Global Climate Governance - United Nations University...Global Climate Governance Scenarios and Options on the Inter-Linkages between the Kyoto Protocol and other Multilateral Regimes

Global Climate GovernanceScenarios and Options on the Inter-Linkages

between the Kyoto Protocol and otherMultilateral Regimes

A Project of the United Nations University Institute of AdvancedStudies and the Global Environment Information Center

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UNU / GEIC / IAS - Global Climate Governance

List of Abbreviations

AIJ Activities Implemented JointlyAIPN Association of International Petroleum NegotiatorsBOT Build Operate and TransferCBD Convention on BiodiversityCDM Clean Development MechanismCDMJV Clean Development Mechanism Joint VentureCDMJVA Clean Development Mechanism Joint Venture AgreementCER Certified Emission ReductionsCO2 Carbon di-oxideCOP Conference of the PartiesMOP Meeting of the PartiesMMT Methylcyclopentadienyl Manganese TricarbonylERT Emission Reduction TargetsERU Emission Reduction UnitsETC Emission Trading ContractEU European UnionGEIC Global Environmental Information CentreGHG Greenhouse GasICC International Chamber of CommerceIFF Intergovernmental Forum on ForestsIPF Intergovernmental Panel on ForestsKP Kyoto ProtocolISO International Standards AgreementITTO International Tropical Timber OrganisationJI Joint ImplementationJOA Joint Operating AgreementJVA Joint Venture AgreementMAI Multilateral Agreement on InvestmentMEA Multilateral Environmental AgreementMFN Most-Favoured-Nation StatusNAFTA North American Free Trade AgreementNT National TreatmentPAMs Policies and MeasuresPPM Production and Processing MethodsQELR Quantified Emission Limitation ReductionQELRO Quantified Emission Limitation Reduction ObjectivesSO2 Sulphur di-oxideSPS Sanitary and Phytosanitary (GATT,1994)TBT Technical Barriers to Trade Agreement (GATT, 1994)UNCITRAL United Nations Commission on International Trade LawUNCTAD United Nations Conference on Trade and DevelopmentUNIDO United Nations Industrial Development OrganisationUNFCCC United Nations Framework Convention on Climate ChangeUNU United Nations UniversityUNU/IAS United Nations University Institute of Advanced StudiesWTO World Trade Organization

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The United Nations University, GlobalEnvironment Information Centre (GEIC) and theUNU Institute of Advanced Studies (IAS) initi-ated this research in order to contribute to the ef-fective implementation of the Kyoto Protocol. Theresearch approaches the issue of implementationfrom a strategic perspective. By looking at theimplementation trends and future direction of theProtocol, the research identifies clear implicationswith other multilateral regimes. Through the iden-tification and explanation of the inter-linkages,potential incompatibilities, and synergies, theUNU/GEIC /IAS project aims at creating aware-ness of possible areas for policy consideration be-fore key rules, guidelines and modalities are nego-tiated.

Based on nine commissioned papers by aca-demics and experts in their relative areas, the ad-vice and input from two working group meetingsand a final assessment and review meeting heldSeptember 17-18, 1998 at the UNU Center inTokyo, the main findings of the report are as fol-lows:

1. Potential incompatibilities and implicationsbetween the Kyoto Protocol and the interna-tional trade regime exist and should be con-sidered.

Executive Summary

2. Although a multilateral investment regime hasnot been fully negotiated, namely the proposedMAI, the existing negotiating text and currenttrends in the regime negotiating process haveclear implications to the Kyoto Protocol’sCDM.

3. The private sector will play a increasingly sig-nificant role in the market mechanisms of theProtocol. The current compliance and disputesettlement system as envisioned under the Pro-tocol may not be suffice to create a stable andefficient environment in order to govern thissector’s participation in the market mecha-nisms. Model contractual agreements or stan-dardized provisions could be a useful meansof ensuring compliance. They could also pro-vide access to an existing dispute settlementsystem under international private contractuallaw for parties engaged in the CDM, jointimplementation and emission trading trans-actions.

4. Further research in terms of the relationshipof the Protocol to other MEAs is required.However, very preliminary and initial con-cerns of the maintenance of biodiversity anddeforestation of tropical forests in light ofthe Protocol’s mandate may exist.

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policies responses to avoid possible conflicts andto capitalize on the synergies with other regimescan be considered.

The Report is divided into two distinct parts.Part I, as contained in this document, identifiesand explains the relationship between the Proto-col and other multilateral regimes. Four regimesin particular were addressed:

(1) The interrelationship between the Kyoto Pro-tocol and international trade namely theWorld Trade Organization (“WTO”) Agree-ments, and regional trade agreements (EU andNAFTA).

(2) The interrelationship between the Kyoto Pro-tocol and the international investment regime,namely the proposed Multilateral Agreementon Investment (“MAI”).

(3) The interrelationship between the Kyoto Pro-tocol and private international contractual re-gimes: The use of model contractual agree-ments for transactions carried out under theflexibility mechanisms, such as joint imple-mentation and CDM projects and emissionstrading, and the role of model contracts inensuring compliance with the Protocol andproviding access to alternative dispute settle-

The successful negotiation of the Kyoto Pro-tocol to the United Nations Framework Conven-tion on Climate Change Convention(“UNFCCC”), completed in December 1997, re-sulted in an historic agreement on climate changegovernance, with major impacts on environmen-tal, trade and economic policies. In particular, theKyoto Protocol contains several so-called “flexibil-ity mechanisms,” providing for emissions trading,joint implementation and a Clean DevelopmentMechanism—economic instruments designed toutilize market forces to aid in implementation ofthe Protocol’s environmental goals. A number ofmatters were unresolved in the Protocol, such asthe specific means for implementing the flexibil-ity mechanisms and issues concerning complianceand dispute settlement. The wide-ranging impli-cations of the effects of the Protocol also raise is-sues about its relationship to other environmentalagreements as well as with trade and investmentregimes.

This research was initiated by UNU in or-der to examine the potential interfaces betweenthe Kyoto Protocol and other multilateral regimes.The UNU believes that this is a strategic time tomake such considerations before the completionof the “unfinished business” left after Kyoto. In sodoing, it is the intent of this research to createawareness of the inter-linkages so that appropriate

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Introduction

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(4) The inter-relationship between the Kyoto Pro-tocol and other Multilateral EnvironmentalAgreements (“MEAs”).

Part II of the report, which will be released later,will create hypothetical but plausible scenarios con-cerning the differnet regimes’ inter-relationshipwith the Kyoto Protocol through descriptive illus-trations and examples. It will also, to a limited ex-tent, present policy recommendations based on theexpert review meeting convened at the UNU Cen-ter in September 1998.

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consensus could not have been achieved withoutleaving many issues for future negotiations.

The centerpiece of the Protocol is, of course,its legally binding emission commitments for An-nex I Parties. The Protocol also contains fourmechanisms for implementation of these commit-ments—(1) domestic policies and measures (Ar-ticle 2) and “offshore” activities under the so-calledflexibility mechanisms, (2) joint implementation,(3) the Clean Development Mechanism and (4)emission trading.

The Protocol also contains a number ofprovisions related to compliance such as those re-lated to measurement, reporting, monitoring andverification. Under Article 18, procedures andmechanisms to determine and address cases ofnoncompliance will be agreed to at the First Meet-ing of the Parties to the Protocol (“MOP 1”). SinceKyoto, attention has focused primarily on the flex-ibility mechanisms, largely overshadowing the do-mestic policies and measures and the mechanismsfor ensuring compliance.

2.1. The Agenda for COP4

The main issues concerning implementationof the Kyoto Protocol to be addressed at COP 4

Before turning to the analysis of the inter-linkages with the other multilateral regimes, it isperhaps useful to outline what was agreed to atthe Third Conference of the Parties to the Cli-mate Change Convention (“COP 3”) and whichissues were left unresolved.

When the Kyoto Protocol was adopted inthe early morning after almost 72 hours of round-the–clock negotiations, most of those present weretoo exhausted to fully comprehend what had justbeen agreed to. Since that historic morning, muchtime and effort and been expended by all thoseinvolved in the process to try to make sense of whatwas agreed to in the Kyoto Protocol and under-stand its implications.

When the negotiators emerged from the ex-haustion and excitement of Kyoto, they began torealize just how much had been left unresolvedand how many decisions had been left for futuremeetings. In retrospect, this large burden of un-finished business was inevitable. The practicalcomplexity of some of the issues at stake, such asemissions trading, and the last minute develop-ment of some provisions—most Parties did noteven see the text on the CDM until 48 hours be-fore it was adopted—meant that the details couldnot have been worked out in Kyoto. At the sametime, the differences among the Parties meant that

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Unfinished Business of theKyoto Protocol

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are:

• Matters related to the Clean DevelopmentMechanism (Article 12),

• International emissions trading (Article 17),• Joint implementation (Article 6),• Land use change and forestry, and• The impact of single projects on emissions in

the commitment period.

A number of other issues are also on theagenda for COP 4, particularly the issue of volun-tary commitments by non-Annex I Parties and re-view of the implementation of commitments andother provisions of the Climate Change Conven-tion.

2.2. MOP 1 and Beyond

While the structure of the flexibility mecha-nisms will be elaborated at COP 4, the details con-cerning the so-called “credibility mechanisms”,provisions relating to measurement and reporting,monitoring and verification and noncompliance,will not be agreed to until MOP 1. These mecha-nisms are critical, however, in ensuring compli-ance with the commitments on emissions.

For example, Articles 7 and 8 establish thatAnnex I Parties must provide supplementary in-formation on the actions they are taking to meettheir commitments under the Protocol and thatthis information will be reviewed by expert reviewteams. Guidelines for the reporting of informa-tion and the expert reviews will be developed atMOP 1, after the Protocol has entered into force.

Under Article 18, procedures and mecha-nisms to determine and address cases of noncom-pliance are also to be agreed at MOP 1. The even-tual shape of these noncompliance procedures willbe important in determining whether or not thecommitments of Kyoto are effectively imple-mented and enforced.

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Neither the Climate Change Conventionnor its Kyoto Protocol include specific trade pro-visions. However, given the purpose of these trea-ties to limit the emission of greenhouse gases, theirpotential impact has great economic and commer-cial significance and will certainly have importanteffects on international trade and investment. Theneed for policy coherence between the climatechange and international trade regimes was recog-nized by both the Parties to the Climate ChangeConvention and the negotiators of the Kyoto Pro-tocol. Both the convention and the Protocol em-phasize the need for coherence between trade and

environmental policy. (See Box 1)

The next step in the process of implement-ing the Kyoto Protocol is to define the detailedmeans to achieve the emission targets, both do-mestic policies and measures and internationalmarket based flexibility mechanisms, namely, jointimplementation, the CDM and emissions trad-ing. Depending on how these measures are de-fined, they could raise issues about compatibilitywith the WTO agreements, regional trade agree-ments and a multilateral investment regime.

Box 1

Article 3 of the Climate Change Convention states:

The Parties should cooperate to promote a supportive and open international economic system that wouldlead to sustainable economic growth and development in all Parties, particularly developing country Par-ties, thus enabling them better to address the problems of climate change. Measures taken to combatclimate change, including unilateral ones, should not constitute a means of arbitrary or unjustifiable

Article 2, paragraph 3 of the Kyoto Protocol states:

The Parties included in Annex I shall strive to implement policies and measures under this Article insuch a way as to minimize adverse effects, including the adverse effects of climate change, effects oninternational trade, and social, environmental and economic impacts on other Parties, especiallydeveloping country Parties and in particular those identified in Article 4, paragraphs 8 and 9, of theConvention, taking into account Article 3 of the Convention. The Conference of the Parties serving asthe meeting of the Parties to this Protocol may take further action, as appropriate, to promote theimplementation of the provisions of this paragraph.

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The Kyoto Protocol and the

International Trade Regime

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3.1. Relationship between the Kyoto Protocoland the World Trade Organization

In the WTO Committee on Trade andEnvironment (“CTE”), there has been consider-able discussion on the current and potential rela-tionship between multilateral environmental agree-ments (“MEAs”) and the WTO. As the WTO andMEAs represent two different bodies of interna-tional law, it is clear the relationship between themshould be fully understood and coherent. In thiscontext, the results of the discussions in the CTEare relevant for a full appreciation of the relation-ship between the WTO Agreements, the ClimateChange Convention, the Kyoto Protocol and anysubsequent legally binding instruments to addressclimate change.

What has clearly emerged is the acceptanceby its Members that the WTO has no special ex-pertise as to how to deal with environmental prob-lems such as the heating of the upper atmosphere.Nor is it well placed to make judgements on themost appropriate means to achieve objectives ortargets such as greenhouse gas emission reduction.A consensus has emerged that MEAs are the bestway of coordinating policy action to tackle globaland transboundary environmental problems.Members of the of the WTO are, however, con-cerned with trade measures applied pursuant toMEAs which can affect WTO Members’ rights andobligations. Of the many MEAs currently ineffect, while only about 20 contain trade provi-sions, some - like the Climate Change Conven-tion and the Kyoto Protocol - are potentially im-portant in commercial and political terms.

Another view is that because of the increas-ing commercial and political importance of someMEAs that clearly deal with transboundary prob-lems such as the effects of greenhouse gas emis-sions, it is perhaps important to adopt a preven-tive attitude and provide greater certainty as con-cern grows about the collective impact of individualcountries on the global commons. As a result, vari-ous proposals have been advanced in the CTE witha view to establishing a framework for the rela-tionship between MEAs and the WTO.

3.2. Environmental Window and Waivers

The proponents of the environmental win-dow approach develop the view that, subject tospecific conditions being met, certain trade mea-sures taken pursuant to MEAs should benefit fromspecial treatment under the WTO provisions; thisapproach has been described as creating an “envi-ronmental window” in the WTO. In the case ofthe Kyoto Protocol, the issue is whether it is ap-propriate to provide for differentiated WTO treat-ment for trade measures applied pursuant to theenvironmental agreement, depending on whetherthey apply between Parties or against non-Partiesand whether or not the measures are specificallymandated in the environment agreement itself.

Another way in which WTO Memberscould choose to derogate from their WTO obliga-tions for environmental purposes is to invoke awaiver under Article IX of the GATT. In excep-tional circumstances, a waiver to a WTO obliga-tion can be granted, subject to approval at a mini-mum by three-quarters of the WTO membership.A waived obligation is time-limited, it must be re-newed periodically, and a trade measure appliedpursuant to a waiver could still be challenged inWTO dispute settlement on the grounds ofnon-violation, nullification and impairment ofWTO rights.

3.3. Domestic Policies and Measures toReduce Greenhouse Gas Emissions

An important challenge facing the WorldTrade Organization (WTO) is dealing satisfacto-rily with the increasingly complex interface be-tween trade policy and considerations relating tothe environment. Current or future measurestaken as part of national programs to address green-house gas emissions and the associated climatechange concerns provide good examples of thecomplexity of this interface.

