INSTITUTIONAL SETTINGS
4.2 INTERNATIONAL NEGOTIATIONS AND THE INTERNATIONAL INSTI-
TUTIONAL SETTING
Article 12 of the Kyoto Protocol suggests that the CDM shall be subject to the authority and guid- ance of the Conference of the Parties serving as the meeting of the Parties (COP/MOP) to the Protocol and be supervised by an Executive Board of the CDM (paragraph 4). The COP/MOP shall, at its first session, elaborate modalities and procedures with the objective of ensuring trans- parency, efficiency and accountability through independent auditing and verification of project activities (paragraph 7). Participation under the CDM may involve private and/or public entities, and is subject to the guidance of the Executive Board.
It is not yet clear how the division of authority will be arranged between the COP/MOP and the Executive Board, bearing in mind that the COP/
MOP will only meet once a year, whereas the Executive Board can meet more frequently.
Accredited operational entities (para 5) (accred- ited by either the COP/MOP or the Executive Board) can undertake the validation, verification, and certification of CERs.
The most likely process for accreditation of an operational entity would be as depicted in following figure (Netto 2001).
A prospective operational entity submits a request for accreditation to the Executive Board. The Executive Board verifies that the prospective operational entity meets the stipulated require- ments and observes the prospective operational entity as it carries out two or three relevant activities. If satisfied, the Executive Board submits a recommendation for accreditation to the COP/
MOP, which in turn designates the operational entity. The Executive Board undertakes a review of the operational entity’s accreditation status every three years, and, when necessary, also undertakes spot-checks. Accredited operational entities carry out two functions: they validate CDM project activities and/or verify and certify CERs. The Executive Board may allow a single operational entity to perform both of these functions.
There are at least three criteria upon which accreditation of an operational entity would be based (OECD 2000):
Ä Demonstrated competence in validating projects and/or in verifying emission reduc- tions associated with particular project types.
Ä Independence from the development,
financing and implementation of CDM project activities.
Ä The capacity and willingness to accept financial responsibility for consequences of errors and omissions.
Validation is the process of independent evalua- tion of a project activity against the requirements of the CDM, carried out by a designated opera- tional entity. Registration is the formal acceptance by the Executive Board of a validated project as a CDM project activity. Registration is a prerequisite for the verification, certification, and issuance of
Figure 4.1 Accreditation Procedure
Operational Entry
Executive
Board COP/MOP
Operational Entities Accreditation
Check for requirements and witnessing of 2-3 activities
Submits request for Accreditation
Review of accreditation every 3 years
Recommends
Verifies and Certifies CERs Spot-checks Designates
Validates CDM Project Activity
CERs related to that project activity. The following figure shows how validation and registration would work internationally (Netto 2001).
Project proponents submit the required informa- tion to the operational entity. The operational entity validates the submission, and either ap- proves or rejects the project. If the project uses an approved methodology, i.e., one described in the United Nations Framework Convention on Climate Change (UNFCCC) CDM Reference Manual, it can go directly to the registration process. A project may be rejected if it does not conform to any of the approved methodologies;
alternatively the operational entity may forward the submission to the Executive Board or COP/
MOP requesting approval for the new methodol- ogy. No agreement has yet been reached on
whether authority for proposing a new methodol- ogy rests with the COP/MOP or the Executive Board. Any new methodology approved would be reported to the repository of approved method- ologies, the UNFCCC CDM Reference Manual, and to the operational entity.
A review of the decision of the operational entity takes place only if an agreed number of Executive Board members, or an agreed minimum number of Parties, request it, within an agreed period.
Again, negotiations have not yet produced any agreement with regard to these criteria.
The main elements of a project validation exer- cise are as follows (OECD 2001):
Ä Assessment of the baseline data.
Ä Assessment of the monitoring plan.
EB or COP/
MOP
EB
Review Repository of approved methodologies
(UNFCCC CDM Reference Manual)
Registration of CDM Project
Activities Project 1 Project 2
… Project n
Only if requested within an agreed period by an agreed number of board members, or an agreed minimum number of Parties.
UNFCCC Parties, Accredited NGOs Project
Proponent
Operational Entry
Submits request for registration, Project Proponent to provide to OE government(s) approval(s)
New method
Approved method Comments
within approved number of days Rejects if not
conform with an approved
methodology. Else forwards to EB
Submits required information
Rejects new method Figure 4.2. Validation and Registration Procedure
Ä Verification that all parties involved have voluntarily approved the project.
Ä Verification that the project contributes to sustainable development, according to the host country criteria.
Ä Confirmation that project proponents have consulted with, and adequately addressed the concerns of, local populations that may be affected by project activities.
