The Compliance or Regulatory Carbon market is underpinned by two major agreements that have been adopted by the international community: the United Nations Framework Convention on Climate Change, 1992 and the Kyoto Protocol, 1997, which entered into force on 16th February 2005.
In 1992, recognising the danger that rising levels of Greenhouse Gases (GHG) posed to the global environment, the world’s governments adopted the United Nations Framework Convention on Climate
Change (UNFCCC). The Convention sets an ultimate objective of stabilising atmospheric concentrations of Greenhouse Gases at levels that would prevent “dangerous” human interference with the climate system. At a meeting in Berlin in March/April 1995, in a decision known as the Berlin Mandate, Parties to the UNFCCC launched a round of talks to decide on detailed commitments for industrialised countries. After two and a half years of intense negotiations, the Kyoto Protocol was adopted in Kyoto, Japan, on 11th December 1997. In February 2005 the protocol came into force with 156 countries having ratified the agreement representing 61% of global emissions.
The Kyoto Protocol sets legally binding targets for the emission of GHGs for the countries of the developed world that have ratified the protocol (Annex 1 countries). The six Greenhouse Gases are:
The protocol binds countries that have ratified the treaty to reduce emissions of these gases by an overall 5% below 1990 levels during 2008 to 2012. In order to meet these targets, Annex 1 parties may directly reduce their domestic emissions but also use the three innovative or “flexibility” mechanisms introduced by the protocol – the Clean Development Mechanism (CDM), Joint Implementation (JI) and Emissions Trading – provided that the country complies with its methodological and reporting obligations under the Protocol. However, parties must provide evidence that their use of the mechanisms is “supplemental to domestic action”, which must constitute “a significant element” of their efforts in meeting their commitments. The modalities and guidelines for implementation of the flexibility mechanisms are contained within the Marrakeseh Accords, agreed at the 7th Conference of the Parties to the UNFCCC, in November 2001.
These flexibility mechanisms provide the legal framework for the trading of carbon credits, placing a price on emissions and thereby providing incentives for people, companies and countries to emit less. Resources are channelled toward the most cost effective means of reducing GHG emissions and at the same time a market demand for new clean energy technologies is created.
This Compliance Carbon Market with carbon credits as the first environmental commodity is growing at a rapid rate with trading volumes now reaching billions of dollars and hundreds of millions of tonnes of carbon dioxide. The market offers growth prospects for business and positive impacts for GHS emission reductions, finance for clean and sustainable development and renewable energy.
The Kyoto Protocol’s three flexible mechanisms
The Clean Development Mechanism (CDM)
A CDM project is basically an investment in an industrialising country that reduces GHS emissions below what they would have been in the absence of the investment. The resultant emission reductions (carbon credits), expressed in tonnes of CO2, may be sold to a government or company in the industrialised world to meet their Kyoto commitments. Emission reductions created under the CDM are referred to as Certified Emission Reductions (CERs). For more details of the CDM click here
Joint Implementation (JI)
Under the JI mechanism companies in industrialised countries can purchase carbon credits from GHG reduction projects implemented in another developed country or in a country with an economy in transition (mainly from countries of the formerly communist Eastern Europe). Emission Reductions from JI projects are called Emission Reduction Units (ERUs).
A cap-and-trade transaction system has been institutionalised where developed countries that have ratified the Kyoto Protocol are allocated emissions allowances based on the negotiated targets. These countries can purchase carbon credits from each other in order to meet their Kyoto commitments.
One of the most important and biggest trading schemes that has been developed to meet the Kyoto targets is the EU Emissions Trading Scheme (EU ETS). This is distinct from the Emissions Trading mechanism outlined above and is an internal scheme the EU has implemented to meet its domestic commitment. The scheme has been in operation since 1st of January 2005, involves all EU member states and also allows limited trading with the CDM and JI Kyoto mechanisms.