system/uploads/attachment_data/file/492972/gs-16-1-distributed-ledger-technology.pdf, accessed 17/05/16. 89 Mason, Hayes & Curran, Blockchain Game Changer: Blockchain and the Distributed Ledger Technology Deciphered, 14 March 2016, at www.lexology.com, accessed 5/04/16. 90 Ibid. 91 Ibid. 8. What Is the Market? This section asks the essential questions: what is the jurisdictions. The questions are: how can this demand be market? Where will demand come from, how and why will proven sufficiently? Sufficiently for what to happen? it grow? 8.2. Market Development: Phased 8.1. Who Will Trade? Why? How Will Development Networking Begin? One answer to those questions is that development of the There are parties already that may wish to participate in market needs to take place in a phased manner. Initially trading across networked carbon markets. As noted in trading might take place between schemes in the same Section 2, as of 2015, there were nearly 40 countries and jurisdiction, for example, in China, the trade may occur 23 sub-national jurisdictions designing or implementing between a compliance entity under one provincial ETS different carbon pricing policies such as emissions (e.g., Guangdong) and a compliance entity under another trading systems or carbon taxes. In the lead up to provincial ETS (e.g., Shenzhen); or in the US, between a COP21, governments submitted their intended nationally compliance entity under RGGI and a compliance entity determined contributions (INDCs) and in 90 of these, under the California ETS. the governments expressed interest in using carbon The next phase might then see trading occur on a markets to reach their emission reduction targets.92 jurisdictionally bilateral basis, for instance, between a Some governments actually indicated that, in addition provincial ETS in China and, say, the California ETS; or to domestic contributions, additional reductions could when the Chinese national ETS is running, between a be achieved with access to international market-based compliance entity under that scheme with a compliance mechanisms.93 entity under the EUETS. This type of stepwise growth Why might they wish to do so? Benefits of linking markets might develop into limited multilateral trading that have been put forward include: arrangements between a group of jurisdictions or ‘carbon club’, the final phase of development seeing full open • a widely accepted price on carbon, bringing greater international (or transnational) opt-in trading. certainty to investors and encouraging more sources of climate finance, which in turn can generate However, while this phased approach might allow for benefits such as technology transfers between the gradual building of confidence in the benefits to be countries and innovation, as well as fostering gained and operability of the concept, it still does not sustainable development; answer the question of how it will happen: what will be required to enable these trades to take place and who • greater depth and liquidity in the markets, affording will provide it? The rules, institutions, infrastructure—the better stability, clearer price movements and necessary wherewithal to make it happen the way it decreasing the risk of price shocks, all of which will needs to happen, that is, in a way that ensures proper, further encourage investment; robust accounting; that affords transparency and integrity; • greater cost efficiency and effectiveness in achieving and that doesn’t compromise the environmental integrity emissions mitigation, the ultimate objective of of any participant’s scheme or that of the overall system. applying the market mechanism. Ultimately, there will need either to be such a clamouring At the moment, however, in the absence of a framework demand that the incentive will exist for parties for trading between schemes and jurisdictions, these (either private or public sector) to apply the required anticipated benefits are only theoretical. In a sense, we resources to provide such wherewithal, or adequately are currently in the position of having obtained some resourced parties—whether national governments or research data, which while promising, doesn’t actually intergovernmental organisations—will see it as part of their prove a demand exists for trading across schemes or remit to commit risk resources in order to stimulate and 92 EnvironmentalDefence Fund (EDF) and International Emissions Trading Association IETA), April 2016, Carbon Pricing The Paris Agreement’s Key Ingredient. 93 Ibid 50. 50 What Is the Market?  51 foster this development. As noted earlier, in Section 3, • networking: the three countries and sectors linked carbon markets are creations of policy and compliance using trading rules proposed on the basis of seven driven, so while it would be encouraging if large private different design options for MV-based trading rules, sector institutions saw it as part of their remit to stimulate specified under the modelling exercise (see Table 3, and foster trading between schemes and jurisdictions, in Section 5.5). that outcome is considered unlikely. The stimulus and The aim is to model and compare impacts under each of incentive is most likely to come from the public sector. these scenarios on: In this respect, the World Bank Group is acting already (a) the prices of the carbon allowances; through the NCM initiative and other programmes such as the Partnership for Market Readiness (PMR). The NCM (b) emissions (both domestic and traded) achieved work plan for 2016 has a country focus: following Peru by each country and each sector; and Thailand, piloting the MAAP in other jurisdictions, as (c) emissions intensity by country and sector; well as conducting feasibility studies with local partners in China, Japan and India. The work plan also includes (d) marginal abatement costs by country and by the modelling and simulation exercise, mentioned earlier, sector; which has the dual purposes of developing trading rules (e) total cumulative abatement costs by country and that might be applied to transactions across schemes by sector; or jurisdictions, and of providing a tangible focus for interested stakeholders. This exercise is further elaborated (f) net trade balance by country and by sector; and in the following section. (g) total costs and revenues by country and by sector. 8.3.  Simulating the Market, Trading Rules, The outcomes of this phase of the exercise will include Testing for Perverse Outcomes, Results, identification of factors that might influence the results for Direction items (a)–(g) under the networking scenario, as well as any potential benefits and/or risks of networking under The NCM initiative is exploring the use of MV to any of the seven design options modelled. The second determine trading ratios for mitigation outcome asset units phase of the modelling exercise would then run and re- deriving from various heterogeneous mitigation actions run the transaction scenarios modelling with the rules and and, for this purpose, has commissioned a modelling and MV assessment process, as well as devising the business simulation exercise to take place over 2016. While there process flow for trading to ensure market integrity. The is no finalised definition for what MV is, for the purpose objective would be design testing and formulating trading of the exercise MV has been defined as the likelihood rules. The third phase of the exercise would then be to that any domestic carbon asset unit actually represents a run a simulation exercise, possibly involving jurisdictions meaningful unit limit or reduction of GHG emissions. and actual market participants and trading entities. A The first phase of the exercise aims to assess the impact significant aspect of this phase would be to achieve of linking mitigation actions both within and across outreach and stakeholder engagement. jurisdictions by setting up an inter-jurisdictional model The preliminary modelling for phase one has looked (based on three G20 countries) and an inter-sectoral at China, Mexico and South Korea and energy related model (based on sectors within a country) to run three emissions in the following thirteen sectors: power; scenarios for the year 2030 as follows: chemicals; manufacturing; mineral products; steel; • no linking: each country/sector has its own ETS; upstream & refining; residential; services; agriculture; road transport; domestic air transport; other transport; and • direct linking: the three countries and sectors all waste.94 This work is on-going. participate in a single carbon market whereby allowances are traded between jurisdictions on a 1:1 basis; and 94 ENERDATA, Using Mitigation Values to Guide the Design of Trading Rules, workshop presentation, 28 May 2016. 