Ä Assessment of the project’s likelihood of producing certifiable emission reductions.
The following figure shows how the verification, certification, and issuance of CERs would take place, based on the picture emerging from current negotiations (Netto 2001).
The project proponent, or the operational entity under contract to the project proponent, under- takes verification activities using existing monitor- ing data and, whenever necessary, site visits. The
operational entity in charge of the verification activities submits the certification report and requests the issuance of CERs by the Executive Board. A review takes place only if requested by an agreed number of Executive Board members, or an agreed minimum number of Parties, within an agreed period. However, none of these criteria have yet been agreed upon.
Key elements in the process of verification, certification, and issuance of CERs are as follows.
Ä Based on the findings of the verification process, emission reductions will be certified as CERs.
Ä The CERs will be distributed to the project host and investor, as stipulated in the agree- ment made between the two parties during the project design and financing stages.
Ä A share of the proceeds will be withheld to cover administrative costs and to assist OE 1
OE 2 ...
OE n
Project Proponent
Operational Entity
Monitoring Data and Site
Visits
EB
Review
Only if requested within an agreed period by an agreed number of board members, or an agreed minimum number of Parties.
EB:
- Assign Serial Number - Collects SOP - Issues into registry accounts
Certification report and request for issuance
Issuance of CERs
Verification activities Monitoring
Report(s) Project Proponent Contracts
Figure 4.3. Verification, Certification, and Issuance of CERs
vulnerable developing countries to adapt to climate change (the CDM tax or adaptation levy).
Ä The CERs will be registered with a unique serial number, and other registry accounts.
No agreement has yet been reached on who should issue the CERs. At least two options are currently being debated: the operational entity, and the Executive Board. Having a private entity certifying the activities of another private entity, as implied by option one, might be problematic unless strong liability rules are agreed upon. An independent public body, such as a standing panel of the Executive Board, could be an alterna- tive option.
4.2.1 Cooperative arrangements A number of cooperative arrangements have been suggested for the CDM. Bilateral and multi- lateral arrangements are used here to illustrate the pros and cons of different structural designs of the CDM (Figures 4.a and 4.b). Other arrange- ments, such as unilateral investment, and mutual fund arrangements, will also be discussed briefly.
It is normally assumed that the CDM project host and the CDM project investor would be separate entities. The relations between the parties would be governed by contractual agreement. Such contractual agreements would specify how much of the implementation costs each party is respon- sible for, and how the resulting emission credits are to be distributed between the investor and the host party. Of course, the host will only be inter- ested in CERs if it can sell them, which would only be possible under the unilateral option outlined below. A much weaker incentive would be the possibility of banking credits against any future commitments.
4.2.2 Bilateral and multilateral arrange- ments
A bilateral CDM could follow the normal bilateral cooperation path. Under a bilateral arrangement, either private or public entities in Annex B coun- tries and developing countries (non-Annex B) could make a bilateral agreement to implement a CDM project. Investor (Annex B country) and host (non-Annex B country) would jointly implement the project. The investor should fulfill various needs of host country.
A multilateral funding mechanism would allow several public and private entities in Annex B countries to invest in CDM projects through brokers. The broker could be a private entity, an international development agency, such as UNDP, or an independent body specifically established for the purpose. Under this arrangement the broker could line up a variety of projects, find investors, and manage projects in a portfolio.
A multilateral arrangement might offer some benefits to host countries, but there are also disadvantages. Under a multilateral arrangement, non-Annex B Parties to the Protocol could formu- late and develop CDM projects without previous agreement with an Annex B Party. Also, while a multilateral CDM would need multilateral entities to facilitate its operation (to act as broker, infor- mation clearinghouse and mobilizer of funds), information on CDM potential would be more accessible through a centralized information clearinghouse. A multilateral arrangement would also be more effective than a bilateral arrange- ment in addressing the issue of geographic equity in the distribution of CDM projects. However, geographical equitable distribution could de- crease the total flow of CDM funding since investment by the private sector in the CDM will likely be based on some or all of the following considerations:
Ä Total project costs.
Ä Transaction costs for registration and credit creation.
Ä Emission abatement cost (US dollars per ton).
Ä Contribution to shareholder value (short-term and long-term).
Ä Public relations benefits.
Ä Level of risk.
4.2.3 Unilateral arrangements
Under a unilateral arrangement, the host country (non-Annex B country) develops a project and obtains necessary financing independently; thus developing countries can act as project investors, investing in their own CDM projects. The host country registers the project and receives all or most of the emission credits, which it then banks, leases, or sells on the international market, pursuant to any international arrangements to do so. Article 12 of the Kyoto Protocol does not make clear whether all CDM emission credits must be transferred to Annex B Parties, or whether a host country can receive a certain percentage of credits and sell them on the international market.
