The United Nations Framework Convention on Climate Change (UNFCCC) was established at the first Rio Earth Summit in 1992. More than 200 countries are “party” to the UNFCCC, and these countries meet every year (with the exception of 2020, due to COVID-19) at the Conference of the Parties (COP). The meeting of the UNFCCC in Glasgow in November 2021 will be COP26.

The 2015 COP in Paris (COP21) opened with the largest gathering of world leaders in history, and it closed with the adoption of the Paris Agreement: a new global accord on tackling climate change. The Paris Agreement, with measures that only took effect in 2020, is distinctly different from the Kyoto Protocol (KP), as it calls for action from all 195 signatory countries and not just the industrialized nations. In addition to mitigation (cutting greenhouse gas emissions), it also agrees action on adaptation (responding to the impacts of climate change) and loss and damage (response to climate catastrophe). It also agrees that wealthier nations should provide finance and technology to help poor and vulnerable countries to take action. Implementation of these actions will be addressed at COP26.

Among the issues that will be addressed at COP26 that have an impact on business and industry, and that Reed Smith will be watching, include:

  • Carbon market mechanisms. These would allow countries to purchase carbon credits (reductions) from other countries to allow the purchasing country to continue to emit within its borders. Carbon markets may also include trade in “negative” emissions such as carbon absorption through forestry.
  • Voluntary carbon market transactions. A hot topic and potential threat to the continued growth of the voluntary carbon market is how to deal with the double-counting question that has arisen in relation to carbon offset projects that fall within a country’s NDC activities; in particular, whether host countries must make corresponding adjustments for voluntary transactions to reflect that the offset is being “claimed” by the off-taker of the credits under the voluntary scheme.
  • Climate Finance. Discussions over the delivery of the US$100 billion finance target are likely, and again will be a critical factor for least developed countries (LDCs). Additionally, COP26 is likely to set the next target for climate finance to be achieved by 2025. Climate finance and carbon markets need to scale up in tandem to provide financial resources to developing countries, which are struggling to finance their climate action programs.

There are other aspects of the Paris Agreement that are expected to be discussed which, while not directly relevant to business and industry, could nonetheless influence the success of the agreement with regard to the above:

  • Funding for loss and damage. While loss and damage is a core part of the Paris Agreement, there is no mechanism as yet within the UNFCCC to fund responses when vulnerable countries (LDCs) experience loss and damage. This is viewed as a critical factor by LDCs to lock down in the negotiations, but it is resisted by many wealthy nations.
  • New nationally determined contributions (NDCs) and agreement on a common timeframe for countries’ NDCs. Agreement will be needed on whether the common timeframe should be five years or ten years. The shorter timeframe would mean more frequent revision of NDCs, potentially driving greater ambition than if they were only revised every decade.

How do carbon market mechanisms, voluntary carbon market transactions and climate finance affect business and industry?

  • Carbon Market Mechanism. Article 6 key outstanding issues:
    • Carryover of legacy credits from the KP Clean Development Mechanism and Joint Implementation projects
    • Accounting rules around double-counting of emissions
    • How the trading mechanisms would lead to a reduction in global emissions rather than simply shifting them around the globe

Resolution of the outstanding issues could see significant incentivization for private sector companies able to aid in the transition to net zero, and therefore commercial opportunity. Thus, Article 6 guidelines need to be completed because international markets are essential for businesses to reach net zero goals. Few companies can meet net zero alone and most will need to cooperate across sectors, regions, and international borders to access high integrity markets for natural climate solutions, geological storage, and other removals.

  • Voluntary carbon market transactions. Corporations across all industries are and will increasingly be turning to the voluntary carbon markets to acquire quality offsets that complement their carbon reduction and environmental, social, and governance programs, in many cases in order to ensure compliance with ever more stringent regulation in this area. It is key to the integrity of voluntary carbon offsets that they can be claimed as having offset value, that is, that the underlying carbon reduction giving rise to the carbon offset has not been claimed elsewhere. Anything less could reduce the effectiveness of the voluntary market as a tool to meet carbon reduction goals in the private sector, and mean that businesses have to rely more heavily on other, more costly means to reduce their carbon footprint. The major voluntary offset program operators are yet to reach a consensus on what the impact of the Paris Agreement NDC accounting and “Internationally Transferred Mitigation Outcomes” market mechanisms will be on offsets generated by projects that fall within a country’s NDC, but many are looking to the COP to resolve the question of whether a corresponding adjustment must be made to account for such offsets, thereby addressing the double-counting risk to the voluntary carbon market.
  • Climate Finance. Under the 2009 Copenhagen Accord, developed coun­tries committed to jointly mobilize US$100 billion a year by 2020, which target has yet to be met. This financing will come from public, private, bilateral, multilateral, and alternative sources of finance. The commitment was formalized in the out­come of the 2010 Cancún COP and reaffirmed as a key element of the 2015 Paris Agreement. Financing resources mean opportunities for business in the countries that receive support.

Where do the negotiations sit on these points coming into COP26?

  • Carbon Market Mechanism. Three weeks of virtual talks by the Subsidiary Body for Implementation and the Subsidiary Body for Scientific and Technological Advice occurred in advance of COP26 in June 2021. These talks were not fruitful and did not bode well for meaningful progress in advance of COP26. Article 6 removes the developed vs. developing countries differentiation that characterized market mechanisms under the KP, so negotiators have to strike the right balance and find a model that works for everyone. There are several reasons that an agreement has yet to be reached:
    • While the Parties have generally agreed on how market mechanisms should work under the framework of the Paris Agreement, there is some disagreement over guidelines on baselines and additionality under Article 6.4. The remaining differences are on the degree to which certain provisions should cover different parts of Article 6.
    • The KP’s market mechanisms create an important precedent, so negotiations frequently end up in the same kind of deadlocks that characterized KP negotiations.
    • Negotiations are highly politicized. This makes the negotiating process more difficult.
  • Voluntary carbon market transactions. As noted above, there are several important elements of the Paris Agreement market mechanisms on the table at COP26, and this is one of them. At the heart of the discussion is the principle that corresponding adjustments should be made where necessary to ensure the robustness of the Article 6 rules. However, it is not clear at this stage whether this will translate into a firm outcome on the specific question of double-counting in relation to voluntary carbon market transactions that fall within a country’s NDC. If agreement on this question cannot be reached at COP26, it may ultimately be left to the voluntary carbon offset program operators to legislate for this issue within the contractual framework of their respective schemes, which could result in a divergence of approach by the key players and create unwelcome uncertainty in that market.
  • Climate Finance. At COP16 in 2009, developed countries pledged to jointly mobilize US$100 billion per year by 2020 to address the needs of developing countries. At COP21, parties decided that, prior to 2025, the parties would set a new collective quantified goal from a floor of US$100 billion per year, taking into account the needs and priorities of developing countries. According to an Organization for Economic Co-operation and Development report, the initial US$100 billion target has not yet been met (let alone any new goal), and delivering greater financial support will be a central theme of COP26.