9. R comm nd d N xt St ps As a general observation, the overall body of work for Market Readiness, to develop the model as it stands as developing the NCM initiative conceptually might be it might suit their domestic circumstances and to engage considered to comprise seven modules or strands: relevant stakeholders locally. As noted, the NCM work plan for 2016 has a country focus, exploring opportunities for • development and refinement of the concept of piloting the MAAP and, amongst other things, conducting ‘mitigation value’ and developing the process for stakeholder consultations in China. assessing mitigation impact; Nevertheless, to the extent that the conceptual work will • using mitigation value to inform trading; continue at some point, there are a number of areas • development of the transaction mechanism for identified in this paper that invite specific, follow-up work. networking; For the purpose of making recommendations as to next steps, these might be grouped into the following five • development of the role and functions for the categories: settlement platform; (i) general development of mitigation value concept • elaboration of a market design; and process for assessment; • development of the International Carbon Asset (ii) how to form the ‘view’ on level of ambition, if Reserve (ICAR); and that concept is developed; • identifying and fostering development of the market— (iii) how to translate mitigation values into exchange participants, size, demand, modelling. rates; However, the emphasis for the immediate future is to park (iv) the supervisory bodies for suitable institutions further development and elaboration of the conceptual making mitigation values assessments and other side of the NCM and focus rather on identifying where the roles identified; and demand might come from. In a sense, this concentrates on the last of the strands listed above, but it takes a (v) the possibilities for introduction of International much more ‘hands on’, tangible manifestation. The Transaction Units and an Index. emphasis is on the institutions within potentially interested jurisdictions, including China, India, Chile, Mexico and others through the World Bank Group’s Program for 52 Gloss r of S l ct d Acron ms BAU Business as usual ISO International Standards Organisation BIS Bank for International Settlements ITL International Transaction Log CCC Central counterparty clearing ITMO Internationally transferred mitigation CDM Clean Development Mechanism outcomes CERs Certified Emission Reductions ITU International Transaction Unit CITL Community Independent Transaction Log JI Joint Implementation CMA Conference of Parties serving as the KP Kyoto Protocol Meeting of Parties to the Paris Agreement LSE London Stock Exchange CO2 Carbon dioxide MiFID Directive on Markets in Financial CO2-eq Carbon dioxide equivalent gas Instruments COP Conference of Parties to the UNFCCC MV Mitigation value COP/MOP Conference of Parties serving as the NCM Networked Carbon Markets (or CMP) Meeting of Parties to the Kyoto Protocol NDC Nationally Determined Contributions COP21 Twenty-First Conference of Parties to the NGO Non-governmental organisation UNFCCC OTC Over-the-counter CRA Credit Rating Agency PA Paris Agreement CV Compliance value POA Programme of Activities DOE Designated Operational Entity PPP Programs, policies and pledges EC European Commission QELRC Quantified emission limitation and ECB European Central Bank reduction commitment EEX European Energy Exchange S&P Standard & Poor’s ESMA European Securities and Markets Authority SBI Subsidiary Body for Implementation ETS Emission Trading Scheme SBSTA Subsidiary Body for Scientific and EU European Union Technological Advice EUETS European Union Emissions Trading Scheme SDR Special Drawing Rights FTSE Financial Times Stock Exchange SO2 Sulphur dioxide FV Financial value SOAP Simple Object Access Protocol FX Foreign exchange SOP Share of proceeds G20 Group of Twenty major economies SSL Secure Socket Layer (EU + 19 countries) STL Supplementary Transaction Log GDP Gross Domestic Product UNFCCC United Nations Framework Convention GHG Greenhouse gas on Climate Change GWP Global warming potential US United States ICAR International Carbon Asset Reserve USEPA US Environmental Protection Agency ICE Intercontinental Exchange VPN Virtual Private Network IISD International Institute for Sustainable WBCSD World Business Council for Sustainable Development Development IMF International Monetary Fund WRI World Resources Institute INDC Intended Nationally Determined WTO World Trade Organisation Contributions WWF World Wide Fund for Nature IOSCO International Organisation of Securities XML Extensible Mark-up Language Commissions IPCC Intergovernmental Panel on Climate Change 53 Ann x A This Annex sets out an extract of relevant sections of the terms of combating climate change. That is not the case, discussion paper titled “NCM and the Post-2020 Global and indeed, can never be the case. Climate Change Regime” by Andrei Marcu. The MV, as a relative value, can be interpreted in more than one way. One perspective is that it shows how 3. B sic Conc pts much the effort to reduce a unit (e.g., a ton of CO2e) in a jurisdiction is worth—relative to another jurisdiction. A number of concepts and definitions need to be Alternatively, it could be expressed as how the effort to examined, and well understood, as they will appear contribute to addressing climate change is rated in a frequently in this paper and used to answer the questions jurisdiction, relative to a defined standard. identified in Section 2. It is especially important to understand what NCM is, and especially what it is not. The MV of unit can also be described as the value stakeholders/society attaches to the effort to reduce a unit The concepts that will be reviewed include: in terms of what it thinks that the jurisdiction should • Markets: Natural vs. Regulatory do to address climate change. In this perspective, the MV can be a function of a number of factors, which may • Markets: Voluntary vs. Compliance include: • Markets: Domestic vs. International • The level of the effort that is promised and • Markets: Under international agreement vs. outside undertaken international agreement • Characteristics of the economy—what is the • Markets: Linked vs. Networked abatement cost curve • Value of Units: Financial, Mitigation, Compliance • Characteristics of the program or activity undertaken to reduced GHG—that is the quality of the program • Networked Carbon Markets and the certainty of delivery of the reduction 3.1. V lu of Units • Resources available to dedicate to mitigation efforts In GHG markets units can have a number of values: • Capacity to undertake mitigation efforts Financial Value (FV), Mitigation Value (MV) and Another perspective can be a probabilistic one (or Compliance Value (CV). The concept of Mitigation Value risk based), and refers to the probability that a unit of is fundamental to the discussions on NMC, as is the reduction in a jurisdiction (credit issued, or allowance relationship between the Mitigation Value and Compliance to emit a ton of CO2e) represents a ton of CO2e. The Value. MV value is therefore a 1 ton x MV = amount of CO2e Mitigation value: The Mitigation Value refers to the reduction that a unit represents. In this perspective the relative value of a unit versus a defined Standard Unit of elements of risk that define the MV are discussed below. reduction. What the concept of Mitigation Value is can be described in a number of ways, but it is also important to Pro r m L v l—C rbon Int rit Risk define what it does not refer to. This risk relates to the extent to which a specific low- MV is a relative value that is helpful in defining the carbon program or activity (e.g., regulatory instrument, fungibility of units in heterogeneous carbon markets price instrument and quantity instrument) will achieve where it is difficult to compare the value of different units. its intended outcome. The challenge is to establish an approach that can accommodate the wide range of new MV does not refer to the atmospheric impact of a unit of a and