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This is a working paper prepared by Friends of the Earth International, for the use of Governments and their negotiators as well as the media. The international FoEI Network is comprised of 61 member groups around the world, as well as affilations with ENDA and RAN. The paper contains our recommendations at this time, based on the best information available about how various components of the CDM system could function. These recommendations are subject to revision depending on how the negotiations surrounding the CDM unfold.

CONTENTS

I. Introduction
II. General Principles and
Basic Criteria
III. Definitions
IV. Additionality in Practice
V. Sinks
VI. Governance Issues
VII. Avoiding Disincentives To Action In Annex I Countries
NOTES AND REFERENCES

I. Introduction

Friends of the Earth is aware of the political background that led to the birth of the Clean Development Mechanism (CDM) during virtually the last hours of the Kyoto meeting (1). Whatever the motivations and intentions of various Parties that agreed to the wording on the CDM, almost the entire structure of the skeleton arrangement remains to be designed, built and then operationalized.

FoEI also is fully aware that there are major difficulties with Article 12 as it is written, which raise legitimate concerns for many non-governmental organizations. Use of the CDM could open up a giant loophole for Annex I countries, which would undermine the Climate Convention. Unless a CDM project is truly additional , Article 12 opens up a major loophole. Article 12 allows developed countries to take credit for projects undertaken after 2000 and before the first commitment period, to be used in meeting their first commitments, thereby effectively allowing additions to the emissions budget of an Annex I party. Thus, unless the project is additional, that emissions increase would not be compensated for by a reduction in emissions of the non-Annex I Party during the budget period.

The CDM has the potential to become highly effective in promoting cost-effectiveness through the achievement of win-win options world-wide. But from an environmentalist standpoint, it is also the riskiest of the ‘flexibility mechanisms’. Its operation could ‘blow open’ the cap on Annex I Parties’ emissions mandated by Article 3, rendering ineffectual the constraints imposed by the Protocol. (2)

It is with these realities in mind that FoEI is suggesting criteria and recommendations for decisions by the COP/MOP on key aspects of the CDM.

The CDM has three main objectives under Article 12.2: (3)

• Assisting Parties not included in Annex I in achieving sustainable development.
• Contributing to the ultimate objective of the Convention.
• Assisting Parties included in Annex I in achieving compliance with their emission limitation and reduction commitments under Article 3.

Article 12 provides two important conditions:

• Emission credits under the CDM should flow from "real, measureable, long-term benefits related to the mitigation of climate change."
• Emissions reductions should be "additional to any that would occur in the absence of the certified project activity."

Can these objectives and conditions be achieved without opening up huge loopholes? Admittedly, this will be very difficult, as there is an enormous difference between assisting non-Annex I countries with more climate-friendly sustainable development and assisting Annex I countries in meeting their greenhouse gas reduction commitments.

One can expect positive results from the CDM only if a sound system of governance is agreed, and if its evolution is guided by criteria that are oriented toward fulfilling the conditions expressly articulated in Article 12. For example, with sound criteria in place to guide decision making, the CDM could catalyze the use of low or zero carbon and environmentally sound technologies that otherwise would not have been used. Conversely, a CDM that lacks adequate criteria and governance will quickly lead to the opposite results, thereby undermining the Climate Convention and Kyoto Protocol.

Some examples of what FoEI doesn’t want to see occur with the CDM are credits given for so-called 'clean' coal’ or construction of fossil-fuel infrastructure such as pipelines and other such carbon intensive capital stock with long lifetimes. Yet there will be enormous pressure to allow this because of vested interests and profit opportunities. (4)

FoEI suggests to governments and international bodies that it is imperative to agree early on criteria, principles, rules, methodologies and institutional arrangements that will allow the CDM to help developing countries in appropriate ways, while making it difficult if not impossible for the CDM to be used to undermine the Convention and Protocol.

