1 GLOBALLY NETWORKED CARBON MARKETS December 2013 Chandra Shekhar Sinha, World Bank CSinha@worldbank.org
2 Are the benefits of a Global Carbon Market beyond reach? Global Carbon Market Widely-used price on carbon Improved price predictability Scale Cost efficiency Strong signal to the market The Trend: A bottom-up, rather than a top-down mandate The bottom-up approach has dual drivers climate change and other domestic priorities Leading to heterogeneous, fragmented markets Prag, Briner, and Hood 2012
Market instruments driven by domestic policy Examples of Global Connectivity in 2012 Development of the China ETS Chile, Costa Rica and others looking at ETS systems A carbon tax based offset systems being developed in South Africa, Mexico, Colombia White and green certificate programs (e.g. India) with linkages to CO2 markets being considered 3 Source: Adapted from Prag et al (2012)
4 Forms of Connectivity Type Definition Example Full Compliance unit in one jurisdiction is accepted without restriction in the linked jurisdiction Planned linking of EU-ETS with the Swiss (from 2015). Linking Limited Market participants may transfer units between markets, but restrictions may limit the direction of transaction, the amount and quality/sector of units. Planned linking of EU-ETS with the Australian ETS (until 2018). Indirect Markets are not linked directly, but have access to the same third carbon market. Both the EU-ETS and the voluntary Japanese System allow the use of CERs. Networking Fungibility of units across schemes facilitated by a rating system and discounting. Currency and bond markets.
Networking Carbon Markets Networking Carbon Markets 5 Definition The connection of one carbon market system with another. The systems might be: cap and trade schemes, offset generating schemes, Nationally Appropriate Mitigation Actions (NAMAs) or some other type of carbon market system. Key benefits 1. Political: connecting carbon market systems signals a common effort to reduce greenhouse gas emissions (GHG). 2. Economic: 1. Lowers aggregate costs of achieving GHG reductions by changing the distribution of mitigation activities to achieve GHG reductions at the lowest possible cost. 2. Can increase market liquidity and price stability. 3. Reduces the problem of leakage of economic activity to jurisdictions that do not regulate emissions in the same way. 3. Administrative: allows regulators to share best practices in program administration including procedures for MRV, tracking systems as well as overall program design.
6 Idea: Globally-networked Carbon Markets Independent rating system and independent rating agencies risk-based approach to rate the environmental integrity and climate change mitigation value of carbon assets in the international market. International Carbon Reserve Convert ratings into discounts and exchange rates Help in achieving predictable international carbon price Help in addressing market risks and failures International Settlement Platform Track cross-border trades and possible clearing house function
7 Idea: A Globally-networked Carbon Markets Jurisdiction B Jurisdiction C A Jurisdiction A A B F A B C Ratings of assets D C Jurisdiction D E D Ratings Independent Private Rating Agency 1 Independent Private Rating Agency 2 Independent Private Rating Agency 3 Ratings A B Opt-In Opt-In Information Opt-In (Carbon assets or $$$) International Carbon Reserve (ICAR) International Settlement Platform Opt-In Rules: Use rating as basis for Carbon exchange rate Benefits of ICAR available to opt-in jurisdictions All international trading registered in the International Settlement Platform Asset / $ Flow Information Flow A Carbon Asset Class
8 Idea: A Globally-networked Carbon Markets Jurisdiction B Jurisdiction C Jurisdiction A A A B F E A D B C Δ in deposit Δ in Ratings New Rating Independent Private Rating Agency 1 Independent Private Rating Agency 2 Independent Private Rating Agency 3 D C Jurisdiction D A B New Opt-In International Carbon Reserve (ICAR) International Settlement Platform Opt-In Rules: Use rating as basis for Carbon exchange rate Benefits of ICAR available to opt-in jurisdictions All international trading registered in the International Settlement Platform Change in rating impacts exchange rate could trigger adjustment in deposit and or agreed domestic measures Asset / $ Flow Information Flow A Carbon Asset Class
9 Independent Rating of the environmental integrity and climate change mitigation value of carbon assets a paradigm shift A ton of CO 2 emitted is a ton of CO 2 anywhere A ton of CO 2 reduced is not a ton of CO 2 everywhere Common top-down standards used to get to a ton is a ton Binary In or Out Discounting / exchange rates rather than pass / fail (race to the top) Transparent approach to addressing risk and uncertainty Transparent approach to addressing subjectivity The asset value incorporates consideration of jurisdiction-level overall approach
10 Independent Rating of the environmental integrity and climate change mitigation value of internationally-traded carbon assets International fungibility requires: Environmental integrity Perceived appropriate level of effort Common frame of reference Environmental integrity (activity / program / mechanism: real, measurable, long term, additional) Credibility: will sum of policies, implementation, track record achieve stated goal and is the sectoral coverage reasonable? Ambition: is stated goal good enough? By Whom: Independent, private sector rating agencies For Whom: Decision-makers in any opt-in jurisdiction Private sector market participants The International Carbon Reserve
2013 2014 2015 11 Roadmap for the rating system Protocol development Piloting Scale-up Development of 3 modules through a consultation process In partnership with by DNV 3-5 programs (NAMAs, PoAs) or ETS jurisdictions for piloting Linked to market making function of Carbon Reserve Managed by independent rating agencies Global Agreement International allowance units replace offsets and allowances Rating is a measure of risk re activity and credibility (because now all country targets are based on agreed allocations - no difference between country targets and what target should be - only a question of whether the country is on track to meet the target - ICAR assets either retired (end of game) or converted to international allowance units if international reserve function is deemed useful.
