A Seat at the (Trading) Table: Non-Market Mechanisms in the Paris Agreement

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A Seat at the (Trading) Table: Non-Market Mechanisms in the Paris Agreement

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        University of Eastern Finland Law School Master’s Thesis in Environmental Policy and Law Supervisor: Harro van Asselt

29 April 2020 Writer: Rosanna Anderson 300159

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Dedicated to Grandma,

for passing down her love of education

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ABSTRACT

UNIVERSITY OF EASTERN FINLAND Faculty

UEF Law School

Unit

Master’s Degree Programme in Environmental Policy and Law

Author

Rosanna Anderson

Name of the Thesis

A Seat at the (Trading) Table: Non-Market Mechanisms in the Paris Agreement

Major

Climate Change Law

Description

Master’s thesis

Date

29 April 2020

Pages

Climate change science has evolved rapidly in recent decades, bringing climate change policy onto the international agenda. Despite the inherent uncertainty of climate change, there is high confidence that the average global temperature has increased by approximately 1°C compared to pre-industrial levels and this is likely to reach 1.5°C between 2030-2050. In response, the United Nations Framework Convention on Climate Change and subsequent agreements such as the Kyoto Protocol and Paris Agreement have sought international solutions to address climate change. The current target in the Paris Agreement is to limit the global average temperature to “well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels”. Concerningly, recent reports indicate that international efforts are failing to reach the level of ambition required and that there is a wide discrepancy between the science, national emissions reduction targets and fossil fuel production plans. In the current agreements, the policy tools adopted by the UNFCCC are predominately market-based mechanisms (MBMs). However, Article 6.8 of the Paris Agreement has provided the first avenue for using non-market approaches (NMAs) in the UNFCCC.

Accordingly, the purpose of this paper is to provide some clarity on the interpretation of Article 6.8 and explore its potential to increase ambition and effectiveness in international actions to tackle climate change. Firstly, this paper explores what NMAs are in the context of climate change policy and how the concept has evolved.

The main research tool in this section is a mapping of historical country Party submissions in UNFCCC debates relating to NMAs, particularly in the lead up to the Paris Agreement. This paper then looks at the legal elements of Article 6.8 and how they may influence future NMAs under the Paris Agreement. Finally, this paper considers supply side climate policy as a case example of an NMA which could be implemented under Article 6.8. The key findings of this paper are that MBMs have received more attention than NMAs and, consequently, are far better defined in international climate change policy. Secondly, the paper examines how questions of historical and future responsibility for climate change continue to divide UNFCCC country Parties during negotiations. Lastly, there are many synergies between Article 6.8 and supply side policy, highlighting a potential new avenue for increased climate change ambition. Building on this research, areas of possible further study include in-depth analyses of country Parties’ positions on NMAs, NMAs pilot projects and the potential for NMAs to impact on future norms of international climate change law.

Key words

Non-Market Approaches, International Climate Change Law, Paris Agreement, Article 6.8, Climate Change Policy

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ABBREVIATIONS

°C Degree Celsius

AIJ Activities implemented jointly

AWG-LCA Ad Hoc Working Group on Long-Term Cooperative Action under the United Nations Framework Convention on Climate Change

ADP Ad Hoc Working Group on the Durban Platform for Enhanced Action AILAC Independent Association for Latin America and the Caribbean

CERs Certified Emission Reduction Units CDM Clean Development Mechanism

CMA Conference of the Parties serving as the meeting of the Parties to the Paris Agreement

COP Conference of the Parties to the UNFCCC ERUs Emission Reduction Units

ETS Emissions Trading Scheme

EU European Union

FVA Framework for Various Approaches GCF Green Climate Fund

GHG Greenhouse Gas

IPCC Intergovernmental Panel on Climate Change ITT Ishpingo Tambococha Tiputini

JMAM Joint Mitigation and Adaptation Mechanism for the Integral and Sustainable Management of Forests

LDCs Least Developed Countries MBMs Market Based Mechanisms

NAMA Nationally Appropriate Mitigation Action NDC Nationally Determined Contribution NMA Non-Market Approach

OECD Organisation for Economic Co-operation and Development OPEC Organization of the Petroleum Exporting Countries

REDD+ Reducing Emissions from Deforestation and Forest Degradation SDGs Sustainable Development Goals

SIDs Small Island Developing States

SBSTA Subsidiary Body for Scientific and Technological Advice tCO2 Tonnes of Carbon Dioxide

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UN United Nations

UNDP United Nations Development Programme UNEP United Nations Environment Programme UNFCCC UN Framework Convention on Climate Change USD United States Dollar

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1. CHAPTER 1: INTRODUCTION

1.1 Background

Climate change science is a dynamic and complex field which has rapidly expanded in recent decades. On a basic level, significant anthropogenic emissions of greenhouse gases (GHGs) have resulted in increased retention of solar radiation within the Earth’s atmosphere, leading to an increase in temperature.¹ The Intergovernmental Panel on Climate Change (IPCC) has stated that it is “extremely likely” the increase in average global temperature has been caused predominately by human activity.² This paper accepts this as a fact. There is also high scientific confidence that the average global temperature has increased by approximately 1°C compared to pre-industrial levels and this is likely to reach 1.5°C between 2030-2050.³ Due to the atmospheric lifespan of carbon dioxide and other GHGs, the changes in temperature will “persist for centuries to millennia”.⁴ Even if warming is limited to less than 2°C, the world will still have to face significant consequences including the loss of reefs around the world and a rise in sea levels of several metres, creating widespread displacement.⁵ With so much at risk, a strong international policy response is crucial.

However, recent analyses indicate that the world’s action is failing to match required ambition and the limited timeline to turn this around is rapidly shrinking. Indeed, more carbon has entered the atmosphere as a result of human activity since international discussions on climate change action began in earnest, than “in the entire history of civilization preceding it”.⁶

The United Nations Framework Convention on Climate Change (UNFCCC) and its subsequent agreements, represents the most universal response to climate change. From their conception, the UNFCCC international negotiations have required the balancing of the needs, values and interests of all its 197 Member States and other stakeholders. Key issues which have defined the negotiations include balancing environmental and economic

1 Metz 2010, p. 30.

2 IPCC 2013, p. 17; IPCC language specifically correlates to a certainty estimate: extremely like refers to a probability of 95-100%.