The following list is FoEI’s initial set of illustrative principles, rules and criteria that need to be agreed by the Parties if the CDM is to be useful - and not harmful - in meeting the objectives of the Climate Change Convention and its Kyoto Protocol.

II. General Principles and Basic Criteria

Given the differing perspectives of Annex I countries and developing countries during the Kyoto negotiation, it is no surprise that their views about how the CDM might work are quite different. Thus, there are two different kinds of "proposals" for operationalizing the CDM that are being discussed informally.

Annex I countries have been putting forward what can be called the "bilateral" approach. FoEI sees this as being directly linked to their proposals for Joint Implementation under Article 6. This approach focuses on the needs of investors, is oriented more toward the private sector, and foresees development and implementation of CDM projects as being based on contracts signed on a project-by-project basis. Proponents of the bilateral approach don’t want to see much of a CDM bureaucracy created. Instead, they prefer a "clearing-house" mechanism that puts potential investors in touch with hosts. The bilateral approach is seen by most Annex I countries as another flexible mechanism "to reduce their compliance costs by generating cheap emission reduction ‘offsets’ overseas." (5)

In contrast, the "multilateral" or "portfolio" approach, which is favored by most developing countries, is seen as a way of better ensuring that CDM projects are consistent with their development priorities, and also that the direct economic benefits for developing countries are greater than they would be using the bilateral approach. (6) In addition, there is an equity aspect in being able to allocate some CDM proceeds to fund the adaptation costs of especially vulnerable countries. In this model, Certified Emissions Reductions (CERs) would be bought from the CDM itself, rather than having host countries directly involved in buying and selling individual CERs. Proceeds would be channeled to host countries that have submitted to the CDM portfolios of projects for certification, following a positive certification.

FoEI is aware that most Annex I parties prefer the bilateral approach, which would minimize the CDM’s administrative structure and would focus on deals between companies and government. In our view, however, Article 12 was allowed into the Protocol precisely because it is meant to be different from other Joint Implementation schemes, and is in essence a "multilateralized form of JI which respects host country priorities and national sovereignty". (7)

The multilateral, portfolio approach is the preferred option for FoEI. In our view, this is the best way to ensure that (1) CDM projects are compatible with host country development strategies, (2) there are substantial net receipts from selling CERs to channel to developing countries, (3) there is a surplus that will be available for mitigation in the most vulnerable countries, and (4) a wide range of developing countries have the chance to benefit from carbon-friendly investments rather than the small number of countries that now command the greatest percentage of foreign direct investments. (8)

The following list contains a number of key principles that FoEI submits must be part of a viable CDM structure:

• The CDM should be used to promote the cleanest technology options available. Therefore, it should support "climate friendly" technologies. As a general matter, fossil fuel projects should not qualify for credit under the CDM. FoEI submits that criteria for the CDM should guide support mainly to a robust variety of renewable energy projects (9) and demand-side efficiency and conservation projects.
  
• Projects should have some form of COP/MOP approval before being authorized for crediting. (10)
• Project credits should be given only when they are achieved, and not when the feasibility study is done or the project is approved.
• No banking credits should be permitted until common methodologies for implementation, monitoring, reporting and independent verification are agreed on, and the Executive Board and other operating entities are established. (11) This approach will provide and incentive for all governments to address these important issues early on. (12)
• Parties should be able to participate in the CDM only if they have ratified the Kyoto Protocol, submitted inventories and national communications pursuant to Article 12 of the Climate Convention and Articles 7 and 10 of the Protocol, and ratified the compliance regime that will be developed pursuant to Article 18 of the Protocol.
• In order to assist African countries to participate, given its relatively lower level of infrastructure development and greater need for capacity building, a special "pilot project phase" should be created to ensure that suitable projects are identified and funded in a timely way. This should be financed with a combination of aid and soft loans. One key focus should be on how to bring energy services to the rural poor.