First, it is important to note that a num-ber of the specific policies and measures promotedby the Kyoto Protocol as means of achieving itenvironmental goals are not only consistent withmeasures promoted by the WTO Agreements, butare mutually supportive. Some of the ways in

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which the Kyoto Protocol aims to achieve its goalof reducing greenhouse gas emissions include thepromotion of the “progressive phasing out of mar-ket imperfections, fiscal incentives, tax and dutyexemptions and subsidies in all greenhouse gasemitting sectors that run contrary to the objectiveof the Convention and application of market in-struments” (Article 1, subparagraph (a)(v)). Thisis very much in line with the WTO objective ofthe progressive removal trade restrictions and dis-tortions.

There is not, however, a great deal ofspecificity in the Kyoto Protocol as to the mea-sures that can be applied to meet its objectives.The Protocol specifies that Parties are bound toadopt policies or measures in a manner to pro-mote sustainable development. Examples are poli-cies or measures to enhance energy efficiency, pro-tect and enhance sinks and reservoirs, promoteresearch and development, increase the use of newand renewable forms of energy and environmen-tally sound technologies, phase out fiscal incen-tives and exemptions in greenhouse gas emittingsectors, promote the application of market instru-ments. Energy, carbon and other taxes, mandatoryand voluntary standards, subsidies for environmen-tally friendly production processes, labelling andcertification schemes and the sale and transfer ofemission permits within or between groups ofcountries are also examples of PAMs which mightbe introduced on the national level. Such actionsare to be taken in accordance with national cir-cumstances.

The specific domestic policies and measuresemployed to reduce emissions will certainly havea bearing on world trade. They will affect the costsof production of traded goods and therefore thecompetitive position of producers in the worldmarket. Offsetting measures will be called for bythose whose competitive position is adversely af-fected by cheaper imports not subject to the samemeasures in the country of origin. Measures suchas these may well raise complex questions with re-spect to WTO consistency and the conditions un-der which border taxes, for example, can be ad-justed to accommodate a loss of international com-petitiveness.

Recent studies have specifically addressed thesituation where national measures, such as energyefficiency standards or carbon and energy taxeswhich are not applied to imports provide foreigncompetitors with an economic advantage. It hasbeen argued that it is likely that as countries de-velop their national response strategies, trade mea-sures will play an increasingly important role. Car-bon and energy taxes have been introduced to datein five European countries and all include someform of compensatory measures ranging from to-tal exemptions for certain sectors, reduced ratesfor most energy-intensive processes, ceilings fortotal tax payments, subsidies for energy audits etc.Exemptions and other such features have also beenintroduced to accommodate competitiveness ofconcerns of energy-intensive industries which ar-gued that they would greatly suffer from similaroperation in countries without such taxation.

What is clear from WTO rules is that withrespect to border tax adjustments, indirect taxeslevied on products because of the energy consumedor the carbon dioxide emitted should not be usedto provide a competitive advantage for domesticproducts. Thus, border taxes should not be in ex-cess of taxes on like products manufactured andsold domestically. This is clear. However discrimi-natory taxes applied to products with the samephysical characteristics (like products) accordingto the production processes employed (e.g. becauseof the energy consumed or carbon dioxide emit-ted) raises serious questions in the WTO. One ofthe major unresolved questions before the WTOCommittee on Trade and Environment remainshow to address the question of indirect taxes suchas taxes on energy inputs applied on process andproduction methods.

To fulfil these commitments domestically,Parties are expected to translate the PAMs intolaws, policies and binding regulatory regimes thatwill curb their use of GHG and meet their indi-vidual targets by the end of the first commitmentperiod (2012). The potential domestic legal instru-ments that could be employed are infinite, butlikely cases are taxes on fossil fuel intensive sec-tors, technical regulations such as pollution con-trols, or subsidies on sectors that are comparativelymore environmentally sustainable or which have

3. The Kyoto Protocol and the International Trade Regime

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less of an effect on climate change. The economicimpact could be far-reaching as the ClimateChange Convention pledges to reduce the use offossil fuel, the most common energy form for bothindustrial sectors and everyday life-styles. At thevery least, such domestic regimes are likely to af-fect the competitiveness of national industries andcould be justifiably imposed on foreign imports.Once such measures are placed on imports to re-store competitiveness, the potential for conflictswith WTO rules that regulate the flow of interna-tional trade could arise.

Similarly, enforcement mechanisms thatcould legitimize discrimination between productsin international trade because of the manner inwhich they were produced in other countriestouches on one of the fundamental principles ofthe WTO. Further, preferential trading of goodsand services between countries - within “bubbles”or regional groupings - is only permitted withinthe WTO if certain strict conditions are met.

3.4. Regulations and Voluntary Standards

Another area of importance to the WTO isthe role of voluntary standards, mandatory regu-lations and conformity assessment procedureswhen used for environmental purposes. Flexibil-ity is also provided for here. The WTO TechnicalBarriers to Trade (TBT) Agreement establishesobligations to ensure that voluntary standards,mandatory regulations and conformity assessmentprocedures do not have as their objective the re-striction of trade. However, the Agreement pro-vides considerable flexibility to accommodate en-vironmental concerns; while it encourages theadoption of international standards and technicalregulations (which may well relate to reducing car-bon emissions in the production of products) toencourage the harmonization of regulations andtherefore to facilitate trade, it specifically recog-nizes that priorities with respect to the environ-ment differ between countries.

The Agreement formally acknowledgesthat this can be fully reflected in domestic regula-tions, and therefore permits the adoption of dif-ferent standards and regulations by any WTOMember. This could relate the amount of energy

used in the production of a good or the level ofcarbon dioxide emission within its borders. Theprincipal obligation (apart from transparency etc.)is that standards and technical regulations shouldnot be implemented in such a way that they re-strict trade more than what is necessary to achievethe policy objective. This is the concept of pro-portionality.

Elsewhere under the WTO rules, the har-monization of international regulations and GATTprovisions is more precisely balanced. The 1994Technical Barriers to Trade Agreement negotiatedin the Uruguay Round recognizes internationalstandards as foundation for creating national tech-nical regulations that would effect trade.

Article 2.4 of the TBT Agreement states:

Where technical regulations are required and rel-evant international standards exist or are immi-nent, Members shall use them, or relevant partsof them, as a basis for their technical regulationsexcept when such international standards or rel-evant parts would be ineffective or inappropri-ate means of fulfillment of the legitimate objec-tives pursued.

Although the perimeters of the definitionof what meets the criteria of and international stan-dard is untested, the proviso does imply that stan-dards ranging from those adopted by the Interna-tional Standardization Organization (ISO) to eco-standards or even standards that are taken pursu-ant to an MEA such as air quality control stan-dards could be an accepted basis for exceptions tothe technical barriers regulations.

3.5. Subsidies

A further point of relevance is that a WTOMember may wish to subsidize a production pro-cess to facilitate the adoption of less carbon pro-ducing technology, or could be competing in theworld market with another country which is do-ing so. The WTO Subsidies Agreement has as itsmain purpose the prohibition of governments pro-viding direct assistance to their own industries toimprove their competitive position. The Agree-ment, however, identifies certain non-actionable

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subsidies. Included in the list of non-actionablesubsidies is assistance to promote the adaptationof existing facilities to new environmental require-ments imposed by law and/or regulations whichresult in greater constraints and financial burdenson firms. These subsidies are, however, carefullycircumscribed to avoid them constituting tradebarriers to improve competitiveness.

3.6. Certification and Labelling

A further consideration is the use of label-ling and certification to convey information to con-sumers, and made effective in conjunction withrestrictions on domestic production or consump-tion (Article XX(g)). Interpretations of what isnecessary and the geographical location of the re-sources being protected, for example, raises diffi-cult questions. For example, labelling designed toinform consumers on product energy efficiencylevels is already used in a number of countries, in-cluding Australia, the US and Sweden. However,what remains unanswered in the WTO is the useof eco-labelling and certification schemes such asproduct and performance standards - which aretraditional areas of GATT/WTO jurisprudence -but also labels which convey how much energywas used in making the product.

3.7. Emission Trading

When the WTO rules were created, it isperhaps safe to say that its drafters never envisionedthe trading of air pollution among its parties. Nev-ertheless, stranger things have been traded on in-ternational markets, and in many ways tradingemissions is not essentially different from tradingother types of by-products such as hazardous wasteor used oil. Notwithstanding the nature of the itembeing traded, if it is conceded that emissions areindeed a product or a service to be traded on in-ternational markets, then which parts, if any, ofthe Protocol enabling and regulating this trade,would be likely to come into conflict with WTOrules?

As it stands, the “relevant principles, rules,modalities, rules and guidelines” are still undefined.

However, several possibilities are on the negotiat-ing table. Among these are calls for the tight regu-lation of the emissions trading system by means ofa monitoring and verification process. For instance,if the selling party were in compliance with itsemission requirements, the trade would be unre-stricted. However, if monitoring showed a poten-tial for noncompliance or a serious complianceproblem, then the trade would be banned or theseller would be sanctioned for trading while outof compliance. Such a compliance system wouldof course have implications for WTO rules on ‘like-products’ and PPM. The Protocols provisions re-stricting the trading of emissions to Annex B Par-ties only could also be seen as barrier to trade par-ticularly from the perspective of developing coun-tries (Non-Annex B Parties) which have large in-ventories of emissions credits and might wish totrade on the emissions market, but could only doso by becoming Annex B members.

Such initial concerns over tradable emis-sion permits, present a new area of internationalpolicy yet to be fully considered. Questions tobe addressed include whether tradable emissionschemes fall under the WTO General Agree-ment on Trade in Services, and whether otherflexibility mechanism such joint implementationschemes would be considered an environmentalsubsidy under the WTO Agreement on Subsidesand Countervailing Measures and thereforeexempt from WTO disciplines on subsidies.

3.8. Parties versus Non-parties

The decision taken by governments toagree to the Kyoto Protocol was done with anawareness of the implications with respect to theirWTO commitments. As with any MEA, accep-tance of a legal instrument relating to the reduc-tion of emissions would mean that an individualgovernment has agreed to be subjected to the ob-ligations of that instrument. If trade measures notauthorized by the WTO are provided for, then theWTO Member would have agreed to forgo itsWTO rights. The fact that the legal rights andobligations are not consistent with the WTO is aproblem only if WTO inconsistent measures areapplied to WTO Members not Parties to the Agree-ment.


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3.9. Dispute Settlement

Based on the experience of the discussion ofMEA dispute settlement procedures in the CTE,it seems reasonable that eventually disputes con-cerning trade related measures in the Kyoto Pro-tocol between WTO Members who are also Par-ties to the Protocol on the application of these mea-sures should in the first instance be pursued underthe dispute settlement procedures of the Protocol.It has also been suggested in the CTE that MEAParties might stipulate ex ante that they intendtrade disputes among them arising out of imple-mentation of the obligations of the MEA to besettled under the MEA’s provisions. It could beargued that this approach can help ensure the con-vergence of the objectives of MEAs and the WTOwhile safeguarding their respective spheres of com-petence, thus overcoming problems arising fromoverlapping jurisdictions.

If, however, the Convention, Protocol or anyfollow up Agreement does not provide for the trademeasures under dispute, then what is permissibleunder the WTO is relevant. It will be reasonedbelow that the relationship between the measuresthat are candidates for implementation to reducecarbon emissions and WTO obligations is a com-plex one. For example, any measure taken underthe General Exceptions provision of the WTOmust be either necessary to protect human, ani-mal or plant life or health (Article XX(b)), or re-lated to the conservation of exhaustible naturalresources.

3.10. The Kyoto Protocol and Regional TradeAgreements

3.10.1. NAFTA

The NAFTA is a relatively progressive tradeagreement in terms of the environment. Its archi-tects have had the foresight to draft its provisos toaddress many of the potential problems that couldarise between it and multilateral environmentalagreements. Perhaps the most innovative provisionis Article 104 that expressly sets out the relation-ship of NAFTA rules with certain MEAs contain-

ing trade related measures. The Article states “inthe event of an inconsistency between specific traderelated obligations set out in the internationalagreements contained in Annex 104.1 such obli-gations shall prevail…” Presently four agreementsare contained in the Annex: (a) the Conventionon International Trade in Endangered Species ofWild Fauna and Flora; (b) the Montreal ProtocolSubstances that Deplete the Ozone Layer (c) theBasel Convention on the Control ofTransboundary Movements of Hazardous Wastesand their Disposal and (d) the Canada-UnitedStates and Mexico-United States agreements con-cerning the transboundary movement of hazard-ous waste.

In effect, Article 104 gives supremacy tothe obligations contained in the MEAs. The onlyqualifier is that the Party, when it has a choice ofequally effective means of achieving a given obli-gation that it choose a measure which is the leastinconsistent with the NAFTA rules. The Articlefurther elaborates that the Parties may agree in writ-ing to add amendments to the names of the trea-ties contained in the Annex. Arguably, since theKyoto Protocol does contain several trade-relatedprovisos that it too should be added to the Annex’slist. By doing so this would leave moot any debateover incompatibilities between the NAFTA andthe Protocol’s market mechanisms, such as emis-sions trading.

In terms of the Protocol’s policies and mea-sures that are to be implemented domestically thesewould be dealt with under NAFTA’s rules con-cerning standards that are pursuant to legitimateobjectives (Article 915.1). Similar to the EU man-datory requirements and the WTO’s Article XX(b) and (g), the NAFTA permits its Parties to setdifferent levels and types of standards to inter aliaprotect its environment. However, the standardmust follow basic rules. It must be: (a) nondis-criminatory on imported and ‘like-products’; (b)not be an unnecessary obstacle to trade; (c) useinternational standards as a foundation for nationalstandards; and (d) apply the principle of equiva-lency when judging whether domestic and foreignstandards are similar.

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An interesting provision built into theNAFTA is that standards are also judged accord-ing to other factors such as climate, geography, andscientific justification. Whereas under the WTOthe formulation of a standard is not provided, theNAFTA explicitly recognizes how standards andlegitimate objectives are to be formulated. Para-doxically, this basis for standards may also providean alternative argument for defending domesticmeasures enacted to protect the global commonsbut pursuant to an MEA. For example, if the Partycan argue that the environment of the global com-mons is linked to the domestic environment, thanthe measure could be acceptable on the groundsof Article 915.2. Take for example climate change,since a domestic standard can use as a foundationfactors such as climate and geography, a Partymight justify a standard on fossil fuel citing theIPPC finding that GHG are having a discernableimpact on climate and its further finding that thiswill impact low lying regions and areas more sus-ceptible climatic change. Having argued the im-pact and the scientific evidence on climate change,it could rely on geographic or a climatic argumentto justify the standards in order to protect its lowlying areas.