3 IPCC 2018, p. 6.

4 Ibid, p. 7.

5 Rich 2019, p. 4.

6 Ibid, p. 180.

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concerns, how to apply the principle of common but differentiated responsibilities and respective capabilities and obtaining and distributing financial resources to address mitigation and adaptation costs. In addition, concepts such as climate justice, historical responsibility and climate debt have appeared frequently in debates. Agreeing upon an ambitious, specific and politically acceptable target has resulted in many tense negotiations, particularly in light of inherent uncertainty in climate science and an uneven global distribution in climate change effects and the ability to respond to these. Decisions related to the policy tools which should be employed to address climate change have also generated significant political, academic and social commentary and debate. Modern debates continue to discuss the benefits and trade-offs of different policy approaches. Building on these debates, this paper contributes to the understanding of policy approaches, particularly non- market based approaches and supply side regulation.

1.2 Purpose and Research Questions

Previous studies have explored how current policy measures are failing to reach the ambition required to avoid catastrophic climate change. For example, the most recent international agreement on climate change, the Paris Agreement,⁷ is based on nationally determined contributions (NDCs) in which country Parties specify their own reductions and aim to maintain warming “well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels”.⁸ However, in 2018 the IPCC held with high confidence that even if country Parties achieved their NDCs under the Paris Agreement, it would still lead to warming beyond 1.5 degrees Celsius, at around 3 degrees Celsius by 2100.⁹ Research such as the Emissions Gap Report¹⁰ and the Production Gap Report¹¹ also reveal wide discrepancies between the science, emissions reduction targets, current policies on climate change and fossil fuel production plans. These reports outline potential actions that could be taken to try and bridge the existing policy gaps and facilitate a just transition away from fossil fuels. Within this frame of reference, this study looks at

7 Paris Agreement to the United Nations Framework Convention on Climate Change (adopted 12 December 2015, in force 4 November 2016), in UNFCCC, COP Report No. 21, Addenum, at 21, U.N. Doc.

FCCC/CP/2015/10/Add, 1 (Jan. 29, 2016) (Paris Agreement).

8 Paris Agreement, Article 2.

9 IPCC 2018, p. 20.

10 UNEP, Emissions Gap Report, 2019.

11 SEI et al. 2019.

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potential policy gaps which could be addressed to increase global ambition. In the current agreements, the policy tools adopted by the UNFCCC are predominately market-based mechanisms (MBMs). Accordingly, one policy gap receiving nascent attention is the use of non-market approaches (NMA), which are still being defined within the Paris Agreement.

Another example is fossil fuel supply side policy, which focuses on regulating the upstream activities and presents an opportunity for enhanced ambition.¹²

This paper operates within the context of the current climate science, ongoing UNFCCC debates and concerns about the inadequacy of the current response, with a specific focus on NMAs. The research questions addressed are:

1. What are non-market approaches in the context of climate change policy?

a. How has the concept of non-market approaches evolved in the context of the UNFCCC?

2. What are the legal elements of Article 6.8 of the Paris Agreement?

a. What are potential non-market approaches under Article 6.8 of the Paris Agreement?

b. What is supply side climate policy and how could it be implemented under Article 6.8 of the Paris Agreement?

The key research contribution of this paper is the mapping of historical country Party submissions in UNFCCC debates relating to NMAs to provide guidance on the interpretation of Article 6.8 of the Paris Agreement. This mapping shows the long and tense process undertaken in order to incorporate NMAs into the Paris Agreement. It also aims to provide clarity on the possible functions, applications and forms that NMAs under Article 6.8 could take. A brief history of MBMs in climate change policy is also provided, in order to highlight existing policy gaps and demonstrate roles which NMAs could play in the future. Second, this paper contributes a case study of the synergies between Article 6.8 and supply side policy, demonstrating the type of international collaboration which could be implemented under Article 6.8. The purpose is to provide a possible interpretation of Article 6.8 and emphasise important potential consequences of the law, such as increased ambition and effectiveness in international actions to tackle climate change.

12 Ibid.

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1.3 Methodology

In this paper, the policy approach is used to explore possible interpretations of Article 6.8 by reviewing the history of NMAs within the UNFCCC negotiations. The policy approach incorporates sources beyond legislative sources in order to gain information about the setting in which a particular policy was developed and how it could be interpreted. This approach is often used when the law itself offers insufficient information on a topic, a relatively common issue in international environmental law as many norms are still emerging.¹³ Article 6.8 of the Paris Agreement was selected as the focus of this research as it is the first specific provision in the UNFCCC dedicated to NMAs. As a recent and relatively poorly defined provision, there is little certainty around its possible functions. Accordingly, research in this field can help to advance its understanding and demonstrate its potential to make an impact.

The negotiation history of NMAs in the UNFCCC has been selected for this research because it provides an accessible and official outline of different countries’ views on NMAs in climate change policy in recent years. Similar to a social constructivist approach, the policy approach highlights the role of Member States as active actors making policy choices related to international climate change regime and shaping the global response.¹⁴ States are both the key legislators and regulated subjects under international law and it is their actions which create, dissolve or promote norms within this sphere.¹⁵ Mapping the negotiation history of NMAs in the UNFCCC thus contextualises the decision-making process by highlighting central actors, such as Bolivia, opponents and the reasoning behind these positions. The policy approach also subjectifies the historical of exclusion of NMAs from the international climate change regime. Instead of portraying the late inclusion of NMAs into the UNFCCC as the natural result of policy choices based on science or cost-benefit analysis, this review demonstrates the influence of national priorities and agendas hindering their adoption. In addition, this approach shows how different countries perceived of NMAs during negotiations, including matters such as the various principles, aims and limitations which should be incorporated into NMAs and the potential competing interests and

13 Bodansky 2010, p. 6-8.

14 Landefeld 2019, p. 48.

15 Hall 2017, p. 258.

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concerns. The broader perspective enabled by the policy approach means that all these different factors can be taken to build up an understanding of Article 6.8.

A narrower, doctrinal approach is used to analyse the text of Article 6.8 of the Paris Agreement. Guidance relating to the interpretation of Article 6.8 is yet to be agreed upon and the section has not been relied upon, resulting in a lack of clarity of the provision. The doctrinal approach is traditionally used for determining the meaning of legislation and how it may apply to a specific case,¹⁶ making it well-suited to analyse the elements of Article 6.8.

