The Attraction of Regulatory Models: Challenges & Opportunities

1. The Attraction of Regulatory Models and their ChallengesBrainstorming from a German/Russian Practitioner Notes for a presentation that ended up not being held because of a timing conflict Planned for Groningen 29. May 2013 Max Gutbrod

2. Kyoto 3 • Evaluation of General Experience3 • Current Airline and Possible Future Transport Issues4 • Global or Regional Carbon Tax5 • Attention to Gas Flaring in General6 • Auditing according to the Energy Efficiency Law7 • “Green” Tariffs8 • Equator Principles9 • Global Corporate Procurement Rules 10 • Carbon Reporting 11 • Conclusions 12

3. Kyoto Evaluation of General Experience The history of application of Kyoto-type mechanism, measured under the angle of governance, gives an interesting example in that the lack of success of Kyoto in Russia shows where the shortfalls in governance in general and in particular in terms of environmental protection in Russia are, namely: The implementation of non discriminatory standards applicable to a larger number of privates was not even tried. There was no Russian reduction target, no distribution of reductions among the industry and no internal cap and trade system. In discussions on implementation, there was quite some lobbying for the implementation of an internal market as the attraction of having an infrastructure of its own seemed to be very substantial. A narrow view of the regulator on what was required for being recognized as a project host was a significant cause for the lack of sophistication of projects. For instance, there were no projects in transport or housing, and most projects were in the oil and gas area. A similar problem is likely to arise whenever environmental rules are devised – whereas most Western jurisdictions will have an understanding of what the term “enterprise” is to mean, Russian law and practice lacks a similar definition The Russian legal system in practice surprisingly easily accommodated concepts typical for emission purchase agreements (ERPAs). The fact that it was not clear what the legal qualification of the object of sale remained under dispute did not really play a role in practice. Stability of decisions on allocations of ERUs was an issue often raised but not been tested in practice. The understanding of due process and rules as well as judicial protection in administrative procedures continues to be an issue. Infighting of state bodies delayed implementation substantially. Russia’s ability to deal with global markets and related risks was less than that of other countries.

4. Current Airline and Possible Future Transport Issues Russians positioning as opponent of the inclusion of the parts of the flights that take place on non European soil seems half hearted For the reasons mentioned above, it is unlikely that a functioning local market and/or a Russian or Eurasion cap-and-trade system can be built up any time soon It is to be assumed that a number of further ICAO member countries are taking a similar approach and facing similar issues (by way of comparison, the USA not only lost one of the very first WTO cases, but was sanctioned because the internal political process took more time than was awarded by the then panel) A system whereby the Russian state would receive a sum equivalent to the cost of the ERUs that would have to be released by the relevant EU-state should be acceptable The same applicable to other transport? Shipping? Would this become a foot in the door for further?

5. Global or Regional Carbon Tax • Would be likely to influence behavior only in a very indirect manner • Example gas flaring • Long investment cycles, accordingly stability ot taxation would be required to encourage investment required to create the preconditions for minimizing tax • Taxation would typically be levied on those that operate oil extraction sites. This taxation might indirectly encourage investing into infrastructure (pipelines that transport gas or chemical plants) that is required to prevent gas flaring. It is however difficult if at all possible to predict how likely it is that taxation leads to such investment. Issues to be considered: • Frequent changes in taxation in Russia • Excise taxes on the export of oil that substantially decrease the margins for export of oil • Prices of gas may be subject to multiple regulatory influence (similar to tariff regulation) • State monopoly on oil pipelines does not easily allow for privates to take part in investment • Accordingly, even assuming criteria of the environmental tax would be very well defined, this tax would have a relatively indirect influence

6. Attention to Gas Flaring in General Appears to have high degree of Russian and global attention Consistency of approaches of attention and reporting questionable – see selection of topics in and promises in http://www.sustainableenergyforall.org/tracking-progress Assume tackling gas flaring would be best done by a multi-billion investment which may raise politically sensitive issues but still be viable, is a comparably weak international institutions a worthwhile instrument to further development?