heterogeneous low-carbon programs that are now ton of CO2e reduced. It is used as a relative value to help emerging. Currently, systems like the Clean Development define the value of units coming from different carbon Mechanism provide only a binary ‘yes or no’ outcome pricing systems. One expression that has been sometimes on the validity and verification of emissions reductions. in relation to MV is that “a ton is not a ton.” This has been However, this limits the ability to differentiate among interpreted as implying that a ton of GHG reduced in one projects that have met minimum requirements, or to place does not have the same environmental effect in evaluate to what degree projects perform, vis-à-vis the 54 Annex A  55 threshold. As a result, there is a wide range of low-carbon probabilities defined above). However, as circumstances programs and activities whose overall benefits/risks are changed, and “hot air” emerged as an issue, the MV of an not captured by this approach. This is evident in certain AAU from the former Eastern Block was seen as less than sectors, geographies and areas of activity with the highest 1, and less than the MV of a Japanese or NZ AAU. sustainable development potential, or those which This is a relative and judgmental value, but there was contribute most to transformational change. a clear differentiation that emerged. AAUs from one jurisdiction were seen as representing a high probability Jurisdiction Level—Policy/Regulatory Risk of 1 ton of reduction, while the other one, rightfully or Policy/regulatory risk relates to the extent to which a wrongfully, was seen as less probable as representing jurisdiction’s collective low-carbon policies will achieve the 1 ton of reduction. This was reflective of the desire of intended outcomes. It involves technical considerations, those purchasing an AAU that it represent a 1 ton actual such as the extent to which the set of policies designed effort to reduce, not an incidental reduction. to achieve the mitigation target within the existing policy The MV of CERs provides another example. Gold Standard context are likely to achieve the intended outcome. It also CERs and “regular CERs,” in spite of having gone through involves political considerations, such as the extent to the same CDM regulatory cycle, receive a higher MV from which the government has the political will, track record, stakeholders. The added Gold Standard filter re-assures and institutional strength to maintain or adjust policies to those willing to purchase CERs or reductions that it has a achieve appropriate mitigation targets. high probability to actually represent a ton CO2e reduced. Global Level—Relative Climate Mitigation Compliance value: This is the value that the regulator Contribution decides to assign to a unit used for compliance purposes in a jurisdiction. A unit could have multiple CVs: Assessing a jurisdiction’s relative climate mitigation contribution relates to the extent to which its climate • Domestic, in the jurisdiction where it was issued mitigation targets are perceived as a sufficient contribution • International to the global effort to limit global warming. The objective of this approach is to incentivize jurisdictions to increase • Domestic, in the jurisdiction where it is imported, and their level of effort. used for compliance A Mitigation Value can be determined and assigned by a As opposed to the Mitigation Value of a unit, where any regulator, or by any stakeholder. Those that wish to assign stakeholder can assign a MV, in a compliance regime it is a MV to a unit of GHG reduction can use many algorithms only the regulator that can decide the compliance value in and factors. an given jurisdiction. Alternatively, the regulator may decide, voluntarily, that it delegates that decision to another body. It is important to note that both concepts outlined above represent a valid point of view in terms of relativity For illustration purposes, CERs resulting from HFC concepts, and are in some ways, a mirror image of each projects have different CVs. Whereby a CER is worth a other. The former sees relativity in the effort that is put into tone for UNFCCC compliance, it is valued at 0 (zero) for reducing a ton of CO2 in different jurisdictions. The later compliance under the EUETS. It is therefore possible that sees relativity in what can be achieved with a unit of effort, the issuing regulator and the regulator that controls the or in a more classic way, what is the probability that a unit compliance process, if not the same, may assign different reduction in a jurisdiction represents 1 ton of CO2e. values to the same unit. What these two concepts also share is a degree of subjectivity in assigning value, whether it is to the Relationship between MV and CV relative effort, or the probability of delivery. The body of knowledge and experience developed in assigning An important element in creating fungibility across probability of outcome is much better understood, heterogeneous markets is the relationship between MV and consequently this paper will take the definition of and CV. That relationship is not well understood, and yet it Mitigation Value as being the probability of a unit of can be used to explain many of the symptoms emerging reduction from a jurisdiction represent 1 ton of CO2e. in GHG markets, and which need to be addressed. For illustration purposes we will provide an example. As discussed above, the regulator, or any stakeholder When the KP was agreed, AAUs were assigned by the can set a MV. It is an important value as it provides the regulator (the COP) at a MV = 1 (that is representing credibility of the GHG market, which is purely regulatory in the probability of representing a reduction, in terms of nature, and therefore needs a license to operate. 56  Annex A The tendency of the regulator is to set (assume) a CV One aspect that needs to be highlighted is the fact = MV = 1. As long as this equation holds true, the GHG that the MV and CV of units, can be binary or risk market will maintain credibility, and will be allowed to adjusted. For illustration purposes, currently a CDM function. project is deemed to be additional (and meet the rest of the regulatory cycle). In the case that project is deemed Once the set CV is different from the generally accepted additional a CER is issued. If not there is no issuance. MV, then the market losses credibility, and is under pressure to introduce measures to address the situation. A The reality is that as a counterfactual argument, a project few examples can illustrate this type of situation. can never be said with 100% certainty to be additional or not. As such, an alternative approach would be to assign When KP was signed, the COP, as a regulator, saw AAUs it a risk-adjusted value (between 0% and 100%). as having as MV = CV = 1. Stakeholders initially accepted This would be an approach more in line with the realities this MV. However, as soon as significant amounts of “hot of how the credits are created and the MV of a unit of air” starting to emerge in Russia, Ukraine, etc., perception reduction. of AAU having a MV less than 1 became prevalent. However, the CV of the AAUs was maintained at 1 for KP Financial value. This is the value that the market place compliance, which led to a loss of credibility of AAUs (the assigns to a compliance unit, and will be dependent on ones available on the market were from former Eastern a number of issues, including demand/supply balance, Block countries) as a trading for compliance unit, while market liquidity of the product, etc. However, the FV maintaining its accounting function. is likely to be dependent on the MV as well as the perceived relationship between the Mitigation Value This situation eventually led to pressure to “do something” and the Compliance Value. The FV is a function of the about surplus AAUs. That pressure materialized in Doha, MV in two ways. Firstly, if the CV = MV then the market when provisions were introduced to eliminate the surplus will pay accordingly, 1 or less than 1. Alternatively, if AAU in the SCP of the KP. there is a discrepancy between the determined MV, and The EUETS finds itself in a situation that is not dissimilar. assigned CV, this leads to the expectation of a regulatory There is currently a huge surplus of EUAs primarily due intervention, with implications for its FV. to the economic recession (could be seen as EUETS “hot While market