The sources generally reviewed for a doctrinal approach include legislation and explanatory legal documents, both of which are explored as part of this paper.¹⁷ One criticism of the doctrinal approach is that fails to consider context when analysing legislation.¹⁸ For this reason, the policy and doctrinal approaches complement each other. Chapters 3 and 4, in particular, demonstrate how these two research approaches work in tandem. In Chapter 3, the doctrinal approach is used to identify legal elements of Article 6.8. In Chapter 4, the policy approach then explores how these elements could apply to supply side policy and other relevant matters such as political feasibility, economic factors and potential co- benefits. The doctrinal approach ensures that the analysis of Article 6.8 properly considers the legal aspects of the provision, while the policy approach draws on country Party submissions and other relevant documents to give context and greater depth to the analysis.

As demonstrated, the two methodologies are used in this paper because they work together to comprehensively highlight how the legal elements of Article 6.8 are shaped by the evolving concept of NMAs in the UNFCCC.

1.4 Limitations

The scope of this research is limited to the mapping of country Party submissions related to NMAs in the UNFCCC, particularly focused on the Paris Agreement, a doctrinal analysis of Article 6.8 and the exploration of a case study on supply side policy and Article 6.8. The study focuses broadly on UNFCCC Party submissions in the period 2007-2015, with an emphasis on the final years before the Paris Agreement in 2015. The doctrinal analysis of Article 6.8 draws upon more recent UNFCCC documents to show the ongoing work in this

16 Pendleton 2017, p. 234; Bodansky 2010, p. 5.

17 Pendleton 2017, p. 235.

18 van Hoecke 2013, p. 3.

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area. These points of focus indicate several key limitations to this study. The subjects reviewed are limited to Parties to the UNFCCC and excludes other potentially important stakeholders such as observers, the private sector and civil society. The types of documents reviewed could also be broadened. Currently, this study is predominately limited to official Party submissions to the UNFCCC relating to the negotiations on new mechanisms between the Kyoto Protocol and the Paris Agreement, which excludes other documentation which could give an insight into country narratives regarding non-market mechanisms. For example, drawing on opening remarks from country Parties at UNFCCC Conference of the Parties (COPs) and other relevant submissions to the UNFCCC may provide a broader understanding of national priorities and how these affect national positions on NMAs.

Similarly, reviewing non-UN documentation such as national press conferences may provide greater insight into national narratives on NMAs.

The overview provided on NMAs is a further limitation in this study. NMAs are extremely broad and exist in many forms throughout international, national and regional forms of regulation. It is not the purpose, nor within the scope, of this paper to provide a comprehensive overview and definition of all possible policy mechanisms which could be perceived as non-market. Furthermore, there are many bodies and functions attached to the UNFCCC which can be categorised as NMAs, such as the Green Climate Fund (GCF).

Similarly, there are numerous campaigns and advocacy groups calling for the curtailing of GHG emissions through the use of NMAs or mixed policy mechanisms in the international environmental sphere. There is no doubt that these broader processes have had an impact on the development of the Paris Agreement and these are acknowledged where possible and appropriate.¹⁹ This paper does not, however, attempt to outline all the key environmental movements advocating for NMAs in international climate change policy which occurred during the studied time period. Accordingly, these processes are largely treated as separate from the specific negotiations under the UNFCCC which resulted in Articles 6.8 and 6.9.

While this research aims to highlight the underdevelopment of NMAs compared to MBMs within the UNFCCC arena and touches on general critiques of neoliberalism, it leaves open the possibility for further research into the ideological basis for this phenomenon. Likewise,

19 See i.e. the brief discussion on the Rights for Mother Earth in Chapter 3.

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it does not provide an evaluation of the effectiveness or impact of NMAs and MBMs within the international climate change regime.

1.5 Structure

MBMs and NMAs are defined by their mutual exclusion. Thus, in order to give substance to the concepts of NMAs and MBMs, Chapter 2 starts by defining key elements of market mechanisms, in particular Pigouvian taxes and pollution trading permits. It then provides an overview of the background of market and non-market mechanisms in early environmental policy and international climate change conferences. MBMs in the international climate change regime, specifically the Kyoto Protocol and the Paris Agreement, are then outlined.

In order to demonstrate the value which NMAs could offer and the policy gaps which they could address, Chapter 2 provides a critique of market-based approaches.

The purpose of Chapter 3 is to give context and historical insight into the development of Article 6.8 of the Paris Agreement. This is achieved through a review of country Party submissions on NMAs within UNFCCC negotiations from 2007 up until the Paris Agreement was adopted in 2015. This highlights the diverse perceptions of NMAs in the lead up to the Paris Agreement and the adoption of Article 6.8. Particular attention is paid to submissions from country Parties advocating for NMAs, nations with high vulnerability to climate change and governments with significant leverage in international discussions.

The second section of Chapter 3 is a doctrinal legal analysis of Article 6.8, with guidance drawn from the continuing work being done on an NMA framework and other relevant documents from the UNFCCC negotiations. The different elements of Article 6.8 are identified and dissected to provide some clarity on the potential function of policies implemented under the provision. The final section of Chapter 3 provides an overview of general elements of NMAs which would need to be considered when designing any policies or mechanisms to be implemented under Article 6.8.

Building on the background and analysis in Chapter 3, Chapter 4 uses a case example to explore how a supply side non-market mechanism could look under Article 6.8. An explanation of supply side policy is first provided. This includes an outline on the role of fossil fuels in global GHG emissions and highlights the potential for supply side policies to reduce and monitor these emissions. Chapter 4 then explores the synergies between Article

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6.8 and supply side policy to demonstrate how the international expansion of non-market, supply side regulation could be facilitated under Article 6.8. This analysis includes a review of the UNFCCC as a forum, the roles of different actors, the role of the market and an overview of co-benefits from supply side policy. The limitations of this case example are then discussed in the final section. The overall purpose of this section is to highlight the viability of Article 6.8 as an avenue for ambitious NMAs which can make a genuine, positive impact on global efforts to reduce GHG emissions.

Chapter 5 provides a final overview of the elements discussed in this paper and highlights their potential for application in future research.