3.10.2. EU

Under EU law there exists few potential incom-patibilities with the Kyoto Protocol. The EU hasdeveloped a relatively strong legal framework,which carefully defines the relationship of Mem-ber States and the EU vis-à-vis internationalagreements. On environmental matters the EUhas nonexclusive powers to enter to internationalagreements on the environment, which means,depending on the competence, the Communityand the Member States can participate togetheras a whole or separately. The competence de-pends on whether the Community has adoptedinternal rules on the environmental matter athand. If it has, the Community alone has thecompetence to participate. In practice if thereexist no internal rules or the rules are of a “mini-mal requirement”, meaning they are only looselyconstrued, then the Member States and the Com-munity decide together, through the Council,how they will negotiate and sign the internationalagreement.1 In the case of the Climate Change

Convention, the Member States gave the com-petence of the negotiations to the Community.


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4.1. The Clean Development Mechanism andthe Proposed OECD Multilateral Agreementon Investment

Both the Kyoto Protocol and the draftMultilateral Agreement on Investment (MAI) at-tempt to influence the pattern of private sectorinvestment from developed to developing coun-tries. The Kyoto Protocol, when in force, willstimulate investments in the developing world inprojects that reduce emissions of greenhouse gasesthrough a Clean Development Mechanism. Ifadopted and ratified, the MAI will set high globalstandards for the protection of investors and in-vestments against discrimination, and against ille-gal expropriation. Although negotiated under theauspices of the Organisation for Economic Coop-eration and Development (OECD), the MAI willbe open to membership of both developed anddeveloping countries.

This discussion of scenarios concerninginteraction between the CDM and the MAI is nec-essarily speculative, as the detailed investment rulesof the Kyoto Protocol’s CDM have yet to be agreedand the MAI remains in draft form, its adoptionby no means assured. Nevertheless a study of thetwo instruments even in their present forms is ofinterest as it allows an exploration of the potentialconflicts and synergies that may exist between ef-

forts to use international law to both promote andto channel international investment flows. Fur-thermore, the greater use of market mechanismsin multilateral environmental agreements, and thepowerful trend towards strengthened investor pro-tection, advises towards exploring these issues, evenif neither the Kyoto Protocol nor the MAI takequite the final shapes that we presume. It is alsohighly like that even if the MAI is not adopted, amultilateral investment regime will be negotiated,possibly within the WTO, prior the completionof the first commitment period under the KyotoProtocol in 2012.

4.2. Potential Interaction between the CDMand the MAI

By providing a stable regulatory environ-ment for investment, the MAI would support theCDM’s general objective of promoting flows ofcapital from developed to developing countries.However, depending on how the details of theCDM rules are designed, there is some potentialfor conflict between the two regimes. Referencewill be made to an initial analysis of this potentialundertaken by the OECD Secretariat.

4

The Inter-relationship Between theKyoto Protocol and a Proposed Inter-

national Investment Regime

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4.2.1. The Broad Scope of the MAI

Both a project activity and any CER itmight generate would fall within the broad scopeof the MAI’s definition of an investment. A CERhas the characteristics of an investment, that is,the commitment of capital or other resources (i.e.technology transfer); the expectation of gain (i.e.an increase in domestic emissions allowances), andthe assumption of risk (i.e. the risk that the projectwill not generate CERs). The CER may be a formof debt, such as a financial instrument; or a rightconferred pursuant to law or contract, such as agovernment authorization or permit.

The MAI’s broad definition of investorwould extend rights to all private entities, or stateowned enterprises involved in a CDM transaction.It would not, however, include investments madeby states themselves. States are not considered tobe in need of any additional protection as inves-tors, and would avail themselves of the diplomaticchannels or the State-to-State dispute settlementor noncompliance procedures under the Protocolto defend their rights.

4.2.2. Nondiscrimination—Most FavouredNation and National Treatment Requirements ofthe MAI

The MAI prohibits both de facto and dejure discrimination by the host state between for-eign and domestic investors (the National Treat-ment standard) and between two foreign inves-tors from different states (the Most Favored Na-tion standard). This means that host country regu-lations that discriminate between these categoriesof investors either expressly, or in their effect wouldbe open to challenge either by under the MAI byeither States or investors.

A potential for conflict may arise if a Partyhosting a CDM project is encouraged or requiredby the Protocol to expressly discriminate betweeninvestors on the basis of the status of their homecountry in at least three ways:

4.2.3. Annex I Versus Non-Annex I Parties

Although not expressly prohibited by Ar-ticle 12, it is unclear whether investors from non-Annex I Parties would be entitled to participate inCDM activities. Under some conceptions of“additionality” project sponsors may be requiredto demonstrate North to South flows of financialresources before a project activity could be certi-fied. In such a case investors from non-Annex IParties might be denied access to either to eligibleproject activities, or to CERs. It may be arguedthat a non-Annex I investor, without emissionsreduction commitments of its own would have noincentive to invest in CDM projects. If CERs aredesigned as a tradable commodity, it is entirelypossible that an investor without commitments ofits own would see the investment potential in buy-ing and holding CERs to sell to the highest biddershould supplied become scarce.

4.2.4. Complying Versus Non-ComplyingParties

The Protocol Parties may wish to condi-tion an investor’s eligibility to participate in CDMactivities on the basis of whether its home countryis currently in compliance with its commitments.Article 6 of the Protocol (joint implementation)sets a precedent by suspending a Party’s right toadd ERUs generated by an JI project to its assignedamount if issues are raised with regard to eitherthe investor or the host states compliance.

It may be argued that a Party to the Proto-col that has authorized the use of such sanctionsin general would be unlikely to (or even legallyestopped from) invoking the MAI to challengesuch a sanction when it is applied against on of itsown investors. However, the MAI’s investor-statedispute settlement procedures may allow the in-vestor, who may care less about the niceties of in-ternational legal obligations, to challenge a mea-sure, even if its government feel otherwise.

4.2.5. Party Versus Nonparty

While this is not explicit in Article 12,most conceptions of the CDM would probablynot allow investors from host countries not Par-

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ties to the Protocol, or at the very least, those notParty to the Convention to participate in the gen-eration and sale of CERs. This would be justifiedboth for enforcement reasons, as a non-Party hostcountry could not be expected to hold its investorto comply with CDM rules, and to provide all po-tential host countries an incentive to join the Pro-tocol. This distinction may well be necessary asArticle 12 paragraph 10 appears to allow CDMproject activities to be certifiable as early as 2000,most likely prior to the entry into force of the Pro-tocol.

Indeed the OECD Secretariat own analy-sis of potential conflicts between the MAI andMEAs that used quotas and permits noted that:

If quotas or permits are earned by enterprisesas a return on participation (investment) ina pollution reducing project in a developingcountry, the question would arise as to whetherthe ineligibility for such a quota or permit(return) of enterprises of countries not Partyto the system constituted a discriminatorymeasure of the project host. If the eligibilityrequirement were established by an interna-tional regime, that might be interpreted forMAI purposes to be a measure of each Partyto it.

The OECD Secretariat qualifies the riskby suggesting that the barring investors from non-Parties to the Protocol from eligibility may not benecessary, as a CER would have no value in thelegal system of the investor’s home country. Thisanalysis is, however, based on the assumption thatCERs would not have an inherent value as an in-vestment that could be sold on to investors in homecountries where they did have value.

4.2.6. Foreign Versus Domestic Investor

Under some conceptions of the CDM, ahost country or its own domestic investors wouldbe eligible to invest in CDM project activities with-out the involvement of any foreign investor. For-eign capital would be flow only at the point whenthe CERs were ready to be sold on. In order topromote an endogenous, climate friendly technol-ogy in a particular sector, a host country might

decide to bar foreign investors from CDM eligibleproject activities in the same sector, at least untilthe domestic producer was prepared to competewith foreign rivals. The MAI prohibition on pre-establishment discrimination would preclude suchan approach which would discriminate against for-eign investors.

4.2.7. Performance Requirements

Article 12 provides that CDM project ac-tivities should assist developing countries in achiev-ing sustainable development, and should promotereal, measurable and long-term benefits. By someanalyses such criteria would lead a host country torequire a CDM project activity to shorten the chainof production by using locally produced goods orservices, to build domestic capacity by employinglocal citizens, or to transfer technology to localfirm. These employment and performance require-ments, even if imposed equally on domestic andforeign investors, would potentially violate theMAI.

The MAI’s prohibition on performancerequirements would be softened in two ways.Firstly, the enumerated requirements may be em-ployed in circumstances where they are condi-tioned on the “receipt or continued receipt of anadvantage”. If CERs generated by project activi-ties are seen as being within the control and lar-gesse of the host state, then conditioning theirtransfer to an investor on the basis of performancerequirements may be permissible.

Secondly, the MAI text has a specific envi-ronmental exception applicable to the provisionon performance requirements. Modeled on Ar-ticle XX of the GATT1994, the performance re-quirement exception would allow measures thatmight otherwise have violated the MAI if the hostcountry can establish that they are “necessary forthe conservation on of living or nonliving exhaust-ible natural resources.”

4.2.8. Expropriation and Compensation

4.2.8.1. Direct Expropriation

The transaction at the core of the CDM

4. The Inter-relationship Between the KP and the Proposed MAI

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(Article 12(3)) is described so ambiguously as toleave unanswered a fundamental question: who hasrights to the CER or the expectation of a CER atwhat stage in the CDM cycle? The issue is of greatimportance from the stand point of investor pro-tection in that efforts by the host state to control orretain a CER for various reasons may be character-ized as an “expropriation” of the investor’s property.

For example, as part of either a domestic oran international compliance regime, a host countryacting of its own volition or on instruction from aProtocol body, might suspend the validity of CER.As has been indicated Article 6 of the Protocol (jointimplementation) sets a precedent by suspending aParty’s right to add ERUs generated by an JI projectto its assigned amount if issues are raised with re-gard to either the investor or the host states’ com-pliance.

Parties have, furthermore, yet to resolvewhether host countries should be entitled to re-tain a share of any CERs generated within theirterritory. Some have argued that a host should beable to collect a “resource rent” for maintainingthe regulatory framework necessary for hosting theproject activity. If standard rules are not agreedamong the Parties on this issue disputes might ariseover the ad hoc expropriation of all or some of theCERs expected by an investor.

4.2.8.2. Indirect Expropriation

The scope of expropriation in the draftMAI sets a new global standard. Regulatory tak-ings, or state measures such as taxation and licens-ing, which may affect foreign investments do nottraditionally amount to expropriation unless theyare discriminatory or have the precise intent andeffect of confiscation. The MAI, like NAFTA uponwhich it is modeled, expands the international stan-dard for expropriation to cover “regulatory” tak-ing. The MAI prohibits the taking of any stateaction or measure that has the equivalent effect ofdirect or indirect nationalization or ‘creeping’ ex-propriation. There is standing available to an in-vestor concerning an alleged breach of an obliga-tion which “causes loss or damage to the investoror its investment”.

Whether the MAI would require compen-sation for the passage of regulations that reducethe potential for generating profits, or otherwisecause loss or damage to the investment, is a matterof current debate. The experience with NAFTAto date demonstrates that the current wording ofthe expropriation provision would support theseclaims. The liberalized MAI imposes broad obli-gations on states and new rights for investors. To-gether, this increases the possibility that any stateregulation will directly or indirectly discriminateagainst one or more investors/investments. Withbroader grounds for discrimination, and a highstandard of compensation, investor’s rights to dis-pute resolution mechanisms against states willundoubtedly influence domestic policy develop-ment under an MAI regime.

This section of the reprot will now turn to twoscenarios that will test at a deeper level the poten-tial relationship between the CDM and the MAIfrom the perspectives of a non-CDM investor anda CDM investor.

4.3. Party or Nonparty Investors

4.3.1. The MAI and the Non-CDM Investor

The CDM, as with all environmental regu-latory instruments, may be vulnerable to attackunder the MAI if it provides the basis for any fa-cially neutral regulation that has a disproportion-ate impact on a foreign investor. For example,every CDM project activity must achieve both en-vironmental and financial additionality in orderto be certified. This means that the project activ-ity must bring about overall benefits that wouldnot have occurred in the host country in the ab-sence of the project. A counterfactual baseline, orreference case, must therefore be constructed (ei-ther on a multilateral or bilateral basis) to describewhat the host country would have done in theabsence of the project activity. The counterfactualbaseline must be reliable and verifiable, in orderto achieve the global reduction of GHG emissions.If CDM emissions reductions that are not addi-tional are allowed to be certified and are offsetagainst Annex B commitments, overall global emis-sions will increase against a business as usualbaseline.

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The COP/MOP will likely devise a com-mon framework for a counterfactual baseline thatis susceptible to third party scrutiny. The frame-work may be extremely prescriptive (such as theexisting framework for GEF product activities,which requires that a project baseline must reflecta minimal standard of ‘environmental reasonable-ness’) or it may give the parties involved in theproject activity more latitude when defining thebaseline on a project by project basis. We will as-sume the latter for this analysis.

Once a baseline is established between thehost country and the Annex I investor, and aproject activity has been certified, the host coun-try may choose to adopt regulations which sup-port the baseline so that the project activity willbe verified and produce CERs. For example, ahost country may enter into an agreement with anAnnex I investor for the establishment and opera-tion of a solar energy facility. Further to the CDMrequirement of environmental additionality fromthis project, a regulation is passed to prohibit theestablishment, (use, or operation) of coal fired fa-cilities in the country.

Of course, this regulation is passed for avalid environmental purpose related to air qualityand further to the ultimate CDM objective of re-ducing overall GHG emissions. In this scenario,if a foreign investor is operating a coal fired plantin the host country and is the only such investorin the country, that investor may claim that it hassuffered de facto discrimination and initiate anaction for expropriation against the host under theMAI.

Analogies can be drawn from the NAFTAchallenge of a Virginia based company, Ethyl Corp.(Ethyl), against the Canadian government for en-acting legislation to ban the import and interpro-vincial transport of the gasoline additive MMTon the grounds that it is a dangerous toxin. MMTis a manganese-based compound that is added togasoline to enhance octane and to reduce engine“knocking”. Ethyl is the only North Americanproducer of MMT and a Canadian company di-rectly benefited from the ban on MMT. Ethylsued the Canadian government for approximately

$250 million (U.S.), arguing that MMT is safeand that Canada’s ban on the additive constitutesan illegitimate expropriation of Ethyl’s assets,namely it’s Ontario plant which did the final mix-ing of MMT. The Canadian government chal-lenged the jurisdiction of the panel to hear the caseon the grounds that Ethyl followed improper pro-cedure in bypassing their state government in ini-tiating the claim. The panel ruled against them,finding that Ethyl had standing under NAFTAprovisions which are almost identical to those inthe MAI. Shortly thereafter, the claim was settledfor approximately $13 million (U.S.) and an apol-ogy by the Canadian government.

