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THIS PAGE WAS UPDATED ON: 05/27/99

lead.jpg (22302 bytes)    Volume 4 
   Number 2
   28 May 1999 

THE KEY TO THE SUCCESS OF THE KYOTO PROTOCOL: INTEGRITY, ACCOUNTABILITY AND COMPLIANCE
Annie Petsonk, International Counsel, the Environmental Defense Fund
and Chad Carpenter, IISD


Enforcing compliance among sovereign nations is the fundamental challenge of any international treaty. Essential to the success of the Kyoto Protocol will be mechanisms that invite sovereign nations to report their emissions performance with integrity, that provide incentives for sovereigns to comply with their emissions limitation obligations, and that hold sovereigns accountable for any failures to comply.

At the Workshop on the Kyoto Protocol Mechanisms, held in Bonn in April 1999, which drew a number of experts from governments, academic institutions, and environmental and business NGOs, all participating in their individual capacity, experts from Switzerland and from the Environmental Defense Fund (EDF) put forward proposals to address compliance. The EDF proposal focused on using a staged set of progressively stringent accountability and compliance consequences to encourage compliance, through a blend of "buyer" and "seller" liability. The EDF proposal is described in "Cooperative Mechanisms and The Kyoto Protocol: The Path Forward," available at www.edf.org. Proposals on the same topic have been advanced by the World Wildlife Fund (WWF) (contact nmabey@wwfnet.org) and by other organizations, including Greenpeace. The proposal by the expert from Switzerland, which was referred to in the Workshop and will be referred to here as "the Swiss proposal," focused on leveraging compliance through rigorous annual reporting coupled with automatic restrictions on exports of emissions units. The Swiss proposal is described below.

Following these presentations, a number of experts at the Workshop recommended a fusion of the two proposals. After summarizing the Swiss proposal, this article proposes a set of eight rules that fuse the Swiss and EDF proposals. A set of "Annual Reports of Emissions and Transactions," and a five-year "Emissions Budget Balance Sheet" for a hypothetical Annex B Party, illustrate the operation of these eight rules in practice.

The Swiss Proposal. The Swiss expert proposed that no Annex B Party should be allowed to sell or "export" assigned amount units (AAUs) under Kyoto Protocol Articles 3.11 and 17, emissions reduction units (ERUs) under Articles 3.11 and 6, or certified emissions reduction units (CERs) acquired by it under Article 12 (collectively, "emissions units"), unless it could show, on an annualized basis, that the emissions units it sought to sell were "extra," i.e., that the Party would not need those units to comply with its emissions limitations during that year. The determination of whether the units were "extra" would be made by comparing the Party’s actual emissions for each budget year with the amount of allowable emissions units it held in its emissions budget account for that year. The Swiss proposal assumed that each Party’s total allowable emissions would be divided by five (the number of years in the budget).

For the first year, it would be impossible to tell whether any emissions units were "extra" in relation to actual emissions until the end of the year, when the first year’s actual emissions were counted. Accordingly, under the Swiss proposal, no sales or exports of AAUs/ERUs/CERs could take place during the first year of the five-year emissions budget. For each year after the first year, an Annex B Party could only export "extra" AAUs, ERUs, or CERs, i.e., units "left over" from the preceding year. For example, if in the first year of the five-year emissions budget, an Annex B Party’s actual emissions were less than one-fifth of its assigned amount, then, in the second year, the Annex B Party could sell or export those extra or left over units. If, in the second year of the five-year budget, the Annex B Party’s actual emissions were less than one-fifth of its assigned amount plus any purchases/imports minus any sales/exports, then, in the third year, the Party could sell or export those left over units. And so on for each year of the budget.

Discussion of the Swiss Proposal At the Bonn Workshop. At the Bonn Workshop, experts noted in particular two key features of the Swiss proposal: the requirement of annual reporting of actual emissions and transactions; and the automaticity of the mechanisms for accountability.

Experts identified two advantages of the Swiss proposal. First, by requiring annual reporting of emissions and transactions, the Swiss proposal communicates to all Parties important information about how each Party is doing in limiting its emissions in relation to its overall target. Second, by limiting transactions to only those units which are truly surplus, the proposal essentially would ensure that all transactions occurred in, effectively, "insured" tons - tons that the sovereign had deemed to be truly surplus for purposes of meeting its overall target. No "overselling" could occur, although the problem of encouraging sovereigns to limit actual emissions to allowable levels would still exist. The Swiss proposal would provide strong compliance incentives that take effect during the budget period.

