Sarah
Kuen
European
Academy
of
Legal
Theory
(2009)
[email protected]
Analysis of Clean Development Mechanism Transactions from a Law and Economics Perspective
The
Clean
Development
Mechanism
(CDM)
was
established
by
the
Kyoto
Protocol
to
the
United
Nations
Framework
Convention
on
Climate
Change
(UNFCCC)
to
enable
and
foster
the
development
of
projects
in
developing
countries
that
would
reduce
greenhouse
gas
(GHG)
emissions,
while
at
the
same
time
promoting
technology
transfer
and
sustainable
development.
Furthermore,
the
CDM
was
also
designed
to
support
industrialized
countries’
commitment
to
reduce
GHG
emissions
in
a
way
that
would
be
more
cost
efficient
compared
to
the
domestic
costs
of
reduction.
The
CDM
generates
project‐level
emission
reductions
that
are
measured
by
assessing
the
additional
reduction
achieved
relative
to
a
business‐as‐usual
baseline.
Those
reductions
are
then
certified
and
become
Certified
Emission
Reductions
(CERs)
that
can
be
sold
on
the
carbon
market
and
used
by
industrialized
countries
towards
achieving
compliance
with
their
Kyoto
Protocol
emission
reduction
commitments.
The
role
of
CDM
projects
in
promoting
technology
transfer
and
sustainable
development
has
often
been
decried
to
be
in
contradiction
with
the
cost‐efficiency
objective
in
CDM
project
economic
analysis.1
This
tension
originates
in
the
1
See
H.
H.
KOLSHUS,
J.
VEVATNE,
A.
TORVANGER
and
K.
AUNAN,
‘Can
the
Clean
Development
Mechanism
attain
both
cost‐effectiveness
and
sustainable
development
objectives?’,
Centre
for
International
Climate
and
Environmental
Research
(CICERO),
Oslo,
Working
Paper
2001:8;
M.
BURIAN,
‘The
Clean
Development
Mechanism,
Sustainable
Development
and
its
Assessment’,
HWWA‐ Report
264,
Hamburg
Institute
of
International
Economics,
2006;
P.
NUSSBAUMER,
‘Clean
Development
Mechanism
and
Sustainable
Development’,
Universitat
Autònoma
de
Barcelona
/
ICTA,
Revised
version
/
August
2006;
G.
EKLÖF,
‘Broken
Illusions
–
CDM
in
Practice’,
Svenska
Naturskyddsföreningen,
EO
Grafiska,
Stockholm
2006;
A.
OLHOFF,
A.
MARKANDYA,
K.
HALSNAES,
T.
TAYLOR,
‘CDM
Sustainable
Development
Impact’,
UNEP
project
CD4CDM,
UNEP
Risø
Centre
on
Energy,
Climate
and
Sustainable
Development;
WWF
report,
‘Is
the
CDM
fulfilling
its
environmental
1
international
process
establishing
CDM
as
one
of
the
flexibility
mechanisms
of
the
Kyoto
Protocol.
The
governance
model
of
CDM
results
from
a
compromise
negotiated
between
industrialized
and
developing
countries
during
the
international
negotiations
under
the
UNFCCC.
Interpretation
of
this
compromise
continues
to
influence
the
way
different
actors
involved
in
CDM
transactions
behave
and
how
they
perceive
the
objectives
of
CDM
purchase
agreements.
The
following
analysis
will
attempt
to
demonstrate
that
behavior
in
CDM
transactions
reflects
this
tension.
From
one
perspective,
CDM
contracts
can
be
seen
as
fulfilling
the
need
for
fair
and
equitable
purchase
agreements
between
parties
with
the
aim
of
promoting
technology
transfer
and
sustainable
development.
On
the
other
hand,
they
can
be
seen
as
an
instrument
that
aims
at
preventing
and
mitigating
the
risks
inherent
to
such
contracts,
with
the
aim
of
maximizing
cost
efficiency
in
acquiring
CERs
generated
by
CDM
projects.
The
degree
to
which
the
parties
involved
in
these
transactions,
notably
buyers
and
sellers,
will
privilege
one
or
the
other
aspect,
is
contingent
on
their
position
in
the
CDM
transaction,
and
their
inherent
objectives
as
well.
The
conclusion
of
this
paper
will
highlight
how
the
original
tension
stemming
from
the
CDM
dual
goal
influences
parties’
behaviors
and
expectations
in
CDM
transactions.
Parties’
weight
and
power
(in
financial
and
knowledge
terms)
shift
the
balance
towards
achieving
more
cost‐effective
results,
consequently
decreasing
the
CDM
potential
contribution
to
sustainable
development.
Possible
ways
to
bridge
both
objectives
in
CDM
transactions
would
require
establishing
a
certain
equilibrium
between
the
parties,
a
better
understanding
of
sustainable
development
benefits
and
the
integration
of
social
corporate
responsibility
into
CDM
contracts.
The
first
section
of
this
paper
will
introduce
the
context
of
the
Clean
Development
Mechanism,
its
legal
basis
in
the
United
Nations
Framework
Convention
on
Climate
Change
and
its
Kyoto
Protocol,
as
well
as
its
political
and
governance
foundation.
The
second
section
will
focus
on
presenting
the
CDM
process,
the
project
cycle
and
the
key
players
involved
in
CDM
transactions.
The
third
section
will
develop
the
objectives?
An
evaluation
of
the
CDM
and
options
for
improvement’,
prepared
for
WWF
by
the
Öko‐ Institut,
November
2007.
2
contractual
agreements
around
CERs,
with
a
particular
emphasis
on
the
key
features
that
such
contracts
entail
in
terms
of
risks
and
costs
allocation.
3
1 Context
1.1
United
Nations
Framework
Convention
on
Climate
Change
(UNFCCC)
The
United
Nations
Framework
Convention
on
Climate
Change
(UNFCCC)
has
been
adopted
on
9
May
1992
in
New
York,
and
entered
into
force
on
21
March
1994.
193
countries
and
the
European
Community
have
ratified
it2.
It
is
thus
widely
accepted
as
the
basis
for
international
politics
on
climate
change.
Nevertheless,
the
UNFCCC
was
the
result
of
“…the
conflicts
and
the
constellation
of
actors
and
interests
that
characterized
the
negotiations
and
which
remained
rather
similar
during
the
Kyoto
process.”3
The
Convention’s
ultimate
objective
is
stated
in
its
article
2
as
the
“stabilization
of
greenhouse
gas
concentrations
in
the
atmosphere
at
a
level
that
would
prevent
dangerous
anthropogenic
interference
with
the
climate
system.”
This
objective
is
accompanied
by
principles
contained
in
article
3,
i.e.
the
principles
of
equity
and
precaution
that
should
take
into
account
Parties’
“common
but
differentiated
responsibilities
and
respective
capabilities.”
Furthermore,
Parties
should
also
“promote
sustainable
development
as
well
as
an
open
international
economic
system
without
disguised
restrictions
on
international
trade.”4
However,
the
Convention
does
not
contain
any
legally
binding
targets
for
industrialized
countries
to
reduce
GHG
emissions.5
“The
international
regime
on
climate
change
is
process‐oriented
in
that
its
institutions
and
procedures
are
designed
to
support
a
constant
development
and
2
UNITED
NATIONS
FRAMEWORK
CONVENTION
ON
CLIMATE
CHANGE.