III. Definitions

There are myriad definitional quandaries that remain to be worked out, beginning with the project eligibility criteria set out in Article 12(5) (13), the difficult issues surrounding "baselines", and defining what counts as a "project". Whether one is in an Annex I or non-Annex I country, it will be essential to know well in advance what activity will be allowed to generate certified emissions reductions (14). Definitions should be clarified as quickly as possible.

Baselines are a first order issue. How will baselines be determined, and who has the ultimate decision on whether a proposed baseline is acceptable? ⁽¹⁵⁾ The AIJ phase didn’t, unfortunately, produce a common understanding of baselines. However various baselines are defined, there will be serious incentives for either side – or both – to cheat by inflating the alleged quantity of reductions. The CDM must not allow this to occur, as it would fatally undermine the Climate Convention.

FoEI recommends the following:

• A certifiable CDM project must yield demonstrable net economic as well as environmental benefits.
• There must be verifiable proof of the additionality of CDM projects.
• There must be a stringent cap on allowing credit to Annex I countries for CDM investments. (17) Without an agreement on an appropriate cap, FoEI does not see the CDM as being viable.

In this context, access to the CDM should be accompanied by:

• Full compliance by Annex 1 countries regarding additional commitments under Article 4.3 of the Convention.
• Development of accelerated technology transfer programmes under Article 4.5 of the Convention.
• Substantial revision of present energy-related lending by multilateral development banks (MDBs) and export credit agencies (ECAs), so that they fully support the goals of the Convention and Protocol. All MDBs and ECAs should agree to fully calculate greenhouse gas emissions and state the climate change implications of all future lending and other activities carried out by their institutions.

COP3 only just began to discuss the use of forests and other 'sinks' under the CDM as a way of offsetting emissions rather than reducing them at source.

There is a major decision to be taken on whether sinks of any sort can qualify under the CDM framework and if so, there are major difficulties to be resolved in how to deal with sinks of various types. Obviously, verifiability is an essential component in any event, but if sinks are allowed to provide the basis for any credit, then the verifiability will need to be robust, based on methodologies for measuring CO ₂ sequestration that don’t yet exist. Questions have been raised as to whether native forests could be replaced with plantations under the CDM. FoEI submits that the Parties should expressly prohibit that option.

There is a strong case in favor of leaving sinks out of the CDM, which is FoEI’s position. (18) At the very least, however, any decision to include some or all sinks should be deferred indefinitely, to give time for the methodologies to be designed, tested and agreed on. (19)

VI. Governance Issues

Regarding the transparency of the CDM, decisions on the nature and constitution of the Executive Board and Operational Entities are crucial (21). FoEI makes the following recommendations:

• The Executive board should be independent, with a clear mandate and powers to govern development of the CDM.
• Board members should be appointed by Parties and should represent the full range of organizations and interests.
• Southern countries should have majority of seats on the Board, in order that Southern development considerations are properly emphasized by the Board’s decisions, and the Board should be approved by the COP/MOP.
• There should be at least two seats on the Board for environmental NGOs, one from the north and one from the south.
• Operational entities need to be approved by the COP/MOP and should be independent bodies based in each host country participating in the CDM, or at least in the region.

Setting up viable verification, monitoring, auditing and reporting processes is a key part of the overall governance system, which will be crucial to the success of the CDM, as well as of the Convention and Protocol (22). FoEI makes the following recommendations:

• Ideally, potential hosts should prepare strategies in advance, identifying the role and opportunities for CDM technologies in the country, before CDM projects are considered (23). The process of preparing these strategies should be transparent to civil society, including opportunities for participation by interested groups and NGOs.
• Verification methodologies need to account for additionality, baselines and carbon leakage.
• To support the process of verification, a comprehensive legal framework and rules must be in place before crediting begins. This includes agreed common methodologies for implementation, monitoring, reporting and independent verification, which should be consistent and transparent to civil society. (24)
• Verification procedures should incorporate the full range of stakeholders, including local NGOs, and should build on experiences with the AIJ (activities implemented jointly) programme. (25)
• Independent monitoring teams should be created and funded to spot-check project activities. They should have the capacity to verify quickly whether the reported CERs are being achieved and actualized.
• There should be an International Registry of CER transactions that is maintained in an up-to-date way and is fully accessible to the public. (26)
• Auditing standards for evaluating CER transactions must be subject to the same standard in order to ensure the financial integrity of the "books" on an international basis. (27)

