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Countries, businesses start down path of implementing Article 6 rulebook

28 February 2022 Max Tingyao Lin

Some countries and private-sector players have begun exploring the paths to implementing the Paris Agreement's rulebook on carbon market mechanisms in the hope of expanding international trade.

During COP26 last November, UN member states finally agreed on initial rules that can enforce Article 6 of the 2015 climate deal, which covers carbon markets, although some blanks were still to be filled in at meetings following the Glasgow climate summit.

The mechanism for Article 6.2 allows countries to authorize offset projects that can generate internationally transferred mitigation outcomes (ITMO). Such credits are mainly designed to be exchanged among UN members to meet their climate goals as stated in their Nationally Determined Contributions (NDC). Theoretically, businesses also can acquire them for compliance or voluntary purposes.

Switzerland, the first mover in the ITMO market, sealed several bilateral framework agreements to develop offset projects in Peru, Ghana, Senegal, Georgia, Vanuatu, and Dominica even before the rule book was finalized—though no project is operational yet.

In a forum on Article 6 implementation earlier this month, Simon Fellermeyer, an official from Switzerland's Federal Office for the Environment, said more deals are expected in the next three years.

"The core [purpose] of these agreements is to clarify the authorization process for the activities in the context of Article 6.2, and that will of course provide investment security," Fellermeyer said.

The Alpine nation aims to cut its GHG emissions by at least 50% below 1990 levels by 2030 and to net zero by 2050. ITMOs can be used for up to 25% of its GHG cuts.

Martin Hession, a policy specialist in international carbon markets at the European Commission (EC), said the EU is studying how to account for the ITMOs within its regulatory framework, given the Swiss deals. Switzerland is not a member of the EU.

The EU's Emissions Trading System is the world's largest compliance carbon market by liquidity, and it has a linking agreement with Switzerland's trading scheme that effectively merges the two systems.

Separately, the Japanese government has initiated some workshops on how to certify carbon credits generated from offset projects under the Joint Crediting Mechanism (JCM) as ITMOs. A public consultation on such certification is to be concluded by March.

Backed by Tokyo and the Asian Development Bank (ADB), JCM projects are generally developed with Japanese funds and technical assistance. In fiscal years 2013 through 2021, the Japanese Ministry of Environment selected 205 projects in 17 partnering countries, of which 50% are related to renewables and 40% for energy efficiency.

Masuda Shogo, deputy director of the ministry's office of market mechanisms, said Japan will seek to develop more JCM projects in Africa and the Indo-Pacific region. Japan will also strengthen its cooperation with the ADB, the World Bank, and the UN Industrial Development Organization to further develop the mechanism, he added.

"The JCM, as a pioneering mechanism under Article 6, will benefit not only for GHG emission reductions, but also for the sustainable development of the partner countries," Shogo said.

Under Article 6.4, a separate mechanism is still under development. Public and private sector players can develop offset projects that generate a type of carbon credit tentatively known as A6.4ers under the supervision of the UN Framework Convention on Climate Change (UNFCCC). Each country will decide on how to use the credits to meet its NDC and in accordance with its national laws.

According to the UNFCCC Secretariat, the members of the supervisory body for the program are due to be nominated by the end of February. The body will have several meetings in the coming quarters to iron out the detailed rules on how to certify and monitor Article 6.4 projects, which will effectively replace the Clean Development Mechanism (CDM) under the Kyoto Protocol.

Brazil, a major host country for CDM projects, is developing a domestic carbon trading regime that will incorporate future Article 6.4 credits.

"We are working on the development of new regulatory instruments … We can think of these support units as a way to channel climate finance from public and private sources to developing countries," said Marina Carrilho Soares, second secretary of the Brazilian foreign ministry's environment division II.

An extra push

During the recent International Energy Week conference in London, some industry participants expressed hope that the Article 6 rulebook can further boost the already buoyant voluntary market.

All projects authorized under Article 6.2 or Article 6.4 will need to go through "corresponding adjustments," according to the rulebook. This means that when carbon credits are transferred to an overseas buyer, the host country cannot count the emissions reduction towards its NDC.

Experts believe the adjustments could help avoid double counting of the projects' climate benefits. Such a mechanism is not the norm in the unregulated voluntary market for the moment.

"It would mean that … we get much more high-quality offsets on the voluntary market" from future Article 6 projects, said Kerstin Pfliegner, partner for corporate sustainability and climate change at consultancy ERM.

Katie Sullivan, managing director of the International Emissions Trading Association trade body, said the rulebook can serve as an "integrity framework" for future compliance and voluntary carbon markets as "they mature and eventually converge."

Amid growing net-zero commitments in the corporate world, Trove Research estimated the primary voluntary market size grew to $951 billion in transaction value last year from $328 billion in 2020. More than half 2021's traded credits were from nature restoration or REDD+ projects.

There are strong expectations that the market for such nature-based solutions credits will continue to grow after more than 100 countries signed a $22.4 billion pledge to stop deforestation during COP26.

"The private sector has a very important role to play here also, incorporating directly with country governments who have large land-based offset potential," Pfliegner said.

Regulators' reluctance

The world of carbon trading is not limited to the voluntary market. More than a dozen countries have established compliance markets to regulate domestic emissions, and Sullivan said their combined market size reached approximately $1 trillion last year.

But the governments are generally not keen to count current voluntary credits in their compliance regimes. China and Mexico are among the countries that allow limited usage of voluntary credits in their national markets.

"These two different types of assets [compliance and voluntary credits] can work together, but there needs to be a continuing growth in the integrity of the [voluntary] credits," S&P Global Platts EU/UK Compliance Analyst Michael Evans said.

However, Article 6 could play a role in harmonizing the standards in the compliance and voluntary markets. The EU is considering a proposal to allow aircraft operators to use credits from the Carbon Offsetting and Reduction Scheme for International Aviation regime—which include voluntary credits certified by Verra and Gold Standard, among others—and future A6.4ers to meet their ETS requirements.

"The regulation is changing. There is a picture which can see a relationship between allowances and the voluntary carbon market develop," Evans said.

Posted 28 February 2022 by Max Tingyao Lin, Principal Journalist, Climate and Sustainability

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