Experts also identified four concerns with the Swiss proposal. First, it was noted that the determination of whether tons were truly "surplus" could be cumbersome, given that information about actual emissions will always lag behind information about transactions. Countries indicated that data on actual emissions for any particular year could take as long as two years to compile, effectively preventing any transactions for as much as three years. But some countries also acknowledged that if the market placed value on early reporting, emissions reports could be reported much sooner, perhaps as early as six months after the close of the reporting year.

Second, by restricting the determination of "surplus" emissions units to those that are surplus on an annual basis, the Swiss proposal would essentially transform the five-year emissions budgets approach of the Kyoto Protocol into five one-year emissions budgets, eliminating the "temporal" or "when" flexibility of the emissions budget approach. This could raise problems for countries whose actual emissions depend to some extent on activities and events beyond their sovereign control. For example, for countries in electricity grids where there is a mix of fossil and hydropower, an unexpected drought in the hydro portions of the grid area - including, potentially, in other nations - could necessitate short-term increases in fossil generation in order to meet demand. Under the Swiss rule, transactions in emissions units would be unavailable to those countries during drought years.

Third, it was noted that the Swiss proposal would discriminate against poorer countries in Annex B. A wealthy Annex B Party might have the capital on hand to finance new technologies that would enable it to reduce emissions domestically or purchase emissions units from other nations and thereby end up with "extra" or left over emissions units. But a poorer Annex B nation might need to sell some emissions units early in the budget period in order to finance the new technologies that will enable it to reduce emissions. The Swiss proposal would deprive poorer nations of the opportunity to leverage emissions units for financing technology transfer.

Fourth, it was noted that the Swiss proposal fundamentally did not address the compliance issue in full. The fact that a country yearly has extra or left-over emissions units, does not by itself mean that the country will be in compliance after the commitment period. It is possible that, because of high economic growth or sectoral problems, a country might encounter significant emissions rises in year 4 or year 5, in total resulting in non-compliance. In that case, some of the already sold emissions units would then, in effect, be 'over-sold,' and some further provision would need to be made - e.g., automatic true-up, mandatory deduction, or devaluation of already transferred emissions units - in order to make the atmosphere whole and to provide a compliance pressure on Parties.

In light of these concerns, experts then inquired whether it would be possible to fuse the annual accountability and information-provision features of the Swiss proposal together with the compliance aspects of the EDF proposal? On that basis, the following "fused approach" is offered.

A Fused Approach: Eight Rules for Accountability And Compliance.

One key element of the Swiss proposal that could greatly enhance the transparency, accountability, and compliance component of the Kyoto Protocol is its requirement that, on an annual basis, actual emissions must be compared with emissions units available following transfers. A second key element of the Swiss proposal is its automaticity. That is, the Swiss proposal provides a set of accounting consequences that apply automatically, without the need for the political process associated with compliance systems in international legal instruments.

Building on these sound features, it is possible to match the flexibility of the five-year budget approach with a set of automatic, progressively stringent consequences that encourage sovereign compliance, and that leverage compliance through the transparency of rigorous annual reporting. The elements of the fused approach would comprise a set of eight rules, as follows.

Rule #1: Annual Monitoring and Reporting of Actual Emissions. The Kyoto Protocol already requires transparent annual reporting of emissions of all gases, from all sources, and uptake by all sinks. (Kyoto Protocol, Articles 5 and 7.) While reporting in terms of carbon dioxide equivalence is already implied (Article 5.3), the Parties should adopt a rule clarifying that all annual emissions reporting should be stated in terms of tonnes of carbon dioxide-equivalence.

Rule #2: Real-Time Tracking and Reporting of Emissions Units, Including Transfers. Articles 3.10-3.12 require the Parties to utilize specific accounting rules to ensure that all transactions in AAUs, ERUs, and CERs are recorded as additions to and subtractions from Parties’ emissions accounts. As the Swiss proposal makes clear, real-time reporting of transactions and account balances can be a critical element in fostering accountability and compliance. Building on the Swiss proposal, the Parties should adopt a rule requiring real-time reporting by all Parties, to all Parties, directly, or through the Secretariat, or through a website with appropriate paper back-up, of all AAU, ERU, and CER transactions in serialized units, as well as real-time reporting of account balances.