STATUS
OF
RATIFICATION
.
http://unfccc.int
3
S.
OBERTHÜR,
H.E.
OTT,
The
Kyoto
Protocol
–
International
Climate
Policy
for
the
21st
century,
Springer,
Berlin,
1999,
p.
33.
4
S.
OBERTHÜR,
H.E.
OTT,
idem,
p.
34.
5
Except
for
the
notion
in
Article
4.2
(a)
that
“the
return
by
the
end
of
the
present
decade
to
earlier
levels
of
anthropogenic
emissions
of
carbon
dioxide
and
other
greenhouse
gases”
would
contribute
to
modifying
longer‐term
trends
in
GHG
emissions,
which
is
sometimes
interpreted
as
meaning
that
industrialized
countries
had
to
limit
their
emissions
in
the
year
2000
to
1990
levels
at
the
most.
4
implementation
of
the
regime.”6
The
UNFCCC
constitutes
the
cornerstone
of
this
model,
in
that
it
established
the
institutional
framework
and
the
procedures
that
can
be
used
by
the
Parties
to
further
develop
international
climate
change
policy
and
this
“…
in
the
light
of
the
best
available
scientific
information
and
assessment
on
climate
change
and
its
impacts,
as
well
as
the
relevant
technical,
social
and
economic
information.”
(Article
4.2
(d)).
The
shell
provided
by
the
UNFCCC
was
also
the
basis
for
the
adoption
of
the
Kyoto
Protocol.
1.2 Kyoto
Protocol
The
Kyoto
Protocol
to
the
UNFCCC
is
“one
of
the
most
ambitious
treaties
ever
adopted,
it
is
probably
also
one
of
the
most
ambiguous
legal
instruments.”7
The
core
idea
of
this
Protocol
is
to
establish
legally
binding
commitments
on
the
part
of
industrialized
countries
to
cut
GHG
emissions.
Article
3
of
the
Protocol
contains
the
joint
commitment
of
industrialized
countries
to
reduce
their
aggregate
GHG
emissions
by
at
least
5%
below
1990
levels
in
the
commitment
period
2008‐2012
(countries
listed
in
Annex
B
of
the
Protocol).
Article
3.7
and
Annex
B
of
the
protocol
provide
the
corresponding
country‐specific
“quantified
emission
limitation
and
reduction
commitments”,
resulting
in
differentiated
binding
targets
and
timetables
for
industrialized
countries.
The
GHG
resorting
under
the
Protocol
are
listed
in
Annex
A,
i.e.
CO2,
CH4,
N2O,
hydrofluorocarbons
(HFCs),
perfluorocarbons
(PFCs),
and
sulphur
hexafluoride
(SF6).
The
reductions
of
CO2,
CH4,
and
N2O
are
based
on
the
year
1990,
while
the
reductions
of
the
fluorinated
gases
are
subject
to
Parties’
choice
for
the
year
1995
as
a
possible
alternative
base
year.
Economies
in
transition
are
granted
a
certain
degree
of
flexibility
in
the
choice
of
their
base
year.
The
Kyoto
Protocol
provides
for
so
called
“flexibility
mechanisms”
in
order
to
provide
geographical
flexibility
to
Parties
in
implementing
their
commitments,
i.e.
6 7
S.
OBERTHÜR,
H.E.
OTT,
idem,
p.
37.
S.
OBERTHÜR,
H.E.
OTT,
op.cit.,
p.
95.
5
whereas
these
commitments
are
linked
to
their
territories,
these
mechanisms
allows
Parties
to
realize
emission
reductions
outside
of
their
national
borders.
These
include
the
Joint
Implementation
of
projects
among
industrialized
countries
(article
6),
the
Clean
Development
Mechanism
which
enables
the
joint
implementation
of
projects
between
developing
and
industrialized
countries
(article
12),
and
a
scheme
for
Emission
Trading
among
industrialized
countries
(article
17).
The
main
objective
of
these
mechanisms
is
to
reduce
the
costs
of
industrialized
countries’
compliance
with
the
Kyoto
targets.
1.3 Clean
Development
Mechanism
The
Clean
Development
Mechanism
(CDM)
is
sometimes
called
the
“Kyoto
surprise”.8
Its
success
lies
in
the
fact
that
it
takes
many
developing
countries’
concerns
into
account
by
establishing
a
multilateral
framework
for
project‐based
cooperation
between
industrialized
and
developing
countries.9
The
Kyoto
Protocol
established
the
general
framework
for
CDM,
which
was
further
elaborated
upon
by
a
number
of
decisions
taken
in
the
context
of
the
Conference
of
the
Parties
to
the
UNFCCC,
the
so
called
Marrakesh
Accords10.
1.3.1 A
Flexible
Mechanism
The
CDM
is
defined
in
article
12
of
the
Kyoto
Protocol.
The
language
used
in
paragraphs
12.2
and
12.3.
“…
reveals
divergent
purposes
and
objectives
of
the
CDM
with
respect
to
industrialized
and
developing
countries.”11
On
the
one
hand,
CDM
is
to
assist
developing
countries
“in
achieving
sustainable
development
and
in
contributing
to
the
ultimate
objective
of
the
Convention”
(article
12.2.).
On
the
other
8
S.
OBERTHÜR,
H.E.
OTT,
idem,
p.165.
S.
OBERTHÜR,
H.E.
OTT,
op.cit.,
p.
165.
10
UNFCCC,
2001,
REPORT
OF
THE
CONFERENCE
OF
THE
PARTIES
ON
ITS
SEVENTH
SESSION,
HELD
AT
MARRAKESH
FROM
29
OCTOBER
TO
10
NOVEMBER
2001.
doc.
FCCC/CP/2001/13,
FCCC/CP/2001/13/Add.1,
FCCC/CP/2001/13/Add.2,
FCCC/CP/2001/13/Add.3,
FCCC/CP/2001/13/Add.4
11
S.
OBERTHÜR,
H.E.
OTT,
idem,
p.
168.
9
6
hand,
CDM
is
to
assist
industrialized
countries
“in
achieving
compliance
with”
their
quantified
target
under
Article
3
(Article
12.2.).
While
developing
countries
will
benefit
from
project
activities
under
the
CDM,
the
emission
reductions
accruing
from
CDM
projects
(called
Certified
Emission
Reductions
of
CERs)
will
be
set
off
against
part
of
the
obligations
of
Annex
I
Parties
(Article
12.3.).
The
divide
between
industrialized
countries
and
developing
countries’
approach
to
the
CDM
can
be
further
observed
in
the
governance
system
put
forward
by
both
sides
during
the
negotiations,
i.e.
a
bilateral
model
versus
a
multilateral
or
portfolio
model.
In
the
multilateral
model,
the
CDM
functions
as
an
intermediary
between
investors
and
developing
countries
hosting
the
projects
by
collecting
the
projects
and
selling
the
CERs
on
to
industrialized
countries.
This
model
allows
for
more
control
at
the
international
level
and,
hence,
for
the
developing
nations
through
the
selection
of
projects
and
the
supervision
of
their
implementation.
