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The Institute for Agriculture and Trade Policy (IATP)1 appreciates this opportunity to respond to some of the questions posed in the TSVCM consultation document. We are particularly grateful that the TSVCM offers the option of responding to the consultation document in a letter, rather than only responding to survey questions. IATP responded in December 2020 to the survey questions for the draft TSVCM report and found it difficult to fit our responses within the character count limits of the questions boxes. We summarized elsewhere some of our responses in the context of a market integrity concern noted, but not discussed in the draft report, nor, indeed, in this consultation document — excessive speculation (Exhibit 31).2

Our responses to the consultation questions mostly concern the “Legal principles and contracts” section of the document, with some remarks on “credit level integrity.” The reason for our focus is that the TSVCM recommendations will be applied to contracts traded either on existing exchanges or in Over the Counter (OTC) trading, whether bilateral or on Swaps Execution Facilities. The “how” of trading is at least as important as what is traded. The TSVCM phase II consultation has little to say about the role of exchanges in emissions futures trading except “Exchanges are expected to set their own trading terms (see example in the Technical Appendix).” (slide 42) Given the possibility that different exchanges will trade offset futures on different terms, it is surprising that the Task Force’s Legal Principles and Contract Working Group does not have more to say about harmonizing exchange rules for trading emissions offset futures contracts, such as the CME Global Emissions Offset futures contract, and exchange traded offset swaps. Exchanges compete for business, so the likelihood of deregulatory arbitrage among exchanges to capture part of the anticipated boom in offset and avoidance credit trading should not be dismissed. 

“We have to be open to the idea that the voluntary market might fail”

IATP is not privy to insider details about disagreements among the TVSCM’s 400 plus members. But to judge by a recent article in Bloomberg Green, among the disagreements are varying opinions about transparency of TVSCM decision making and about the environmental integrity of the offset credits: “’If they [offset emissions project developers] generate a lower carbon benefit than they claim and the company [buying such offset credits] is still emitting, well then you end up with more emissions than you would have otherwise,’ said [Eli] Mitchell-Larson [a consulting environmental scientist]. ‘We have to be open to the idea that the voluntary market might fail.’”3 The consequences of market failure would be much greater than economic damage to market participants and to exchanges. The consequences could include failure of market participants to prioritize making investments to directly reduce their emissions and adapt to climate change, while they imprudently and preponderantly invest in poor quality offset and/or avoidance credits.

If the emissions offset projects were found to be fraudulent or simply misrepresent the amount of emissions offset or misrepresent Economic Social and Governance (ESG) attributes described in the offset credit contract, the value of the contract could abruptly fall. If instances of fraud or misrepresentation were numerous and well-publicized, investors might not buy a disreputable contract even at the fallen price. If enough investors held large positions in an offset futures contract and the contract price fell rapidly in automated trading systems, exchanges would be forced to throw kill switches to stop the price fall and declare a market event to regulators, which likely would trigger an investigation of the contract. If such market events became frequent for several offset contracts, the voluntary carbon market could fail.4 And, as Mitchell-Larson suggests, the failure would not impact negatively just participants in the offset and avoidance credit value chain, but the climate itself and its inhabitants.

The consultation document reports that 45% of emissions offset buyers responding to a TSVCM phase I survey, as of October 2020, were concerned about a “lack of environmental and social integrity of certain projects” (slide 50) from which offset and avoidance credits would be derived. Forty-one percent of buyer respondents were concerned about the double-counting of emissions reductions, avoidance and/or removals by the projects’ home country (mostly a TVSCM identified dozen or so developing countries) and the buyers’ home country (mostly corporations and financial firms in North America and Europe) in reporting Nationally Determined Contributions (NDCs) to the U.N. Framework Convention on Climate Change (UNFCCC). (slide 50) Twenty-one percent of buyers were concerned that UNFCCC negotiations might not produce an agreement on “corresponding adjustments” to NDCs to avoid double-counting, which, if widespread among UNFCCC member governments, would vitiate any claim that emissions trading will result in absolute and overall emissions reductions consistent with the UNFCCC Paris Agreement of 2015. Underlying the concerns of the buyers is whether emissions reductions, avoidances and/or removals could be measured accurately from credible baselines.

