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Introduction of International Law Related to the CDM Development Process


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Title: Introduction of International Law Related to the CDM Development Process

Introduction of International Law Related to the
CDM Development Process

Peter Corne China Business Group Eversheds
LLP November 2007
  • I.
  • Overview of the International Legal Framework

Basic International Treaties on CDM
  • United Nations Framework Convention on Climate
    Change (UNFCCC) was signed in 1992 and came
    into force on 21 March 1994
  • Kyoto Protocol (the Protocol), aimed at
    reducing greenhouse-gas (GHG) emissions, was
    signed in 1997 and became a legally binding
    treaty on 16 February 2005
  • The Marrakesh Accords were adopted in 2001 to
    flesh out the Protocol rulebook and further
    advance implementation of UNFCCC
  • To-date, 175 countries have ratified the Protocol

Inside the Kyoto Protocol
  • The Protocol sets up quantitative objectives
    for reducing GHG emissions up to 2012
  • Annex I countries are obliged to reduce their
    collective emissions by at least 5 during
  • Credits obtained from 2000 to 2008 may be used to
    achieve compliance

Three Flexible Mechanisms
  • Three mechanisms set out in the Protocol for
    emission reduction
  • JI Joint Implementation (Article 6)
  • (Annex I countries Annex I countries)
  • CDM Clean Development Mechanism (Article 12)
  • (Annex I countries Non Annex I
  • IET International Emission Trading (Article
  • (Annex B countries Government Annex B
    countries Government)

Implementation of Kyoto
  • EU launched the European Climate Change
    Programme in 2000
  • UK successful emission control and a centre of
    emission trading
  • Canada behind target - recent legislation

Different Approaches China Vs India
  • India has the most issued CERs
  • China has the highest overall projected CER
  • Unfettered competition Vs government regulation

Indian Vs Chinese Project Development
  • More than 50 (11 out of 20 projects) rejected by
    the CDM Executive Board until August 2007 are
    from India, none from China
  • 55 out of 136 projects that have been available
    for public comment before the end of 2005 but not
    been registered so far are from India, but only
    three from China
  • Most of the Indian projects have not been
    developed on account of the CDM incentive and
    thus do not fulfil the additionality criterion

Indian Vs Chinese Project Development (ii)
  • Indian DNA thus far does not seen its role as
    providing a PDD quality check
  • Indian DNA supports principle of unilateral CDM
  • China's DNA has a list of far-reaching
    requirements that project developers have to
  • Unilateral CDM is now allowed but only takes up a
    small proportion of Chinese submissions
  • ?? Which approach is more efficient to encourage
    environment-friendly projects?

  • II.
  • Fundamental Legal Principals of CDM

Key Rules Affecting CDM
  • The use of CERs must be supplementary to domestic
  • The requirement of additionality
  • The Baseline scenario
  • CDM projects are defined by reference to strict
    conceptual boundaries
  • CDM projects must account for Leakage

  • The Marrakesh Accords demand that emission
    reduction targets of Annex B Countries cannot be
    met solely through JI, ET or CDMs (Flexible
  • At present there is no numerical definition of
  • Although not directly binding on private sector
    participants in CDM projects, the supplementarity
    requirement raises commercial risks both on the
    supply and purchase side of CDM trades

Supplementarity Risks of Infringement
  • Annex I Governments purchasing CERs may seek to
    impose contractual terms on a project permitting
    them to reduce or terminate purchasing
    commitments where they have a supplementarity

Supplementarity Risks of Infringement (ii)
  • Annex I Governments may unexpectedly withdraw
    support for a project in development (which
    otherwise meets requirements) on these grounds.
  • This poses a development risk to sponsors

Supplementarity Risks of Infringement (iii)
  • Inability of individual Annex I investors to
    manage this risk (as they cannot control the
    activities of other investors of the same
    country) may dampen demand from the private
    sector for CERS

  • III.
  • Recent Negotiations and Discussions
  • On International Rules

Negotiations on Post-2012 Arrangements
  • Negotiations on-going
  • Participants all recognize achievements through
    UNFCC and the Protocol
  • Abandonment of the Protocol post 2012 will be a
    global tragedy
  • CDM a good tool to mobilize climate-friendly
    policies and investments, but need to be improved
  • Further discussion in Bali next month