The
bilateral
model
focuses
on
the
private
sector
and
mainly
functions
as
a
clearing‐house
system.
Companies
or
governments
from
industrialized
countries
invest
directly
in
projects
and
in
return
receive
the
CERs
they
generate.
Indeed,
for
industrialized
countries,
“the
CDM
primarily
aims
to
employ
private
investment
and
market
forces
for
reducing
GHG
emissions
(and
generating
CERs),
thus
minimizing
transaction
and
administrative
costs.”
The
CDM
“would
facilitate
matching
potential
of
investors
with
partners
in
host
countries”,
and
in
this
way
“assist
in
arranging
funding
of
certified
project
activities
as
necessary”
(Article
12.6.).12
To
put
it
short,
the
CDM
challenge
lies
in
the
need
to
balance
the
support
for
green
and
de‐carbonized
private
investments
in
developing
countries,
while
building
a
reliable
and
sustainable
system.13
This
state
of
affairs
is
further
reflected
in
the
CDM
actual
governance
system
and
the
interactions
among
the
several
actors
involved
in
CDM
project
activities,
while
also
heavily
influencing
contractual
relations
concerning
the
selling
and
purchase
of
CERs.
12
S.
OBERTHÜR,
H.E.
OTT,
op.cit.,
p.
173.
S.
OBERTHÜR,
H.E.
OTT,
idem,
p.
185.
13
7
1.3.2 Governance
system
The
CDM
governance
system
is
based
on
a
compromise
between
the
multilateral
or
portfolio
model
and
the
bilateral
model
where
an
international
executive
entity,
the
Executive
Board
(EB),
oversees
the
day‐to‐day
operation,
and
takes
decisions
on
single
projects.
The
EB
is
the
final
approval
entity
for
CDM
projects’
selection
(registration)
and
effective
implementation
(certification
of
CERs
generated
by
the
projects).
The
Executive
Board
was
established
at
the
seventh
session
of
the
Conference
of
the
Parties
to
the
UNFCCC
(COP‐7)
and
has
ten
members
representing
both
industrialized
and
developing
countries.
The
Executive
Board
is
responsible
for
making
recommendations
to
the
Conference
of
the
Parties
Serving
as
Meeting
of
the
Parties
to
the
Kyoto
Protocol
(COP/MOP)
on
modalities
and
procedures
for
the
CDM.
It
approves
new
methodologies
related
to
baselines,
monitoring
plans
and
project
boundaries,
reviews
simplified
procedures
and
the
definition
of
small‐scale
projects
and
reports
to
the
COP/MOP.
It
also
accredits
and
suspends
third
parties
involved
in
the
CDM
project
cycle
(operational
entities),
reviews
accreditation
procedures,
and
makes
publicly
available
proposed
CDM
activities
and
all
procedures
for
developing
a
CDM
project.
Finally,
it
develops
and
maintains
a
CDM
project
registry
and
reviews
project
validation
and
verification
reports.
This
model
allows
for
private
or
governmental
entities
to
directly
invest
in
projects,
to
purchase
CERs
through
intermediaries
such
as
the
“carbon
funds”,
such
established
the
World
Bank
fund
or
private
sector
brokers,
or
exchanges
such
as
the
‘European
Climate
Exchange’,
‘Nord
Pool’
and
the
‘Tianjin
Climate
Exchange’.
Under
this
model,
“…the
development
and
implementation
of
CDM
projects,
and
issues
concerning
distribution
of
benefits
and
risks”14
are
subject
to
contractual
relations
between
the
Parties
and
entities
involved
in
the
project.
14
M.
GRUBB,
Ch.
VROLIJK,
D.
BRACK,
The
Kyoto
Protocol
–
A
Guide
and
Assessment,
Earthscan,
1999,
p.
233.
8
Article
12.5.
of
the
Protocol
sets
three
criteria
to
provide
guidance
for
the
implementation
of
CDM
projects,
namely
voluntary
participation,
environmental
additionality
and
the
achievement
of
real,
measurable,
and
long‐term
climate
benefits.
1)
Voluntary
participation
requires
the
parties
involved
in
the
project
to
express
their
approval.
2)
Environmental
additionality
means
that
the
CDM
project
should
generate
additional
emission
savings,
as
compared
with
what
would
have
happened
otherwise.
The
Kyoto
Protocol
does
not
explicitly
state
that
financing
must
also
be
additional,
but
financial
additionality
became
a
determining
criterion
in
assessing
CDM
projects.
Nevertheless,
to
ensure
that
the
project
financing
is
genuinely
additional
to
finance
that
would
be
obtained
anyway.
3)
The
last
criterion
refers
to
the
achievement
of
real,
measurable,
and
long‐term
climate
benefits,
which
requires
the
definition
of
baselines
and
benchmark
cases
against
which
CDM
project
performance
could
be
assessed.
These
three
criteria
determine
the
eligibility
of
CDM
projects
and
go
beyond
the
criterion
of
least‐cost
emission
abatement.15
Moreover,
the
fact
that
CERs
are
generated
as
a
result
of
assessed
project
performance
and
are
tradable
entails
robust
procedures
for
crediting,
in
order
to
ensure
a
reliable
and
sustainable
system.
Finally,
the
timing
of
the
crediting
procedure
is
also
important
in
order
to
limit
the
scope
for
fraud,
to
limit
risks
for
participants
in
the
transactions
and
to
determine
liability
disputes
in
the
event
of
project
failure.16
1.3.3 CDM
and
Sustainable
Development
Sustainable
development
is
a
concept
that
is
interpreted
in
rather
divergent
ways
depending
on
the
approach
and
concerns
of
the
interpreter.17
However,
there
is
a
consensus
for
determining
sustainable
development
operationally
as
including
15
M.
GRUBB,
Ch.
VROLIJK,
D.
BRACK,
idem,
p.
240.
M.
GRUBB,
Ch.
VROLIJK,
D.
BRACK,
op.cit.,
p.
238.
17
See
A.
MARKANDYA
and
K.
HALSNAES,
Climate
Change
and
Sustainable
development.
Prospects
for
developing
countries,
Earthscan,
London,
2002;
H.
H.
KOLSHUS,
J.
VEVATNE,
A.
TORVANGER
and
K.
AUNAN,
op.cit.
16
9
three
dimensions:
social,
economic
and
environmental.
Social
aspects
range
from
poverty
alleviation,
to
equity
and
improving
local
communities’
standards
of
living.
Economic
aspects
include
financial
benefits
for
local
communities,
positive
balance
of
payments
and
technology
transfer.
Environmental
aspects
concern
the
reduction
of
GHG
emissions,
the
use
of
fossil
fuel,
pressure
on
the
environment
(e.g.
air,
soil,
etc)
and
conservation
of
local
resources
(e.g.
biodiversity,
water,
etc).18
The
CDM
rules
leave
the
definition
and
control
of
sustainable
development
criteria
for
CDM
projects
on
each
country
hosting
projects.
On
the
one
hand,
this
approach
enables
to
define
sustainable
development
criteria
according
to
each
country’s
specific
development
situation.