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2. CHAPTER 2: MARKET AND NON-MARKET MECHANISMS: AN OVERVIEW

2.1 Chapter Overview

NMAs and MBMs are key concepts in this paper. However, the distinction between the two terms varies depending on circumstance and has developed over time. Accordingly, context is required in order to provide some solidity in their definitions and to highlight how market and non-market approaches differ in relation to climate change policy. This chapter explores the development of MBMs in environmental policy and, in particular, how they have been distinguished from NMAs. It then examines the benefits of MBMs and their current use in the international climate change regime. Criticisms of MBMs and how these could be addressed is explored in section 2.5. Finally, section 2.6 reaffirms that the purpose of this chapter is not to position either approach as superior, but merely to highlight how NMAs and MBMs can be complementary tools and ought to be balanced.

2.2 Defining Market-Based Mechanisms

Once an environmental problem has been identified, there are a wide range of approaches and mechanisms which may be used to try and address it. In the field of international climate change policy, MBMs play a substantial role in international emission reduction targets.

Generally speaking, MBMs can be defined as “policy instruments that seek to harness market forces to either reduce pollution or reduce compliance costs”, both actions which can contribute positively to environmental regulation.²⁰ MBMs can be used to affect the market in different ways, for instance, to phase out environmentally harmful activities or to support the establishment of a market for environmentally-friendly technologies. The dominant method to achieve this is to impose a price on pollution, i.e. GHG emissions, so industry will avoid extra costs by reducing or avoiding activities which result in the regulated pollution.

MBMs are far from homogenous and different authors highlight different features of MBMs in order to categorise them or distinguish them from NMAs. Hahn and Stavins, for example, note that economists in 1992 tended to use the concept of flexibility to distinguish between policy mechanisms; namely, command and control mechanisms which allow little flexibility

20 Carlarne et al. 2016, p. 17.

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and market approaches which “provide firms with greater flexibility and incentives” to achieve beneficial outcomes.²¹ By contrast, Hsu emphasises the transactional nature of MBMs, describing them as voluntary transactions made between at least two private parties, which result in one of the parties conferring environmental benefit, in a process which involves “little or no administrative adjudication”.²² He also states that MBMs are decentralised and offer greater autonomy for private entities.²³ In the context of climate change mitigation, market mechanisms could be defined as policy instruments which distort the price of emitting GHGs.²⁴ However, MBMs have also been defined more narrowly in specific UNFCCC contexts. For example, during the Paris Agreement, some country Parties sought to narrow the definition to only mechanisms which result in internationally transferable mitigation outcomes.²⁵ As NMAs and MBMs are generally positioned as mutually exclusive, the changing definition of MBMs results in difficulty solidifying a definition of NMAs.

In general, market mechanisms are now broadly, but not universally, accepted and seen as increasing the efficiency of environmental laws.²⁶ The main forms of MBMs currently in use in environmental policy are taxes on pollution and the trading of permits which enable an entity to partake in a specific amount of an environmentally damaging activity. The concept of taxing units of pollution in order to internalise external costs was devised by A.C.

Pigou in 1920 and is consequentially known as a Pigouvian tax.²⁷ The aim is to increase the price of an undesirable activity, such as emitting carbon, in order to decrease it from occurring.²⁸ Following a government decision to implement Pigouvian taxes, there is an element of power transfer. Rather than a centralised authority deciding upon an acceptable level of pollution, private entities are able to determine how much of the taxed activity they engage in, when they do so and then pay the appropriate level of taxes.²⁹ However,

21 Hahn and Stavins 1992, p. 464.

22 Hsu 2016, p. 245.

23 Ibid.

24 Mehling et al. 2018, p. 659.

25 FCCC/TP/2014/10, para [10].

26 Hsu 2016, p. 241.

27 Hsu 2016, p. 242; Hahn and Stavins 1992, p. 464.

28 Metz 2010, p. 293.

29 Hsu 2016, p. 242–243.

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policymakers retain control to the extent that they set the level of the tax and retain autonomy over imposing further limits or future amendments to the policy.³⁰ A key motivation for utilising Pigouvian taxes is to ensure that industry are held responsible for indirect environmental costs of pollution. For instance, in the 1980s there were efforts in the United States to introduce taxes on sulfur dioxide emissions which cause acid rain in order to reflect the damage to forests, marine life and other economic losses.³¹ While this was not successful, the model of Pigouvian taxes was applied to carbon emissions in the form of carbon taxes throughout Northern Europe (Finland, Sweden, Norway and Denmark) in the 1990s, with more countries closely following.³² The use of carbon taxes continues to grow around the globe as one of the biggest uses of MBMs, and indeed any mechanisms, in climate change regulation.

A second common form of an MBM comes from John H. Dales in 1968. Dales envisioned a system in which companies would have to purchase transferable rights to pollute, thus creating a market for pollution.³³ Similar to Pigouvian taxes, the purposes of such a scheme would be to internalise otherwise external costs of environmental damage caused by industry activities and enable these to be remedied in the most cost-effective manner. Indeed, in an ideal world, the set tax costs, and the price of transferable pollution rights would be same, reflecting the most cost-effective action being taken via the market in order to reduce pollution levels.³⁴ The efficiency of such a scheme depends on its structure, environmental integrity, oversight and enforcement, meaning the perfect market does not function in the real world. Transferable pollution permits are usually a politically popular option, which offers greater flexibility to industry. In the US, for example, after a lack of appetite for a taxation scheme, emissions causing acid rain were eventually regulated via a trading permit system.³⁵ Similarly, the European Union (EU) introduced an GHG emissions trading scheme (ETS) after failing to gain support for a carbon tax due to sovereignty fears and financial

30 Hsu 2016, p. 242–243.

31 New York Times 1983, n.p.

32 Weishaar 2018, p. 1.

33 Hsu 2016, p. 240–241; Hahn and Stavins 1992, p. 464.

34 Hsu 2016, p. 251.

35 Hahn and Stavins 1992, p. 464; Parr 2013, p. 24.

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reasons.³⁶ In relation to climate change, this process involves distributing rights limited by duration and quantity to emit GHG in order to create a market for carbon.³⁷

Other forms of market mechanisms include subsidies and incentives. This category of mechanisms involves financial transfers from the government to companies, taxation exemptions and reductions and other forms of direct financial support.³⁸ Subsidies come in a wide variety of forms and made be applied in specific sectors, such as the transport sector, or for particular activities, including research, development or for winding down operations, including decommissioning costs and remediation of sites.³⁹ Subsidies tend to be a politically attractive option, but their effectiveness in terms of environmental protection is variable depending on what is being subsidised.