The advantage of a unilateral arrangement is that no negotiations on credit sharing are needed.
Consequently, transaction cost would be likely to be lower than under either bilateral or multilateral arrangements.
A unilateral arrangement may overcome many barriers to investment in CDM projects, particu- larly in countries where perceived investment risk is high or where the investment regime is other- wise discouraging to foreign investors. Project credibility and the quality of emission credits could be verified through the process of evalua- tion, verification, and certification by an interna- tionally recognized operational entity. Under these terms unilateral CDM projects may be in Indonesia’s interest at a time of flagging foreign
direct investment. Indigenous resources, espe- cially availability of funds, and the capacity of the developing country to carry out the project successfully, would be critically important in opting for a unilateral CDM arrangement.
4.2.4 Open architecture arrangement For those who regard a direct investor-host relationship as more beneficial - for example two long-standing trading partners - a direct bilateral arrangement may be the most appropriate. Other Parties may consider active facilitation in the project development process as necessary; for them a centralized ‘CDM fund’ could be created to facilitate a combination of investment arrange- ments. Under an open architecture arrangement parties can choose their own cooperative ar- rangements - unilateral, bilateral, or multilateral - according to their needs and the expected advantages.
Under this kind of arrangement, a set of CDM projects is funded by a number of financial intermediaries, such as multilateral development banks, host countries, non-governmental organi- zations (NGOs) and private firms. The interna- tional CDM Clearinghouse could oversee manage- ment of the CDM fund.
A (domestic) fund approach could be used by developing countries following the unilateral model but it would require strong central institu- tions. This approach could overcome some of limitations of the project-by-project bilateral model. An open architecture arrangement would provide economies of scale, reduce transaction costs, spread the risk burden, and provide an opportunity for participation by small investors.
However, government controls would need to be put in place to address the concerns of develop- ing countries about the investment, financial, and developmental elements of the system.
The main features of the funding arrangements proposed for the CDM are summarized in Table 1.
4.2.5 Public participation
TThe issue of public participation in the CDM is still under negotiation. Public participation affects the success of a project. Experience with AIJ projects has shown that the absence of public participation can prevent a project reaching fruition, and in some cases the project may not even get off the ground. Public participation contributes to accountability and transparency, and provides opportunities for building skills and learning-by-doing (Baumert and Petkova 2000).
During the project appraisal process, project proposals should be made available for public comment, for example by placing them on an internet website. The criteria for project appraisal should be established and communicated to the public in a transparent way. Public comment can be used to improve project design. If, as a result of public debate, a project is shown to have harmful impacts or if public opinion is over- whelmingly negative, the project may be rejected.
During project implementation the public should be involved in the project monitoring process.
Local and affected communities could be al- lowed to evaluate whether or not the promised
Several public and private entities in Annex B countries may make an investment in CDM projects through brokers, which can be private entities or international develop- ment agency such as UNDP, or independent body for the CDM. ’Private brokers’ may reduce benefits for non-Annex B countries;
International agencies can line up a variety of projects, find investors, and manage projects in a portfolio;
Non-Annex B countries may formulate and develop projects under the CDM without previous agreement with an entity or party included in Annex B;
Multilateral entities may play roles as a broker, information clearing house and fund mobilizer;
Both private and public entities in Annex B and non-Annex B countries may enter a bilateral agreement to implement a CDM project (more flexible);
Investors should realize various needs of host countries and this may lead to high transaction cost;
Projects shall be implemented jointly by Annex B and non-Annex B Parties;
Follow normal bilateral cooperation path. The procedure should be more transparent than multilateral if the bargaining position of participating non-Annex B Parties is the same as their Annex B partners;
Developing countries could both develop and invest in a CDM project and hold the sole or predominant equity interest;
Allow developing countries to identify and invest in a project in their own country and sell or bank the CERs;
It could promote developing countries autonomy and financial reward;
Requires considerable host country project development and financing capacities;
May bring developing countries to extensive debt financing;
Private sector financial intermediaries, the multilateral development banks and other international entities, or host countries could develop portfolios of individual projects for investment by an array of investors;
It may facilitate investments by reducing the transaction costs associated with individual project investments and reduce or spread investment risks through insurance pools and the like;
Multilateral
Bilateral
Unilateral
Open Architecture
Features
Table 4.1. Feature of funding arrangements for CDM
benefits of the project have occurred. Discrepan- cies could be subject to an appeal process.
Similarly, public participation can be incorporated into the process of verifying and issuing emission credits. A period of time could be allowed for the public to comment on the results of the project and, if they found the verification to be lacking, to submit an appeal.