On
the
other
hand,
it
enables
stakeholders
to
privilege
their
own
understanding
of
sustainable
development,
but
it
also
leaves
the
level
of
standards
and
the
strictness
of
control
to
governments’
own
decision.
In
practice
however,
in
a
market
environment
where
countries
compete
to
attract
CER
buyers,
sustainable
development
criteria
often
became
mere
paper
standards.19
Finally,
sustainability
also
depends
on
the
interests
of
the
parties
involved
in
CDM
projects
and
on
the
incentives
they
get
to
take
it
into
account.
As
the
market
tends
to
value
mostly
the
cost
efficiency
of
carbon
benefits
of
CDM
projects,
while
mostly
ignoring
other
environmental
as
well
as
social
aspects,
it
constitutes
a
rather
weak
incentive
for
market
players
to
consider
sustainable
development
benefits20.
Moreover,
sustainable
development
aspects
are
considered
to
increase
the
transaction
costs
of
projects
and
thus
constitute
a
disincentive
from
a
cost
efficiency
perspective
for
18
See
criteria
and
indicators
for
appraising
sustainable
development
in
CDM
projects
such
as
developed
by
SouthSouthNorth,
Helios
International
and
Gold
Standard.
19
See
K.
BROWN
and
E.
CORBERA,
‘A
multi‐criteria
assessment
Framework
for
carbon
mitigation
projects:
putting
‘development’
in
the
centre
of
decision‐making’,
Tyndall
Centre
for
Climate
Change
Research,
2003,
pp.
19;
J.A.
KIM,
‘Sustainable
development
and
the
CDM:
a
South
African
case
study’,
Tyndall
Centre
for
Climate
Change
Research,
2003,
pp.18;
K.C.
NELSON
and
B.H.J.
DE
JONG,
‘Making
global
initiatives
local
realities:
carbon
mitigation
projects
in
Chiapas
Mexico’,
in
Global
environmental
Change,
13‐1,
pp.
19‐30;
C.
Sutter,
‘Sustainability
check
up
for
CDM
projects’,
Berlin,
Wissenschaftlicher
Verlag,
2003,
pp.
208.
20
See
B.
PEARSON,
‘The
Clean
Development
Mechanism
and
Sustainable
Development’,
Tiempo
Climate
Newswatch,
2004,
pp.
1‐4.
10
many
participants.21
In
this
sense,
the
sustainable
development
benefits
of
CDM
can
be
put
into
question,
as
neither
international
and
national
regulatory
systems,
nor
the
market
guarantee
proper
incentives.
2 The
CDM:
project
cycle
and
participants
In
order
to
ensure
the
proper
functioning
of
the
CDM
“…numerous
safeguards
and
checks
have
been
included
in
the
rules
of
its
implementation,
and
many
participants
will
have
a
say
in
the
process
and
operation
of
CDM
projects.”22
Since
neither
markets
nor
the
regulatory
framework
provide
sufficient
incentives
to
give
overall
sustainability
a
central
role
in
the
development
of
CDM
projects,
it’s
up
to
the
market
players
themselves
to
reflect
the
CDM
dual
goal.
This
is
illustrated
by
one
market
player,
who
in
referring
to
the
sustainability
of
CDM
projects
distinguishes
between
‘Mac
deluxe
and
simple
Big
Macs’.
2.1 Project
Cycle
2.1.1 Overview
The
CDM
procedure
for
determining
eligibility
proceeds
on
a
case‐by‐case
basis
and
consists
of
a
two‐stage
approval
procedure.
The
first
stage
is
at
the
national
level
and
involves
Designated
National
Authorities
(DNA),
designated
by
the
participating
countries’
governments.
Through
their
DNAs,
the
project’s
host
government
and
the
CERs
buyer
country23
evaluate
and
approve
the
project
according
to
their
own
criteria.
The
second
stage
is
at
the
international
level
and
involves
the
Executive
Board
that
assesses
and
registers
projects
according
to
the
“…international
community’s
interpretation
of
how
the
agreed
criteria
should
apply.”24
Moreover,
21
A.
COSBEY,
J‐E.
PARRY,
J.
BROWNE,
Y.D.
BABU,
P.
BHANDARI,
J.
DREXHAGE,
D.
MURPHY,
‘Realizing
the
development
dividend:
making
the
CDM
work
for
developing
countries’,
Phase
I
Report,
International
Institute
for
Sustainable
Development
(IISD),
May
2005,
p.
iv.
22 The Clean Development Mechanism: a user’s guide, Chapter 2: Going through the CDM Process, p.20. 23
The
purpose
behind
this
procedure
is
that
host
country
should
assess
the
project
regarding
its
conformity
to
basic
CDM
requirements
and
national
sustainable
development
strategies,
the
CERs
buyer
country
approval
is
meant
to
authorize
the
sale
of
CERs
on
the
International
Carbon
Market.
24
M.
GRUBB,
Ch.
VROLIJK,
D.
BRACK,
op.cit.,
p.
241.
11
projects
applying
for
the
CDM
should
go
through
a
validation
procedure
performed
by
a
third
party,
accredited
by
the
Executive
Board,
called
the
Designated
Operational
Entity
(DOE).
After
the
project
has
been
put
into
operation,
the
implementation
of
the
project
undergoes
a
monitoring
process
that
is
also
verified
by
a
DOE.
The
DOE
also
certifies
the
CERs
generated
by
the
project
which
have
to
obtain
the
EB’s
final
issuance
approval
in
order
to
officially
become
CERs.
The
scheme
below
illustrates
the
CDM
project
cycle.
Source:
Anja
Kollmuss,
Helge
Zink,
Clifford
Polycarp.
‘Making
Sense
of
the
Voluntary
Carbon
Market:
A
Comparison
of
Carbon
Offset
Standards’
Published
by:
WWF
Germany
March
2008
12
2.1.2 Steps
in
the
Project
cycle
Seven
steps
are
distinguished
in
the
CDM
project
cycle:
a.
Project
designing,
development
and
financing
Project
development
can
take
several
forms,
such
as
a
joint
venture
between
a
local
partner
and
a
foreign
investor
or
an
Emission
Reduction
Purchasing
Agreement
(ERPA)
between
a
local
project
proponent
and
a
foreign
investor.
In
each
model,
the
partners
will
have
different
responsibilities
and
risk
sharing.
At
this
stage,
several
documents
are
foreseen
in
order
to
pre‐screen
the
project
but
also
in
order
to
present
the
project
to
early
stage
buyers,
i.e.
Project
Idea
Note
(PIN)
and
Project
Design
Document
(PDD).
The
drafting
of
each
document
represents
an
increase
of
the
information
size
on
the
project,
hence
more
assurance
for
the
buyer.
Moreover,
most
host
governments
require
a
PIN
document
for
the
approval,
while
other
governments
require
a
PDD,
thus
a
much
higher
level
of
investment
on
the
part
of
the
project
developer.
b.
Participating
government’s
approval
Each
DNA
has
different
requirements
and
procedures
for
the
CDM
project
approval.
The
approval
letter
from
a
Host
Country
DNA
should
state
as
a
minimum
that:
1)
the
project
participants
are
voluntarily
participating
in
CDM;
2)
the
project
contributes
to
the
country’s
sustainable
development
(Decision
17/COP
7).
c.