7. Auditing according to the Energy Efficiency Law • Audits in the West – presumably – are based on standards of professional liability that would be tested by those relying on audits • Owners • Lending banks • Whilst similar standards of professional ethics would exist in Russia, their implementation seems, at best, patchy • Also, standards of contracting in particular in what concerns construction are way behind the West – the description of buildings required for turn-key contracts is not market standard • The members of the more than 150 self regulating organizations that currently are registered therefore have a substantial potential for actually being a delaying factor

8. “Green” Tariffs • Transparency of effects of electricity tariffs little • Whilst a wealth of information on changing policies, prices and profitability of many market players in the electricity industry generally available, the consistency of discussion in particular of pricing issues and issues of allocation of revenue is questionable • It is also questionable in how far the prices paid by end consumer are indeed tied to the amounts that are being consumed, and timing of consumption (“smart grid”) in this context appears to be a major challenge. In other words, many prices are being influenced by, for instance, tariff regulation in a manner that is not tied to consumption. • Tariffs are changed yearly without changes being reliably predictible • Effect of green tariff also questionable because of • access issues • unclear effects and lack of flexibility on pricing

9. Equator Principles • Were supposed to from a global standard of project financing that would eventually develop into a global standard of financing • The number of banks that have committed to the Equator principles is not big • Implementation of Equator Principles is not regulated. Currently, implementation is limited to the self imposed obligation of participating banks to comply with the Equator Principles • Equator Principles appear to be in a process of soul searching and looking out for further options • Accordingly, it is difficult to recommend expansion of the likes of Equator Principles

10. Global Corporate Procurement Rules that Further Energy Efficiency • Would require that a certain carbon element be present in purchases • Look similarly attractive to international compliance programs or controlling ethical standards • Imagine a procurement requirement that can only be fulfilled with difficulties. Examples: Only prochases of local (Russian) apples of a high quality are allowed within a supermarket chain. When is the right time to allow for the purchase of imported (non Russian) apples? How are exemptions graded for internal or group-wide exception?

11. Carbon Reporting • see https://www.gov.uk/government/news/leading-businesses-to-disclose-greenhouse-gas-emissions • would seem to provide for a uniform standard which seems to be interesting to investors • would allow comparison on the way things are handled by companies

12. Conclusions (1) • Much of the global governance is driven by a intuitive assumption that we need some global government type institution. Accordingly, global governance is seen as having failed when no such global government emerges. • In the environmental sphere it is particularly difficult for such a global government to emerge because • There are many different standards by which environmental protection is assessed • There are many different political priorities for environmental protection • As a consequence, the assessments of what is good or necessary for the environment are likely to differ even assuming that all participants in international debates behave reasonable • The difficulties in agreeing on a Kyoto-extension therefore suggest a systemic problem • Complex mechanisms are likely to suffer particularly hard from them being used in a foreign policy negotiating context. The fate of Kyoto in Russia can be used as a paradigm for this: Had it not been a tradeoff against the EU agreement to Russia’s accession to the WTO, implementation might have been more successful as commitment to making Kyoto a success in Russia would have been more general. This could in turn have increased the chances for Kyoto extension. • An alternative approach the trying to form global governments and globally governed issues could be to try agreement on measuring techniques or standards as opposed to trying to agree to share the burden in reaching a result. In a sense, what would be global under the measuring approach would be the parameter, the point of comparison, and not the commitment to achieve something. The WTO in agreeing on trade to be free generally displays this measuring approach. Kyoto, in attempting to provide for a worldwide overall reduction, displays a more all encompassing approach which does not seem viable on a worldwide basis.

13. Conclusions (2) • European models continue to generally be attractive • IFRS as compared to GAAP • European capital markets • Despite the doubts mentioned above, Kyoto-type mechanisms are useful in that they provide for standards • Similarly, carbon report does provide for useful standards • Energy Audits, Energy Savings Contracting, copying of green tariffs, influence on flaring are likely to provide for much less useful standards • It will be key for any standard to be successful that it is used in the longer term and consistency be maintained. In that, regulatory approaches like the ban on the use of industrial gas credits for JI-projects are not overly helpful.

14. Thank you! Max Gutbrod Partner Baker & McKenzie - CIS, Limited Sadovaya Plaza 11th Floor 7 Dolgorukovskaya Street Moscow 127006 Russia Тел: +7 495 787 2700 Факс: +7 495 787 2701 max.gutbrod@bakermckenzie.comwww.bakermckenzie.com