4.3.2. The MAI and the CDM Investor

In another scenario, the CDM project ac-tivity may itself be expropriated by a host state. Ahost state may decide to nationalize a major in-dustry or natural resource for purposes of socialand economic development. For example, CDMproject activities may include land use change andforestry activities undertaken to reduce carbonemissions or increase carbon sequestration. Defor-estation activities lead to combustion and decom-position of woody material and release carbon.Where land is purchased through a CDM projectactivity for the promotion of growth and regen-eration in secondary forests and on pasture lands,and deforestation is prevented, the additional car-bon which is sequestered may generate CERs.

A change of government and/or change inpriorities or circumstance may cause a host state,after agreeing to participate in a carbon sequestra-tion project to nationalize the land for other pur-poses. In addition to claiming expropriation ofthe land, the investor of the forestry CDM project(above) will likely allege the expropriation of theCER certification. For the expropriation of theCER, the investor is likely to claim compensationboth for the value of the land and the anticipatedvalue of the offsets.

4.4. MAI Investor-State Dispute

The investor-state dispute settlement pro-cedures in the MAI would fill a significant gap in

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the Protocol’s institutional structure. At present itis anticipated that only states Parties to the Proto-col would have the power to invoke any of theProtocol’s non-compliance or dispute settlementprocedures. The MAI would be the first interna-tional agreement, open for accession to the globalcommunity, which gives investors new rights andstates additional obligations and provides a mecha-nism for investors to enforce these rights throughinternational arbitration.

Each contracting Party to the MAI givesits unconditional consent to international arbitra-tion in accordance with Article 4 upon signing theagreement. Any issue in dispute with respect to analleged breach of an obligation (i.e. unlawful ex-propriation of a CER or CDM project activity)under the MAI which causes loss or damage tothe investor or its investment, shall be decided inaccordance with the MAI, interpreted and appliedin accordance with applicable rules of internationallaw. A party to the MAI would further have toagree to submit any other investment dispute con-cerning any obligation which the host state hasassumed pursuant to the agreement to enter into aCDM project activity or transfer a CER (whichcan be considered an investment authorization) toarbitration under Article 4. In this case, the rulesof law agreed to by the parties under the agree-ment would prevail.

Where the agreement is silent, the law ofthe Contracting Party and applicable rules of in-ternational law prevail [Article 4, para.14b)]. Theinvestor may choose to submit any dispute whichcannot be settled through negotiation or consul-tation to a number of specified fora under Article14, para. 2. Only the investor has a right to with-draw a dispute once it has been initiated, pursu-ant to paragraph 9e of Article 4. Without a BITto provide similar rights between parties, the com-mon practice would be for a consortia of domesticindustries or multinationals to pressure their homegovernments to bring actions to protect their com-mercial interests. Specious claims which may notbe in the bilateral or global interest are usually fil-tered out by the home government. Absent thisgovernment filter, and based on the experience ofNAFTA, the MAI will likely increase internationalarbitration.

4.5. Regulating Free Markets

The agreement on Article 12 resolved anumber of critical aspects of how the CDM willmanage project-based joint implementationbetween Annex I and non-Annex I Parties to theProtocol. However many gaps remain to be filled,and the negotiating dynamic for the next stage ofthe development of the CDM remainsfundamentally unchanged. This dynamic can nowbe characterised as pitting a market-basedapproach, against an “interventionist approach”based on traditional public sector developmentassistance. Both approaches stress the need for asystem capable of generating credible certifiedemissions reductions (CERs), but differ on the bestmeans of achieving this. The extent to which theCDM might run afoul of the MAI will depend onthe level of state intervention Parties feel will benecessary to achieve the CDM’s policy goals.

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5.1. Introduction

In thought by many observers that the role of theprivate sector will become increasingly significantto the successful implementation and operationof the flexibility mechanisms as set out in the KyotoProtocol. The question that this section raises iswhether the compliance and dispute settlementsystem envisioned thus far is adequate to managethe market mechanisms such as emissions trad-ing, Clean Development, and joint implementa-tion where large amounts of money will inevita-bly change hands visa a vie states, states and pri-vate legal entities, and between private entities andother private entities.

To answer these questions this section first estab-lishes just which private sector or non-state actorscould become involved in the flexibility mecha-nisms. The section then turns to discussing thecurrent compliance and dispute settlement system.Finally having analyzed the system it is argued thatalthough the compliance system is progressive andis likely to achieve overall compliance it is requiresa subsystem at the market mechanism level withbinding power which can effectively enforce thetransactions and efficiently solve disputes betweenthe parties. Therefore it is argued, that the use of amodel contractual forms which could be based onthe existing private international contractual re-

gimes, and which have built-in arbitration and con-flict resolution mechanisms could be one way ofensuring the stability and compliance within theflexibility mechanisms.

5.1.1. The Role of the Private Sector, NGO’s andother “legal entities” in the implementation of theKyoto Protocol

In exploring the role to be played by non-State actors in implementation of the flexibilitymechanisms, this paper discusses: 1) key provisionsof the Kyoto Protocol concerning joint implemen-tation, emissions trading and the Clean Develop-ment Mechanism, 2) some of the international or-ganizations involved in activities related to imple-mentation of the flexibility mechanisms, and 3)ways in which private sector entities and non-gov-ernmental organizations (NGOs) might partici-pate in activities concerning joint implementation,emissions trading and the Clean DevelopmentMechanism.

5.1.2. Key Provisions of the Kyoto Protocol con-cerning Joint implementation, Emission Tradingand the Clean Development Mechanism

The Climate Change Convention estab-lished a pilot phase for Activities Implemented

5

Private Sector, Compliance and Stand-ard Forms: Inter-linkages with Private

Contractual Regimes

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Jointly (AIJ). The term AIJ implies that govern-ments or companies will contract with parties inanother country to implement an activity that re-duces greenhouse gas (GHG) emissions in thatcountry. During the years following its entry intoforce of the UNFCCC, a limited number of AIJprojects were carried out, primarily on a bilateralbasis but also under the auspices of intergovern-mental organizations such as the World Bank.

AIJ related activities were the precursor forthe provisions on joint implementation amongAnnex I countries, emissions trading and the CleanDevelopment Mechanism included in the KyotoProtocol. The relationship among the provisionson joint implementation, CDM and emissionstrading are rather complex, but in general Annex Icountries can receive credit for reducing green-house gas emissions for carrying out either jointimplementation or CDM projects and such cred-its can be used to meet the Annex I countries’ com-mitments to reduce emissions under Article 3.

The Kyoto Protocol to the UNFCCC in-cludes provisions authorizing joint implementa-tion of Annex I country commitments in Article3 and provides a mechanism for calculating theParties emission limitation and reduction obliga-tions under a joint implementation scenario by thetransfer of “emission reduction units.” Article 6 ofthe Kyoto Protocol authorizes emissions tradingamong Annex I countries and Article 12 estab-lishes the Clean Development Mechanism, ascheme for encouraging Annex I countries to carryout emission reduction projects in developingcountries by providing credit for “certified emis-sion reductions” which can be used to meet theAnnex I countries’ commitments under Article 3.

As noted above and stated in Article 17,COP 4 is expected to define “the relevant prin-ciples, modalities, rules and guidelines, in particu-lar for verification, reporting and accountabilityfor emissions trading.” In other words, while theKyoto Protocol authorized emissions trading as amechanism under which Annex I countries canreceive credit for emission reductions for both jointimplementation and CDM activities, the specif-ics of how these interrelated programs will func-tion remains to be elaborated.

5.1.3. International Organization’s Role in JointImplementation, Emissions Trading and the CleanDevelopment Mechanism

International organizations authority for in-volvement in flexibility mechanisms discussed inthis paper arises primarily from language in Ar-ticle 12 of the Kyoto Protocol. Paragraph 5 ofArticle 12 states that “Emissions reductions result-ing from each project activity shall be certified byoperational entities to be designated by the Con-ference of the Parties serving as the meeting of theParties to this Protocol…” and also refers to theparticipation of “public entities” in CDM activi-ties more generally in paragraph 9.

5.1.3.1. The World Bank

The World Bank has been involved from theearly 1990’s in carrying out AIJ activities and hasproposed a Global Carbon Initiative. Under theGlobal Carbon Initiative, the Bank would serve asa broker between buyers and sellers of certifiedemission reductions, assist developing countries inCDM project development and aid potential buy-ers in identifying projects and groups of projectsof interest to them.

5.1.3.2. United Nations Conference on Trade andDevelopment

UNCTAD has proposed playing a role asan intermediary in trading certified emission re-duction credits.

5.1.3.3. Regional Development Banks

While no clear role has been articulated forregional development banks, they are well suitedto assist developing countries in identifying CDMprojects that meet their goals for sustainable de-velopment and achieve emission reductions. Theregional development banks could also serve asregional commodity exchanges emissions tradingand monitor and enforce CDM contracts.

5.1.3.4. United Nations Commission on Interna-tional Trade Law

For both government sponsored and private

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sector activities carried out under both the jointimplementation and CDM schemes, there will bea compelling need for consistency in contractualarrangements. Among other things, such consis-tency would facilitate monitoring and enforcementof the agreements. UNCITRAL could play animportant role in drafting model agreements forthis purpose.

5.2. The Role of the Private Sector Entities andNGO’s

There are two basic reasons that the private sectorwill be motivated to participate in activities relatedto joint implementation, emissions trading and theclean development mechanism. First, in order toachieve their emission reduction commitmentsunder the Kyoto Protocol, national governmentswill need to allocate rights to emit greenhouse gasesamong the current and/or future sources of emis-sions in their own countries, most of which willbe in the private sector. As a consequence, theprivate sector will be required to achieve reduc-tions and, if allowed to do so, may choose to meetsome of its obligations by carrying out joint imple-mentation or clean development projects orthrough trading emission rights.

Second, private sector entities may be motivatedto participate in project activities or emission trad-ing in order to make a profit, if they are engagedin lines of business which are related to these emis-sion reduction activities such as technology devel-opment, power generation, contract negotiationand monitoring and commodities trading.

5.2.1. Multinational and Domestic Corporations

To the extent that corporations in Annex Icountries operate plants which are subject to na-tional emission limitations, they may have an in-terest in achieving their emission reduction obli-gations by carrying out projects in other Annex Icountries or developing countries. Multinationalcorporations in particular may be interested intrading emissions among subsidiaries located indifferent countries.

5.2.2. Commodity Exchanges

On both the national and international lev-

els, private commodity exchanges can help to cre-ate a market for the sale of greenhouse gas emis-sion rights, provide a forum for emissions trad-ing and monitor the quality of the transactions.While it is possible that international organiza-tions such as the World Bank or UNCTAD willplay a role in emissions trading related to CDMprojects, private sector commodity exchangesmay be more qualified to handle private sectoremission trading transactions.

5.2.3. International Power Industry

The international power industry may playa role both in emissions trading to meet its ownemissions reductions obligations and as an ex-ecutor of projects aimed at generating power ina manner which reduces GHG emissions. Powergenerators are also involved in cross border salesof energy, which impact on both national andprivate sector emission limitations.

5.2.4. Technology Developers and Manufacturers

The private sector has a critical role to playin the development and diffusion of technologythat results in lowering emissions of greenhousegases. Developers of energy efficient technolo-gies and processes may seek market opportuni-ties created by joint implementation and CDMactivities.

5.2.5. Non-Governmental Organizations

NGOs have an important role to play inthe implementation of the flexibility mecha-nisms. In particular, they may be critical in help-ing to ensure that: 1) real reductions in emis-sions take place as a result of joint implementa-tion and emissions trading by monitoring thejoint implementation arrangements and emissiontrading transactions which take place amongAnnex I countries, 2) the dual objectives of sus-tainable development in non-Annex I countriesand emission reductions are achieved under theClean Development Mechanism, 3) non-AnnexI countries have the capacity to request technol-ogy and projects which help them to achieve theirsustainable development goals.

5. Private Sector, Compliance and Standard Forms: Inter-linkages with Private Contractual Regimes

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The participation of non-State actors, au-thorized by the Kyoto Protocol, will be critical inachieving the treaty’s environmental objectives.The roles of international organizations, privatesector entities and NGOs in implementation ofthe Protocol’s provisions on joint implementation,emissions trading and the Clean DevelopmentMechanism should be discussed as an integral as-pect of the negotiations on elaboration of theseflexibility mechanisms leading to COP 4 in BuenosAires

5.3. Review of the Existing and Proposed Com-pliance and Dispute Settlement System under theKyoto Protocol

Without concrete obligations, and the monitoringof implementation/compliance with those obliga-tions, it is not practicable to speak of noncompli-ance mechanisms. This is seen clearly in the cli-mate change context, which has proceeded fromgeneral commitments without specific timetablesand targets, to agreement upon such specific com-mitments with attention turned to implementationthereof and to compliance control. The 1987 Mon-treal Protocol, the 1994 Second Sulphur Protocol,and the 1997 Kyoto Protocol suggest a new cycle ofstrengthening compliance systems gradually, and instep with the strengthening of commitments.

5.3.1. The Climate Change Convention

The traditional dispute settlement approachis present in Article 14, which adopts an approachwhich conceptualises disputes as arising between twoor more Contracting Parties in connection with theinterpretation or application of the Convention. Ifever activated, the traditional hierarchy of peacefuldispute settlement mechanisms would apply, rang-ing from negotiation and third party mediation orgood offices, through to arbitration or submissionof the dispute to the International Court of Justice.Under Article 14, recourse to negotiation or othermeans of peaceful settlement is obligatory, with ei-ther Party able to request creation of a conciliationcommission in the event that negotiation is unsuc-cessful; however, the awards of the commission arerecommendatory only. This bilateral dispute settle-ment route is considered to be complementary to

the Article 13 process.

Article 13, on the other hand, is a good ex-ample of the trend away from total reliance on tra-ditional dispute settlement methods in recent mul-tilateral environmental agreements noted above. Itestablishes a multilateral consultative process(“MCP”) for resolution of questions concerning theimplementation of the Convention. Little detail iscontained in Article 13, thus the first meeting ofthe COP established an Ad Hoc Group on Article13 to operationalise the MCP. The sixth and finalsession of this Group was held in Bonn in June 1998where its work was completed in anticipation ofCOP 4. It has adopted the framework for a MCPwhich must now be considered at COP4, includ-ing the resolution of the matters left unresolved inthe Committee.

In earlier sessions the Group has emphasisedthe advisory rather than supervisory nature of theMCP, further distancing the process from a morerigorous form of NCP. The MCP is without preju-dice to the dispute settlement provisions of Article14, the latter applying, mutatis mutandis, to the Pro-tocol. There is no internal “exhaustion of local rem-edies rule” in operation. But there is some doubtwhether Article 14 will ever be invoked in a tradi-tional dispute settlement; indeed, one of the rea-sons for including Article 13 was the perception thattraditional dispute settlement would have a very lim-ited role to play under the Convention where thelikely nature of disputes would not be amenable tosuch procedure.

