GLOBALLY NETWORKED CARBON

MARKETS COMMON FRAME OF REFERENCE AND APPROACH FOR

CLIMATE CHANGE MITIGATION VALUE

February 2014 Wendy Hughes, World Bank

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Outline:

• Looking ahead – efforts to link markets will be valuable in a

range of policy scenarios.

• What is needed to connect heterogeneous markets?

• Fungibility based on relative climate change mitigation value

o Common Frame of Reference

o Rating

o Exchange rates

• Value of these elements beyond linking markets.

• Possible Next Steps.

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Looking Ahead:

• General expectation: most countries will take on some level of self-

ambition.

• A successful Paris 2015 would have many (perhaps most) countries

taking on an increased level of “self-ambition”.

• Level of ambition will grow over time.

• a range of policy tools across countries and across sectors:

“conventional” carbon markets (ETS), other market approaches not

directly carbon, tax and regulation.

• Longer term expectation: all countries have to get to low carbon at

some point – there is a question about the rate at which the transition

will happen – potential role for markets.

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Possible Directions for Global Climate Change Policy

Regime

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price on carbon: significant

international carbon market

driven by goals of cost

efficiency

Long-lasting domestic

policies that include

heterogeneous measures –

basis for and pledge and

review

Combination

of the above

• underlying challenge is the same: actions of one jurisdiction depend on

the ability to evaluate and project actions of other jurisdictions

o so mechanisms to evaluate, project and coordinate levels of effort

across countries and time will be useful.

o Wide range of policy pathways would all benefit from efforts to link

different carbon markets

Connecting Heterogeneous Markets

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The Challenge:

• 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

The Idea: Globally-Networked Carbon Markets

• Independent rating system and independent rating

agencies

- risk-based approach to rate the climate

change mitigation value of carbon assets in

the international market.

• International Carbon Reserve

- convert ratings into exchange rates; help in

addressing market risks and failures.

• International Settlement Platform

- track cross-border trades and possible clearing

house function.

Principles Underpinning Globally-Networked Carbon

Markets

• “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 UN process.

• Encourage participation: learning by doing, and race to the top.

• Private sector friendly.

• Environmental integrity.

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Idea: Globally-networked Carbon Markets

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F

A

C

D

A

D

B

C

E

B

Jurisdiction B

International Carbon Reserve (ICAR)

Independent

Private Rating

Agency 1

Independent

Private Rating

Agency 2

Independent

Private Rating

Agency 3

Information Flow

Asset / $ Flow

Jurisdiction A

Jurisdiction C

Jurisdiction D

A

B

A

Carbon Asset Class

Ratings

Ratings

Opt-In

(Carbon assets or $$$) Opt-In

Opt-In

A

Opt-In Rules:

• Use rating as basis for Carbon exchange rate

• Benefits of ICAR available to opt-in jurisdictions

International Settlement Platform

Ratings of assets

• All international trading registered in the International Settlement Platform

Information

Fungibility: requires relative value of different assets from a climate change

mitigation perspective.

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mitigation

value comes

from the

emission

reduction

associated

with an asset.

Reduction relative to what?

• From a domestic perspective: Emission

reduction relative to what would have

been emitted (sector baseline).

• From an international perspective: emission reduction relative to target

jurisdiction-level reduction is also

important.

• The value of an asset in an international

market has elements of both program

and jurisdiction considerations

Example: relative value of allowances from two ETS systems Program level comparison –asset value associated with emission reduction

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If design, scope or cap are different, reduction relative to domestic sector

baseline that is associated with an allowed emission is different in the different

jurisdictions

t C

O2 e

mitte

d

years

Baseline emission trajectory

Capped emission trajectory

t CO2 reduced

t CO2 emitted a

b

c

System X

t C

O2 e

mitte

d

years

Baseline emission trajectory

Capped emission trajectory

t CO2 reduced

t CO2 emitted

c

d

a

System Y

Example: relative value of allowances from two ETS systems Jurisdiction-Level Comparison

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In terms of the relative value in an international market, what is happening at

the jurisdiction level would matter as well, both credibility relative to own-

target….