actors set the FV in the marketplace, it is air”). This has led the MV of the EUA to be seen as less by no means a rare occurrence to have legislation of than at assigned CV, resulting in efforts to address the regulation or legislation interfere in setting a FV. situation in an ad-hoc manner through back loading, and through the MSR, on a more permanent and predictable basis. Ann x B This Annex sets out the findings of the earlier unpublished of a jurisdiction irrespective of whether it engages concept paper titled “Designing a Model for Networked in NCM trading Carbon Markets,” which draw on the examination of • MV raters: three comparable financial markets, namely the bond/ debt market; the foreign exchange market; and physical • should be subject to regulatory supervision; commodities markets. • rating methodologies should be accredited by the supervisory body and transparent; S ction 4: NCM Mod l, s Focus for Furth r • there should be encouragement for multiplicity Discussion of MV raters; To summarise points/issues elicited from the foregoing, • ‘issuer pays’ problems should be avoided— for the purpose of proposing elements of a model: payment for MV ratings should be structured • Trading should be on an exchange, as opposed to to foster desired policy outcomes, rather than OTC, through a central clearing counterparty model; offering excessive arbitrage opportunities; • Rating: • The NCM model should be flexible enough to allow for policy adjustment, in other words, to allow for • MV rating will be of the jurisdiction overall; the management of the supply of carbon assets in • However, at the beginning, there will also the market to ensure policy goals, just as is the case need to be an evaluation made of the carbon with monetary policy. In this respect, the proposed asset and trading scheme95 to assess whether International Carbon Asset Reserve is relevant, but electronic trading architecture can be applied how should it intervene in the market? Under what to it—that is, whether the carbon assets under conditions? different schemes can be described or expressed • In terms of the trading mechanism, is it to be an in terms of trading attributes in such an exchange mechanism (i.e., based on an exchange architecture. As this involves costs, a preliminary of carbon assets between the schemes) or a price question is whether it can be demonstrated mechanism? empirically that price dislocations exist in the market as it stands, that warrant development • Under an exchange mechanism, since carbon of the architecture. In other words, is there a assets move in both directions, the asset demand for NCM that will justify the cost of this holdings of each scheme should be the same work? immediately after the transaction as before. Query the effect on the MV ratings of the • MV rating is expressed as an opinion—what level jurisdictions engaged in such exchange? Also of confidence will need to be attached to the query what the effect is when the MV ratings opinion to make it acceptable to the market? of those jurisdictions fluctuate up or down • MV rating is relative—as between schemes this subsequently: does that affect the rate at which is acceptable, but query need also to be against those assets may be traded in the future? an empirical standard—and, if so, what is that • Under the price mechanism, the movement of standard? carbon assets is in one direction only. Hence, • MV rating should be capable of applying at any immediately after the transaction, the asset jurisdictional level, that is, national, provincial, holding of one scheme will be less, and the local; it should be possible to have an MV rating holding of the other scheme more, than before 95 Som of th issu s th t mi ht ris in this cont xt includ b nkin nd borrowin ; r ndf th rin ; th l n th of tim c rbon ss t c n b h ld b for it must b surr nd r d und r on sch m or noth r ( nnu l?); wh th r c rbon ss ts b s d on llow nc s should b full fun ibl with c rbon ss ts b s d on proj ct cr dits. 57 58  Annex B the transaction. Will this be material to the MV economy, levels of production, levels of emissions, level rating of those jurisdictions? of ambition in setting targets to mitigate those emissions and so on. A broad range of factors. • There is also the possibility of the exchange mechanism being via a ‘vehicle’ carbon asset— The task of devising frameworks and methodologies for would this be useful? assessing MV is beyond the scope of this paper. For the purpose of this paper, it is assumed simply that there will • MV rating should be based on a broad range be an MV rating. In terms of proposing a model for NCM, of factors, being broader than the concept of however, some further thoughts about the nature of MV “creditworthiness,” more akin to FX rate setting, and ratings are as follows: equally dynamic. As market confidence/sentiment derives from the MV rating, this process should be (i) The MV rating is of the jurisdiction as a whole; by able to withstand rigorous scrutiny; this it is meant, the jurisdiction in which the trading scheme operates—hence, if the scheme operates at a • Pegging of MV ratings—would this be possible? provincial level, then the MV rating is of the provincial Desirable? What purpose would it serve? jurisdiction; • Market participants should include not only entities (ii) The MV rating will translate into the rate of exchange, under the trading schemes, but also market makers or the price, or the ratio, at which a carbon asset and other investors (the application of KYC, anti-fraud generated by the trading scheme in that jurisdiction, and AML protocols being implicit); will be exchanged or purchased; • Trading contract wording should be standardised (e.g., (iii) It will be relative to the MV ratings of other ISDA); jurisdictions; • If it transpires that the carbon assets under different (iv) The MV rating, or exchange rate, may be relative as schemes cannot be described or expressed in between jurisdictions and their respective carbon terms of trading attributes in an electronic trading assets, however, ultimately there needs to be an architecture, such as FpML or FIX, it may be possible empirical standard against which they would be to define standardised grades of asset which can. measured to impart sufficient confidence to the market and regulators. The ‘value’ in carbon assets Proposal for a Model comes from the degree of confidence there is that the reductions are being made, that the scheme is Elements of the proposed model might include: enforced so that the cap on a participant’s permitted • the MV rating and an empirical reference standard; emissions is not exceeded, that emissions permitted under the scheme will gradually be reduced and that • the MV raters; the scheme will continue to be operated, managed • regulatory supervision; and policed appropriately throughout its anticipated lifetime; • carbon asset characterization; (v) For illustration, two suggestions as a way to determine • the Trading mechanism; an empirical reference standard (the “Standard”) • infrastructure; and against which MV ratings, and hence the value of carbon assets, might be judged are: • institutions. • Firstly: • based on international consensus to limit 1. The MV Rating and an Empirical Reference temperature increase to 2oC, which in Standard turn translates into a specified level of The MV rating lies at the heart of the NCM idea. The global emissions per year (annual global MV rating is a rating of the jurisdiction within which the emission cap); carbon trading scheme is located. The jurisdiction issuing • the annual global emission cap is allocated the carbon asset is evaluated as a whole, in terms of on a per capita basis to give annual the mitigation value of the P&Ms—including the trading nation state emission caps (the per capita scheme which generates the carbon assets—it has in approach accords with various UN principles place to mitigate emissions from within its boundaries. on equality and objections can be offset by Factors taken into account might include the profile of its Annex B  59 dropping the historical emissions argument Protocol; credit rating agencies; global consulting firms from the debate); environmental economics consultancies. • the ‘value’ is self-evident: scientists say that The nature of the activity suggests that a cross between a the 2oC cap is the level necessary to avoid DOE and a credit rating agency might produce an entity serious