5.3.2. Noncompliance Under the Kyoto Protocol

The application of the Article 13 MCP tothe Protocol is an issue left undetermined by theProtocol itself. Article 16 of the latter provides thatthe Conference of the Parties serving as a meetingof the Parties to the Protocol shall “as soon as prac-ticable” consider such application, with or withoutmodification. If the Article 13 MCP were so ex-tended, the Protocol expressly provides that suchprocedure would operate without prejudice to theNCP under the Protocol (which in turn is withoutprejudice to the dispute settlement provisions ofArticle 14 FCCC). What is clear is the determina-tion to distinguish a specific noncompliance proce-

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dure under the Protocol from both the dispute set-tlement provisions of Article 14 of the Convention/Protocol and the MCP of Article 13 (if extendedto the Protocol).

It is Article 18 of the Protocol which expresslyrefers to noncompliance in the following terms:

The Conference of the Parties serving as the meet-ing of the Parties to this Protocol shall, at its firstsession, approve appropriate and effective proce-dures and mechanisms to determine and to ad-dress cases of noncompliance with the provisions ofthis Protocol, including through the developmentof an indicative list of consequences, taking intoaccount the cause, type, degree and frequency ofnoncompliance. Any procedures and mechanismsunder the Article entailing binding consequencesshall be adopted by means of an amendment tothis Protocol.

Due to the politically sensitive nature ofnoncompliance procedures, in particular bindingconsequences flowing from a determination of non-compliance, it is not surprising that decision on anysuch characteristics will require the stringent treatyamendment procedures of the Protocol to be fol-lowed. Establishing this significant procedural hur-dle to the adoption of binding consequences fornoncompliance is in part a reaction against the dy-namic development of the Montreal Protocol NCPunfettered by such further requirement of treatyamendment but subject rather to the decision-mak-ing rules of the COP. There is a clear reluctance toprovide a “blank cheque” for binding noncompli-ance consequences to the COP.

The design of a future NCP under the Pro-tocol will entail both institutional and functionalaspects: what is the procedure designed to achieve,and which organ(s) will be responsible for it? Aspecial body will need to be established, most likelya standing committee of legal, economic and tech-nical experts (or generalists with access to a roster ofexperts). Moreover, the relationship between thisbody and the existing Convention bodies will re-quire careful definition. Experience has shown thatthe development of a NCP can take some time.How then will the NCP be operationalised pend-ing the entry into force of the Protocol? This is

particularly problematic given that the key featuresof the flexibility mechanisms under the Protocolhave also yet to be determined.

In fact, these matters have already beenraised in the Subsidiary Body for Scientific and Tech-nological Advice (SBSTA) and the Subsidiary Bodyfor Implementation (SBI) which have met since theadoption of the Kyoto Protocol (Bonn, June 1998).Included on the agenda of each body was consid-eration of suggested elements for a work programmeto operationalise the mechanisms under the KyotoProtocol, in particular joint implementation, theclean development mechanism, and emissions trad-ing. Compliance is identified as one of the outstand-ing issues under each of these mechanisms, whichwill be addressed in turn.

5.4. Flexibility Mechanisms

5.4.1. Joint Implementation

Where joint implementation is pursued,Article 4 provides that a failure to achieve joint emis-sion reduction targets does not absolve Parties fromthe obligation to meet their own emission reduc-tion targets, which are obliged to be set forth in theagreement. This simplifies the application of a NCPto the joint implementation process where there hasbeen a failure to achieve targets, and provides addi-tional incentive for reaching the targets set forth inthe joint implementation agreement. Whilst im-plementation may be joint, responsibility for non-compliance with targets is still that of the individualState.

The verification and reporting criteria whichare to be established at MOP1 (or as soon as practi-cable thereafter) could give rise to noncompliancethresholds, as could the extent to which JI is sup-plemental to domestic implementation measures.The additionality requirement of Article 6(1)(b) pro-vides a further benchmark for the application ofNCP.

5.4.2. The CDM

Article 12 of the Protocol establishes theclean development mechanism (CDM), the pur-pose of which is “to assist Parties not included in


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Annex I in achieving sustainable development andin contributing to the ultimate objective of the Con-vention, and to assist Parties included in Annex I inachieving compliance with their quantified emis-sion limitation and reduction commitments underArticle 3. The executive board and “operating enti-ties” under Article 6 could perform a compliancefunction in respect of the CDM, in which case theissue of whether multiple compliance mechanismswill evolve under the Protocol, perhaps linked withspecific flexibility mechanisms, will need to ad-dressed by the COP/MOP. As under Article 6, theestablishment of auditing and verification criteriawill also give rise to the need also to establish non-compliance parameters.

As with JI between Annex I Parties, con-cerns that Article 3 commitments would be metwholly through the CDM are addressed in Article12(3)(b) which explicitly provides that certifiedemission reductions from such project activities maycontribute to compliance with part of their Article3 commitments (as determined by the COP). Akey concern for all three of the Kyoto mechanismsis to establish an appropriate level of reliance onthese mechanisms, jointly and severally, in additionto domestic implementation. The setting of a pre-cise level would constitute a yardstick against whichcompliance with the supplementarity requirementcould be measured. Finally, as with JI, emissionreductions deriving from CDM project activitiesmust demonstrate that such reductions are addi-tional to any that would occur in the absence of thecertified project activity (Article 12(5)(c)), thus pro-viding a further benchmark for the application of aNCP.

5.4.3. Emissions Trading

Article 3 of the Protocol envisages an emis-sions trading system which will establish a marketamongst Annex I Parties in emission credits. Thereis no time scale for operationalising emissions trad-ing stated in the Protocol, though it is certainly ex-pected to be operational during the first commit-ment period (2008-20012). Any trading is to besupplemental to domestic actions to meet reduc-tion commitments; limiting the operation of thetrading to developed States further meets the con-cern expressed by developing States that such States

would meet their quotas without implementingnecessary domestic measures to reduce emissionssimply through purchasing quota.

5.5. Many Outstanding Compliance IssuesRemain Unresolved

There are thus a large number of design is-sues to be addressed in implementing Article 18 ofthe Protocol, many of which are linked to the de-tails of the flexibility mechanisms yet to be estab-lished. A key concern in the forthcoming negotia-tions, as the flexibility mechanisms are fleshed out,will be to ensure that the substantive commitmentsunder the Protocol do not lead to irresistible pres-sures to weaken the noncompliance mechanismunder Article 18. Absent such a mechanism thereis no realistic alternative for ensuring the effectiveimplementation of the Protocol.

5.6. Interrelationship between the Kyoto Pro-tocol and Private International Contractual Re-gimes: The Development of Model ContractualAgreements for the Flexibility Mechanism

Having reviewed the existing and proposedcompliance and dispute settlement provisions ofthe Kyoto Protocol, it is clear that an overall com-pliance system is envisioned. However, there stillremains no defined dispute settlement or compli-ance system at the market mechanism level. Giventhe inherent relationship of the flexible mecha-nisms to the achievement of the emission targetsand therefore the overall objective of the Protocolsuch a system will undoubtedly need to be con-sidered.

One method of achieving compliance at theflexible mechanism level without having to createa completely new system is for the Parties to agreeon standardized contractual arrangements thathave built in dispute settlement and arbitrationclauses. This section examines the opportunity ofemploying these types of contracts that could beused between public and private legal entities par-ticipating in the Clean Development Mechanism,joint implementation projects and emission trad-ing transaction as envisioned under the Kyoto Pro-

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tocol. The section also distinguishes potential stan-dard forms that could be used to govern the trans-actions, particularly with reference to United Na-tions Commission on International Trade Law(“UNCITRAL”) rules or forms.

5.6.1. Standardisation and the Flexible Mecha-nisms

Is it possible to have a standardised agree-ment for the international governance of the flex-ible mechanisms? The question of standardisationhas elicited much controversy in contract law. Inrelation to a CDM or JI project, the main argu-ment against a standardised agreement would bethat not all CDM or JI projects will be exactlyalike and thus standardisation could underminethe potential for flexibility and dynamism inachieving contract objectives. Given widely vary-ing cultural and commercial circumstances in dif-ferent countries, a case-by-case approach seemslegitimate.

Nonetheless, it is likely that a series of con-tract guidelines will need to be met in order tosecure the achievement of the goals of the Proto-col. Some of the advantages of standardisationinclude the following:

• Standardisation facilitates the conduct of com-mercial/investment transactions thus savingcosts and time;

• It facilitates the comparison and evaluation ofcontractual responsibilities and associated risks,if these are based on the same well-known con-tractual terms;

• It makes financing easier, since financiers wouldbe familiar with contractual terms;

• It enables the parties to plan ahead and to haveeffective control, monitoring and supervisionof projects;

• It reduces the tendency for the private sector toexploit its financial and technical advantage inthe course of negotiations with national or lo-cal authorities;

• It may facilitate subcontracting and negotiat-ing of other project-related contracts;

• Standardised project agreements are more care-fully drafted and as such are usually of a higherquality;

• Standardisation does not necessarily precludeintroducing special conditions if needed, thusensuring flexibility and dynamism.

It could be contended, however, thatstandardisation is not very common or appropri-ate in long-term contracts but rather, as an instru-ment for short-term, immediately consumabletransactions. There is, however, a growing trendin standardising long-term agreements even in thenatural resources sector as evidenced by the ten-dency of host countries to draw up similar modelcontracts to govern such transactions. This isequally true at the international level, where theUnited Nations Industrial DevelopmentOrganisation (UNIDO), the International Cham-ber of Commerce (ICC), the Association of Inter-national Petroleum Negotiators (AIPN) as well asthe World Bank have been working on and evenpublished some standard terms.

Even if standardisation of CDM or JIproject contracts were preferable, the issue arisesas to the type of contract to be adopted. Does theUNCITRAL practice or laws provide any guid-ance?

UNCITRAL was created in 1966 in orderto enable the UN to play a more active role inreducing or removing legal complications in thefree flow of international trade. It has accordinglyproduced a continuous flow of studies, standardterms (for documentary credit) and model rulesor laws (for arbitration and procurement) in areasof international trade law for national enactment.

So far, however, there are no particularUNCITRAL rules or forms for CDM or JI projectcontracts. This is understandable, as these mecha-nism was invented post UNCITRAL, and couldnot have been contemplated by UNCITRAL rulesor forms. It is pertinent to stress though, thatwhichever type of contract is eventually adopted,a conciliation, mediation and, or arbitration clauseshould be a must for every such contract. Thisensures that compliance and dispute settlementproblems at the flexible mechanism level will notjeopardize or impact the overall compliance andachievement of the Protocol’s objectives.


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5.6.2. The CDM

The Kyoto Protocol agreed upon in De-cember 1997 will, if implemented, transform theway energy is produced and used. The agreementmay well turn out to be one of the most signifi-cant, in terms of the impact on lifestyles, of the20th century. If the targets agreed upon in Kyotoare to be achieved, it is now virtually certain thatthe so-called flexibility mechanisms endorsed inKyoto - emissions trading, Joint Implementation(JI) and the Clean Development Mechanism(CDM) - will be utilised on a large and interna-tional scale involving both public and private sec-tors. It is conceivable, even likely, that the natureand scale of foreign energy investment will changeradically.

The basis of all three flexibility mechanismsis trading. Such trading will represent transfers ofcredits, allowances, permits and quotas, all of whichwill be linked directly to the reduction of emis-sions of the greenhouse gases (GHGs) stipulatedin the Protocol.

In the case of JI and the CDM, the legaland contractual implications are great. Not onlywill it be important for contracts to protect theinterests of both sides of a project or crediting deal,but it will also be a requirement that the GHGcredits which result from it are, as the Protocolputs it, “real, measurable and long-term” and “ad-ditional to any that would occur in the absence ofthe certified project activity.”

This will be of added importance for theCDM since the credits which arise from suchprojects will, in total, permit Annex I countries,i.e., the industrialised OECD countries that haveemissions reduction targets under the Protocol, toexceed their combined limits for the 2008-2012budget period. If the CDM is abused, inaccurateor badly designed, credits will not correspond togenuine reductions and the Annex I target will notbe met. CDM contracts must therefore be water-tight from both a commercial and an environmen-tal standpoint. Indeed, the two perspectives areinextricably linked.

While it is evident that CDM contracts

cannot be devised until the UN process provides amore detailed design framework, this section ofthe report seeks to propose a standard form forthe future. It is based on an analysis of the Proto-col, a review of selected proposals made to theUNFCCC for AIJ project support (ActivitiesImplemented Jointly), analysis of UNICITRALrules - and some new thinking.

5.6.2.1. The CDM contract - Issues to be Cov-ered

The fundamental features of a standard formcontract for the CDM should consider the follow-ing:

• A definition of the project;• Commitments by the donor in relation to fi-

nancial investment, GHG reductions (see be-low), project performance, technology co-op-eration and sustainable development;

• Commitments, if appropriate, from the host inrelation to site and/or project ownership, pro-vision of goods and services in relation to ef-fective operation of project and sustainable de-velopment;

Specific aspects to be covered would includethe following:

• Arrangements for the ownership of the projectsite, project and CERs arising from project;

• Detailed identification and quantification (overthe full life cycle of the project) of greenhousegas sources and sinks at the site and which areincluded in emissions baseline, together withassumptions and uncertainties;

• A project schedule and timetable, including theperiod during which emission reductions willtake place with year-by-year forecasts of reduc-tions;

• Estimated total CO2-equivalent emissions re-

duction accruing to the donor investor (andhost if credits are to be shared) over a specifiedperiod. Note that Art. 12 (5) states that emis-sion reductions should be real, measurable,long-term and additional;

• Emissions monitoring process and data collec-tion procedures;

• Procedures for updating estimates of emission

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reductions;• Arrangements for independent auditing, exter-

nal verification and certification;• Assuming that certification takes place before

the transfer of credits, enforcement mechanismswill need to be laid down in the event of non-compliance;

• Penalty arrangements in the event of non-com-pliance by either party, in particular in the eventof emission reductions being lower than esti-mated;

• Commitments relating to Article 12(2) that theCDM should help developing countries achievesustainable development. All non-GHG envi-ronmental impacts of the project should there-fore be detailed;

• Commitments relating to Article 12(8). Thecontract should determine what share of theproceeds are allocated to cover administrativeexpenses and/or assistance to Parties for adap-tation to climate change.

5.6.3. Possible Contract Types for CDMProjects

Generally speaking, there are already a num-ber of example contracts which have been negoti-ated since the Kyoto Protocol was agreed upon,most of which would not squarely fit into theCDM Project framework because these laterprojects were obviously not originally contem-plated by such contractual arrangements. But,considering the substance of CDM Projects, otherexamples of inter-governmental agreements suchas Intergovernmental Co-operation Agreements,Concession Contracts, BOT (Build, Operate andTransfer) Project Contracts, and Joint Venture andService Contracts deserve closer analysis becausethey have certain features which make them moreeasily amenable to the kinds of agreements envi-sioned under the CDM.