2.3 Benefits of Market Mechanisms

MBMs currently play a prominent role in environmental policy on both a national and international level. They have been described as the “keystone of global climate policy”,⁴⁰ with a price on carbon touted as “our best hope for getting us out [of our current climate predicament)”.⁴¹ However, the concept of using MBMs in environmental policy would not have been an instinctive decision even several decades ago. A major stepping-stone in Western society which ultimately resulted in the adoption of MBMs in environmental governance, was a movement in the United States in the 1960s. There was a growing call from the United States’ public during this period for greater environmental protection, largely due to Rachel Carson’s Silent Spring (1962), as well as a greater awareness of ecological interconnectivity.⁴² This led to the concept of the environment as something that the state should regulate and govern over.⁴³ Recognition of this new field of public policy

36 Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a Scheme for Greenhouse Gas Emission Allowance Trading within the Community and amending Council Directive 96/61; van Asselt 2016, p. 339.

37 Mehling 2018, p. 8.

38 Metz 2010, p. 288-289.

39 SEI et al. 2019, p. 5.

40 Ghaleigh 2016, p. 73.

41 Wagner and Weitzman 2015, p. 152.

42 Caldwell 1971, p. 3, 12–18.

43 Ibid.

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meant that the United States’ government was under pressure to develop politically feasible policies which would not significantly impede on the exploitation of natural resources, but would still offer adequate environmental benefits.⁴⁴

Following this process, the main choice of new environmental policy instruments by the United States’ government in the 1970s were command and control instruments.⁴⁵ The system was largely based on the concept of Best Available Technology (BAT), which obligated industry to utilise the best available technology in relation to environmental standards.⁴⁶ As the field of environmental policy matured, these mechanisms faced heavy criticism, particularly following the oil shocks and emergence of issues such as acid rain in the 1980s.⁴⁷ Writing in 1985, Ackerman and Stewart condemned the command and control approaches as “crude, costly, litigious and counterproductive”.⁴⁸ Specifically, the authors argued that this system was economically inefficient, with exorbitant transaction costs and misdirection and waste of resources. In addition, they claimed that the system discouraged innovative approaches to reducing pollution due to disproportionately heavy scrutiny of emerging technologies and was applied in a manner which failed to consider regional, organisational and industrial differences.⁴⁹ They argued in favour of reform of the system, where instead of being sidelined, economic incentives could occupy a fundamental position in environmental law.⁵⁰ Voices calling for MBMs grew in tandem with the criticisms about the inefficiency of the early command and control mechanisms, leading to more widespread use of MBMs.⁵¹

As discussed above, one of the main aims of market-based environmental taxes and permit trading schemes is to internalise the external costs resulting from an activity, while also encouraging a transition away from that activity.⁵² Carbon markets, for example, aim to

44 Ibid, p. 3–9.

45 Hsu 2016, p. 241.

46 Ackerman – Stewart 1985, p. 1333–1334.

47 Grubb et al. 2014, p. 215.

48 Ackerman – Stewart 1985, p. 1333.

49 Ackerman – Stewart 1985, p. 1333–1336; Keohane et al. 1997, p. 2.

51 See e.g., Keohane et al. 1997.

52 Heine et al. 2020, p. 99-100.

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support businesses transitioning away from high carbon activities while gradually increasing the carbon price.⁵³ Thus, industry has time to transition without undue disturbance to energy security or supply. Implementing and gradually increasing the price on carbon and other GHG emissions is one way to steadily achieve emission reductions. The IPCC held with high confidence that a high price on emissions would be necessary to stay within a 1.5°C pathway in a cost-effective manner.⁵⁴ When implemented properly, carbon pricing can also align climate change policies with the key environmental principle of “polluter pays”.⁵⁵ While Heine et al. acknowledge and explore the complications in relation to its application, the basic concept of this principle is that a polluting entity should be responsible for the costs of the damage arising from their conduct.⁵⁶ This principle is also rooted in the UNFCCC, as a key principle.⁵⁷ Therefore, one of the potential benefits of some MBMs is that they aim to make polluters pay for some of the externalities associated with GHG emissions in accordance with principles of international climate change law.

One of the other main purported benefits of MBMs is cost-effectiveness in comparison to more administratively intensive regulation.⁵⁸ This makes MBMs attractive for a number of reasons. Firstly, when selecting policy options, governments generally “seek to achieve positive environmental outcomes in the most economically efficient manner possible”.⁵⁹ Depending on design and implementation specificities, MBMs have the potential to reduce administrative costs, while also reducing the financial burden of compliance on industry.⁶⁰ The World Bank has, for example, stated that a well-functioning carbon market could

“significantly” reduce the cost of mitigation and adaptation action in comparison to a scenario when countries only took domestic action.⁶¹ Secondly, cost-effectiveness increases the attractiveness of investment. Climate policies must be able to engage the private sector,

53 Parr 2013, p. 24.

54 Rogelj et al. 2018, p. 95.

55 Ibid, p. 95.

56 Heine et al. 2020, p. 95-96.

57 Metz 2010, p. 320.

59 Carlarne et al. 2016, p. 17.

60 Schneider 2013, p. 130; Hsu 2016, p. 242; van Asselt 2016, p. 337; Ackerman – Stewart 1985, p. 1341–

1342.

61 World Bank 2019, p. 55.

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governments from countries in many different economic circumstances and other relevant stakeholders. This is because addressing the threat of climate change requires unprecedented levels of investment to fund the transition away from old fuel sources and infrastructure towards new, innovative solutions.⁶² This process is not, according to Keohane, going to occur inevitability as a result of the free market.⁶³ Rather, governments, companies, investors and other entities, guided by and guiding via appropriate policies, can result in environmental gains by harnessing market forces.⁶⁴ Reducing the cost involved in this process is vital in order to encourage participation and ambitious action, otherwise efforts may well fall short of the level of investment required.⁶⁵

Another benefit mentioned in Party submissions related to MBMs is their flexibility.