climate disruption; with the right mix of skills, resources and expertise. Or alternatively, The MV raters should be independent, private sector organizations, subject to regulatory supervision. The • Annual nation state emission caps are based actual entities deemed suitable to provide MV ratings on a country’s INDC (this might risk being will be a matter for the supervisory body. This will be an considered as being too imprecise/susceptible important function, in view of the importance of the role to manipulation, and so as having less ‘value’, performed by these entities, although it will be important by the financial markets, on the basis of the not to elevate them to the special quasi-regulatory proposition that the ‘value’ of the asset is what status which has been afforded credit rating agencies, ultimately drives market sentiment—confidence leading to some of the problems identified in the fall- that what is being purchased has a value that will out from the global financial crisis. One way to address be honoured); this issue would be to encourage a significant number (vi) If the Standard were to be based on either of the of organizations to seek recognition as an MV rater. two alternative approaches outlined above, then Greater numbers would operate against a small number clearly, each nation state could have an MV rating. If having dominance in the market as well as offering the jurisdiction that housed the trading scheme were other benefits, such as better, more diverse scrutiny and sub-national—provincial or local—then the MV rating evaluation of jurisdictions’ mitigation efforts, the trading methodology would need to be able to provide a schemes and carbon assets. rating at that sub-national level as a subset of the How many entities are deemed suitable, in the end, national MV rating. This would be analogous to the will be up to the supervisory body. The entities seeking way in which credit ratings can be made at sovereign, to be recognized as MV raters should satisfy minimum provincial, or municipal levels of government. The MV criteria, for example, in terms of technical and financial rating of the sub-national jurisdiction would contribute capacity; in terms of access to resources, governance, to/be considered in reaching the MV rating of the knowledge base, systems and personnel, training, etc. national jurisdiction overall [or probably vice versa]; The methodologies applied by the MV raters should (vii) Being the result of a large suite of variables, it be accredited by the supervisory body and should be is envisaged that the MV rating will be dynamic transparent—for instance, by being publicly available in nature, more akin to the daily rate settings of (at least to some degree which also takes in account currencies for FX, in its fluctuations, than to the commercial confidentiality issues to the extent relevant). possibly longer timeframe settings of credit ratings; How the MV raters are remunerated for providing the (viii) An MV rating could be ascribed to a jurisdiction, at MV ratings should be structured to foster the desired any time, even without the jurisdiction opting into policy outcomes, rather than offering excessive arbitrage NCM. While the MV rating translates to an exchange opportunities for parties. One possibility might be for rate, or ratio, of a carbon asset and be dynamic and payment setting to be based on a small levy on the subject to [daily/regular] fluctuations, in practice transactions arising from NCM trading. This idea of a it will only be specifically relevant [in terms of its transaction levy has already been applied in the CDM in compliance value] at the time the carbon asset is relation to the Share of Proceeds levies for administrative surrendered or cancelled for compliance purposes, expenses and adaptation. [or possibly also when it expires due to effluxion of [For example, in the case of NCM, any number of MV time in accordance with the rules of the scheme by raters could quote a particular rate (e.g., for Korean ETS- which it was created]. v-EUETS). The pool of funds generated by transactions Korean ETS/EUETS would then be shared between them, 2. The MV Raters except for outliers, e.g., those MV raters whose quoted rates differ by more than a specified percentage from the There are a number of types of organizations that [mean/mode/median] of quotes. This could encourage might serve as possible models for the MV raters: rate setting towards a norm, avoiding more extreme Designated Operational Entities (DOEs) under the Kyoto 60  Annex B assessments skewing the MV rating, and generate greater terms of trading attributes in such an architecture. This will confidence in the rate applied. In cases where an MV determine the extent to which they are fungible. rating is made for a jurisdiction, but it is not engaging in NCM trading, there could be an alternative mechanism, for example, a fixed amount payment, from the pool.] 5. Trading Mechanism How will trading take place? Is the trading mechanism an exchange mechanism (i.e., based on an exchange 3. Regulatory Supervision of carbon assets between the schemes) or a price Oversight of the MV raters might be exercised by the mechanism? UNFCCC/COP through [a constituted body under a new Under an exchange mechanism, since carbon assets protocol, possibly structured along similar lines to the move in both directions, the asset holdings of each CDM Executive Board]. As noted above, they would be scheme should be the same immediately after the recognized as MV raters if they satisfy minimum criteria, transaction as before. However, what might be the effect for example, in terms of technical and financial capacity; on the MV ratings of the jurisdictions engaged in such in terms of access to resources, knowledge base, systems an exchange? Also query what the effect is when the and personnel, training, etc. The supervisory body might MV ratings of those jurisdictions fluctuate up or down also specify methodologies, criteria, etc, to be applied, subsequently: does that affect the rate at which those factors to be considered in carrying out the ratings. assets may be traded in the future? This does not yet Alternatively, the MV raters might submit what they address the CV that might be attached by each jurisdiction proposed as their methodologies, criteria to be applied, to the exchanged assets, or what implications there factors to be taken into account, to the supervisory body may be for the MV rating of each jurisdiction by such for certification, the supervisory body having published determinations. guidelines on what criteria it would apply in making that decision. Under a price mechanism, the movement of carbon assets is in one direction only. Hence, immediately after The methodologies should be transparent, for example, the transaction, the asset holding of one scheme will be by being made publicly available (at least to some degree less and the holding of the other scheme more, than which also takes in account commercial confidentiality before the transaction. [Also query whether this change issues to the extent relevant). As noted earlier, the EU in asset holdings will be material to the MV rating of the Regulation on Credit Rating Agencies might serve as a jurisdiction] model. There is also the possibility of the exchange mechanism being via a ‘vehicle’ carbon asset. Further consideration 4. Carbon Asset Characterization needs to be given as to whether this might be useful or How should carbon assets be characterised for the desirable in the NCM context. However, what does seem purposes of NCM? In one sense, they are more like clear is that the ‘vehicle’ carbon asset would need to be a currency: the value derives from the integrity of the from a jurisdiction with a large over-supply for there to be scheme that stands behind them. In another sense, they sufficient carbon assets available at any time to perform are more like debt securities or physical commodities: this role. They would also need to have a reliably stable ultimately, the contract they represent needs to be MV rating. [At this stage, it’s hard to see what benefit there honoured—there needs to be a mitigation of carbon would be for any jurisdiction to have its carbon assets emissions, tonnes of CO2-eq not emitted or sequestered used in this capacity, however this issue might still be from the atmosphere—they need to be surrendered or researched further.] cancelled against