  • Commitments from developing countries?
  • India
  • China

  • Voluntary vs Compulsory

  • Energy resources are limited
  • Energy policy is strategic for national economy
  • Energy consumption countries and energy
    production countries have different perspectives
  • Internationally, there are different interest
    groups, e.g., OPEC and IEA
  • Even within a country, there are different
    interest groups
  • Difficult to reconcile positions of different
    countries, difficult to reconcile positions
    within a country, US withdrawal from the Kyoto
    Protocol is an example
  • Difficult to established a international
    mechanism after UNFCCC was signed in 1992, it
    took 5 years for the Kyoto Protocol to be signed
    in 1997, and another 8 years for it to be
    approved and took effect in 2005
  • Wise to stick to the established Kyoto mechanism
    and aim to improve it

Discussions on Post-2012 Arrangements
  • Pending formal agreement, there are discussions
  • Unilateral declaration by Annex I countries to
    extensively utilize post-2012 CERs
  • Extension of the period of the next commitment to
    10 years or more
  • Goal for developing countries pledge to reach
    intensity level in given sector, rewarded if
    achieved, no penalty if not achieved
  • Proactive support for post-2012 CERs by
    multilateral financial institutions
  • Post-2012 Carbon Fund launched by EIB

EU ETS Discussion on Post-2012 Improvement
  • Post-2012 cap consistent with 2020 reduction
    target of at least -30 compared to 1990 levels
  • Allowances to be auctioned as from 2013
  • Limits to set quantitative and qualitative limit
    on the use of CDM/JI credits in the EU ETS
  • Expansion of coverage sector (e.g., aviation)
    and GHG (e.g., N2O and CH4 from coal mine)
  • No inclusion of domestic offsets and JI credits
    from EU countries into the EU ETS

  • IV.
  • Key Documents in CDM Project Transaction

Key documents in CDM Project transaction
  • Traditional project documents construction
    agreement, purchase agreement, project finance
    agreement, power purchase agreement etc.
  • Contract with CDM project consultant
  • Contract with DOE
  • ERPA

Key features of an ERPA
  • International sale and purchase agreement
  • Subject matter a special type of good
  • Different degrees of risks at different stages
    approval, construction, cost overruns, project
    underperformance, delays, DOE fails to verify GHG
    emission reductions, rejected by CDM EB, changes
    in laws

Allocation of risks in an ERPA
Risks Seller to assume the risks Buyer to assume the risks
Project Registration/ DNA Approval/ Project Participation Status Conditions Precedent - Seller to apply for Registration Conditions Precedent - Buyer to obtain DNA approval to project participation
CERs shortfalls Seller guarantees minimum purchase quantity negotiate amended delivery schedule Pay cost of purchasing replacement CERs or market value of CERs Terminate contract - Buyer purchases actual quantity - Buyer has first right of refusal to purchase excess CERs
Failure to pay Payment on delivery Upfront payment standby L/C
Legal title to CERs Seller warrants full title to CERs delivered Seller warrants full authorisation to dispose of CERs (in an agency scenario)
Allocation of risks in an ERPA (continued)
Risks Seller to assume the risks Buyer to assume the risks
Creation of a security interest, transfer of assets Seller will not create security interest over project/assets Seller does not transfer project-related assets No corporate restructuring which may affect the Sellers ability to perform its obligations - Seller to notify Buyer when creating security interest on project or assets or when transfer any project-related assets Seller to notify Buyer in scenarios of corporate restructuring
Share of costs Seller bears project operation and monitoring costs, PDD fees, DOE validation fees, verification fees, EB registration fees, share of proceeds Buyer bears PDD fees, DOE validation fees, verification fees
Post 2012 credits Seller grants to Buyer first right of refusal and exclusive period for negotiation Buyer has no first right of refusal and no exclusive period for negotiation
Change in law/ failure of central systems Change in law provisions/ Force majeure provisions/ Change in law provisions/ Force majeure provisions/
Focal point Buyer / CDA acts as focal point Seller acts as focal point
Eversheds China Business Group An integrated team
of experts delivering the advice you need
  • Experienced China practitioners in both London
    and Shanghai
  • Strong Renewable Energy / CDM focus
  • Work for both foreign companies pursuing deals in
    China and Chinese corporations in transactions
    outside the PRC
  • Advice across time zones

  • Eversheds LLP Shanghai Office
  • Peter Corne
  • Managing Director
  • 86 (21) 6137 1001
  • 86 138 1818 3382