emissions trading

Kyoto protocol

In 1992 countries (154) which joined the United Nations Framework Convention on Climate Change (UNFCCC) acknowledged ‘the change in the Earth’s climate and its adverse effects are a common concern of humankind’ and the UNFCCC set out the commitment of the convention countries’ commitment to reduce global warming and to cope temperature increases.

The 1997 Kyoto Protocol went one step further by committing Annex I countries (163 countries have ratified to date) to individual targets to limit or reduce their greenhouse gas emissions. 35 countries and the EU are required to reduce greenhouse gas emissions below levels specified for each of them in Annex B of the treat and the target is a total cut in greenhouse-gas emissions of at least 5% from 1990 levels in the commitment period 2008-2012.

The Kyoto Protocol aims to achieve its environmental goal by the so-called “flexibility mechanisms” covering (a) emission trading (b) joint implementation and (c) CDM. Transfers and acquisitions of emission units are to be tracked and recorded through the registry systems under the Kyoto Protocol. These include a national registry to be established and maintained by each Annex I party.

ETS

Pursuant to the UNFCCC and the Kyoto Protocol, the EU for example has established the Emissions Trading System (ETS) which came into effect on 1 January 2005 to limit CO2 emissions from large industrial sources. The first phase (2005 - 2007) is designed as a 'test-run', to establish the basic operations (e.g. registry system) and trading system and to get them ready for the commitment period starting 2008. The national allocation plans (NAPs) under the ETS (article 9 of the directive 2003/87/EC) impose reduction targets in line with the domestic implementation of each member state's protocol commitment. NAPs for the period 2008-12 would have to be submitted by the end of June 2006.

The ETS covers CO2 emissions of energy activities (combustion installations with a rated thermal input exceeding 20MW, mineral oil refineries, coke ovens), production and processing of ferrous metals, mineral industry (cement clinker, glass and ceramic bricks) and pulp, paper and board activities. Only CO2 will be included in the first phase with the potential to expand this to the other 5 greenhouse gases from 2008.

From 2008 onwards all installations affected by the ETS must be covered. Companies may meet their emission targets by reducing emissions or by buying ‘allowances’ which can be surrendered against their target. Companies without sufficient allowances to cover their emissions will pay a direct financial penalty (40 Euro/tonne CO2 from 2005-7, 100 Euro thereafter) and have to make up the deficit in subsequent commitment periods.

Joint implementation

JI allows an Annex 1 country to meet part of its target by carrying out a project to reduce greenhouse gas emissions in another Annex 1 country under a “two track” approach, depending on whether the host country meets the eligible requirements relating to the transfer and acquisition of emission reduction units (ERUs)

CDM

The clean development mechanism is a an arrangement under the Kyoto Protocol allowing the Annex 1 countries to fulfil their protocol commitments by investing in emission reducing projects in non Annex 1 countries as an alternative to emission reductions. Article 12 of the Kyoto Protocol sets out the objectives of the CDM namely (a) to help Annex 1 countries reduce emissions and (b) assist non Annex 1 countries achieve sustainable development.

The CDM is supervised by the CDM executive board (CDMEB) and under the guidance of the conference and meeting of the parties of the UNFCCC (COP and MOP).

An applicant obtains CERs (certified emissions reductions) by establishing a registered project using methodologies approved by the CDMEB and verified by DOE (designated operational entity, a third party agency) to have real, measurable and long term emission reductions.

CAIR

On 10 March 2005, the US environmental protection agency (EPA) issued the Clean Air Interstate Rule (CAIR) which aims to reduce air pollution by capping emission of sulphur dioxide and nitrogen dioxide in 28 eastern states and the District of Columbia in the US. Under the CAIR, the covered states will have the options of participating in the cap and trade system administered by EPA or other measures chosen by the states. Under the CAIR, companies covered by CAIR will have alternatives to comply with CAIR by e.g. installing pollution control equipment or buying emissions allowances in the emission markets.

Last updated May 2007

The above notes are intended to provide only general outlines and, where applicable, should be read in conjunction with, and are qualified in their entirety by, the full provisions of the relevant ISDA provisions and definitions. They should never be used in place of professional advice. We accept no responsibility for any loss arising from any action taken or not taken by anyone using this material or using this material in conjunction with any ISDA documentation in reliance thereof.

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