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Design: Clarity Global Strategic Communications (www.clarityglobal.net) i ACKNOWLEDGMENTS Synthesis you begin domestic context crediting mechanisms the scope core elements methodologies The preparation of this report was led by the World Bank, with the support of Get2C, Carbon Limits, the Greenhouse Gas Management Institute, INFRAS, and the Stockholm Environment Institute. The World Before Understanding the Bank task team responsible for the report was composed of Joseph Pryor, Marissa Santikarn, Harikumar Gadde, Klaus Oppermann, and Daniel Besley. Janet Peace provided expert technical review. The consulting team included Pedro Martins Barata, Derik Broekhoff, Tani Colbert-Sangree, Michael Gillenwater, Quirin Oberpriller, Jerry Seager, Randall Spalding-Fecher, and Jürg Füssler. The report benefited greatly from the valuable contributions of experts, including government officials, who provided valuable insights and reviewed various drafts of the report. These experts include the following: Jurisdiction/Crediting Using existing Organization Expert mechanism Alberta Alberta Environment and Parks Alberta Environment and Parks Staff Australia Department of Industry, Science, Staff from the Department of Industry, Energy and Resources Science, Energy and Resources Deciding on Deciding on the Developing California California Air Resources Board California Air Resources Board Staff Chile Ministry of Energy Francisco Dall’Orso Ministry of Environment Juan Pedro Searle Rodrigo Borquez Colombia Directorate of Environment and Andrés Camilo Alvarez-Espinosa Sustainable Development Leidy Caterine Riveros Salcedo Germany Federal Ministry of the Environment Malin Ahlberg Japan Ministry of the Environment Yuika Terui Maiko Uga Mexico Secretariat of Environment Iván Hernández Villegas and Natural Resources Ximena Aristizábal Clavijo Adopting, reviewing and revising methodologies Québec The Ministère de l’Environnement et de la Pierre Bouchard Lutte contre les changements climatiques Regional Greenhouse Massachusetts Department of William Space Gas Initiative Environmental Protection Republic of Korea Ministry of Environment Peter Lee Deciding on the Overseeing Establishing governance Saitama Saitama Prefecture Office Yuji Jigata project cycle South Africa Ministry of Finance Memory Machingambi Spain Ministry for the Ecological Transition Teresa Solana and the Demographic Challenge Arantzazu Mojarrieta auditors and supporting frameworks Switzerland Federal Office for the Environment Aric Gliesche State Secretariat for Economic Affairs Philipp Ischer Tokyo Tokyo Metropolitan Government Takuya Ozawa We wish to acknowledge additional valuable contributions and comments provided by Stephanie La Hoz Theuer (International Carbon Action Partnership); Axel Michaelowa and Hanna-Mari Ahonen (Perspectives Climate Group); Zhibin Chen and Qian Guoqiang (Sinocarbon); and Marcos Castro Rodriguez and Rama Chandra Reddy (the World Bank Group). We would also like to thank Kate Epstein and Liz Crooks for their careful editing and proofreading. ii A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS revising methodologies methodologies core elements the scope crediting mechanisms domestic context you begin Synthesis Understanding the Before TABLE OF CONTENTS ACRONYMS 1 SYNTHESIS 2 I GETTING STARTED 7 Using existing 1 BEFORE YOU BEGIN 9 1.1 Purpose of this guide 9 1.2 Fundamental concepts in carbon crediting 12 Developing Deciding on the Deciding on 1.3 Scope of the guide 14 1.4 Outline of the guide 15 1.5 Evaluation criteria for assessment of design options 15 2 UNDERSTANDING THE DOMESTIC CONTEXT 17 2.1 Policy rationale and objectives 17 2.2 Crediting in the policy mix 20 2.3 Stakeholders and the process for designing a crediting mechanism 20 3 USING EXISTING CREDITING MECHANISMS 23 3.1 Spectrum of reliance 23 3.2 Using carbon credits issued by existing mechanisms 24 Adopting, reviewing and 3.3 Outsourcing or replicating design elements 26 II DESIGNING A DOMESTIC CREDITING MECHANISM 29 4 DECIDING ON THE SCOPE 31 4.1 Avoiding overlap with other policies and regulations 31 Establishing governance Overseeing Deciding on the 4.2 Prioritizing sectors and types of mitigation activities 33 project cycle 4.3 Scale of eligible mitigation activities 38 4.4 Geographic scope 38 5 DECIDING ON THE CORE ELEMENTS 39 and supporting frameworks auditors 5.1 Mechanisms to avoid double counting 40 5.2 Policies on crediting periods 41 5.3 Avoiding social and environmental harm 43 5.4 Promoting development benefits 46 5.5 Addressing non-permanence 49 TABLE OF CONTENTS iii Synthesis you begin domestic context crediting mechanisms the scope core elements methodologies Before Understanding the TABLE OF CONTENTS 6 DEVELOPING METHODOLOGIES 53 6.1 Using project-specific and standardized approaches 53 6.2 Determining project eligibility 56 Using existing 6.3 Demonstrating additionality 57 6.4 Quantifying emissions reductions 60 6.5 Monitoring project performance over time 65 7 ADOPTING, REVIEWING AND REVISING METHODOLOGIES 67 Deciding on Deciding on the Developing 7.1 Approaches for adding new methodologies 68 7.2 Important procedural considerations for methodology development 70 7.3 Choosing an approach to methodology development 72 7.4 Procedures for reviewing, revising and updating methodologies 73 II GOVERNANCE AND ASSURANCE FOR DOMESTIC CREDITING MECHANISMS 75 8 DECIDING ON THE PROJECT CYCLE 77 8.1 Project cycle overview 77 