Validation
Validation
is
the
independent
evaluation
of
the
PDD
against
the
UNFCCC’s
requirements.
This
process
is
conducted
by
a
third
party
agency,
named
a
DOE
(Designated
Operational
Entity).
The
DOE
validation
checks
include
aspects
such
as
meeting
UNFCCC’s
participation
requirements,
stakeholders’
comments,
environmental
impact
analysis
or
assessment,
additionality
of
the
GHG
emissions
reduction,
baseline
and
monitoring
methodologies.
In
effect,
the
validation
process
13
confirms
that
all
the
information
conveyed
and
assumptions
made
within
the
PDD
are
accurate
and/or
reasonable.25
d.
Registration
Registration
is
the
formal
acceptance
of
the
validated
project.
It
is
based
on
an
‘automatic
system’
that
starts
from
the
date
the
DOE
submits
all
necessary
documents
and
registration
fee
to
the
CDM
EB
that
puts
the
documents
on
the
website
for
public
comments.
The
registration
of
the
project
ensues
automatically
if
no
‘request
for
review’
is
introduced
by
more
than
3
members
of
the
EB.
e.
Monitoring
At
the
project
implementation
phase,
the
project
proponent
has
to
monitor
the
actual
GHG
emissions
reductions
that
are
taking
place.
The
monitoring
methodology
is
approved
by
the
EB,
along
with
the
baseline
methodology
prior
to
registration.
f.
Verification
and
Certification
Verification
is
based
on
the
monitoring
report
from
the
project
proponent;
more
precisely
the
DOE
checks
its
correspondence
with
the
registered
PDD
and
the
correct
application
of
the
methodologies.
A
DOE
can
conduct
on‐site
inspections
and
request
for
additional
information
if
necessary.
The
frequency
of
verification
is
mainly
a
choice
of
the
project
developer,
assuming
the
DOE
accepts
the
decision.
Frequent
verification
(for
example,
every
year
instead
of
every
three
years)
increases
transaction
costs,
but
also
allows
for
more
frequent
transfer
of
CERs.
Certification
is
the
written
assurance
by
the
DOE
that
during
the
specified
time
period,
a
project
activity
achieved
the
GHG
reductions
as
stated
and
verified,
in
compliance
with
all
relevant
criteria.
Certification
determines
the
actual
GHG
emission
reductions
by
the
CDM
project
activity.
Certification
is
effectively
a
form
of
liability
transfer.
Once
the
DOE
has
signed
off,
any
underperformance
of
the
CDM
25
The
Clean
Development
Mechanism:
a
user’s
guide,
chapter
2,
op.cit.,
p.
27.
14
project
with
respect
to
the
quantity
or
quality
of
the
CERs
is
the
responsibility
of
the
DOE.26
g.
Issuance
of
CERs
The
issuance
process
is
the
formal
issuance
by
the
EB
of
the
CERs
generated
by
the
CDM
project.
It
is
based
on
the
DOE’s
verification
and
certification
reports
and
it
can
be
stopped
by
the
project
proponent
or
more
than
three
CDM
EB
members
requesting
a
review.
A
fixed
percentage
of
the
issued
CERs,
the
‘share
of
proceeds’27,
i.e.
2%
of
the
CERs
are
subtracted
from
the
CERs
issued
by
the
EB
and
are
transferred
to
the
Kyoto
Protocol
Adaptation
Fund
(which
finances
projects
and
programs
that
assist
developing
countries
to
adapt
to
climate
change).
The
net
amount
of
CERs
is
placed
under
an
account
at
the
CDM
registry
created
by
the
CDM
EB.
2.2 Players
in
a
CDM
project
Article
12.9
of
the
Kyoto
Protocol
integrates
private
and/or
public
entities
in
the
CDM.
Most
CDM
projects
are
the
result
of
a
consortium
of
actors
and
interests,
since
the
project
has
to
go
through
an
extensive
process
of
internal
negotiation
and
external
planning
procedures.
Players’
motivation
vary
widely:
for
example,
buyers
can
be
motivated
by
a
need
to
comply
with
actual
or
future
legal
obligations,
by
voluntary
compliance
or
public
relations,
or
by
purely
financial
gains.28CDM
transactions
therefore
involve
a
large
range
of
players,
including
local,
national
and
international
governments
and
agencies,
international
institutions,
the
private
sector,
non‐governmental
organizations,
local
communities
etc.
Their
roles
include
26
The
Clean
Development
Mechanism:
a
user’s
guide,
chapter
2,
op.cit.,
p.29.
27
The
‘share
of
proceeds’
from
certified
project
activities
is
foreseen
to
cover
administrative
expenses
and
to
assist
vulnerable
developing
countries
to
adapt
to
the
adverse
effects
of
climate
change
through
the
Adaptation
Fund.
28
D. FREESTONE, Ch. STRECK, ‘Carbon Contracts, Structuring Transactions: Practical Experiences’, in Legal Aspects Of Implementing The Kyoto Protocol Mechanisms - Making Kyoto Work, Martijn Wilder, Monique Willis, and Mina Guli, Oxford University Press, p. 297.
15
those
of
project
developer,
investor,
CER
seller
or
buyer,
service
provider,
stakeholder,
consultant,
regulator,
…
2.2.1 Key
participants
Project
developers
can
be
municipalities,
foundations,
financial
institutions,
private
sector
companies,
or
NGOs
from
developed
or
developing
countries.
Project
developers
can
also
be
CER
sellers.29
Host
country
and
buyer
country’s
DNAs
play
an
important
role
in
the
formal
approval
of
projects.
The
host
country
approval
is
meant
to
ensure
that
governments
retain
sovereignty
over
their
natural
resources,
including
their
ability
to
mitigate
emissions.
Another
important
aspect
is
the
responsibility
of
confirming
whether
a
CDM
project
activity
contributes
to
the
country’s
sustainable
development
criteria.
However,
international
legislation
governing
the
CDM
leaves
considerable
leeway
in
choosing
to
accept
or
reject
the
sustainable
development
component
of
projects.30
DOEs
are
domestic
or
international
legal
entities
that
have
been
accredited
by
the
CDM
EB.
They
are
involved
at
various
stages
of
the
project.
Their
responsibility
includes
the
validation
of
CDM
project
activities
at
the
outset
of
the
project;
making
publicly
available
CDM
project
design
documents;
receiving
public
comments
on
the
CDM
documents;
incorporating
stakeholder
comments;
and
verification
and
certification
of
CERs
during
the
operation
of
the
project.
The
CDM
Executive
Board
supervises
the
CDM
and
reports
directly
to
the
Conference
of
the
Parties
to
the
UNFCCC
serving
as
the
Meeting
of
the
Parties
to
the
Kyoto
Protocol.
29
The
sustainable
development
component
of
the
CDM
involves
that
local
energy
developers,
community
groups
and
even
NGOs
may
end
up
as
counter‐parties,
but
CER
sellers
can
be
multinational
companies
as
well
(see
2.2.3.
below).
30 The
Clean
Development
Mechanism:
a
user’s
guide,
chapter
2,
op.cit.,
p.26.
