The Future of Carbon Markets

1. The Future of Carbon Markets UKELA Climate Change and Energy Working Party Melanie Shanker email: melanie.shanker@linklaters.com tel: +44 207 456 2994 21 October 2013 Linklaters LLP

2. The Science Matters • The 5th IPCC Report released on 27 September 2013 concludes: • Human activities causing sustained and unequivocal rise in global temps • “Each of the last 3 decades has been successively warmer at the Earth’s surface than any other preceding decade since 1850.” • NEW: CARBON BUDGET - To limit warming to less than 2°C, total cumulative CO2 emissions from all human sources must be limited to 1 trillion tonnes of carbon. • We’re half way there already. • Delayed action will only increase the burden of acting later.

3. Not just a lot of hot air… • Broad scientific consensus if we do not abate there is expected to be… • Increases in global average temperature between 2.6°C and 4.8°C • Sea levels rising 45-82cm * • Desertification and water stress likely in some regions and increased rainfall in others* • Increase in extreme weather events: bushfires, hurricanes, drought and flood.* • IEAWEO 2010: trends show will end up at over 650ppm – temperature increases over 3.5 %. This implies very serious impacts. • August 2012 marked the 36th consecutive August and 330th consecutive month with a global temperature above the 20th century average** • *(Source: Intergovernmental Panel on Climate Change, 5th Report 2013 • **(Source: National Oceanic and Atmospheric Administration National Climatic Data Center, State of the Climate Global Analysis, August 2012)

4. What temperature change means

5. Scale of investment Required • Cost of shifting to a low carbon energy system • Stern Review: 1% annual global GDP ($500bn) for 550ppm CO2e by 2050 (= approximately 3°C) • IEAWEO: $ 550 bn/year to 2030 in renewables and energy efficiency to limit to 450ppm CO2e • NEF Global Futures: $515bn/year over extended period on renewables/energy efficiency 450/550 ppm CO2e • More expensive with delay • Will need to be a combination of public and private money. • Common but differentiated responsibility >>Climate Finance

6. What is Climate Finance? Climate Finance = developed country funds for developing country GHG emissions reduction and adaptation. • What is it actually? • Existing finance ‘mechanisms’ such as: • Clean infrastructure finance • Climate-resilient development assistance

7. Mobilizing Climate Finance • Requires: • Public AND private funds • Removal of certain barriers to entry for the private sector • Two key barriers: • Financing Costs: Low-carbon v BAU? • Foreign investment risk • Policy Solutions • Policy de-risking instruments • Financial de-risking

8. Green Climate Fund • Cancun COP agreed to established in 2010 • The GCF is to “play a key role in channelling new, additional, adequate and predictable financial resources to developing countries by 2020” • Currently governed by a transitional committee • Intention to build with private sector support • 2 private sector observers • Headquarters will be Songdo, Korea • New Exec Director: HelaChiekrhouhou, formerly of African Development Bank

9. Operationalising the GCF • GCF to operate through intermediaries, not as a bank • Interim secretariat has agreed the minimum requirements to be satisfied before donor countries start making commitments to the GCF including: • Risk management and investment frameworks • Resource allocation rules • Initial modalities for operation of the mitigation, adaptation and Private Sector windows • GCF will report to COP but COP will not be able to reverse decisions of GCF. • Private Sector Facility (PSF)

10. NAMAs • NAMA = Nationally Appropriate Mitigation Action • Policies and actions that a country may take to reduce GHG emissions and voluntarily communicated to UNFCCC • Intended to be a way for developing countries to contribute to global mitigation efforts • The exact definition of what is a NAMA is still open but it may facilitate private sector financing • Majority will not generate credits for trading

11. New Market Mechanism and FVA • Disambiguation: The NMM vs new market mechanisms • Modalities of the New Market Mechanism (NMM) and Framework for Various Approaches FVAare still to be agreed (designed) • Credits gained under the NMM could be used by KP Parties for compliance. • Framework for Various Approaches (FVA): “To conduct a work programme to consider a framework for such approaches (including opportunities for using markets, to enhance the cost-effectiveness of, and to promote, mitigation actions, bearing in mind different circumstances of developed and developing countries), with a view to recommending a decision to the Conference of the Parties at its eighteenth meeting.” • Could be a way to link different markets. • Design challenge: how to design an appropriate mechanisms without clear view on demand for credits.

12. Carbon Markets 2.0 • EU ETS: backloading, cap beyond 2020, aviation stop-the-clock • California: cap-and-trade scheme commenced in 2013, covering 85% of California’s emissions. Linking to Quebec. • China: Developing 7 regional trading schemes with purported aim to launch economy-wide scheme by 2015. Shenzhen launched. Shanghai close behind. • Japan: looking developing bilateral mechanisms • Korea: plans to launch an ETS in 2015 covering 60% of South Korea’s more than 600 million tonnes of annual CO2 emissions. • Australia: cap-and trade scheme to be repealed in 2014.

13. Where lawyers are needed? • Carbon markets are highly regulated environments both in terms of the product and the way it is traded • Non-standard documentation and drafting – basis risk • Transition into regulated environments or between phases of schemes • Allocating registry and transfer system risks

14. The Future: “Unburnable carbon”? • “Smart investors can see that investing in companies that rely solely or heavily on constantly replenishing reserves of fossil fuels is becoming a very risky decision.” • Professor Lord Stern • Carbon Tracker Initiative • Stranded Assets – how should environmentally unsustainable assets be valued? • Analysts reports – DB, Citi, GS predict softening of fossil fuel demand • Impacts business, but is also an opportunity. • see: http://carbontracker.live.kiln.it/Unburnable-Carbon-2-Web-Version.pdf

15. Melanie Shanker Tel: +44 (0)20 7456 2994Email: melanie.shanker@linklaters.com Melanie is a Managing Associate in London with a focus on emissions trading and climate change law. She has considerable experience advising in relation to emissions trading, including complex structured transactions under existing and emerging Kyoto mechanisms (CDM, JI and REDD+). Prior to joining Linklaters in 2011, Melanie was in-house counsel for five years at Climate Change Capital, investment manager to the largest private carbon fund in the world. Recent experience includes: advising on a number of structured offset and allowance transactions in the Californian carbon market; advising on the structuring and implementation of an environmental bond deriving returns from carbon monetization and ecosystem services; and advising a co-ordinating managing entity on the implementation of a CDM Programme of Activities in Kenya. 14