The TSVCM’s Credit-Level Working Group proposes an elaborate standards and implementation architecture to ensure that reductions, avoidance and/or removals would be near permanent (save for emissions reduction and avoidance reversals due to forest fires and other Force Majeure events). However, the Working Group has just this to say about the technologies of measuring and reporting emissions: “Accuracy of measurement requires specifications on data collection methods. These may include: sampling approaches and inventory specifications, calibration of meters, calibration and validation of biogeochemical models, specifications for the use of remote sensing tools. The calculation of uncertainty for any method must be defined by the Standard.” (slide 61) Nor does the Technical Appendix have anything further to say about the accuracy of emissions and baseline measurement, crucial factors both for launching the TSVCM model Core Carbon Principle (CCP) contract and for the UNFCCC negotiations on double counting and corresponding adjustments.

A TSVCM leader, Annette Nazareth, has written that the use of Digital Ledger Technology (DLT) will enhance the accounting integrity of offsets in DLT enabled “smart contracts” to greatly reduce the possibility of fraud or misrepresentation of the quantity of emissions offset or avoided by the developers projects. IATP agrees that the use of DLT, with its immutable recordkeeping, can increase the accounting integrity of offset, avoidance and removal contracts.  However, she then writes,

DLT alone, however, cannot resolve all issues relating to the integrity of carbon credits. Due to the complexities of carbon verification, there will likely always be some need for human control. For example, people will need to confirm that sensors are well placed, and that satellites monitoring forests do not reveal child labor violations. Unfortunately, human control also introduces risks. The step of transferring information from humans to the digital DLT may be susceptible to fraud.5

Although Nazareth’s techno-optimism is tempered, it is not tempered enough. It is not just the placement of sensors to measure GHG sequestration that should concern the TSVCM, but the physical robustness and accuracy of sensors in different soil types, depths and topographies6 and the reliability of their digital signals transmitting GHG information to satellites for subsequent downloading and data aggregation.7

This is less a critique of Nazareth’s article than a recommendation that the TSVCM should not rely on DLT to interface NDC registries and voluntary market registries, as she suggests: “DLT gives all involved parties the advantages of transparency, immutability, and avoiding the need for a central arbiter (or political negotiation and agreement).” Even if existing sensor and satellite technologies could accurately measure emissions avoidance, reductions and removals at project scale, the application of corresponding adjustments to avoid double counting would remain a fraught political negotiation, if only for this reason: “Carbon credits can have low environmental integrity, and they will become increasingly difficult to source as countries need to ‘keep’ their reductions to meet domestic targets.8

The developing countries supplying the vast majority of TSVCM envisioned offset and avoidance project credits need to retain at least some of those credits for their own NDC reporting. This diplomatic need is not considered in the phase II consultation analysis.  The TSCVM is excessively circumspect about the relation between the scaling up of voluntary markets and the results of the UNFCCC Article 6 negotiation. The TSCVM Technical Annex should include a “deep dive” into Article 6 negotiations and recommend that TSVCM members read other “deep dives” to better understand the positions of all Parties to the negotiations and how the resulting compromises may affect hoped for TSVCM outcomes.9

TSVCM members may believe it is smart diplomacy to delay negotiating an agreement on Article 6.8 (“non-market mechanisms,” i.e., direct funding of climate action for developing countries) until the rest of Article 6 is first agreed on terms that would help enable and legitimize the scaling of voluntary carbon markets. All UNFCCC members will have to suffer the costs of the accelerating climate crisis, albeit inequitably, if Article 6.8 continues to remain unnegotiated pending agreement on the rest of the Article: “Parties have made good-faith submissions with constructive suggestions on enabling ambition, governance, and use of proceeds in Article 6.8, but for the most part these contributions have been sidelined in favor of a negotiating agenda fixed on the creation of carbon markets and ITMOs [Internationally Transferred Mitigation Outcomes].”10 Smart climate diplomacy would be a scenario in which the TVSCM members who are also members of the International Emissions Trading Association would lobby their governments to allow Article 6.8 to be negotiated and agreed as a separate article so that more adequate and urgently required climate finance can be mobilized for mitigation and adaptation projects and planning programs in developing countries.

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