the compliance obligation of a regulated In the absence of a primary transaction, such as an entity. international trading transaction in the case of FX, Carbon assets cannot be characterized as falling neatly necessitating an exchange mechanism for carbon into one or another financial market model. They have assets, a price mechanism seems simpler and more characteristics of all three considered. More important, efficient. As the carbon assets will move only in perhaps, is whether the electronic trading architecture one direction, there will be half the administrative can be applied to them: whether the carbon assets under adjustments in registries that would be required different schemes can be described or expressed in by the exchange mechanism. This may not be a Annex B  61 significant issue in an electronic age, nevertheless, less be a need to develop cross-border [trading] rules and a administration would mean less costs. crossing-platform.] Trading should be through an exchange, with a central clearing counterparty to reduce counterparty default 7. Institutions risk. There should be standardized wording for trading contracts used globally, with schedules attached according As noted above, a supervisory body to recognise MV to which carbon asset was being traded into which other raters and accredit their MV rating methodologies should trading scheme. Parties wishing to trade should do so be set up and the proposal is that this be done by the through brokers registered with the exchange (and it is UNFCCC/COP [as a constituted body under a new implicit that appropriate KYC, anti-fraud and AML protocols protocol, possibly structured along similar lines to the would be applied). Whether there is a single exchange, CDM Executive Board]. in the form of the proposed International Settlement Whether an International Settlement Platform needs to be Platform, or a number of exchanges spread globally but established as a central clearing and settlement institution linked electronically, will probably depend on the size is an open question. A determination would need to be of the NCM market. The exchange (or exchanges) will made whether it may be simpler and more efficient to perform settlement and clearing and should be linked engage with existing exchanges—the majority of which do electronically to registries in the jurisdictions that have not have international reach—or create a new dedicated opted into the NCM, either directly or through a central platform to clear trades via existing clearing bodies. registry such as, or modeled on, the ITL. Whatever approach is taken to the exchange(s), they The exchanges and the brokers would all be regulated will need to be linked to the registries operated by the under applicable financial regulatory provisions. Whether different trading schemes. In this context, it may be all trading contracts for carbon assets would be regulated decided to establish a further institution in the form of a as financial instruments, or whether financial regulation central registry, modeled along the lines of the ITL [or just would only apply to derivatives contracts, would need to use the ITL]. This institution would then have links to each be resolved, in the context of developments in financial of the registries in the different schemes. regulation. The importance of NCM to global efforts to mitigate the effects of climate change may be considered such as to 6. Infrastructure warrant the establishment of dedicated institutions as an exchange and as a central registry. If this were the case, Will the carbon assets across all the heterogeneous trading then it would be more efficient for these functions to be schemes be fungible and, if so, to what extent? To answer carried out by the same institution. this question, the different schemes need to be evaluated to see whether an electronic trading architecture can be The NCM proposals include the establishment of the applied to them: whether the carbon assets under those International Carbon Asset Reserve which, as considered different schemes can be described or expressed in terms above, would perform a role analogous to that which of trading attributes in such an architecture. Standardised central banks have in applying monetary policy. How contract wording will be required for transactions involving the ICAR would be established and how, when and why those assets which do fit within the trading architecture. it might intervene in the market are matters for further The other infrastructure required comprises the electronic consideration beyond the scope of this paper. links between exchanges (if more than one) and between the exchange(s) and registries, or the ITL-type central registry (if it is decided to establish one). [There would Ann x C A glossary of key definitions is proposed as follows: Concept/Expression/ Term Definition Explanatory Notes administrator or the legal entity that operates, manages and has the will most usually be an arm of regulator legal power to enforce compliance with an ETS or cap- government in the jurisdiction where the and-trade scheme scheme operates allowances means a carbon asset that is: usually measured in base units of • usually issued (either free or by auction) by a a tonne carbon dioxide equivalent compliance scheme administrator to scheme greenhouse gas (CO2-eq GHG), participants (‘compliance entities’)—entities whereby Global Warming Potentials emitting GHGs who have obligations under the of other GHGs are used to give the scheme to mitigate their emissions equivalent number of tonnes of CO2, • compliance entities will be required to surrender and GWP CO2 = 1 allowances equivalent to their GHG emissions for the compliance periods determined under the scheme (e.g. annually) baseline the emissions scenario that exists in the absence of the the starting point for measurement of PPP the MV of a PPP business-as-usual the level of emissions that will occur if no mitigation also can be the baseline against which (BAU) scenario action is taken to measure mitigation performance cap-and-trade an emissions mitigation scheme in which regulated caps are reduced over time to send a entities’ emissions are capped; they must surrender price signal to the regulated entities as carbon assets against actual emissions; can trade units to when abatement is cheaper than of carbon assets: selling if emissions below cap, buying paying for more carbon assets if their emissions exceed cap carbon asset an instrument generated as part of a scheme, project carbon assets include: or program the purpose of which is mitigation of • ETS allowances carbon emissions. In some jurisdictions, the legal • INDC units system may classify a carbon asset as a ‘chose in • Credits/offsets action’, meaning that it confers a right enforceable at carbon assets will be issued as part of a law. May be classified also as a ‘financial instrument’, scheme that allows for trading in those depending on application financial regulations in the assets, so that entities with compliance particular jurisdiction. obligations can buy assets to make up Usually measured in base units of a tonne carbon any shortfall for compliance purposes, dioxide equivalent greenhouse gas (CO2-eq GHG), or sell any assets that are surplus to whereby Global Warming Potentials of other GHGs are requirements, to derive a financial gain used to give the equivalent number of tonnes of CO2, from having emissions below their limit and GWP CO2 = 1 Can take the form of an ‘allowance’ or a ‘credit/offset’: • allowances: • are usually issued (either free or by auction) by a compliance scheme administrator to scheme participants (‘compliance entities’)— entities emitting GHGs who have obligations under the scheme to mitigate their emissions 62 Annex C  63 Concept/Expression/ Term Definition Explanatory Notes • compliance entities will be required to surrender allowances equivalent to their GHG emissions for the compliance periods determined under the scheme (e.g., annually) • credits/offsets: • are generated by projects which avoid or reduce emissions that would otherwise occur, or which sequester GHGs from the atmosphere, in both cases, compared to a baseline • need to be real, measurable and verifiable, as well as additional to BAU • can be surrendered on a voluntary basis, by entities that do not have compliance obligations; depending on the rules of the relevant compliance scheme, may also be able to be