16
Stakeholder
participation
and
public
meetings
are
effective
to
ensure
transparency
in
the
CDM
process.
CDM
projects
are
subject
to
a
specific
requirement
to
invite
local
stakeholders
for
comments.
This
local
stakeholder
consultation
process
is
distinct
from
the
comments
from
stakeholders
that
DOEs
are
required
to
collect
during
the
project
validation
phase,
where
stakeholders
at
the
international
level
are
invited
to
provide
their
comments
regarding
the
specific
CDM
components
of
the
activity.
The
rationale
is
to
empower
the
international
and/or
national
community,
especially
NGOs,
to
monitor
projects
proposed
for
the
CDM.31
2.2.2 Other
players
Other
stakeholders
may
include
banks,
equity
investors,
technology
suppliers,
electricity
purchasers,
etc
depending
on
how
the
project
is
structured
(e.g.
production
and
sale
of
electricity,
or
production
of
electricity
for
own
use).
Sources
of
CDM
project
finance
can
vary
from
private
to
governmental
or
international
entities.
For
example,
the
project
developer
can
look
for
a
private
partner
to
ensure
financial
support
for
the
project,
the
World
Bank
has
established
special
funds
in
order
to
develop
CDM
projects
and
sell
CERs
(Prototype
Carbon
Fund,
BioCarbon
fund,
etc).
Countries
such
as
The
Netherlands,
Denmark,
the
UK,
Spain,
etc
have
also
set
up
special
funds.
Sources
of
CDM
project
technology
can
vary
from
investors
to
consultants
and
partners
in
project
technologies
(equity,
forward
purchase
etc.).
They
will
provide
advice
on
the
feasibility
of
a
project,
prepare
methodology,
PIN,
PDD,
ensure
the
transfer
of
technological
know‐how,
and
project‐manage
the
process
of
CER
generation,
including
validation,
registration,
and
verification.
31
The
Clean
Development
Mechanism:
a
user’s
guide,
chapter
2,
op.cit.,
p.26.
17
2.2.3 Sellers
and
Buyers
The
sale
and
acquisition
of
CERs
needs
to
be
placed
in
the
overall
context
of
the
carbon
market.
The
carbon
market
includes
two
main
types
of
transactions:
the
trade
of
emission
allowances
that
are
created
and
allocated
by
a
regulator,
such
as
the
Assigned
Amount
Units
under
the
Kyoto
Protocol
or
allowances
(EUAs)
under
the
EU
emission
trading
scheme;
and
Project‐based
transactions
where
buyers
participate
in
the
financing
of
a
project
that
reduces
GHG
emissions
and
obtain
emission
credits
in
return.32
There
is
an
overlap
between
both
types
at
the
European
level,
in
the
sense
that
the
European
trading
scheme
allows
CERs
to
be
traded
within
its
framework
(CERs
are
said
to
be
‘fungible’
with
EUAs).
As
regards
transactions
with
CERs,
another
distinction
that
can
be
made
is
the
one
between
the
primary
market
and
the
secondary
market.
‘Primary
transactions’
are
transactions
between
the
original
owner
(or
issuer)
of
the
carbon
asset
and
a
buyer.
’Secondary
transactions’
are
transactions
where
the
seller
is
not
the
original
owner
(or
issuer)
of
the
carbon
asset.33
Hence,
the
secondary
market
is
a
financial
market
with
spot,
futures
and
options
transactions,
where
transactions
only
indirectly
give
rise
to
emission
reductions,
unlike
transactions
in
the
primary
market.34
Market
players
use
secondary
markets
to
hedge
their
exposure
to
price
or
volume
risks
in
primary
markets,
and
in
this
market
concerns
about
price
risk
therefore
predominate.35
In
2008,
secondary
transactions
exceeded
primary
transactions,
although
this
is
a
new
trend
that
is
partly
due
to
the
economic
meltdown.36
There
are
many
different
buyers
looking
to
purchase
CERs,
and
their
motivations
include
achieving
compliance
with
EU
ETS
or
Kyoto
targets,
demonstrating
social
32
‘State
and
Trends
of
the
Carbon
Market
2004’,
World
Bank,
June
2004,
p.
9.
33
World
Bank,
2004,
op.cit.,
p.
70.
34
‘State
and
Trends
of
the
Carbon
Market
2009’,
World
Bank,
p.
2.
35
World
Bank,
idem,
p.
39.
36
For
the
year
2007,
primary
transactions’
flow
was
7.433
MUS$
for
552
MtCO2e.
Secondary
transactions’
flow
was
5.451
MUS$
for
240
MtCO2.
In
2008,
the
trend
was
6519
MUS$
for
389
MtCO2
for
the
former,
while
the
latter
reached
26.277
MUS$
for
1.072
MtCO2.
Source:
World
Bank,
Carbon
Trend
2009.
18
responsibility37,
or
market
speculation.
The
main
buyers
‐
mostly
financials
and
energy
marketers
‐
originate
from
the
European
Union.
Buyers
can
be
distinguished
in
two
main
categories:
compliance
and
non‐compliance
buyers,
the
former
being
motivated
to
acquire
CERs
to
achieve
compliance
with
the
Kyoto
Protocol,
the
EU
ETS
or
other
domestic
legislation
requiring
the
submission
of
credits
or
allowances.
European
buyers
dominate
the
CDM
market
for
compliance,
with
a
combined
market
share
of
over
80%.
Private
sector
companies
have
been
the
most
active
buyers,
with
slightly
less
than
90%
of
volumes
contracted
(this
includes
Joint
Implementation38
project
purchases).39
CER
sellers
are
equally
various
and
are
mainly
originated
from
developing
countries
(the
main
seller
countries
being
China,
Brazil
and
India).
Developed
countries
sellers
are
investing
entities
that
choose
to
invest
in
a
project
and
directly
own
the
generated
CERs
either
for
their
own
compliance
or
for
financial
speculation.
Seller
profiles
range
from
big
public
or
private
companies
to
small
businesses,
NGOs
and
local
associations.
However,
much
less
is
known
about
CER
sellers
apart
from
their
country
of
origin.
The
carbon
market
is
dominated
by
numerous
project
proponents
but
only
few
large
buyers.
The
concern
for
cost‐efficiency
on
the
one
hand
and
sustainable
development
on
the
other
hand
varies
greatly
according
to
the
market
actor’s
objectives
and
nature.
In
order
to
illustrate
the
concerns
of
each
actor,
we
drew
a
table
reflecting
their
most
37This
type
of
market
is
called
the
‘retail
market’
and
accounts
for
a
very
small
part
of
the
overall
CERs
transactions.
‘For
the
ERs
in
this
market
segment,
development
institutions
and
Non
Governmental
Organizations
(NGOs)
are
often
used
in
the
project
design
or
as
verifiers,
providing
a
“seal
of
approval”
formally
or
informally
to
projects
that
satisfy
pre‐defined
environmental
and
social
criteria.’
World
Bank,
2004,
op.cit. 38
Joint
Implementation
is
a
flexibility
mechanism
created
by
the
Kyoto
Protocol,
which
is
similar
to
the
CDM,
but
involves
industrialized
countries
only
39
World
Bank,
2009,
op.cit.,
p.