Rule #3: Failure To Report: The Parties should also adopt a rule specifying that failure to report actual emissions, transactions, or account balances within specified time periods will place a Party in non-compliance. The rule should specify that one automatic consequence of this type of non-compliance should be that a Party that fails to report within the specified time period is precluded from undertaking transfers until the reporting violation is cured.

Rule #4: Defining Non-Compliance With Emissions Limitations. The key principle on which accounting rules for compliance should be based is, at the end of the commitment period, are a Party’s actual net emissions less than the assigned amount units it holds, as adjusted for transfers? The Parties should adopt a rule stating this fundament point: If, at the end of the commitment period, a Party's actual emissions exceed its assigned amount units adjusted for transfers (including AAUs, ERUs, and CERs), then the Party is in non-compliance, and is subject to the compliance measures of Article 18 in addition to the automatic consequences described below.

Building from that fundamental proposition, a progressively stringent set of consequences can be fashioned, using the rigorous annual reporting requirements of the Swiss proposal, and pairing those with accounting rules that provide compliance incentives both during the budget period and at the end of the budget period.

Compliance Incentives During The Budget Period. The Parties could adopt rules establishing two progressively stringent compliance consequences that will be applied automatically during the budget period.

Rule #5: Automatic Discount of Transferred Emissions Units If Emissions Exceed Trigger Level During the Budget Period. The Parties should adopt a rule specifying that if actual net emissions during the budget period exceed a pre-specified trigger point, e.g., 110% of total allowable emissions during the budget period, then an automatic discount will be applied to all AAUs/ERUs/CERs transferred by that Party within the past year that have not yet been tendered for compliance purposes. The discount could be set equal to the amount by which the Party’s actual emissions exceed assigned amounts. For example, if a Party’s actual emissions are 110% of assigned amounts, then any AAUs/ERUs/CERs transferred by that Party in the past year would be discounted by 10%.

The effect of this automatic discount would be to create market pressure in favor of compliance among purchasers, sellers, and private entities. Purchasers of AAUs/ERUs will seek to purchase from Parties whose actual emissions are well below this trigger point, since purchasers will not want to see the value of their investments diminished if the seller’s emissions go past the trigger point. Selling nations will compete to try to keep their emissions below the trigger point, in order to be able to sell "high-quality" or full-value tons in a competitive marketplace. Private entities in seller nations that have worked hard to reduce emissions and thereby generate ERUs or extra AAUs, will not wish to see the value of their investment diminished if their country’s emissions hit the trigger point - so they will urge their national authorities to do a better job on national compliance, in order to preserve the value of their investments. In fact, any government that wishes, as a matter of its sovereign choice, to adopt the full Swiss proposal, could offer "insured" emissions units for sale. Such "insured" units, in which the selling sovereign nation effectively guarantees that it will ensure that the units are not affected by the automatic discount, would command a premium in the marketplace.

Concerns have been raised that such "buyer liability" would weaken market liquidity, since buyers would be hesitant to purchase emissions units if they knew those units would be subject to the automatic discount. However, the time-limited approach described above would maintain market liquidity, since the discount would apply only to AAUs/ERUs transferred in the past one year, and only to those AAUs/ERUs which had not yet been tendered for compliance purposes. In fact, the operation of such a rule would encourage early tenders for compliance - providing yet another example of the potential of this approach to foster sovereign compliance.

Rule #6: Automatic Prohibition on Sales When Emissions Exceed Specified Levels. The Parties should adopt a rule specifying that if actual net emissions during the budget period exceed a later pre-specified trigger point, e.g., 120% of total allowable emissions during the budget period, then an automatic prohibition on further transfers by that Party will be applied. The effect of this rule would be to prevent cascading non-compliance, whereby a Party effectively floats atmospheric debt in order to buy its way back into compliance.

Compliance Incentives At End of Budget Period. As noted above, the fundamental rule that Parties would need to agree on is that if at the end of the budget period, a Party’s net emissions exceed the assigned amounts it holds as adjusted by transfers, then the Party is in non-compliance, and is subject to compliance consequences under Article 18.