5.6.3.1. Intergovernmental Co-operation Agreements

These are agreements entered into by gov-ernments for and on behalf of their respective sov-ereign states and can be of a general, frameworknature or relate to a specific CDM Project. Theyusually provide, among other things, proceduresand joint institutions for co-operation program-

ming, for project preparation and evaluation aswell as for implementing projects and monitoringtheir performance. These ongoing efforts to de-velop suitable intergovernmental co-operation con-tracts can be complemented by the further delib-erations of the COP under the Kyoto Protocol.Intergovernmental agreements relating to specificCDM Project(s) could contain provisions relatingto:

• The partial, or full assumption of risk of non-performance of such projects by their respec-tive home countries. Where projects are initi-ated by private legal entities, the home statesshould bear partial assumption of risk. But,full assumption of risks should be borne byhome states if projects are initiated by their re-spective public sectors;

• Provisions regarding financing and market ac-cess conditions to enable the proper and effec-tive implementation of the CDM;

• Host state guarantees regarding stability of theenabling regulatory regime, including the termsof the CDM agreement; and

• Host state guarantees relating to the uninter-rupted supply of energy and natural resources,where these are applicable to the CDM Project.

Some of the advantages of intergovernmen-tal co-operation agreements include the following:

• This type of agreement seeks to link projectcontracts with international law through homestate commitments to assume performance re-sponsibility;

• It provides a convenient framework for projectagreements on the enterprise level by shieldingsuch enterprises from the vagaries of host coun-try regulatory regimes;

• The reduced number of participants allowscommitments to be more concrete and precisein terms of specific sustainable developmentgoals and strategies or quantified emission limi-tation and reduction objectives (QUELROs);

• Since this type of agreement can take a varietyof forms, it is flexible enough to correctly re-flect the degree of state intervention in con-crete cases of co-operation at the project level;

• The rules or terms of the agreement may bebilaterally negotiated, thus allowing innovative


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solutions and a gradual evolution of the entireprocess.

The main disadvantage of these types ofagreements stems from the assumption of the equalbargaining power of the respective parties, whichis not usually the case. Indeed, it is not unlikelythat the unequal bargaining power and the inad-equacy or absence of experience on the part ofdeveloping countries will result in an agreementthat reflects this lopsided relationship in favour ofthe industrialised country. The solution lies indrafting such agreements to meet the differing,legitimate expectations of the parties. This wouldimply, inter alia, that:

• The agreements should not be exclusively re-flective of the defensive interest of the invest-ing or exporting countries;

• They should equally reflect elements of the col-lective interests of developing countries andactions in keeping with those interests such astechnology co-operation, financial resourcesand respect for sovereignty over natural wealthand resources;

• They should contain concrete commitmentsfrom the parties aimed at creating a package ofmutually beneficial interdependence.

5.6.3.2. Concession Contract

The term “concession” connotes “owner-ship” or, what in common-law systems is describedas a “free-hold interest”. It is an arrangementwhereby the private sector is granted the right todevelop a public infrastructure project. The con-cession system has become transformed in the lightof the exigencies of modern international commer-cial transactions. The following are some of thefeatures of the modern concession contract:

• It gives exclusive right to the concessionaire toundertake its operations in a given area, includ-ing other ancillary operations within a certainduration with the possibility of renewal;

• The concessionaire has exclusive rights to man-age its operations without undue interferencefrom the host government;

• It sets out clear commencement, work, andother obligations, which may include the filing

of work reports;• It involves a simplified tax system that enables

the concessionaire to effectively amortise itsinvestments within a reasonable period of time;

• Pricing is always set by the concessionaire but,with government supervision;

• Dispute settlement is usually by ad hoc arbi-tration with the laws of the host country andinternational law as the choice of law clause;

• There is a possibility for revocation in excep-tional circumstances.

The concession system has been modifiedin recent times to accommodate various other typesof projects, with a considerable reduction in hostgovernment participation and control. It is possi-bly one of the most attractive options for CDMProjects, since it enables the private sector to exer-cise a free hand in developing and managing theproject, with minimal host government interfer-ence. Innovative contractual clauses can be draftedto synchronise with the objectives of the CDM.

It is important to note that, in all contracttypes, the problematic issues are always in invest-ment guarantees: non-expropriation, repatriationof investment/revenues, stabilisation clauses andduty free imports, just to mention a few. Theseissues deserve much more than a mere mentionhere. While in theory, the foreign private investorcan obtain maximum government guarantees forthe security of his/her/its investments by very clearcontractual provisions, in practice, the governmenthas some shrewd ways of bringing about tangiblechanges or the termination of an agreement.

Non-consensual modifications of economicdevelopment agreements may arise outside therealms of clear cases of breach of contract or forcemajeure from:

(a) government’s unilateral action taken on theground of public purpose;

(b) a fundamental change of circumstances ren-dering the performance of the agreement un-duly onerous or wholly or partially fruitless

Traditionally, foreign private investors havetended to protect themselves by contractual de-vices such as inserting stabilising clauses, choice

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of law clauses and arbitration clauses. Thestabilisation clause aims to protect the originalcontractual terms from future legislative changesofthe host state, which may have negative repercus-sions in terms of taxation, environmental controlsand other regulatory matters. The choice of lawclause is usually aimed at subjecting the agreementto some other law (usually international law orgeneral principles of law) besides the laws of thehost state, which could be changed at will. Thearbitration clause is usually aimed at choosing aneutral forum for settling disputes that may arisefrom the agreement. The combined effect of theseclauses is to internationalise the contract.

While there have been a number of verypersuasive objections to the theory ofinternationalisation, current trends appear tofavour a delicate balancing of the often conflict-ing interests of foreign private investors on the onehand and host governments on the other. Thisapproach involves the recognition that no sover-eign state can divest itself of its primary responsi-bilities of protecting public interests and promot-ing sustainable economic development on the onehand, and ensuring some adequate guaranteesagainst the consequences of unilateral governmentaction on the other. These responsibilities mayinvolve an obligation to renegotiate contracts ifand when the original contractual equilibrium hasbeen modified by a fundamental change of cir-cumstance. Such a clause affords the possibilityfor the “dynamic stability” of the original con-tractual terms.

5.6.3.3. BOT (Build, Operate and Transfer)Project Contracts

BOT Project Agreements may be said tobe modified versions of the concession contract.There can be considerable diversity in their formand content, ranging from “huge, complex con-tracts, tailor-made for a particular infrastructureproject to straightforward and to some extentstandardised contracts for each infrastructure sec-tor, as in China’s BOT programme.” To this ex-tent, they can be said to be as flexible and dynamicas compared to concession contracts. Again, inview of the fact that in the construction, imple-

mentation and maintenance of some CDMProjects, like their AIJ counterparts, science, engi-neering and construction works would play a con-siderable role, the attractiveness of BOT ProjectAgreements can not be over-emphasised.

However, they have to be specially and care-fully drafted to fit into the legal systems withinwhich they are to operate. Legal systems that areless supportive of, or less transparent to, the BOTapproach may require far more comprehensiveprovisions in BOT Agreements than those that aremore supportive or transparent.

The potential advantages of using the BOT Projectcontractual approach to both the private and publicsector are illustrated in Table 1.

5.6.3.4. Joint Venture Agreements (JVA)

The “joint venture” is “a business arrange-ment in which two or more parties undertake aspecific economic activity together”. Althoughthere are different variants of joint ventures (JVs),they are generally a popular way of pooling to-gether scarce financial and technical resources forthe purpose of carrying out a commercial under-taking. The JV contract spells out the terms ofthe joint venture, especially the financial commit-ments of each partner and the modalities for shar-ing of profit, which need not necessarily be in equalproportion. In the energy sector, host governmentssee JVs as an effective way of participating in thedevelopment of their natural resources, with theconcomitant prospect of technology transfer.

The CDM will involve an arrangement be-tween non-Annex 1 and Annex 1 Parties, by whichthe former benefits from project activities result-ing in certified emission reductions and the lattermay use the certified emission reductions accru-ing from such project activities to contribute tocompliance with part of their quantified emissionlimitation and reduction commitment. In prac-tice, though, both industrialised and developingcountries could use private and public entities toundertake CDM joint ventures (CDMJV).Clearly, a CDM joint venture agreement(CDMJVA) would be the most appropriate frame-work to guide the commercial and legal relation-


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Private Sector

Public Sector

• Gives private sector a free hand tofinance the project, rather than dependon contribution from host government,which may cripple project because ofgovernment’s other commitments.

• Use of private sector financing toprovide new sources of capital, whichreduces public borrowing and directspending and which may improve hostgovernment’s credit rating.

• Ability to accelerate the developmentof projects that would otherwise haveto wait for, and compete for, scarcesovereign resources.

• Ability to accelerate the developmentof projects that would otherwise haveto wait for, and compete for, scarcesovereign resources.

• Use of private sector initiative andknow-how to re duce projectconstruction costs, shorten schedulesand improve operating efficiency.

• Use of private sector initiative andknow-how to re duce projectconstruction costs, shorten schedulesand improve operating efficiency.

• Private sector is responsible for theoperation, maintenance and output ofthe project for an extended period(normally the government wouldreceive protection only for the normalconstruction and e quipment warrantyperiod).

• Allocation to the private sector ofproject risk and burden that wouldotherwise have been borne by analready encumbered public sector.

• Involvement of private sponsors andexperienced commercial lenders,which ensures an in-depth review andis an additional sign of projectfeasibility.

• Gives government a breathing space tosource indigenous and skilledmanpower comparable to the privatesector.

• Able to recoup the costs of technologytransfer, training of local personneland the development of nationalcapital markets towards the transfer ofthe project.

• Public gains from technology transfer,the training of local personnel and thedevelopment of a na tional capitalmarket.

• Private sector establishes a benchmarkagainst which the efficiency of similarpublic sector projects can be measuredand the associated opportunity toenhance management of infrastructurefacilities.

• Public sector can measure itsefficiency against the benchmarkestablished by the private sector inrespect of similar projects andassociated opportunities to enhancemanagement of infrastructure

Table1: Potential advantages to both private and public sector of using BOTapproach for infrastructure development

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ship between such entities. A standardisedCDMJVA can be adapted to take care of the spe-cial requirements or substance of the clean devel-opment mechanism. Table II is an attempt tosummarise some common advantages and disad-vantages of the JVA.

Two observations should be made here.The first relates to the varying objectives of thejoint venture partners (investor on the one handand host government on the other). Whereas thehost government would be more interested in at-taining sustainable development, including tech-nology transfer for the benefit of the nationaleconomy, the investor would be more interestedin making a profitable return on its investment.The second relates to the host government’s abil-ity to meet its cash-call obligations (in practice,usually the responsibility of the appointed govern-ment agency, or public enterprise). Many feel thatcash-strapped non-Annex I countries can hardlybe expected to meet their financial commitmentsunder the JVA.

However, in no contractual arrangement isan investor’s objective identical with that of thehost government. Furthermore, fears about thehost government’s inability to meet its cash callobligations under the CDMJVA would be arrestedby Article 12(6) of the Protocol. And, even if theCDMJVA is not a favoured option because of hostgovernment involvement, it is, nonetheless, an at-tractive option for several companies willing andable to pool their resources to undertake a CDMProject in a non-Annex I country.

5.6.3.5. Risk Service Contracts

This is usually a camouflaged concession,BOT or joint venture arrangement. In risk ser-vice contracts, the services of an investor, who as-sumes the legal status of “contractor”, are hired bythe sponsoring (hiring) state. In the case of a CDMarrangement, the task of the contractor would bethe construction, maintenance and implementa-tion of the CDM Project, or the training of per-sonnel for the purposes of managing any suchproject. After successful execution of the contract,the contractor is reimbursed for its costs and in-vestments and paid for its services by the sponsor-

ing state. The contractor bears the entire finan-cial risks of the undertaking and is reimbursed af-ter its successful execution. This explains why itis sometimes referred to as the “Risk Service Con-tract”.

The main distinction between risk servicecontract and the joint venture or sole-investor ar-rangement is that in the former, the contractorprovides a service, and gets its payment from thesponsor, while in the latter, the investor puts uprisk capital and gets its return from an expectedflow of profits from the venture (usually shared inthe case of a joint venture).

A further distinction should be made be-tween a risk service contract and a real service con-tract. Whereas in the former, the host or sponsor-ing state pays for the services of the risk servicecontractor, in the latter, someone else pays. Thelatter situation may arise where, for example, ahome country, or international agency hires theservices of an independent contractor (service con-tractor) to undertake certain services for the ben-efit of a third party beneficiary which is also a hostcountry. In this situation, there is no contractualrelationship in the legal sense of the term (privityof contract) between the host country and the ser-vice contractor as such, since the service contrac-tor receives payment from the sponsoring homestate or international agency.

Exceptionally, there could be a sub-contractbetween the service contractor and the host coun-try for the rendering of the particular service it hasbeen hired to perform, even when the sponsor isnot the host country. Even in this latter situation,the service contractor gets paid by the sponsoringagency rather than the host country.

An example of the real service contract isthe Phare/Tacis Multi-country Project. In thatproject, for instance, the contracting authority, theEuropean Community (EC) hires a consortia (ser-vice contractor), comprised of two or more part-ners with a view to provide, among other things,training and a good level of understanding of theEnergy Charter Treaty and the Protocol on the partof selected key personnel of each of the Phare part-ner countries. This is done with a view to bring-


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PROJECT DEVELOPERS VIEWPOINT

HOST GOVERNMENT’S VIEW POINT

Advantages

• Moulding a project in a form which iscompatible with government policies

• Maximising national sovereignty

• Minimising political risk

• Receiving subsidised or risk-freeparticipation

• Improving predictability and stabilityof operational conditions

• Sharing in the rewards of value added

• Providing a communication channel tothe government

• Influencing training, education labourrecruitment and labour policies

• Availability of tax or other investmentincentives

• Influencing decisions on sourcing andpricing of plant, equipment,production inputs and services

• Influencing destination and p ricing ofproducts

• Minimising any perceived adverseeffects of FDI

Disadvantages

• “Soft” value of host country’s capitalcontributions

• Need to c ontribute capital or otherassets

• Less efficient decision-making andfinancing structures

• Need to offer tax incentives

• Exposure to risk of loss of confidentialcommercial information and knowhow

• Exposure to business risks

• Exposure to risk of incompatibilitywith government bureaucrats

• Exposure to risk of incompatibilitywith foreign partner.

Table II: Some Common Advantages and Disadvantages of the JVA

Source: Adapted from R. Pritchard et al., “The Use of Joint Ventures in FDI”, in R. Pritcharded., Economic Development, Foreign Investment and the Law: Issues in Private Sector Involve-ment and the Rule of Law in a New Era (London: Kluwer Academic Publishers, 1996), p. 178.