33.
The
twenty
top
buyers
are
listed
as
follow:
EcoSecurities,
Carbon
Asset
Management
Sweden,
AgCert,
EDF
Trading,
IBRD,
Mitsubishi,
RWE,
Vitol,
Cargill
International,
Carbon
Resource
Management,
CAMCO,
Marubeni,
Trading
Emissions,
ENEL,
MGM
Carbon
Portfolio,
Kommunalkredit,
Essent
Energy
Trading,
Agrinergy,
Energy
Systems
International,
Climate
Change
Capital.
Source:
Unep
Risoe
CDM
database,
July
2009.
19
likely
prevailing
inclination.
This
table
only
aims
at
reflecting
the
propensity
of
each
type
of
buyer
and
seller.
The
categorization
is
based
on
two
factors:
the
actor’s
assumed
primary
objective
and
its
social
objectives.
In
terms
of
sustainable
development,
local
seller
(public
or
private
entities)
concerns
can
be
assumed
to
mainly
include
employment
creation,
energy
security
improvement,
additional
fiscal
revenue
and
foreign
exchange
income,
improvement
to
project
IRR,
and
technology
transfer.40
However,
an
NGO's
primary
objective
can
be
assumed
to
be
more
social
and
environment
oriented,
with
less
considerations
for
economic
aspects.
In
this
sense,
cost‐efficiency
constitutes
a
smaller
constraint
in
the
balance
with
sustainable
development
concerns
for
local
sellers41,
NGOs
and
non‐compliance
buyers,
but
that
does
not
prevent
them
from
being
motivated
by
financial
gains
as
well.
Foreign
investors
also
tend
to
see
the
CDM
objectives
in
terms
of
technology
transfer.
However,
they
see
high
risk,
great
uncertainty,
high
costs
and
low
payback,
i.e.
‘all
the
hallmarks
of
a
poor
investment
proposition.’42 Compliance
buyers’
primary
concern
is
the
purchase
of
CERs
to
comply
with
their
domestic
obligations
in
a
cost‐efficient
manner.
Hence,
sustainable
development
will
tend
to
be
an
additional
objective
for
governments
and
NGOs
more
so
than
for
other
buyers.43
Private
corporations’
considerations
for
sustainable
development
are
sometimes
driven
by
concerns
for
public
image
or
additional
gains
on
the
secondary
market
where
they
can
obtain
a
price
premium
for
‘Mac
deluxe’
projects.
Non‐compliance
buyers
will
most
often
be
attracted
by
financial
gains
and
to
a
lesser
extent
by
40ZHU
XIANLI
and
PAN
JIAHUA,
‘China’s
CDM
Policies
and
Their
Development
Implications:
Major
Concerns
for
CDM
Implementation’,
Research
Centre
for
Sustainable
Development,
Chinese
Academy
of
Social
Sciences,
Chinese
Journal
of
Population,
Resources
and
Environment
2006
Vol.
4
No.2,
p.
24.
41
‘Developers
of
unilateral
projects
are
faced
with
lower
transaction
costs
as
explained
above
than
foreign
developers.’
See:
MICHAEL
JAHN,
AXEL
MICHAELOWA,
STEFAN
RAUBENHEIMER,
HOLGER
LIPTOW,
‘Unilateral
CDM
–
Chances
and
pitfalls’,
GTZ,
November
2003,
version
3.2,
p.
8.
42
A.
COSBEY,
J‐E.
PARRY,
&
all,
op.cit.,
p.
27.
43
For
EU
member
states,
it
is
has
been
argued
that
political
and
strategic
concerns
with
carbon
trade,
including
strong
ties
with
some
developing
countries
drive
them
to
take
into
sustainable
development
in
their
purchase
strategy.
See
M.
GRUBB,
‘On
carbon
price
and
volumes
in
the
evolving
‘Kyoto
Market’’,
OECD
Global
Forum
on
Sustainable
Development:
Emission
Trading.
Concerted
action
on
tradable
emission
permits
country
forum,
OECD
headquarter,
Paris
17‐18
March
2003,
pp.
20.
20
sustainable
development.
It
should
also
be
noted
that
the
European
‘linking
Directive’44
expressly
mentioned
sustainable
development
as
one
of
the
objective
of
CDM
projects,
encouraging
EU
Member
States
to
take
it
into
consideration
in
the
development
of
their
approval
procedures.
This
is,
however,
not
an
obligation.
Large‐scale
hydropower
plants
are
often
seen
to
be
a
less
sustainable
form
of
renewable
energy
generation.
In
2009,
the
EU
therefore
issued
harmonized
guidelines
for
the
compliance
of
hydropower
projects,
in
line
with
the
World
Commission
on
Dams’
recommendations.45
Member
states
voluntarily
implementing
them
have
to
check
whether
hydropower
projects
applying
for
a
letter
of
approval
comply
with
the
guidelines.
This
new
regulation,
combined
with
NGOs
grievances,
influenced
market
actors
consideration
for
large
hydropower
projects.
Starting
from
2013,
the
modified
‘linking
directive’
introduces
the
possibility
to
require
new
conditions
for
CDM
projects.46
Overview
of
sellers’
and
buyers’
motivations:
International
Local
Sellers
Primary
market
Secondary
market
Sust.
dvlpt
Cost‐eff.
Sust.
Dvlpt
Cost‐eff.
Private
corporation
++
+++
Public
++
++
Private
corporation
+
+++
++∗
+++
+++
+
NGO
+++:
highest
propensity;
++:
middle
propensity;
+:
low
propensity
/
∗
Back‐to
back
contracts
where
the
CERs
owner
sells
the
ERPA
to
a
buyer
on
the
secondary
market.
44
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/EC.
45
World
Commission
on
Dams,
‘Dams
and
Development:
A
New
Framework
for
Decision‐Making’.
November
2000.
46
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/EC
Amended
by:
Directive
2004/101/EC
of
27
October
2004
L
338
18
13.11.2004,
Directive
2008/101/EC
of
19
November
2008
L
8
3
13.1.2009,
Regulation
(EC)
No
219/2009
of
11
March
2009
L
87
109
31.3.2009,
Directive
2009/29/EC
of
23
April
2009
L
140
63
5.6.200.
21
Non‐compliance
compliance
Buyers
Primary
market
Secondary
market
Sust.
dvlpt
Cost‐eff.
Sust.
dvlpt
Cost‐eff.
Private
corporation
+
+++
+
+++
Public
++
+++
+
+++
Private
corporation
+
+++
+
+++
+++:
highest
propensity;
++:
middle
propensity;
+:
low
propensity
2.3
Special
features
of
CDM
Projects
CDM
projects
have
special
features
that
enhance
the
complexity
of
a
purchase
agreement
on
the
market.
One
of
them
is
the
share
of
proceeds:
“What
distinguishes
a
CDM
project
from
any
other
investment
is
the
gaining
of
CERs,
and
since
in
most
projects,
consortia
of
investors
make
contributions
on
terms
and
under
contractual
arrangements
that
may
well
be
confidential,
the
fee
must
necessarily
be
extracted
as
part
of
the
overall
crediting
process.”47
Another
special
feature
is
environmental
additionality,
as
the
quantification
of
emission
reductions.