8.2 Using a full project cycle 79 8.3 Streamlined project cycle 83 Adopting, reviewing and revising methodologies 8.4 Considerations for project cycle approach 84 9 OVERSEEING AUDITORS 85 9.1 Accrediting and approving auditors 85 9.2 Developing standards and guidelines for validation and verification 88 9.3 Managing conflicts of interest between auditors and project proponents 89 Deciding on the Overseeing Establishing governance project cycle 9.4 Reviewing auditor performance 92 10 ESTABLISHING GOVERNANCE AND SUPPORTING FRAMEWORKS 93 10.1 Program governance and regulatory systems 93 10.2 Enforcement, liability, and appeals 97 auditors and supporting frameworks 10.3 Registry infrastructure 99 ANNEX I: TYPES OF CREDITING APPROACHES 102 ANNEX II: SCALED-UP CREDITING 103 REFERENCES 105 iv A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS revising methodologies methodologies core elements the scope crediting mechanisms domestic context you begin Synthesis LIST OF FIGURES Understanding the Before Figure 1-1. Existing regional, national, and subnational carbon crediting mechanisms 11 Figure 1-2. Example of how carbon crediting works 12 Figure 1-3. Crediting at different levels and scope of this guide 13 Figure 1-4. Outline of designing a domestic crediting mechanism 15 Figure 1-5. Trade-offs between design criteria 16 Figure 2-1. Example of process for making policy decisions for a crediting mechanism 21 Using existing Figure 3-1. Options for using existing crediting mechanisms in a domestic context 24 Figure 4-1. Example of overlap with an ETS 32 Figure 4-2. Coverage summary of existing regional, national, and subnational crediting mechanisms 35 Figure 5-1. Types of development benefits of carbon crediting projects 45 Developing Deciding on the Deciding on Figure 5-2. Possible reversal risks for biological sequestration projects 49 Figure 6-1. Considerations for project eligibility 56 Figure 6-2. Over-crediting annual variation through zeroing negative abatement 65 Figure 8-1. Project cycle options 78 Figure 10-1. Governance functions for crediting mechanisms 94 Figure 10-2. Key institutions in domestic crediting mechanisms 95 Figure 10-3. Example of range of functions for key institutions 96 LIST OF TABLES Adopting, reviewing and Table 2-1. Potential policy objectives for crediting mechanisms 18 Table 3-1. Examples of countries allowing use of credits issued by existing mechanisms 26 Table 3-2. Examples of outsourcing crediting features or functions 27 Table 3-3. Examples of replicating design elements of existing mechanisms 28 Table 4-1. Sectoral and mitigation activity scope of some existing crediting mechanisms 36 Establishing governance Overseeing Deciding on the project cycle Table 4-2. Scale of mitigation activity in some existing crediting mechanisms 37 Table 5-1. Safeguards in some existing crediting mechanisms 44 Table 5-2. Development benefits in some existing crediting mechanisms 47 Table 6-1. Project-specific versus standardized approaches 55 and supporting frameworks auditors Table 7-1. Approaches to developing methodologies and key actors involved 69 Table 7-2. Choosing an approach for methodology development 71 Table 8-1. Typical elements of a monitoring report 81 Table 8-2. Full cycle versus streamlined cycle 84 Table 9-1. California’s auditor conflict of interest risk assessment guidelines 89 Table 9-2. Validation and verification standards among selected existing crediting mechanisms 90 Table A-1. Types of crediting approaches 102 TABLE OF CONTENTS v Synthesis you begin domestic context crediting mechanisms the scope core elements methodologies LIST OF BOXES Before Understanding the Box 1-1. Carbon crediting mechanism categories 10 Box 1-2. Key terms used in the guide 13 Box 2-1. Transferring domestically generated carbon credits under the Paris Agreement 19 Box 2-2. Example of stakeholder input on methodology approval: California 22 Box 3-1. “Gatekeeping” criteria used in CORSIA 25 Box 4-1. Examples of how different jurisdictions avoid overlap between crediting and other carbon pricing instruments 33 Using existing Box 4-2. Interaction between carbon credits and certificates from clean energy programs 34 Box 4-3. Direct environmental benefits in California 38 Box 5-1. Double counting: Paris Agreement and CORSIA 41 Deciding on Deciding on the Developing Box 5-2. The Gold Standard for Global Goals 48 Box 5-3. VCS AFOLU pooled buffer account 51 Box 6-1. California US Forest Projects Protocol—an example of standardized approaches 54 Box 6-2. Combined project-specific and standardized approaches 56 Box 6-3. Positive and negative lists to filter for additionality 57 Box 6-4. Typical additionality tests 58 Box 6-5. Multiple additionality tests: California 59 Box 6-6. GHG principles 61 Box 6-7. Leakage 62 Adopting, reviewing and revising methodologies Box 8-1. Use of full versus streamlined project cycles in existing crediting mechanisms 79 Box 8-2. Digitizing MRV and automating project cycle management 83 Box 9-1. Using auditors to perform validation and verification 86 Box 10-1. Buyer liability: California 98 Box A-1. Example of piloting scaled-up crediting 104 Deciding on the Overseeing Establishing governance project cycle auditors and supporting frameworks 1 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS ACRONYMS AFOLU Agriculture, Forestry and Other Land Use CARB California Air Resources Board CCER Chinese Certified Emissions Reduction CDM Clean Development Mechanism CORSIA Carbon Offsetting