Josephine V. Yam

Carbon Finance

Clean Development Mechanism: An Effective Market Mechanism for EU ETS Compliance

Josephine V. Yam, March 2012
This article will discuss why the Clean Development Mechanism (CDM) of the Kyoto Protocol is integral to the European Union (EU)’s Emission Trading System (ETS), despite the criticisms hurled against it. The three major criticisms are that many CDM projects do not meet the “additionality” criteria, that the CDM provides a perverse incentive to developing countries considering climate policies that adopt limits on greenhouse gas (GHG) emissions, and that the CDM does not produce real reductions in GHG emissions. After explaining how those criticisms are overcome, this paper will conclude that the CDM is integral to the EU ETS because it provides industrialized countries with greater flexibility to comply with their Kyoto obligations at the least economic cost while providing developing countries with the opportunity for sustainable development.

The CDM is one of three flexible market mechanisms created under Article 12 of the Kyoto Protocol. It allows industrialized countries (Annex I parties) to invest in sustainable GHG emissions reduction projects in developing countries (non-Annex I parties). These emissions reduction projects generate emissions credits or offsets which Annex I parties may use to meet their emissions reduction commitments under the Kyoto Protocol (Nigoff, 2006). Despite its practical function as a market-based compliance mechanism, the CDM has been severely criticized on three fronts.

First Criticism: CDM Does Not Meet Additionality Criteria

The first criticism is that many CDM projects do not meet the “additionality” criteria of the Kyoto Protocol (IER, 2010). For a project to be accepted as a CDM project, one major requirement is that it must be “additional” to the “business-as-usual” scenario (IER, 2010). This means that project must be environmentally additional so that it reduces GHG emissions below what they would have been without such project. It also means that the project must be economically additional so that it cannot be financially attractive without the additional carbon finance that the offsets bring (Bumpus & Liverman, 2008). Both forms of additionality rely on project developers describing counterfactual or non-existing future scenarios. Consequently, CDM projects are open to exaggerated baselines and claims of emissions reductions that have not actually occurred, which result in no actual environmental additionality (Gronewold, 2010). They are also open to exaggerated claims of offsets being generated because of the projects, even though they would have happened anyway due to other revenue streams, which result in no actual financial additionality (Bumpus & Liverman, 2008).

In response to this criticism, the CDM Executive Board has adopted stringent requirements and standard emissions calculation methodologies to prevent abuse of the offsetting system by instituting safeguards in the existing methodology (Hausfather, 2008). It has also expanded the definition of additionality to encompass other tests. For example, the “barrier test” considers if there are specific barriers, such as technology availability, that can be identified as holding back development in the sector that would be overcome with the project. Also, the “common practice test” considers if the project’s methods differ from prevailing practices in the industry (Sawyer, Stiebert, & Beugin 2011).

Second Criticism: CDM Discourages Adoption of Climate Policies

The second criticism is that the CDM provides a perverse incentive to developing countries considering adopting climate policies that put limits on emissions (Hausfather, 2008). To be eligible for CDM investments, developing countries must not have their own binding targets and timetables for emission reductions (McCully, 2008). Thus, a government would be hesitant to voluntarily cap methane from its landfills or to encourage energy efficiency if in doing so it makes these activities not additional and thus, not eligible for CDM income (Schatz, 2008).

In response to this criticism, the CDM Executive Board has stipulated that the CDM would not take into account national climate policies into the baseline calculation that have been implemented after November 2001. This would avoid punishing national governments of CDM host countries that have passed progressive climate policies for the deployment of renewable energies from having done so (Wang & Chen, 2010). This is because in doing so, these governments actually support the Kyoto Protocol’s goal in addressing anthropogenic contributions to global warming (Nigoff, 2006).

Third Criticism: CDM Does Not Produce Net GHG Reductions

The third criticism is that the CDM does not produce net reductions in global GHG emissions. By its very nature, the CDM is an insufficient measure to halt climate change as it fails to reduce global GHG emissions. When a non-Annex I party transfers emissions credits to an Annex I party, the latter uses the credits to offset an increase of its own emissions. In effect, they are merely swapping emissions reductions abroad for a domestic increase, leading to no net reduction in global emissions (Schatz, 2008). By failing to promote net reductions in global emissions, the CDM serves as an insufficient and neutral weapon against climate change (Schatz, 2008). When a CDM credit represents an emission reduction, there is no global benefit because offsetting is a zero-sum game (McCully, 2008). Thus, majority of GHG emissions reductions will be produced merely by handing in CDM certificates to the United Nations, instead of being produced through actual pollution reductions (McCully, 2008).