surrendered in respect of compliance obligations carbon asset exchange the rate, or ratio, at which a carbon asset generated the exchange rate may not exist as a rate under a scheme in one jurisdiction might be traded separately defined metric, but rather (concept yet to be into a scheme in another jurisdiction simply be the price agreed by parties to tested for feasibility) a transaction, as informed by the MVs of the respective jurisdictions carbon integrity risk AM: the risk that a PPP will achieve its intended CI risks are: characterization; governance (concept yet to be outcome and management; GHG assessment tested for feasibility) IISD: the risk that emission reductions or removals boundary; GHG estimation; GHG reported for a PPP actually occurred and are monitoring; reporting attributable to the interventions implemented as part of it IISD: the risk that reductions or removals resulting from a PPP are not (i) real, measurable and verifiable and additional to what would have occurred in their absence; or not (ii) real, permanent, additional, verified, avoid double counting and achieve net decrease and/ or avoidance of GHGs to preserve environmental integrity central counterparty Federal Reserve, Chicago: a process by which financial Clearing denotes all activities from clearing transactions are cleared by a single (i.e., “central”) the time a commitment is made for a counterparty who interposes itself between contract transaction until it is settled. Clearing parties to become buyer to every seller and seller to of payments is necessary to turn every buyer the promise of payment into actual movement of money from one bank to another. In trading, clearing is necessary because the speed of trades is much faster than the time for completing the underlying transaction. It involves the management of post-trading, pre- settlement credit exposures to ensure that trades are settled in accordance (continued) 64  Annex C Concept/Expression/ Term Definition Explanatory Notes with market rules (even if a buyer or seller should become insolvent prior to settlement). Processes included in clearing are reporting, monitoring, risk margining, netting of trades to single positions, tax management and failure risk management clearinghouse a financial institution that provides clearing and settlement services for financial transactions compliance value (CV) the value ascribed by the administrator/regulator of if the carbon asset has been issued by (concept yet to be an ETS, to a unit of a carbon asset, at the time it is the administrator under that scheme, it tested for feasibility) surrendered for compliance purposes under that ETS would usually be given a value CV = 1; if the carbon asset has been issued under the scheme of another jurisdiction, the administrator might be guided by the MV of that other jurisdiction in ascribing a CV to that scheme’s carbon asset at the time of surrender credit means a carbon asset which is: usually, but not necessarily, measured • generated by projects which avoid or reduce in base units of a tonne carbon dioxide emissions that would otherwise occur, or which equivalent greenhouse gas (CO2- sequester GHGs from the atmosphere, in both eq GHG), whereby Global Warming cases, compared to a baseline; Potentials of other GHGs are used to • need to be real, measurable and verifiable, as well give the equivalent number of tonnes of as additional to BAU; CO2, and GWP CO2 = 1 • can be surrendered on a voluntary basis, by entities that do not have compliance obligations; depending on the rules of the relevant compliance scheme, may also be able to be surrendered in respect of compliance obligations; emissions trading an emissions mitigation scheme, that usually operates scheme (ETS) as a cap-and-trade scheme exchange a central location bringing together brokers and can be either physical location or dealers/traders in commodities or financial instruments electronic location financial value (FV) the price a buyer is willing to pay for a unit of a carbon will depend on a number of market asset factors, including demand and supply, market liquidity, and depth of the market; will also be influenced by the carbon asset exchange rate between the relevant jurisdictions Annex C  65 Concept/Expression/ Term Definition Explanatory Notes Intended Nationally national statement to be made by UNFCCC Parties Determined setting out their mitigation goal which eventually can be Contributions (INDC) transformed into a legally binding commitment, must be transparent, quantifiable, comparable, verifiable and ambitious, reflecting the principles of Arts. 4.1 and 4.2 re national circumstances, etc. INDC unit carbon asset generated by an ETS introduced as part of the PPPs established by a country’s INDC Index statistical composite that measures changes in the each index has its own method economy or a financial market, often expressed as of calculation; components may changes from a base year or a preceding month be weighted according to certain characteristics, e.g., stock index weighted for market cap International the unit of a ‘transaction currency’ introduced for the Transaction Unit purpose of facilitating trading between schemes in diverse, heterogeneous jurisdictions jurisdiction means the relevant level of government, which may although some sub-national ETS be national or sub-national; to be a jurisdiction there are applied at provincial level, while needs to be clear legislative and administrative control others are at city or local level, these exercised over a geographic area with clearly defined distinctions are unhelpful as not all and accepted boundaries countries apply province/city/ municipal distinctions in the same way level of ambition the intended target level of mitigation, sought to be achieved by all the PPPs implemented, as stated by a jurisdiction mitigation means stabilising GHG concentrations in the can be achieved in two ways: atmosphere at a level that would prevent dangerous (i) limiting or reducing anthropogenic anthropogenic interference with the climate system, GHG emissions by sources to the which is the ultimate objective of the UNFCCC atmosphere, or (ii) preserving or enhancing sinks or reservoirs of GHGs mitigation value (MV) concept yet to be tested for feasibility mitigation value concept yet to be tested for feasibility outcome mitigation value concept yet to be tested for feasibility assessment agency (continued) 66  Annex C Concept/Expression/ Term Definition Explanatory Notes Networked Carbon WBG initiative, inter alia, to facilitate fungibility of carbon Markets (NCM) assets between heterogeneous efforts to mitigate GHG initiative emissions offset same as a credit programs, policies and means the policies, programs and pledges put in place pledges (PPP) by a jurisdiction to mitigate its GHG emissions settlement delivery of the transacted financial instrument (carbon settlement comprises the ‘physical asset) against payment, usually simultaneously, and settlement’ (delivery) and the ‘financial otherwise in accordance with the counterparties’ settlement’ (the payment against contractual agreement delivery) settlement platform similar to a clearinghouse, a financial institution that these days the functions of exchange, performs the role of central clearing counterparty so as settlement platform and central clearing to minimise transactional risk of counterparty failure counterparty might be bundled up into a single financial institution unit of measurement the base unit in which a carbon asset is measured, or most often, a tonne carbon dioxide in which emissions are measured equivalent greenhouse gas (CO2-eq GHG), whereby Global Warming Potentials of other GHGs are used to give the equivalent number of tonnes of CO2, and GWP CO2 = 1 Ann x D This Annex sets out three example NCM transaction • The applicable exchange rate, on the date of the scenarios: transaction, determines the number of carbon units that are credited to the buyer’s account in the buyer’s • the Foreign Unit converted model registry in the carbon units of the buyer’s jurisdiction: • the Foreign Unit imported model the regulator/scheme administrator in Jurisdiction B cancels the 12,000 A units received in the registry • the International Transaction Unit model account and issues in their place 8,000 B units • The transacted number of seller’s carbon units are Example NCM Transaction Scenario: Foreign Unit debited from the seller’s