The International Emissions Trading Association has called for the European Commission to clarify rules on UN-backed carbon offset use in the third phase of its emissions trading scheme in order to boost ebbing market confidence.

While the current focus of the international negotiations may be on collecting from Government sources the $30bn fast-start funding promised as part of the Copenhagen Accord, it is clear that at least the larger target of $100bn a year by 2020 cannot be met without a very large private sector contribution. The only existing mechanism to incentivise private sector low carbon investment in developing countries is the CDM. The EU has been key for the development of the CDM. Yet largely as a result of decisions taken or expected by the EU, market confidence in the CDM is at very low ebb. While there is no shortage of ideas for replacement mechanisms, none of them yet comes close to providing a balance of risk, reward and liquidity sufficient to tempt investors.

IETA is very concerned about this situation and its consequences for international climate negotiations, and says that a vital principle of private financing appears to have been lost: the need to guarantee regulatory certainty and business continuity for investors.

If new regulatory risks impact investments already made, new investors will not come in or support new mechanisms. This principle is the key to build private sector confidence in any offset mechanism, and to stimulating and incentivising abatement projects. The private sector urgently needs certainty in order to be able to regain the confidence in the CDM.

IETA says that there are three things the Commission should do now to persuade private finance to stay in the market and build a case for increasing investment:

1. Clarify, in accordance with the longstanding interpretation of the supplementarity principles, that half of the additional emissions reductions efforts can come through international offsets if and when the EU moves to a higher emission reduction target.
2. Bring to a close the debate on the eligibility of carbon instruments for compliance in the ETS. Firstly, the Commission must clarify that rules will not change for phase 2. If restrictions should be proposed for phase 3 - either by excluding certain types of credits, or by requesting more than one credit for emitting one tonne of CO2 - they must not be retroactive, and should be based on objective criteria, a thorough impact assessment and early stakeholder consultation. The EU, as the largest market for such credits, should also exercise great caution before taking action that could severely damage the only existing major international offset mechanism. A policy that creates uncertainty on eligibility is already leading to dramatic decreases of private financing allocated to reducing emissions, rather than increasing the scaling up that the EU, and IETA, wants to see. The EU has already stated that many countries from which CERs have been sourced in the past will be excluded unless a bilateral political agreement is reached – no information is available about what sort of agreement is intended or when it will be negotiated. Faced with such uninsurable political risk, most investors will simply stop investing directly or only at heightened discount rates. Is that really what the EU wants?
3. Develop additional market instruments with global reach and discuss them in international fora, and with key partners. The Commission should also engage with private sector interests seeking to develop practical and workable approaches to the use of sectoral crediting and other instruments, such as Green Bonds and the mixture of bonds and carbon financing, and offsets from CCS, nuclear and REDD+ (within supplementarity limits). Efforts to design new instruments without the involvement of those who are expected to make them work would be fruitless. IETA has recently circulated a number of papers discussing some of these options.

IETA has repeatedly called for the addressing of structural inadequacies in the CDM registration and credit issuance processes that severely hamper further expansion of the mechanism. But these problems are just a taste of the challenges to come in setting up a robust scaled‐up abatement scheme to channel finance to developing countries for emissions reduction investment that they cannot manage on their own.

Source: IETA