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ing their legislation in line with ECT requirementsand harmonising their legal, policy and institu-tional framework with the EC. The consortia (Ser-vice Contractor) does not get paid by the benefi-ciary countries, Central and Eastern EuropeanCountries (CEEC), but by the sponsor or con-tracting authority, the EC. Similarly, the COPcould, in addition to arranging for funding forCDM Projects, hire a Private or Public entity asservice contractor to construct and implement aCDM mechanism in a non-Annex I country.While this would be with the consent of the par-ties, the service contractor would not get paymentfrom the host country, but instead from the COP.Details regarding quantification and allocation ofcredits can be worked out within the frameworkof the service contract.

As in every other contractual arrangement,the potential for conflicts always exists in the realservice contract because of its peculiar arrange-ment. The real service contractor may be boundunder the real service agreement not to indulgecorrupt officials of, for example, the host countryor to abide by certain standards. This may how-ever pose practical difficulties, as the host countrymay set its own agenda in the “national interest”,including the imposition of import duties and levy-ing of taxes. These are no doubt very thorny is-sues in practice since poor governments can noteasily refrain from either levying taxes or impos-ing duties on imports. If these difficulties are notanticipated and an amicable resolution properlyprovided for, the effective execution of the real ser-vice contract is bound to be prejudiced.

5.6.4. Possible Contract Types for Other Flexibil-ity Mechanisms

The contract forms for ET and JI are sim-pler than those for the CDM in the sense that thereare already a number of pilot projects implement-ing the former mechanisms. Since emissions, oremissions reductions, amount to tradable com-modities in the ET mechanism, a simplestandardised contract for the buying and sellingof ‘permits’, ‘allowances’ or ‘emissions reductions’by which one Party agrees to sell and the otheragrees to buy such tradable commodities could bedrafted. Besides, precedents already exist in the

United States, where ET has been successfullyemployed in limiting emissions of sulphur diox-ide (SO

2). However, considering that assigned

amounts, defined by article 3 of the Protocol, maybe traded, an emissions trading contract (ETC)within an umbrella or framework intergovernmen-tal agreement is possible.

Also, since JI envisages Annex I countriesundertaking GHG reduction projects within otherAnnex I countries, by means of which reductionsare credited to the country financing the project,while debiting the excess reductions of the hostcountry, an intergovernmental agreement that de-fines the framework for this joint venture relation-ship between the home country and host countryis appropriate as a necessary starting point. How-ever, considering that countries can authorise pri-vate companies to develop JI projects, while re-serving the powers of approval, certification ofemissions reductions, and or monitoring and veri-fication, for themselves, the option of using eitheran intergovernmental framework agreement or anintergovernmental agreement relating to a specificJI Project is not a sine qua non. On the contrary,the JV, BOT or even Service Contract are equallyfeasible and viable options. Whatever contractform is employed for JI, it is the substance of thecontract that really matters. Such a contract hasto state very clearly, inter alia:

• How to establish a baseline for the calculationof real emissions reductions of projects;

• How to monitor, verify and certify real emis-sions reductions;

• How to scale down the administrative andtransaction costs of projects.

At the risk of sounding repetitive, it must be reit-erated that a contentious issue will be investmentguarantees, in particular tax and import duty is-sues. A review of intergovernmental and inter-organisational/government agreements such asTacis EC and UNDP agreements indicates thatthere is always a promise by the beneficiary hostgovernment to provide import duty exemptionsand impose no taxes. But, these promises wouldbe difficult, if not impossible, to adhere to in prac-tice, since developing country governments areurgently in need of revenue for the development


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of their national economies. The prudent approachseems to be to anticipate these potential disrup-tive tendencies in an investment regime and toprovide adequate safeguards that would not onlyminimise the damage to investment, but also en-able both parties to renegotiate the original termsof the contract where a fundamental change of cir-cumstance so dictates.

5.6.5. Conclusions and Recommendations

This section of the papers examined the useof contracts for achieving the Clean DevelopmentMechanism (CDM) and other flexibility mecha-nisms envisioned under the Kyoto Protocol . Itcan be concluded that, while IntergovernmentalCo-operation, the Concession Contract, the BOTProject Contracts, Joint Venture Agreement (JVA)and the Service Contract are preferable because oftheir inherent flexibility and adaptability in ad-vancing the objectives of these flexibility mecha-nisms; in practice, it is the substance of the agree-ments in question rather than the form that mat-ters most in terms of effectiveness. It is also neces-sary to add that these distinct forms can be usedfor perhaps 3 broad scenarios:

• An intergovernmental agreement (either aframework agreement or one relating to a spe-cific project) between two or more Annex Icountries for emissions trading, which may beaccompanied by a specific standardised emis-sions trading agreement;

• An intergovernmental agreement between twoor more Annex I countries, which may be fol-lowed by a specific Concession, BOT, JVA orService Contract in respect of a JI Project;

• An intergovernmental agreement between An-nex I and non-Annex I country, followed by aspecific Concession, BOT, JVA, or Service Con-tract in respect of a CDM project in a non-Annex I country.

However, certain general principles are fun-damental for any contract to be effective both interms of the relationship between the parties tothe agreement and in terms of achieving generalcontract objectives. These include but are not lim-ited to the following principles:

• Full conformity with the requirements of theUNFCCC, the Kyoto Protocol and any subse-quent agreement relating to the CDM. In par-ticular, the contract should define the emissionsreduced (CERs); how they should be measured,verified, certified and shared between the con-tract parties; how the project stimulates sustain-able development; liability arrangements in theevent that the project fails to deliver the con-tracted CERs.

• Strong arbitration, dispute settlement provi-sions and clear procedures for choice of forummust be included in any standard agreement.

• Equity or fairness and transparency in appor-tioning rights and obligations between the par-ties. This may involve “affirmative action” tocounteract unequal development and compen-sate for the structural weaknesses of develop-ing country party;

• Cost effectiveness in the pursuit of contractobjectives;

• Unambiguous stating of terms, which shouldinclude modus operandi for implementationand enforcement, financial mechanism, disputesettlement, liability and compensation for dam-ages or failure of the undertaking;

• The principle of both host and home state co-responsibility for international economic andenvironmental co-operation.

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With respect to the relationship betweenthe Kyoto Protocol and other MEAs, the projectexamined the inter-linkages between the Protocoland forestry and bidiversity related issues.However, the results presented in this section areonly preliminary and admittedly did notcomprehensively examine important relationshipsbetween the Protocol and all other MEAs. Theintent of the project however, is to continuecarrying out further research particularlyconcerning institutional cross-linkages andgovernance issues between other multilateralenvironmental treaties.

6.1. The Framework Convention on ClimateChange/Kyoto Protocol, the Biodiversity Con-vention and other UNCED Instruments

Ecologically, climate, forests and bio-diversity are all deeply interconnected.Institutionally, the international instruments thatdeal with these areas are slowly coming to termswith this, and the overlaps between the areas arebecoming increasingly recognized. The use ofterrestrial sinks, as mandated within the KyotoProtocol, as a mechanism to help in mitigatingclimatic change may become the epi-center of thisrelationship. Unfortunately, it is possible that thisnew approach will not necessarily complement theother UNCED documents. A conflict with theother UNCED documents may develop because,

irrespective of the questions pertaining touncertainties of this method of mitigation and itspossible inequities, carbon sinks in an internationalcontext may introduce an incentive to increasecarbon-fixing plantations.

With the assistance of international tradingmechanisms, it will be possible for the developedcountries to claim credit for reductions made indeveloping countries. The financial benefits thatnon-Annex I countries may get from this aresubstantially more desirable and attractive than thefailure to receive any compensation at all for thesame service provided by their natural forests.Moreover, ultimately, there is no internationaldictate that prevents such countries from choosinga path that destroys their natural forests, andreplaces them with plantations. Such actions,stemming from the catalytic effects of the KyotoProtocol, although not contra to specificinternational mandates, may certainly be againstthe spirit of Convention on Bio-diversity and theForest Principles.

6.1.1. The Climate Change Convention

The indirect relationship between theFCCC and the other UNCED documents can bereadily inferred from the FCCC’s emphasis uponan ecosystem approach. This approach is made

6

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apparent in the objective of the FCCC, which isto achieve the stabilization of greenhouse gas con-centrations in the atmosphere at such a level thatwould prevent dangerous anthropogenic interfer-ence with the climate system. Such a level shouldbe achieved within a time-frame sufficient to al-low ecosystems to adapt naturally to climatechange.1By inference, such ecosystems include for-ests and biodiversity.

The direct relationship between the FCCCand the other UNCED documents can be seen inits consideration of sinks, reservoirs and the netapproach2 for greenhouse gases. This relationshipcan be traced back to provisions within the 1992FCCC. The “role and importance in terrestrial ...sinks and reservoirs of greenhouse gases” was notedin the preamble, and the use of sinks as a methodto slow climatic change was used repeatedly in thesection on commitments within the FCCC.3 Thisapproach was reiterated in the 1995 Berlin Man-date4 and the 1996 Geneva Declaration.5 Finally,the Kyoto Protocol, with its mandate to reducegreenhouse gases to 5% below 1990 levels by theyear 2012, calls upon parties to make:

Net changes in greenhouse gas emissions by sourcesand removals by sinks resulting from direct hu-man-induced land-use change and forestry ac-tivities, limited to afforestation, reforestation anddeforestation since 1990.6

In opening the door for the use of sinks, the Pro-tocol also put into place an important caveat withregard to the protection and enhancement of sinksand reservoirs for greenhouse gases. That is therequirement for each signatory to:

take into account its commitments under rel-evant international environmental agreements;promotion of sustainable forest managementpractices, afforestation and reforestation.7

6.1.2. The Convention on Biological Diversity andits Conference of the Parties.

The direct connections between theConvention on Biological Diversity (CBD) andother international instruments is seen initially inthe preamble which suggests that it is “desirable

to enhance and complement existing internationalarrangements.” Elsewhere, the Convention callsfor the establishment of appropriate forms of co-operation with the executive bodies of suchconventions8 and instructs the Secretariat to co-ordinate with other relevant international bodies.9

Such co-operation with other bio-diversity-relatedconventions has been a standing item included inthe agenda of all of the Conferences of the Parties(COP) to the CBD.10

Indirectly, the preamble suggests that: “Itis vital to anticipate, prevent and attack the causesof significant reduction or loss of biologicaldiversity at source.” Elsewhere, the signatories arerequired to identify and monitor processes andcategories of activities likely to have significantadverse impacts on the conservation andsustainable use of biodiversity.11 Where these“significant effects” are recognised, it is necessaryto: “regulate or manage the relevant processes andcategories of activities.”12

Climate change and deforestation (amongother problems) were noted as causes of concernwithin this ambit.13 However, the FCCC is not atreaty that relates to the conservation of bio-diversity in an obvious manner.14 Nevertheless,prior to the CBD, the Global Bio-diversityStrategy15 suggested that it was important that theother UNCED agreements on climate and forestsbe made mutually compatible with the CBD.16

Specifically, it warned:

Bio-diversity could be destroyed by some of thestrategies proposed for mitigating atmosphericcarbon-dioxide build-up - among them,proposals to replace mature forests with younger,more rapidly growing ones. The provisions ofboth the conventions on climate and biologicaldiversity should therefore prohibit global-warming prevention or adaptation strategies thatinvolve the degradation or conversion of diversenatural ecosystems... By the same token... tothe extent that a forest agreement slows the lossof natural forests, it supports the objectives ofthe CBD... But if the agreement uncriticallymandates ‘net afforestation’ strategies without astrong commitment to both conserving naturalforests and fostering bio-diversity in planted

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forests, it may contravene the spirit and provisionsof the CBD.17

The direct linkage between the CBD andthe FCCC was confirmed in May 1988, at thefourth Conference of the Parties to the CBD.Here, the Executive Secretary was requested to“strengthen relationships with, in particular, theUnited Nations Framework Convention onClimate Change and its Kyoto Protocol.”18

6.1.3. The Possibility of Forests as Terrestrial Sinks

The promotion of the role of forests as animportant concern within the regime for controlof climatic change has been long realized. A typi-cal position advocating the management of for-ests with attention to their important value as car-bon sinks is that of the IPCC’s 1996 TechnicalPaper on Technologies, Policies and Measures forMitigating Climate Change. This paper suggestedthat:

Managing forests in order to retain and increasetheir stored carbon will help to reduce the rateof increase in atmospheric carbon dioxide andstabilise atmospheric concentrations... there isconsiderable potential for mitigation throughimproved management of forest lands for car-bon conservation, storage and substitution, inbalance with other objectives.19

This type of statement is useful in establish-ing the ambit of the role of forest concerns withinthe climatic change debate. As it stands, there arethree categories of promising forestry practices thatmay promote the sustainable management of for-ests and at the same time conserve and sequestercarbon.20

The first of these pertains to practices forthe conservation of existing pools of carbon. Thiscategory includes such options as controlling de-forestation, (probably the most cost-efficient wayof reducing current levels of carbon dioxide emis-sions); improving forest harvesting regimes andprotecting forests from other anthropogenic dis-turbances such as fire and pest outbreaks.

The second concerns practices for the en-

hancement of carbon sequestration and storage.This includes expanding forest ecosystems by in-creasing the area or density of natural and planta-tion forests.

The final option involves substitution prac-tices that aim at increasing the transfer of the car-bon in forest biomass into energy or products, ie.,the use of forest biomass rather than fossil fuel forboth energy and products, and also in place of ce-ment-based products and other non-wood build-ing materials. Substitution management has thegreatest potential for removing carbon in the longterm. It views forests as renewable resources, andfocuses on the transfer of biomass carbon intoproducts that are substitutes for fossil fuels, ratherthan on increasing the carbon pool itself. For ex-ample, substitution of plantation wood for coalin the generation of electricity can reduce carbonemissions by an amount of up to four times thecarbon sequestered in the plantation.

The literature on this subject commonlybypasses the third option and concentrates uponslowing down deforestation, afforestation and re-forestation.21 It has been suggested that 700 mil-lion hectares (Mha) of land might be available forcarbon conservation and sequestration.22 Underbaseline conditions23 this would involve slowingdeforestation (138 Mha) and promoting naturalforest regeneration (217 Mha) in the tropics, com-bined with the implementation of a global refor-estation program (345 Mha of agro-forestry andplantations). Such figures could possibly offsetcumulative fossil fuel emissions by 12-15% overthe same time.24 In total, it is the tropics whichhave the greatest potential to conserve and seques-ter the largest quantity of carbon (80% of the to-tal potential). The tropics are followed by the tem-perate (17%) and the boreal zones (3%) in de-scending order of carbon-sequestering potential.25

More than half of what the tropics could conserveand sequester would be due to promoting naturalregeneration and slowing deforestation in tropicalforests.26

Finally, it is important to note that the lit-erature has been forthright in assuming that sinksremain distinctly secondary in response strategiesto climate change.27 As such “while forests can help

6. Inter-relationship Between the Kyoto Protocol and Other MEA’s

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moderate net carbon emissions, increasing treeplantations cannot compensate for the lack of acomprehensive and enlightened energy policy.”28

That is, “forest management... needs to be balancedwith other objectives.”29

6.1.4. Influences On Other UNCED Concerns.

It was asserted in the Kyoto debates thatthe inclusion of sinks in the emission reductionobjectives might actually end up running counterto the objectives of other international treaties. Itwas further suggested that measures designed tobenefit the climate might “do greater harm to theenvironment at large.”30 This contention may bewell-founded in that the potential economicadvantages of carbon sequestration created by theKyoto protocol mechanisms could conceivablyresult in the creation of powerful incentives tobegin or to accelerate environmentally destructiveor devastating practices, such as the felling of oldgrowth forests, the destruction of biodiversity, and/or the movement of indigenous peoples. This kindof inadvertent side-effect could occur as aconsequence of efforts to secure geographical spacefor quick conversion to carbon sinks. For example,planting fast-growing mono-culture forests to fixcarbon, with the sole motive of getting emissionscredits, whether for one’s own country or for itsfinancially poorer partners.