Country X Emission Reduction Own-Target and Sector Sub-targets

t C

O2

em

itte

d

years

Building efficiency program ETS power sector

Fuel efficiency standards REDD program

t C

O2

em

itte

d

years

target

Actual / projected

Reduction from ETS on track

target

Example: relative value of allowances from two ETS systems Jurisdiction-level Comparison

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…and whether “own-target” is good enough……

Country X Emission Reduction Own-Target Compared to

International Expectations

t C

O2

em

itte

d

years

Building efficiency program ETS power sector

Fuel efficiency standards REDD program

t C

O2

em

itte

d

years

Own-target

International expectation

Own-target

Fungibility in the International Market Requires:

• Approach to rate likelihood of achieving targets: RATING

o Significant element of ex-ante: risks and probability

• move from domain of evaluation “was it achieved” to the domain of rating “what is the risk of non-delivery / default”?

o Rating Characteristics:

• built in incentive for credibility

• maximum independence from political process

• Common Frame of Reference Against which to compare Jurisdiction-level targets

• Is its own target good enough?

• Options for Common Frame of Reference – domestic price? - national pledges? - ambition index?

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• Program level Rating: “ what is the risk that the program will not

achieve its stated reduction target?”

• Credibility Rating of jurisdiction’s own stated climate change

mitigation target or pledge: “what is the risk that the jurisdiction

will not meet its stated mitigation target?”

• Ambition adjustment

Rating = f {program rating, credibility rating, ambition adjustment}

What Goes into a Rating?

REGULATORY • GHG Performance

standards

• Technology

standards

• Fuel standards

PRICE • Carbon tax

• Capital subsidies

•Feed-in Tariffs

•Energy Efficiency

Tariffs

QUANTITY • Cap and Trade

• Offsets

• Credit and baseline

• Clean Energy

Standard

• RECs

Program Credibility Ambition

Adjustment

GHG RISK GHG CONTRIBUTION

14 IN

STR

UM

ENT

TYP

E

Ex-ante

Ex-post

Possible Rating Landscape

DNV NAMA

Rating Protocol

Who would use the Rating? Outside the context of Carbon Markets

• Program rating:

o Investors: guide the flow of financing to programs with strong prospects

ex-ante;

o Development aid: to guide / attract non-market support

• Credibility rating:

o investors: is there a stable outlook for low carbon policy;

o International negotiators: input beyond effectiveness of current policy

portfolios - outlook for political and economic factors

o Sellers: could signal the prospect of new demand

• Ambition index / ambition adjustment:

o investors in any sector (not only low carbon): is the economy robust

against a “carbon shock”?

o Could impact overall sovereign risk rating and attractiveness of a country

as an investment destination in general.

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Who would use the Rating? In the context of Carbon Markets

• Ad Hoc / Bilateral Markets:

o Investors – could help direct investment to most successful low

carbon opportunities

o Domestic regulators: to make decisions on whether or not certain assets could be used for compliance – either by regulated entities or

by governments making up a gap – ad hoc, bi-lateral;

• Globally-networked carbon markets:

o ICAR and participants opting into Globally-Networked Carbon

Markets approach: rating as the basis for climate change mitigation

value exchange rates across different assets necessary for partial

linking across multiple jurisdictions.

International Carbon Reserve (ICAR)

International Carbon Reserve would:

• Convert the independent rating information to determine the

exchange rates at which it would manage and trade assets from

participating jurisdictions.

• Be the mechanism for “opting in” to the globally-networked carbon

market.

• Provide performance “feedback” via ratings impact on exchange

rates 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 exchange

rates)

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International Carbon Reserve (ICAR)

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.

• Provide market surveillance and information

• Other?

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Roadmap

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20

14

/20

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Pilot Rating / Reserve Fund

3-5 Countries

-establishes rating approach,

-market maker for new assets

- Possibly housed at World Bank or IFC

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16-2

01

7

Pre-Reserve

More countries

- a track record for rating

Possibly still housed at the World Bank or IFC

Po

st 2

02

0

ICAR

Large enough to make an impact in terms of providing a Reserve Function

Housed outside the World Bank Group

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.

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.

• Pilot ratings approach with a pilot “market maker” fund launching in

2014 / 2015.

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THANK YOU.

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