Australia noted that MBMs enable countries to “mobilise private finance” and make climate change plans which “fit national circumstances”.⁶⁶ MBMs also empower industry by enabling individual companies to make decisions and set priorities about where reductions should take place.⁶⁷ This delegation of decision-making power, according to Ackerman and Stewart, is appropriate because it enables decisions to be made by individuals involved in industry activities who are familiar with specific details.⁶⁸ Overall, they claim that this process should enable decision-makers to “set intelligent priorities, make maximum use of the resources … encourage environmentally superior technologies, and avoid unneeded penalties on innovation and investment”.⁶⁹ Diversifying from the use of public funds and adapting in accordance with national industry and revenue streams may significantly and positively impact on the political feasibility of climate change policy, a matter of critical importance.⁷⁰ This flexibility must be, however, restrained by the need to have appropriate enforcement and procedures in place to ensure environmental protection is also achieved through MBMs. Specific to trading market mechanisms, for example, there were four key

62 Mehling 2018, p. 4-5.

63 Keohane 2016, p. 3.

64 Ibid, p. 3.

65 Mehling 2018, p. 4-5.

66 FCCC/AWGLCA/2011/MISC.2, p. 3-6.

68 Ibid, p. 1335–1340.

69 Ibid, p. 1352, 1365.

70 Gupta et al. 2007, p. 752.

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criteria identified by Ackerman and Stewart in order to have successful MBMs.⁷¹ Namely, the ability to accurately establish a baseline of emissions, to conduct fair auctions for industry to purchase emissions, to maintain a registry for permit rights and to encourage observance of the permits by use of penalties in cases of non-compliance.⁷² Modern markets for tradeable pollution rights continue to highlight the significance of these criteria to ensure success.⁷³ This demonstrates the balancing process involved in MBMs, and indeed almost any policy mechanisms, between stakeholders such as policy-makers, environmental advocates and industry.

2.4 Market-Based Mechanisms in the International Climate Change Regime

While the first scientific studies relating to the greenhouse effect came out as early as 1880, the potential consequences of humanity’s stark increase in carbon emissions were not on the political agenda until later.⁷⁴ In the international sphere, public awareness and concern about climate change and other environmental issues such as biodiversity loss, grew parallel to United States’ developments throughout the late 20^th Century.⁷⁵ Resultantly, international conferences brought together world powers and scientists to deal with emerging environmental threats. This culminated in the 1972 Stockholm Conference, the first UN Conference on the Human Environment, bringing together 114 nations, non-governmental organisations and other stakeholders and establishing the basis for the foundation of the United Nations Environment Programme (UNEP) in June 1972.⁷⁶ In 1979-1989, momentum for building for a “binding framework to reduce carbon emissions – [and the world’s major powers came] far closer than we’ve come since” to achieving this.⁷⁷ In early conferences, however, the United States used its international clout to effectively veto discussions on any binding climate change treaty.⁷⁸ An example was the push by environmental activists in for a 20% reduction in emissions by 2020 in 1989 at the Noordwijk Ministerial Conference,

72 Ibid, p. 1347.

73 See e.g., Schneider 2013; Metz 2010.

74 Ivanova 2017, p. 17.

75 Koivurova 2014, p. 30–31; Bodansky et al. 2017, p. 100; Van Asselt et al. 2015, p. 8–11; Sands – Peel 2018, p. 21–51.

76 Ivanova 2017, p. 17.

77 Rich 2019, p. 5.

78 Ibid, p. 8.

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following a similar target and ban model as used in the Montreal Protocol.⁷⁹ However, countries eventually settled upon the development of an instrument with a non-binding target. There were accusations of “sabotage” by the US⁸⁰ and mere “face-saving” by EU Member States.⁸¹ Similar, were concerns that countries had sought to avoid an enforceable mechanism, instead choosing to rely on “dodgy market mechanisms”.⁸²

Heading into the United Nations Conference on Environment and Development in Rio, Brazil 1992, there were strong expectations and hope for an outcome which could “save our planet”.⁸³ On the other hand, there were also concerns about national sovereignty and other connected rights, such as the ability to develop and enjoy economic growth.⁸⁴ Concerns were partially addressed through the General Assembly 44/228⁸⁵ which outlines the limits on the types of mechanisms to be considered in Rio and reinforces national rights in relation to matters such as economic growth and exploitation of natural resources. The outcome was the UNFCCC which was adopted on 9 May 1992 at the UN Headquarters in New York and entered into force on 21 March 1994.⁸⁶ The UNFCCC has been ratified by 197 parties and provides near universal direction for the development of the international climate change regime, including annual meetings and institutional structure. Article 2 of the UNFCCC outlines the international objective to stabilise “greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system”. Article 3 outlines key principles such as intergenerational equality, common but differentiated responsibilities, sustainable development, how to approach scientific uncertainty and promotion of “a supportive and open international economic system that would lead to sustainable economic growth and development in all Parties”.

Crucially, the UNFCCC set the stage for countries to record and report on national emissions

79 Ibid, p. 135–143.

80 Ibid, p. 171.

81 Rich 2019, p. 179.

82 Klein 2019, p. 247.

83 Palmer 1992, p. 1007

84 Ibid, p. 1008.

85 General Assembly Resolution on United Nations Conference on Environment and Development: United Nations Conference on Environment and Development, G.A. Res. 44/228, U.N. GAOR, 44th Sess., Supp. No.

49, U.N. Doc. A/44/49 (1990).

86 Ivanova 2017, p. 17.

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and climate change mitigation programmes, as well as to start seeking ways to limit emissions. However, the non-binding nature of the UNFCCC left open many details of the form of the international response to climate change to be refined through subsequent agreements, including the exact nature of mechanisms which would be used to achieve its objective.