Rule #7: Limited True-Up Period. For Parties facing Article 18 sanctions, a "True-Up" period (e.g., of 6 months) would gives sovereigns the opportunity to cure their non-compliance. Economic fluctuations, weather shifts, and changes in oil prices that occur late in the emissions budget period could cause unexpected non-compliance at the end of the budget period, even among Parties that have otherwise taken great efforts, in good faith, to comply with the Protocol. A Party that is acting in good faith will want to move quickly to cure this non-compliance, and should be given the opportunity to do so. Accordingly, the Parties should adopt a rule specifying a limited True-Up period at the end of the compliance period.

Rule #8: Making The Atmosphere Whole. However, a Party may fail to "True-Up" its emissions account. In that case, the atmosphere will be burdened by that Party’s non-compliance, and it will be burdened by increased concentrations of long-lived greenhouse gases, whose atmospheric lifetime exceeds the duration of the next budget period. Accordingly, simply deducting the excess emissions from the Party’s next-period assigned amount is not enough to "make the atmosphere whole." Therefore, in addition to the compliance consequences the Party may face under Article 18, the Parties should adopt a rule specifying that if, after the True-Up period, a Party’s actual emissions still exceed its assigned amount, then the excess must automatically be deducted from the Party’s next emissions budget, with an Atmospheric Penalty (e.g., the deduction could be done at a ratio of 1.2:1.0).

Together, this blend of the rigorous annual reporting and automaticity of the Swiss proposal, and the system of progressively stringent compliance consequences of the EDF proposal, could provide a framework that would provide powerful incentives favoring sovereign compliance.

A "structural" element that would be needed to make this system work would be an agreement by the Parties that traded emissions units - AAUs, ERUs, and CERs - will be identified by country and year of origin, and in the case of ERUs and CERs, by project of origin. This identification would enable the market to provide feedback to each nation, delivering a powerful incentive for nations to improve their environmental performance. With such a rule, emissions units from high-performing nations will be able to command higher market prices, and will also earn better ratings from the private, non-governmental carbon quality "rating" services that are likely to develop. Therefore, the requirement of identification of traded emissions units in a standardized, serialized format is a key element of Reporting under Rule #2 above.

 

 

Eight Rules for Accountability and Compliance

Rule #1 Annual Monitoring and Reporting of Emissions: All annual emissions reporting should be stated in terms of tonnes of carbon dioxide-equivalence.
Rule #2 Real-Time Tracking and Reporting of Emissions Units, Including Transfers: All Parties should be required to report, in real time, to all other Parties, directly, through the Secretariat, or through a website with appropriate paper back-up, all AAU, ERU, and CER transactions. Parties should be required to report, in real time, their emissions account balances. All transactions should be reported in standardized serialized units that identify the units traded by country and year of origin, and in the case of ERUs and CERs, by project of origin.
Rule #3 Failure To Report: A Party’s failure to report actual emissions, transactions, or account balances within specified time periods will place a Party in non-compliance. The Party may not undertake any further transfers until the reporting violation is cured.
Rule #4 Non-Compliance With Emissions Limitations: If, at the end of the commitment period, a Party's actual emissions exceed its assigned amount units adjusted for transfers (including AAUs, ERUs, and CERs), then the Party is in non-compliance, and is subject to the compliance measures of Article 18 in addition to the automatic consequences established by the other Rules.
Rule #5 During the Budget Period Automatic Discount of Transferred Emissions Units If Emissions Exceed Trigger Level: If, during a budget period, a Party’s actual net emissions equal 110% or more of its total allowable emissions (net of transfers) during the budget period, then any AAUs/ERUs/CERs that the Party has transferred within the past year that have not yet been tendered by another Party for compliance purposes will be automatically discounted by the percentage of the excursion.
Rule #6 During the Budget Period Automatic Prohibition on Sales When Emissions Exceed Specified Levels: If during the budget period a Party’s actual net emissions exceed 120% of total allowable emissions (net of transfers), then the Party is prohibited from selling/exporting any further AAUs/ERUs/CERs.
Rule #7 End of Budget Limited True-Up Period: At the end of the budget period, a Party whose actual emissions exceed its assigned amount (net of transfers) faces compliance consequences under Article 18. In addition, the Party must bring its emissions account into balance within six months.
Rule #8 End of Budget Period Responsibility To Make The Atmosphere Whole: If a Party fails to balance its emissions account within six months, then, in addition to the compliance consequences the Party faces under Article 18, the difference between its actual emissions and its assigned amount (net of transfers) shall be deducted from the Party’s next emissions budget at a ratio of 1.2:1.0.