12 The International Carbon Reserve Exchange rates based on ratings International carbon prices Address market risks and failures
13 International Carbon Reserve would: Convert the independent rating information to discount rates and determine the exchange rates at which it would manage and trade assets from participating jurisdictions. Be the mechanism for opting in to the globallynetworked carbon market. Provide performance feedback via ratings impact on value of units deposited in the reserve. Have rules / conditions which jurisdictions would agree to when opting in (including willingness to use ratings as basis for discounting / exchange rates)
14 International Carbon Reserve could: Provide functions that help manage certain market risks and market failures, in conjunction with jurisdiction-level mechanisms Provide a source of liquidity and a liquidity and shared high price buffer function might be important for smaller, emerging carbon markets; Provide a back-up for domestic reserves in some of the larger markets; Provide a market maker function might be of interest to jurisdictions intending to focus on offset assets. Support a stable international carbon price Provide market surveillance and information Other?
15 Principles Opt-in approach: jurisdictions participate if they see value. Respect Sovereignty: facilitate the most efficient trading up to the level that each jurisdiction chooses to engage. Compatible with a top-down global agreement when this is achieved. Encourage participation: learning by doing, and race to the top. Private sector friendly. Environmental integrity.
16 Why jurisdictions might choose to opt in Gives their private sector access to greater market opportunities ( selling countries ) Attracts financing that otherwise would not flow ( buying countries ) Addresses consumer concerns that carbon price could go too high ( selling countries ) Access to reserve functions ( buying and selling countries )
Mid 2014 2015/16 Post 2020 17 Roadmap for the Carbon Reserve Pilot Fund 3-5 Countries -establishes rating approach, -market maker for new assets - Possibly housed at World Bank or IFC Pre-Reserve More countries - a track record for rating Possibly still housed at the World Bank/IFC ICAR Large enough to make an impact in terms of establishing an international price on carbon Housed outside the World Bank Global Agreement International allowance units replace offsets and allowances Rating is a measure of risk re activity and credibility (because now all country targets are based on agreed allocations - no difference between country targets and what target should be - only a question of whether the country is on track to meet the target - ICAR assets either retired (end of game) or converted to international allowance units if international reserve function is deemed useful.
18 Immediate Next Steps with input / active involvement from WG members: Further work on developing and testing the rating protocol Progress the development of an Ambition Index Advance thinking and modeling of options / costs / benefits for an ICAR. Re-convene Working Group early CY2014. Pilot ratings approach with a pilot market maker fund in 2014.
Summary Summary Linking low carbon development systems is a big undertaking. Linking reduces national control over domestic policies. Networking/ connecting carbon markets have similar benefits: a. Political: connecting markets systems signals a common effort b. Economic: i. Lowers aggregate costs of achieving GHG reductions ii. Can increase market liquidity and price stability. iii. Reduces the problem of leakage of economic activity c. Administrative: allows regulators to share best practices 19 A practical Rating system can be the basis for networked/ connected carbon markets An International Carbon Reserve can help with exchange rates and common market functions
THANK YOU. 20
Recognition of allocations from other trading schemes for compliance (allowing trade between ETS systems) Two-way linking: two cap-andtrade regimes allow trading between covered firms in each scheme Allowances One-way linking: a cap-and-trade system recognizes allowances from a foreign ETS or emission reductions (i.e. credits or offsets) from a project-based system (e.g. CDM) System with high abatemen t cost Equalizes marginal abatement costs System with Low Abateme nt cost ETS Lowers cost of complianc e Offset system (e.g. CDM) or other ETS Funds Key Considerations Linking can lower aggregate costs of achieving emissions reductions Linking can increase market liquidity and price stability Linking with systems without appropriate measurement and verification may harm the environmental integrity of the ETS Linking ay reduce national control over domestic climate change policies
Connecting Carbon Markets 22 Full harmonization is not necessary to make linking possible Some design features must be compatible to facilitate linking disparate ETS jurisdictions Must have mutual design compatibilities Nature of the cap (e.g. fixed, dynamic, etc.) Cost-containment mechanisms Time-flexibility measures (banking, borrowing) Robust monitoring, reporting & verification systems Desirable to have mutual design compatibilities Coverage and scope Point of obligation (i.e. upstream or downstream) Method of allocation (i.e. gratis vs auctioning) Compatible registry systems Fungiblity of GHG units (i.e. interchangeability of allowances and offsets in different jurisdictions) Compliance periods Based on Mehling (2009)