From the first COP in Berlin 1995, MBMs were flagged as potential vehicle for achieving the objectives of the UNFCCC.⁸⁷ The first MBMs programme was the pilot phase of activities implemented jointly (AIJ), with annual synthesis reports to be prepared by the Subsidiary Body for Implementation and the Subsidiary Body for Scientific and Technological Advice (SBSTA). The purpose of the pilot was to increase experience with international MBMs and determine how they could be implemented, including discussions on geographical distribution of projects and which types of projects would be feasible.⁸⁸ Environmental integrity, financial benefits and impacts on developing countries also emerged as areas to be studied during the pilot.⁸⁹ Despite teething difficulties in relation to establishing additionality with reliable baseline setting, the use of AIJ projects continued to grow.⁹⁰

2.4.1 Kyoto Market Mechanisms

The major boost for MBMs in the international climate change regime came in the form of the Kyoto Protocol. The Kyoto Protocol is a key document in the climate change regime, covering some 75% of GHGs responsible for climate change, including carbon dioxide, methane and nitrous oxide.⁹¹ The discussion of whether or not to include market mechanisms into what would eventually become the Kyoto Protocol was the subject of robust debate and reaching consensus proved challenging during the 1997 COP in Japan.⁹² Their inclusion was supported predominately by the US, with backing from the “Umbrella Group”, including Australia and Canada, and the EU opposing.⁹³ The EU resisted these flexibility mechanisms,

87 FCCC/SBSTA/2001/7, p. 3; Depledge 2017, p. 41.

88 FCCC/SBSTA/2001/7.

89 Ibid.

90 Ibid.

91 Metz 2010, p. 33.

92 Freestone 2016, p. 105.

93 Bodansky et al. 2017, p. 101; Wara 2008, p. 1760.

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as they sought to have more focus on domestic emissions and to increase stringency of emission reduction targets.⁹⁴ The ultimate outcome of the negotiations was the inclusion of the first flexibility and market mechanisms to encourage cost effective climate change mitigation.⁹⁵ The specific market mechanisms introduced by the Kyoto Protocol are the Clean Development Mechanism (CDM) (article 12), the Joint Implementation (article 6) and cooperative measures for emissions trading (article 17).⁹⁶ The most significant rules for the Kyoto Protocol were determined in the Marrakesh Accords, at COP7 in 2001. Major decisions from the Marrakesh Accords included the establishment of the CDM executive board and the Joint Implementation supervisory committee.⁹⁷ The rules retained a considerable measure of flexibility, largely reflecting the United States’ position.⁹⁸ The CDM, in particular, has enjoyed high political popularity and participation rates across the developing world.⁹⁹ While there are some concerns about the design of the CDM, discussed in section 2.5.1, it has opened up many markets to the prospect of a price on carbon. The important role played by MBMs is reflected in Party submissions to the UNFCCC. In 2009, for instance, both New Zealand and Australia indicated that access to fully functional and efficient international carbon markets was essential for them to achieve their emission targets.¹⁰⁰

Despite the Kyoto Protocol negotiations outcome, the United States’ Senate unanimously passed a resolution outlining concerns with a new climate agreement which included binding targets for Annex I Parties only.¹⁰¹ The resistance in the United States eventually resulted in their exit from Kyoto Protocol negotiations and a failure to ratify the agreement. This action was taken largely on the basis that the agreement was economically detriment to their economy and the exclusion of developing countries, especially China, from binding

94 Bodansky et al. 2017, p. 160; van Asselt and Gupta 2009, p. 334.

95 Bodansky et al. 2017, p. 105-107; Freestone 2016, p. 105; Schneider 2013, p. 130; van Asselt and Gupta 2009, p. 331.

96 Schneider 2013, p. 131; Freestone 2016, p. 106; van Asselt and Gupta 2009, p. 333.

97 Depledge 2017, p. 41.

98 Bodansky et al. 2017, p. 107, 161, Freestone 2016, p. 108; Carlarne et al. 2016, p. 8.

99 Wara 2008, p. 1764.

100 FCCC/AWGLCA/2009/MISC.6, p. 7; FCCC/AWGLCA/2009/MISC.4/Add.3, p. 3.

101 Oreskes and Conway 2010, p. 215.

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targets.¹⁰² Notably, even as President George W. Bush confirmed the United States’ exit from the Kyoto Protocol, he emphasised the need to “ensure continued economic growth”

and to “pursue market-based incentives”.¹⁰³ While the exit of the United States threatened the Kyoto Protocol, negotiations were held with Russia. These negotiations were successful, with Russia ratifying the accord in late 2004, effectively saving the agreement.¹⁰⁴ With the ratification of the Kyoto Protocol, MBMs secured their position in the international climate change regime.

Annex B of the Kyoto Protocol contains binding emission reduction targets for 39 parties, including the EU, the United States and several countries marked as undergoing a transition to a market economy. The Kyoto Protocol’s cooperative measures mechanism is based on a global cap and trade scheme among Annex B countries, with the various possibilities to link other countries, including the flexibility mechanisms.¹⁰⁵ National emission caps correspond to assigned units which can be traded among by traditional market means or through project work via the CDM and Joint Implementation mechanisms. The CDM and Joint Implementation focus predominantly on project initiatives within both the private and public sectors and offsetting for emissions trading.¹⁰⁶ However, they operate in different spheres.

The CDM allows Annex B Parties to finance projects in developing countries and gain allowances for certified emission reduction units (CERs).¹⁰⁷ The purpose is for developing countries to fund GHG emissions reduction projects in countries where the cost will be lower, allowing for cost-effectiveness.¹⁰⁸ The outcomes of CDM projects should be “real, measurable and long-term” and result in additional reductions which would not have occurred but for the CDM.¹⁰⁹ The Joint Implementation mechanism facilitates projects between Annex B Parties and can be used to generate Emission Reduction Units (ERUs).

Many countries have introduced ETSs to broaden the carbon trading market under the Kyoto

102 The White House, 2001; Driesen 2012, p. 212.

103 Ibid.

104 Freestone 2016, p. 110.

105 Schneider 2013, p. 131; Hsu 2016, p. 248.

106 Schneider 2013, p. 131; Bodansky et al. 2017, p. 179–193; Freestone 2016, p. 107.

107 Schneider 2013, p. 131; Wara 2008, p. 1761.

108 Nagy and Varga 2009, p. 67.

109 Ibid.

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Protocol, including the use of CERs and EURs.¹¹⁰ These are not market mechanisms under the Kyoto Protocol, but have implications for the overall environmental integrity and effectiveness of the scheme.