How questions are answered about administrative fees – who bears them, how are they to be raised or charged, which entity holds them – will have an important impact on governance of the system. FoEI makes the following recommendations:

• In order to fund the CDM’s administrative expenses, an initial percentage of the project’s total financing cost should be levied as a charge. At some point, an "adaptation" charge should be introduced based on a share of the proceeds from the project. (28)
• The World Bank Group should not be allowed to house or operate any part of the CDM’s financial mechanism, given the large conflicts of interest inherent in its own portfolio. Thus, the World Bank is unable to play an "honest broker" role.

FoEI urges that the CDM should not be allowed to be used by developed countries to undercut their obligations to reduce domestic emissions. If the CDM does not have appropriate rules and verification mechanisms, its operation will likely undermine the fundamental goal of the Climate Convention. FoEI recommends the following:

• A certifiable CDM project or group of projects must not provide a major disincentive to domestic action by the Annex 1 party involved, aimed at achieving compliance with Annex 1 emission limitation and reduction commitments under Article 3.
• In order to ensure that the necessary domestic actions are taken in Annex I countries and that the CDM is not undercutting the objective of the Convention and Protocol, there should be a numerical cap on Annex I countries using certified emissions reductions to meet their assigned Article 3 commitments. A cap is clearly foreseen in the phrase "part of" (Article12.3b). FoEI suggests that the credits available to Annex I countries from the CDM be limited initially to 3 % of each country’s individual reduction obligation. (29)
• CERs associated with the CDM should be separately accounted for, and at least initially should not be tradable.

1. As Farhana Yamin has noted in "Issues and Options for Implementation of the Clean Development Mechanism", FIELD, June 1998, p. 3: "No Party’s proposals resemble the CDM. Pre-Kyoto there were no published papers about it. The CDM is very much a creation of political necessity drawing on Brazilian proposals concerning the Clean Development Fund and various proposals concerning joint implementation. Its details were worked out in informal contact groups in the last few days of Kyoto, spearheaded by the Brazilian delegation with US support. Its final inclusion in the Protocol is intimately linked to trade-offs and deals struck between countries over apparently unrelated issues. And much of the detail of how it will work has been left to future negotiations at COP-4 and beyond." Note also that neither the GEF nor the Climate Convention’s financial mechanism is even mentioned in Article 12 or elsewhere in connection with the CDM.
   
2. See Yamin, p. 2.
   
3. The purpose of the clean development mechanism shall be to assist Parties not included in Annex I in achieving sustainable development and in contributing to the ultimate objective of the Convention, and to assist Parties included in Annex I in achieving compliance with their emission limitation and reduction commitments under Article 3."
   
4. FoEI also strongly opposes giving credits for investments in nuclear power and large dams.
   
5. Yamin, p. 6. This article contains a good description of the thinking and informal discussions about the bilateral and multilateral approaches.
   
6. For example, CER prices might be higher than under the bilateral approach because the CDM would be the sole supplier and might be able to negotiate higher prices. Because of diversification among types of projects and countries, risk would likely be reduced compared to the project-by-project bilateral approach. See Yamin, p. 7.
   
7. See Yamin, p. 7.
   
8. However, we acknowledge that the bilateral approach initially will attract more interest on the part of the corporate sector in Annex I countries, and thus it is important for the multilateral approach to be managed so as to attract appropriate investments by the private sector.
   