In response to this criticism, the EU ETS system has placed quantitative restrictions on member countries in respect of their use of the CDM as a compliance mechanism for purposes of meeting their Kyoto obligations. This restriction is pursuant to the goals of the “supplementary principle”, one of the main pillars of the Kyoto Protocol. The principle espouses that internal abatement of emissions should take precedence over external participation in flexible mechanisms, including the CDM (Schatz, 2008). This restriction ensures that Annex I countries do not buy their way out of domestic emissions reductions obligations (Schatz, 2008).

Position & Conclusion

In view of the above discussion, this writer believes that the CDM is integral to the EU’s ETS, despite the criticisms hurled against it. This is because it provides industrialized countries with greater flexibility to comply with their Kyoto obligations at the least economic cost while providing developing countries with the opportunity for sustainable development.

The CDM Executive Board and the EU ETS central authority have shown their flexibility and adaptability to adopt revised targeted policies and more stringent requirements and methodologies to effectively address the criticisms raised against the CDM.

Regarding the first criticism, more stringent requirements in determining additionality as well an expanded scope of additionality have been adopted. Regarding the second criticism, a revised policy approach has been taken such that national climate policies are no longer considered in baseline determinations. Regarding the third criticism, a quantitative restriction in the use of CDMs was put in place to support the Kyoto Protocols’ supplementary principle. In doing so, the CDM Executive Board and the EU ETS central authority have been able to correct the design flaws in the CDM that may have created perverse incentives that opened the doors to its deliberate or otherwise inadvertent misuse by CDM stakeholders.

Indeed, the abundance of low-cost emissions reduction opportunities in the developing world continues to serve as the driving force behind burgeoning CDM transactions (Schatz, 2008). Verily, the CDM has proven to be an effective mechanism that provides non-Annex I countries the opportunity to participate in sustainable development while simultaneously providing Annex I countries an additional method to meet their committed Kyoto emissions reduction targets (Nigoff, 2006).

The CDM has proven to be, after all, a good deal for the planet.


Josephine V. Yam
Josephine is CEO & Co-Founder of B3 Canada, a mission-driven organization in Canada dedicated to building breakthrough boards through innovative board matching services for businesses, professionals and nonprofits.

Josephine is a highly accomplished lawyer-social entrepreneur with significant years of professional legal, policy, leadership and entrepreneurial experiences in the private, public and nonprofit sectors in Canada and internationally. She has been admitted to practice law in New York (USA), Alberta (Canada), Ontario (Canada) and the Philippines. She has also been interviewed on international television such as CNN and CNBC and featured in the international news magazine Newsweek.

Josephine recently graduated from Stanford University's Executive Program for Non-Profit Leaders. She also completed her Master of Laws (LLM) degree at the University of Calgary, Faculty of Law. Complimenting her advanced education at Harvard Law School and the University of Toronto, Josephine currently serves as one of the Energy Futures Lab Fellows of The Natural Step Canada.

Before founding B3 Canada, Josephine was the Executive Director of the Environmental Law Centre of Alberta and Lead Advisor for Corporate Consulting at the Pembina Institute. As Board Member of Immigrant Services Calgary, a large registered charity, Josephine served as Corporate Secretary, member of the Executive Committee, Board Development & Nominating Committee, Audit & Finance Committee and CEO Evaluation Committee. In the public sector, Josephine served as Senior Legal Counsel with the Government of Alberta’s Ministry of Justice and Ministry of Energy. In the private sector, Josephine worked with the international law firm Baker & McKenzie in its Hong Kong, Manila and Toronto offices, the Asian Development Bank and Procter & Gamble.

With her significant legal and senior management experiences in the private, public and nonprofit sectors in Canada and internationally, Josephine deeply understands that cross-sector collaboration in social innovation is crucial to achieving positive change in the world. This is what drives her deep commitment to advance B3 Canada’s mission of strengthening the board leadership capacity of Canada’s nonprofit sector as a force for good in society.

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