2.4.2 Paris Agreement Market Mechanisms

Provisions for MBMs were once again included in the Paris Agreement. Article 6.1 outlines that Parties to the Paris Agreement have the choice to “use voluntary cooperation” to implement NDCs in order to increase mitigation and adaptation ambition and also to

“promote sustainable development and environmental integrity”.¹¹¹ Article 6.2 provides that voluntary cooperatives which “involve the use of internationally transferred mitigation outcomes towards [NDCs]”, are to “promote sustainable development and ensure environmental integrity and transparency … [and] the avoidance of double counting”.¹¹² Likewise, Article 6.3 also refers to this decentralised mechanism for international transfers of mitigation outcomes.¹¹³ Articles 6.4 to 6.7 constitute the new sustainable development mechanism, also aimed at the use of MBMs.¹¹⁴ As of 2019, around half of the 185 submitted NDCs stated an intention to use or to consider the use of Article 6 to achieve their targets.¹¹⁵ While success depends on how effectively Article 6 is implemented, a recent report estimated that international cooperation under Article 6 could reduce the cost of emissions reduction by up to $250 billion USD annually, by the year 2030.¹¹⁶ Some clarification is still required in terms of rules, but pilot projects have commenced for Article 6 market mechanisms, including the International ITMO Purchase Program of the KliK Foundation and the Climate Cent Foundation based in Switzerland.¹¹⁷

The use of ETSs have also continued to increase since the Kyoto Protocol, covering approximately 15% of global GHG emissions in 2018 and rising with the introduction of

110 See i.e. International Carbon Action Partnership 2019.

111 Nishimura 2018, p. 52.

112 World Bank 2019, p. 55.

113 Howard 2017, p. 178; Ari and Sari 2020, p. 244.

114 Barry 2016, p. 8–9; Bodansky et al. 2017, p. 236-237.

115 International Carbon Action Partnership 2019, p. 8; World Bank 2019, p. 53; International Emissions Trading Association and Carbon Pricing Leadership Coalition 2019, p. 2.

116 International Emissions Trading Association and Carbon Pricing Leadership Coalition 2019.

117 World Bank 2019, p. 11, 57; International Carbon Action Partnership 2019, p. 3, 8-10.

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China’s national ETS planned for 2020.¹¹⁸ While prices need to rise to match the costs estimated to reach the 1.5°C target in the Paris Agreement, the broadening scope incorporates many developing countries and cements carbon pricing as a cornerstone in current climate change policy.¹¹⁹ Challenges in implementing the market elements of Article 6 remain, but the steps taken so far suggest that they are considered key to achieving a robust and ambitious outcome from the Paris Agreement.

2.5 Critiques of Market-Based Mechanisms

As the use of MBMs in the UNFCCC has matured, they have been subject to scrutiny by the international community. The development of policy instruments requires consideration of a number of factors, such as, the desired environmental benefits, other sought-after outcomes, the stakeholders and their interests involved and the resources and capacities of the relevant governing authority.¹²⁰ In relation to environmental policy, for example, Hahn and Stavins argue that its purpose expands beyond protecting environmentally quality, and necessarily involves trade-offs for policymakers, particularly in terms of cost- effectiveness.¹²¹ There is no objective framework for determining the ‘best’ policies and the perspective on how to balance environmental protection and policy costs will vary between stakeholders. In any regulatory regime, reflection and review is important. In the climate change regime, however, this process is crucial due to the potential catastrophic consequences of climate change: achieving even incremental temperature decreases or, conversely, failing to avoid global average temperature increases, can result in vastly different outcomes for the global population. Accordingly, analysis helps to ensure that the international climate change regime uses effective mitigation and adaptation tools. The criticisms of MBMs which have arisen range from concerns about characteristics of specific mechanisms, such as the CDM and Joint Implementation in the Kyoto Protocol, to condemnation of the broad underlying market ideology.

118 Mehling et al. 2018, p. 655.

119 World Bank 2019, p. 3, 25-26, 47-48.

120 Keohane et al. 1997, p. 1, 12–15, 30.

121 Hahn and Stavins 1992, p. 464.

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2.5.1 Critiques of Kyoto Market-Based Mechanisms

Reviewing the function of mechanisms introduced by the Kyoto Protocol highlights concerns associated with the use of MBMs. One key issue in this field is the impact of flexibility mechanisms on environmental integrity of the Kyoto Protocols mandated levels of emissions reduction.¹²² In particular, there is a concern that the Kyoto MBMs may cater to industry and development, at the expense of environmental integrity. This is not simply an issue of industry receiving undue profits. If functioning improperly, the CDM and other flexibility measures may lessen overall emission reductions if sponsored projects do not result in additional reductions but are still claimed and used as offsets.¹²³ To demonstrate, in the first operational period of the CDM, the EU ETS provided the largest demand for CERs.¹²⁴ The quality of the CERs, therefore, has global impacts for climate change action as developed countries can used them to lessen domestic efforts.¹²⁵

The CDM has generated considerable academic scholarship and criticism in relation to overall effectiveness, issues calculating accurate baselines and the environmental integrity of claimed reductions.¹²⁶ Wara, for example, claims that the design of CDM has resulted in manipulation of baselines in order to inflate offsets created, resulting in “windfall profits”

for industry.¹²⁷ Wara also argues that in 2008, the CDM was paying “perverse incentives”

to projects involving refrigerant chemicals, especially a category of hydrofluorocarbon known as HFC-23.¹²⁸ Other studies have found that the overall benefits of the CDM with regards to lowering emissions are “uncertain” and that it has achieved only “limited” impact on sustainable development.¹²⁹ By contrast, Mehling claims that the CDM resulted in “a documented ability to dramatically reduce the cost of achieving mitigation commitments”

122 See i.e., van Asselt and Gupta 2009.

123 van Asselt 2016, p. 347.

124 European Commission 2020, n.p.

125 van Asselt and Gupta 2009, p. 333; Nagy and Varga 2009, p. 64.

126 See e.g., van Asselt 2016; Schneider 2013; Wara 2008; Nagy and Varga 2009.

127 Wara 2008, p. 1763, 1781-1789.

128 Wara 2008, p. 1781-1785. Since this time, some countries such as New Zealand have taken steps to ban or regulate the use of HFC-23 CERs, see e.g., Beckford 2011. Parr 2013 also builds on Wara’s arguments relating to HFC-23 to criticise the free market approach of the CDM.

129 Nagy and Varga 2009, p. 70.

A Seat at the (Trading) Table: Non-Market Mechanisms in the Paris Agreement