The
difficulties
pertaining
to
this
exercise
are
connected
to
its
technical
and
commercial
aspects.
The
definition
of
accurate
methodologies
is
quite
challenging
for
projects
where
baselines
and
benchmarks
are
difficult
to
assess
(e.g.
landfill
gas).
On
the
other
hand,
businesses
are
making
profits
on
taking
managerial
judgment
in
the
face
of
uncertainty.48
Assessments
of
projects
can
vary
widely
according
to
companies.
Moreover,
those
claims
are
often
contingent
on
confidential
projections
of
costs
and
performance,
and
unknown
price.
Another
issue
concerns
the
CDM
projects’
cost‐effectiveness.
Indeed,
the
more
cost‐effective
the
project
is,
the
more
uncertain
the
additionality.
47
M.
GRUBB,
Ch.
VROLIJK,
D.
BRACK,
op.cit.,
p.232.
M.
GRUBB,
Ch.
VROLIJK,
D.
BRACK,
idem,
p.
229.
48
22
“In
purely
economic
terms,
any
project
that
would
only
require
a
small
incremental
benefit
(such
as
CERs
at
low
cost)
to
make
it
proceed
would
also
only
require
a
small
shift
in
market
conditions
to
make
it
viable
without
crediting.”49
CERs
are
project‐level
emissions
reductions
that
are
measured
by
assessing
the
additional
reduction
achieved
relative
a
determined
baseline,
and
as
such
do
not
have
an
intrinsic
value.
Their
value
is
driven
by
legislation,
and
the
expectation
of
legislation.
Carbon
value
is
dependent
upon
political
developments
and
commercial
perceptions.
However,
the
factors
determining
the
CER
price
might
change
as
legislated
markets
emerge,
and
well‐structured
CDM
transactions
can
enhance
CER
value.
3 Emission
Reduction
Purchase
Agreements
(ERPA)
The
Clean
Development
Mechanism’s
dual
goal
of
funding
sustainable
development
while
generating
cost
effective
greenhouse
gas
emission
reductions
requires
carefully
structured
contracts
in
order
to
achieve
the
best
equitable
arrangement.
CDM
projects
are
implemented
through
a
network
of
legal
arrangements
between
project
participants,
investors,
banks,
contractors
and
purchasers
of
the
ultimate
products
from
the
project
(including
CERs).
All
players
are
highly
dependent
on
each
other,
either
through
the
approval
procedures
imposed
by
international
or
national
regulators
or
through
arrangements
between
them.
Their
behavior
and
any
contractual
arrangements
between
them
will
very
much
depend
on
their
respective
responsibilities
within
the
CDM
process.
The
greater
the
number
of
parties
involved
in
a
CDM
project,
the
more
risks
will
need
to
be
allocated.
The
perspective
of
the
parties
is
an
additional
challenge,
as
they
might
have
extremely
different
business
and
cultural
perspectives.50
Therefore,
the
resulting
purchase
agreement
will
often
reflect
parties’
unequal
relations
and
capacities,
while
it
is
not
clear
which
goal
of
the
CDM
is
emphasized
on.
49
M.
GRUBB,
Ch.
VROLIJK,
D.
BRACK,
idem,
p.
228.
The
Clean
Development
Mechanism:
a
user’s
guide,
chapter
6,
op.cit.,
p.70.
50
23
This
section
will
first
determine
ERPA’s
key
features.
The
second
part
will
identify
a
series
of
risks
pertaining
to
ERPAs.
The
third
part
will
structure
the
risk
allocation
and
cost‐burden
sharing,
while
the
last
part
will
present
three
typical
ERPA
structures.
3.1
ERPA
key
features
By
the
term
contract,
it
is
meant
“a
specification
of
the
actions
that
named
parties
are
supposed
to
take
at
various
times,
generally
as
a
function
of
the
conditions
that
hold.
The
actions
typically
pertain
to
delivery
of
goods,
performance
of
services,
and
payments
of
money,
and
the
conditions
include
uncertain
contingencies,
past
actions
of
parties,
and
messages
sent
by
them.”51
ERPAs
are
international
sale
and
purchase
agreements,
whose
subject
matter
is
a
special
type
of
good,
i.e.
Certified
Emission
Reductions.
The
seller
commits
to
deliver
CERs
generated
by
CDM
projects
to
the
buyer
under
uncertain
conditions.
Therefore,
conditions
included
in
ERPAs
will
relate
to
various
risks:
approvals,
construction,
cost
overruns,
project
underperformance,
delays,
DOE’s
failing
to
verify
GHG
emission
reductions,
rejection
by
CDM
EB,
changes
in
laws,
etc.
Moreover,
if
we
agree
that
ERPA
conditions
include
“messages
sent”
by
the
parties,
we
can
further
infer
that
the
main
purpose
of
an
ERPA
is
twofold:
ensuring
equitable
CDM
transactions
on
the
one
hand
and
mitigating
and
sharing
risks
on
the
other
(by
recording
the
agreement,
identifying
responsibilities,
establishing
rights,
and
managing
risks
related
to
CDM
projects).
Accordingly,
ERPAs
should
be
tailored
to
reflect
risk
and
risk
tolerance
of
project
and
parties,
and
at
the
same
time
lead
to
an
equitable
arrangement.
The
legal
agreement
will
have
the
objective
of
protecting
both
the
buyer
and
seller
from
the
risk
of
non‐performance
by
the
other
party
and
help
minimize
risks
in
different
51S.
SHAVELL,
Economic
Analysis
of
Contract
Law,
Harvard
Law
School,
John
M.
Olin
Center
for
Law,
Economics
and
Business,
Discussion
Paper
No.
403
February
2003,
http://papers.ssrn.com,
Chapter
13
p.1.
24
situations.52
Moreover,
risk
allocation
is
usually
reflected
in
price.
Therefore,
the
identification
of
risks
by
the
buyer
and
the
seller
is
important.53
The
following
analysis
will
focus
on
primary
transactions
where
CER
sellers
are
at
the
same
time
project
developers
in
developing
countries,
while
buyers
are
companies
in
industrialized
countries
that
need
to
comply
with
their
domestic
obligations.
This
choice
can
be
justified
by
assuming
that
primary
transactions
involving
these
types
of
actors
are
the
most
common.
We
might
however
sometimes
refer
to
other
types
of
buyers
in
order
to
make
a
parallel
analysis.
In
‘Economics
and
Law’
terms,
we
can
consider
that
ERPAs
are
incomplete
contracts
(not
all
contingencies
are
singled
out
in
the
contract),
that
both
the
seller
and
buyer
are
risk
averse,
and
that
they
will
always
try
to
maximize
risk
mitigation
measures
in
an
ERPA.
Furthermore,
sellers
face
highly
uncertain
production
costs,
while
buyers
attribute
a
certain
value
of
performance
to
contracts
depending
on
market
conditions
and
their
own
compliance
obligations.
Parties
are
also
assumed
to
be
asymmetrically
informed.
In
this
case,
the
Pareto
efficient
outcome
would
be
for
the
seller
to
produce
if
and
only
if
c