6.1.5. Plantations: Promotions and Limitations

The number of plantations world-wide hasdramatically increased in the last 15 years, in factthey have roughly doubled between 1980 and 1995and are growing at a rate of 2.6 million hectaresper year.31 This increase is a positive one in manyways, particularly in terms of forestry instrumentssuch as the Forest Principles, the IPF and Agenda21, however, it also raises some concern. Theconcern is primarily focused over the loss ofbiodiversity.

Plantations are highly variable they maybe monoculture or mixed, composed of indigenousor exotic species, large scale or small scale,structurally complex or simple. These parametershave important effects on their success or costs.Failure, in terms of social and ecological costs, is

well documented.32 Many diverse forest ecosystemsand the biodiversity within them have been, andcontinue to be, transformed into high yieldingmono-culture tree-plantations—these nowresemble fields of crops as opposed to natural forest.Plantations cannot produce the full range of goodsand services that can be supplied by the naturalforest, particularly non-wood forest products andsome environmental functions.33 This realizationcaused the CBD to recognize that only “someforests” can play a crucial role in conservingbiodiversity.34 This delineation with the word“some” was due to the debate between the virtuesof the plantation as opposed to natural forests.35

Given such concerns, it has been stipulatedthat the encouragement of the use of plantationsfor carbon sinks and to get emissions reductionscredits must be done extremely carefully. That is,according to the Forest Principles, increases inforest cover and forest productivity should beundertaken in ecologically, economically, andsocially sound ways.36 Agenda 21 suggested thegreening of “suitable areas”37 and the IPF stipulatedthat plantations should be “complementary tonatural forests.”38

6.1.6 Questions Over Demand, Economic Valueand Deforestation

A growing concern over the use of sinks as methodsequestering carbon under the Kyoto Protocol isthe choice that countries with tropical forestsreceive no financial recompense for keeping theseforests standing, while they may however receivefinancial benefits if they plant fast growing, carbonfixing plantations. This is despite the fact thatexisting tropical forest may indeed sequester higheryields of carbon as compared to reforestedplantations.

Overt demand to increase carbon-fixingsinks in tropical countries exists for two reasons.Firstly, plantations grow much quicker in thetropics, and the quicker that something grows, thesooner the investment will be reaped.39 Forexample, annual growth rates of 3-5 cubic metersper hectare in eastern Canada and 10 cubic metersper hectare in the Southeastern United States palein comparison to rates as high as 25 cubic meters

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in Indonesia and 30-40 in Brazil in the sameperiod. And while it takes at least 15 years inAlabama (USA) to grow pine large enough to cut,rotations of eucalyptus in Brazil can be as short as4-6 years.40

The ability to have a quick turn around oninvestment will be aided by a second factor whichis that the costs per unit of carbon sequestered orconserved generally increase from low to highlatitude countries from between $2-$8 per ton.With such a large price differential in aninternational market, it can be expected that, asthe IPF recognized, carbon rights will go to thosewho can provide the lowest cost service.41 Howeverthose countries which provide the lowest costservice may need space to plant such sequestering,profit-making sinks. The need for space may createan incentive to cut down existing tropical forests.

The main concern for climate change arises ifone considers that the existing tropical forestsmay already sequester more carbon thanplantations. Tropical forests and the ecologicalservices they provide to the internationalcommunity should make them “extremelyvaluable”42 (in a financial sense). A number ofinternational documents have suggested that thisshould be investigated further.43 With regard totheir role in climate regulation (i.e., what it wouldcost if the carbon they sequester had to besequestered by an alternative method), it isestimated that the forests in Brazil alone are worthan estimated value of $1,300 U.S. dollars peryear, per hectare.44 Other studies have suggestedthat replacing the carbon storage function of alltropical forests would cost an estimated $3.7trillion U.S. dollars - the equivalent of the grossnational product for Japan.45

This situation may now introduce aneconomic paradox, which acts against theprinciples of the CBD, the Forest Principles, andalso actually makes climatic change worse. If thescenario described above actually begins to occur,the world’s climate will worsen in direct proportionto the extent to which natural forests (especiallyold growth ones) are sacrificed for the purpose ofstarting plantations. Obviously, it is far better notto convert forests with a large initial standing

biomass of carbon and comparatively slow growthrates to managed stands, because it may take anextended period for the net carbon sequestered toreturn to its initial value.46 Put another way, largeamounts of carbon could be released into theatmosphere during transitions from one forest typeto another, since the rate at which carbon may belost during times of high forest mortality is greaterthan the rate at which it may be gained throughgrowth to maturity.47

Finally, a potentially ominousenvironmental side-effect of reforestation may beincreased emissions of nitrous oxide. This isparticularly so if reforestation is accompanied byextensive use of nitrogen fertilizer. The risk forincreased nitrous oxide emissions may beparticularly great in areas of tropical forests, whichin their natural form are already major sources ofthis gas.48

One answer to this paradox is to perhapsoffer economic incentives or compensation to thecountries which possess tropical forest not todeforest, so as to protect and conserve the benefitsthat such ecosystems provide to the globalenvironment.

6.1.7. References

1FCCC. Article 2.

2The Net approach views greenhouse gases within a netambit. That is, a final net figure is arrived at by ascertaininggross emissions, then subtracting any greenhouse gases whichwere removed from other methods, such as carbon fixingfrom this target.

3FCCC. Article 4.1.(b); 4.1.(d); 4.2.(a); 4.2.(b); 4.2.(c). Seealso Article 3.3.

4This recognised that the signatories agreed to strengthentheir commitments with removals of “anthropogenic emis-sions by source” and “protecting and enhancing sinks andreservoirs of greenhouse gases.” Sections II & III. The Ber-lin Mandate. Decision 1/CP.1. (1995). This is reprinted inthe United Nations Climate Change Bulletin. 7(2):7.

5This hoped that the then forthcoming Kyoto Protocol wouldhave commitments regarding “forestry” and reduction tar-gets “with respect to ... anthropogenic emissions by sourcesand removals by sinks...” Paragraph 8 of the Geneva Decla-ration. (1996). This is reprinted in the United Nations Cli-mate Change Bulletin. 12(3):7.


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6Kyoto Protocol. Article 3.3.

7Kyoto Protocol. Article 2.3.

8CBD. Article 23.3.(h).

9CBD. Article 24.1.(d). Article 25 of the Convention goesso far to note that: “The provisions of this Convention shallnot affect the rights and obligations of any Contracting Partyderiving from any existing international agreement, exceptwhere the exercise of those rights and obligations would causea serious damage or threat to biological diversity.”

10See UNEP/CBD/COP/2/Inf.2.

11CBD. Article 7(c)

12CBD. Article 8 (l).

13IUCN (1994). A Guide To The Convention on BiologicalDiversity. (Environmental Policy and Law Paper No.30.IUCN. Gland). 10, 36.

14This is unlike the Ramsar Convention on Wetlands, TheConvention on International Trade in Endangered Species,and the Bonn Convention on the Conservation of MigratoryAnimals.

15Put together by the WRI, IUCN, UNEP, FAO &UNESCO

16WRI, IUCN, UNEP (1992). Global Biodiversity Strategy:Guidelines for Action to Save, Study, and Use Earth’s BioticWealth Sustainably and Equitably. (Washington).

17Ibid.

18See Decision IV/15. The Relationship of the ConventionWith the Commission on Sustainable Development andBiodiversity Related Conventions. UNEP/CBD/COP/4/12.

19Intergovernmental Panel on Climate Change. (1996) Tech-nical Paper on Technologies, Policies and Measures for Miti-gating Climate Change. (WMO. Geneva). 55.

20See IPCC. (1995). Climate Change 1995: Impacts, Adap-tations and Mitigation of Climate Change: Scientific-Tech-nical Analyses. (Cambridge University Press. Cambridge).775.

21Reforestation involves planting trees on previously croppedland. The time limit is usually land which was deforestedwithin the previous 50 years. Afforestation is the replantingof land which had forests on it 50 years or more previously.

22Intergovernmental Panel on Climate Change. (1996) Tech-nical Paper on Technologies, Policies and Measures for Miti-gating Climate Change. (WMO. Geneva). 55.

23Today’s climate and no change in the estimated availableamount of land.

24IPCC. Supra note 22.

25Ibid. This is because the carbon released per acre of cutforest is greater in tropical than in temperate regions. This isdue to the fact that the tropical forest crown, unlike that ofthe temperate forests, contains more carbon than the soil.

26See IPCC. (1995). Climate Change 1995: Impacts, Adap-tations and Mitigation of Climate Change: Scientific-Tech-nical Analyses. (Cambridge University Press. Cambridge).775.

27For example, just to keep pace with global carbon dioxide

emissions (about 3.2 billion tonnes per year), planting treesin an area the size of India annually would have to be imple-mented. Even if all the available land speculated upon wasreafforested, - approximately 4 million square kilometres(about half the size of Australia) even then, only 10% of theestimated emissions from fossil fuel burning world widewould be achieved by sequestration. See Schneider, S.H.(1989). Global Warming. Sierra Club Books. San Francisco.188-189. Adger, W.N. & Brown, K. (1994). Land Use andthe Causes of Global Warming. Wiley. London. 189-195,227-230.Likewise, in 1990, the US announced that they would plantone billion trees in every subsequent year. However, eventhis massive reforestation project would only be equivalentto a 5% reduction of annual US carbon dioxide emissions.See Crutzen, P. (1993). ‘Linkages Between Global WarmingAnd Other Aspects of Global Environmental Change.’ InMintzer, I.M. (ed). Confronting Climate Change: Risks, Im-plications and Responses. (Cambridge University Press. Cam-bridge). 15, 28.

28Pachauri, R.K. (1993). ‘Wait and See Versus No Regrets:Comparing the Costs of Economic Strategies.’ In Mintzer.Ibid. 237, 240.

29IPCC. Impacts. Supra note 26. 778.

30Nauru, the Marshall Islands and Kenya all made similar

points on this issue. See Response From Parties. Ibid.MISC.4.pp.28. & MISC. Add 1. pp.19.

31Food and Agriculture Organisation. (1994). The State ofFood and Agriculture: 1994.(FAO. Rome). . 269.

32Ibid. 268-271. The 1995 IPCC Assessment stated : “Theestablishment of plantations is becoming less socially andpolitically desirable, especially with the global concern forbiodiversity and other social, cultural, land-tenure andeconomic factors.” See IPCC. Impacts. Supra note 105. 781.

33They are also generally more vulnerable to fire, windstorms,disease and other naturally occurring events. See Noss, R. &Cooperrider, A. (1994). Saving Nature’s Legacy: ProtectingAnd Restoring Biodiversity. (Island Press. Washington). 195,

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197.

34See UNEP/CBD/COP/3/L.8.

35See Earth Negotiations Bulletin. (1996). Future Programof Work for Terrestrial Biological Diversity. 09:65.

36Principle 8(a) & (b) of Agenda 21; Article 6(a) of the ForestPrinciples.

37Chapter 11, paragraph 12.

38IPF. Supra note 33. Paragraph 28(b).

39See Booth, D. E. (1992) ‘The Economics of Old-Growth

Forests.’ Environmental Ethics. 14 :43-60.

40See Brown, L. et al. (1998). Vital Signs: The EnvironmentalTrends That Are Shaping Our Future.(Earthscan. London).124.

41Intergovernmental Panel on Forests. (1996). ScientificResearch, Forest Assessment and Development of Criteriaand Indicators for Sustainable Forest Management. E/CN.17/IPF/1966/25. 8 August 1996. Paragraph 36(c).

42 Subsidiary Body on Scientific, Technical and TechnologicalAdvice. (1996). Economic Value of Biological Diversity.UNEP/CBD/SBSTTA/2/13. 9 July. Paragraph 47.

43The need to develop methodologies to calculate thefinancial benefit of such services was noted in the ForestPrinciples, and Agenda 21. (11.22(a). Specifically, Agenda21 hoped to help improve and develop “methodologies for acomprehensive assessment that will capture the full value offorests, with a view to including that value in the market-based pricing structure of wood and non-woodproducts.”(11.23.(j). Likewise, the Forest Principles hopedthat: “Decisions taken on the management, conservation andsustainable development of forest resources should benefit...from a comprehensive assessment of economic and non-economic values of forest goods and services and of theenvironmental costs and benefits.” Principle 6(c). See alsoPrinciple 13(c).

44See UNEP (1995). Global Biodiversity Assessment. (Leadauthors, Heywood, V.H. & Watson, R.T). CambridgeUniversity Press. Cambridge.. 880.

45Food and Agriculture Organisation. (1994). The State ofFood and Agriculture: 1994.(FAO. Rome), 288.

46See Marland, G. (1992). ‘Should We Store Carbon In Trees?’ Water, Air and Soil Pollution. 64: 181-195.

47IPCC. (1996). Climate Change 1995: Impacts,

Adaptations and Mitigations. (Cambridge University Press.Cambridge). 13-14.

48See Crutzen. Supra note 112. 29.


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The preliminary results of the project indicated the critical importance of takinginto account the linkages between the Kyoto Protocol and other international regimes inorder to ensure the Protocol’s effective implementation. In particular, the relationshipsbetween the Protocol and international trade and investment regimes highlight the needfor considering the potential conflicts in elaborating the details of the flexibility mechanismsat COP 4. The project results also emphasized the role of the private sector inimplementation of the Protocol, specifically in carrying out CDM and joint implementationprojects and emissions trading transactions. Research on the use of standard contracts fortransactions under the flexibility mechanisms showed their potential value in ensuringcompliance with the environmental goals of the Kyoto Protocol.

Finally, the results highlighted the need for further research in the areas in whichpreliminary results have already been achieved as well as in the areas of non-complianceand the relationship between the Kyoto Protocol and other MEAs.

7

Conclusions

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Documents

Global Climate Governance - United Nations University...Global Climate Governance Scenarios and Options on the Inter-Linkages between the Kyoto Protocol and other Multilateral Regimes