9. Renewables should be defined as excluding large hydropower dams.
   
10. This must be done in an efficient and timely way.
    
11. Article 12(10) allows CERs obtained during the period 2000-2007 to be credited in as yet undefined ways to achieve compliance in the first commitment period, 2008-2012.
    
12. These tasks should be carried out in a timely manner so that tangible progress can be made.
    
13. These criteria include (1) voluntary participation and approval of the parties involved, (2) real, measurable and long-term environmental benefits, (3) additionaal in both financial andenvironmental terms. Note that the latter two items involve the vexed question of "baselines".
    
14. Because the effects flowing from any approved activity under the CDM must be clearly visible and quantifiable, in order to provide a realistic basis for the financially viable CER, special care must be taken in defining a qualifying project.
    
15. FoEI cannot accept a baseline in the CDM context without it being legally linked to a natiuonal program. Art 4.1(b) and 10(b) seem to head in this direction.
    
16. These benefits should contribute to the ultimate objective of the Convention - prevention of dangerous anthropenic inference with the climate system.
    
17. This is essential in order to ensure that Annex I countries undertake the necessary actions in their own countries to reduce greenhouse gas emissions, especially during the formative years of the Climate Convention. See the discussion in Section VII below.
    
18. There is no parallel provision to Article 6(1), for example, expressly mentioning anthropogenic removals by sinks in connection with "emission reduction units" to be issued in connection with the CDM. Note that the inclusion of Annex I Parties’ domestic sinks is subject to strict conditions in Article 3.3 and 3.4. The program of work already agreed on to flesh out those restrictions, beginning with a workshop prior to COP4, while the SBSTA has requested a focused report form the IPCC about the "land use change and forestry" (LUCF) sector. Obviously, if sinks are to be allowed in the CDM context, they also must be appropriately limited. Suitably qualified experts with sufficient resources will be needed to do this job properly.
    
19. For example, it is essential for the IPCC to have adequate time to prepare detailed special reports on how sinks of various types might be integrated into the CDM.
    
20. See the discussion of this set of operational decisions in Yamin, pp. 41-50. For example, whether the Executive Board is a subsidiary body of the COP/MOP or whether it is instead the main organ remains to be agreed.
    
21. Article 12(4) requires the COP/MOP to establish an executive board to supervise the CDM.
    
22. See the discussion of this set of operational decisions in Yamin, pp. 51-56.
    
23. See Art. 4.1(b) and (c).
    
24. Article 12(7) gives the COP/MOP the job of elaborating "modalities and procedures with the objective of ensuring transparency, efficiency and accountability through independent auditing and verification of project activities".
    
25. A review of current AIJ experiences show that these methodologies are inconsistent in practice, are too often non-transparent, and thus are subject to variable reporting. Variations in project methodologies, such as what discount rate to use for the cost-benefit analysis of the technology) have large effects on calculations of $/tonne CO2.
    
26. Alternatively, the UNFCCC could perhaps continue playing the kind of role it has with AIJ, whereby they receive the reports. The key question is whether it has the characteristics needed for maintaining such a registry.
    
27. In this regard, it would be desirable for the independent auditor to provide a signed report commenting on the veracity of management’s books.
    
28. Article 12(6) envisions a role for the CDM in arranging funding of certified project activities, while Article 12(8) requires the COP/MOP to ensure that "a share of the proceeds from certified project activities is used to cover administrative expenses as we as to assist developing country Parties that are particularly vulnerable to the adverse effects of climate change to meet the costs of adaptation." It seems premature to indicate a precise figure for this charge, which must be derived from a better understanding of what administrative expenses are being covered, and how large a surplus is needed to constitute the special fund to benefit those most vulnerable.
    
29. The COP/MOP has to decide how to define "part of" and whether the same figure will be applied to all Parties or be differentiated. The 3% figure we are recommending could be reviewable after several years of experience, based on a statistically verifiable analysis by the IPCC or another appropriate body.