account in the seller’s Conversion Model registry: regulator/scheme administrator in Jurisdiction A doesn’t need to do anything after the 12,000 A Jurisdiction A Jurisdiction B units have been transferred out of the A registry MV = A MV = B account Compliance Value Trades A units Trades B units • Jurisdiction A regulator/scheme administrator Compliance entity A wishes Compliance entity B wishes to sell 12,000 A units to to buy 12,000 determines the CV of A units Compliance entity B A units from Compliance • Jurisdiction B regulator/scheme administrator entity A determines the CV of B units On xx/yy/zz date: • CV doesn’t come into the transaction equation, e.g., MV A/B translates into an exchange rate of 0.67 (that because the units surrendered against compliance in is, 1.5 A units = 1 B unit) any jurisdiction will always only ever be the domestic units of that jurisdiction 12,000 A units debited 8,000 B units credited Compliance entity A’s Compliance entity B’s Financial Value account in A registry account in B registry • The price reached by Seller A and Buyer B will be substantially influenced by the exchange rate on the date of the transaction, as in effect, this will Transaction determine the compliance value • The respective MVs of the two jurisdictions translate • As the exchange rate derives from the respective into an exchange rate between them (how this is MVs, the price should be a reflection of the relative worked out will be critical, but assume for purpose of MVs of the two jurisdictions. this example it can be) • The counterparties agree how many of the seller’s carbon units they wish to transact 67 68  Annex D Example NCM Transaction Scenario: Foreign Unit • The transacted number of seller’s carbon units are Imported Model debited from the seller’s account in the seller’s registry: regulator/scheme administrator in Jurisdiction Jurisdiction A Jurisdiction B A doesn’t need to do anything after the 12,000 A units have been transferred out of the A registry MV = A MV = B account Trades A units Trades B units Compliance Value Compliance entity A wishes Compliance entity B wishes • Jurisdiction A regulator/scheme administrator to sell 12,000 A units to to buy 12,000 determines the CV of A units. Compliance entity B A units from Compliance entity A • Jurisdiction B regulator/scheme administrator determines the CV of B units. On xx/yy/zz date: • CV becomes relevant on the date [aa/bb/cc] that e.g., MV A/B translates into an exchange rate of 0.67 (that Compliance entity (buyer) B wishes to surrender them is, 1.5 A units = 1 B unit) to the Jurisdiction B regulator/scheme administrator 12,000 A units debited 12,000 A units credited against compliance obligations under Jurisdiction B Compliance entity A’s Compliance entity B’s ETS. On that date, Jurisdiction B regulator/scheme account in A registry account in B registry administrator determines what CV to give to the Jurisdiction A units. If the exchange rate has changed between the dates, xx/yy/zz and aa/bb/cc, then what Transaction the CV Buyer B gets for the 12,000 A units on aa/ bb/cc may be different from that which would have • The respective MVs of the two jurisdictions translate applied on xx/yy/zz. Buyer B carries that risk. into an exchange rate between them (how this is worked out will be critical, but assume for purpose of Financial Value this example it can be) • The price reached by Seller A and Buyer B will be • The counterparties agree how many of the seller’s influenced by the exchange rate on the date of carbon units they wish to transact the transaction, but only to the extent that: (a) the exchange rate is relevant to the CV on that date, • The applicable exchange rate, on the date of the which may be a function of the NCM arrangements, transaction, is immaterial to the transaction as e.g., might be exchange rate on date of transfer the number of carbon units that are credited to converts directly to CV, or alternatively, might be left the buyer’s account in the buyer’s registry are the up to Jurisdiction B regulator/scheme administrator; same as the number debited from the seller’s and (b) the surrender date for compliance in account in the seller’s registry: the regulator/scheme Jurisdictional B is proximate to the transaction date. administrator in Jurisdiction B by agreement with Jurisdiction A, accepts A units and credits the 12,000 A units received in the registry account to Compliance entity (buyer) B Annex D  69 Example NCM Transaction Scenario: International Transaction Unit ‘Transaction Currency’ Model Jurisdiction A Index (‘II’) based on e.g., all Jurisdiction B MVs of trading jurisdictions; Index has notional International Transaction Units (ITU) MV = A MV = B Trades A units Trades B units Compliance entity A wishes to sell 12,000 Compliance entity B wishes to buy 12,000 A A units to Compliance entity B units from Compliance entity A On xx/yy/zz date: e.g., MV A/II translates into an exchange rate of 0.67 (that is, 1.5 A units = 1 ITU) 12,000 A units debited Compliance entity 8,000 ITUs held in Seller A’s A’s account in registry A pending account on International Settlement Platform 8,000 ITUs transferred from Seller A’s pending account to Buyer B’s pending account e.g., MV II/B translates into an exchange rate 1.2 (that is, 0.8 ITUs = 1 B unit) 10,000 B units credited Compliance entity B’s account in registry B Transaction • CV doesn’t come into the transaction equation, because the units surrendered against compliance in • The respective MVs of the two jurisdictions translate any jurisdiction will always only ever be the domestic into an exchange rate between each of them units of that jurisdiction. respectively and the Index (how this is worked out will be critical, but assume for purpose of this Financial Value example it can be); • The price reached by Seller A and Buyer B should be • The counterparties agree how many of the Seller A’s substantially influenced by the two exchange rates carbon units they wish to transact; applicable on the date of the transaction, as in effect, this will determine the number of B units received by B; • The applicable exchange rate A/II, on the date of the transaction, determines the number of ITUs that • As the exchange rates derive from the respective are credited to the Seller A’s pending account on the MVs in relation to the Index, the price should be a International Settlement Platform; reflection of the relative MVs of the two jurisdictions to the Index and ultimately, to each other; • On financial settlement, the ITUs in Seller A’s pending account are transferred to Buyer B’s pending account; • However, nothing above prevents the Buyer B from speculating on an improvement of the exchange • The applicable exchange rate II/B, on the date of rate II/B, by continuing to hold the ITUs in its pending transaction (or on whichever date Buyer B decides account and only transferring them to its account to move them from its International Settlement in registry B as B units, when that more favourable Platform pending account to its account in registry B), rate applies or when it absolutely needs to, e.g., for determines the number of B units that are credited to compliance reasons. 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Jennifer Austin, Networked Carbon Markets Concept December 2014. http://unfccc.int/resource/ Development—Using Mitigation Value to Guide docs/2014/cmp10/eng/05.pdf, accessed 17 August Design of Trading Rules, September 2015 (prepared 2015 as part of NCM initiative, unpublished) 70 References  71 UNFCCC (2015), Synthesis Report on the aggregate Response, Public Policy for the Private Sector, Note effect of the intended nationally determined Number 8, October 2009, http://siteresources. contributions, FCCC/CP/2015/7, unfccc.int/ worldbank.org/EXTFINANCIALSECTOR/ resource/docs/2015/cop21/eng/07 Resources/282884-1303327122200/Note8.pdf, .pdf accessed 15 April 2015 World Bank (2015), State and Trends of Carbon Pricing World Bank, Networked Carbon Markets, generally: 2015, Washington, DC link: http://www.worldbank.org/en/topic/ World Bank Group (2009), Financial and Private Sector climatechange/brief/globally-networked-carbon- Development Vice Presidency, ‘Credit Rating markets Agencies, No Easy Regulatory Solutions’, Crisis http://www.worldbank.org/en/topic/climatechange/brief/globally-networked-carbon-markets Contact: Bianca Ingrid Sylvester Tel: 202.473.4549 email: bsylvester@worldbank.org