and Reduction Scheme for International Aviation ETS Emissions trading system GHG Greenhouse gas ICAO International Civil Aviation Organization ISO International Standards Organization MRV Monitoring, reporting, and verification tCO2e Metric tons of carbon dioxide equivalent NDC Nationally Determined Contribution SSR Sinks, sources, and reservoirs VCS Verified Carbon Standard A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 2 Synthesis SYNTHESIS 1. BEFORE YOU BEGIN This guide to developing domestic carbon Carbon crediting refers to the process of issuing emissions crediting mechanisms is intended to assist reduction units to project activities in recognition of national and subnational policymakers quantified and verified emissions reductions. These considering whether and how to establish reductions are calculated as the difference between a carbon crediting mechanism in their emissions from the project and emissions from a baseline jurisdiction. The guide provides insights into scenario, which represents the scenario assumed to the decision points for designing a crediting occur in the absence of the crediting mechanism. mechanism and how to tailor the mechanism to achieve domestic policy objectives. Carbon credits can be used for different purposes; most often they are used to offset or partly compensate This guide is divided into 10 chapters for emissions covered by mandatory domestic carbon representing the key elements that must pricing instruments such as carbon taxes or emissions be considered when setting up a domestic trading systems (ETSs) and to help companies achieve crediting mechanism. These chapters should voluntary emissions reduction goals. While various types of crediting exist, this guide focuses only on be seen as the building blocks for developing crediting single-project activities and programs of a crediting mechanism, rather than linear steps activities. Further, it is primarily intended to be used in a decision-making process. Policymakers by policymakers in jurisdictions considering carbon can decide on issues simultaneously or in a crediting to achieve domestic climate policy objectives, different order than envisioned here to suit the and therefore, international crediting is not considered. specific circumstances of their jurisdiction. Carbon crediting provides a framework to support activities reducing greenhouse gas (GHG) emissions, as well those increasing removals of carbon dioxide.1 To be effective, crediting mechanisms should only credit projects that are additional—that would not have occurred in the absence of the crediting mechanism. They should also avoid over-crediting—that is, being issued with credits that represent more emissions reductions than what occurred. Robust additionality tests and conservative quantification methodologies can guard against these risks. Policy options for creating a crediting mechanism are assessed against three key criteria: environmental integrity, transaction costs for project proponents, and administrative burden on the government. The trade-offs between these criteria are likely to shape much of the structure of any crediting mechanism. For example, policy options that strive for a high level of environmental integrity could result in higher transaction costs for project proponents. 1 For simplicity of language, throughout this guide “emissions reductions” is used to cover both emission-reducing and sink-enhancing activities. 3 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Synthesis 2. UNDERSTANDING THE 3. USING EXISTING DOMESTIC CONTEXT CREDITING MECHANISMS Carbon crediting does not stand alone in the policy mix; Building a domestic crediting mechanism from the ground it requires other policy instruments to create demand up can be a significant undertaking, requiring financial for credits. It also can complement other climate resources, technical capacity, and regulatory expertise. To policy measures and tools, including regulation and reduce the time and effort (and depending on the broader other carbon pricing instruments. Policymakers need policy objectives) policymakers can allow credits issued to carefully assess the broader policy mix not only to by existing crediting mechanisms to be used for domestic determine the role of the crediting mechanism but also policy purposes. This can be advantageous where to determine how to manage interactions with other there is an immediate need for credits, may help attract policies that may complement, overlap, or undermine international investments and, can be attractive if domestic the effectiveness of the crediting mechanism. policymakers lack the necessary sources and expertise to start a domestic mechanism. If policymakers consider The policy objectives carbon crediting can achieve include this approach, only Chapters 4 and 5 will be relevant. y reducing emissions at a low cost, leading Policymakers can also draw on specific elements of to an overall increase in cost-effectiveness existing crediting mechanisms or outsource specific of achieving a specific emission goal; functions, like accreditation of auditors, methodologies for quantifying emissions reductions, or registry systems. y lowering cost of compliance for businesses seeking In all such cases, policymakers will need to carefully to fulfil other emissions reduction mandates; assess the relevant tools and elements from existing mechanisms to ensure they have the appropriate scope, y driving positive social, environmental, and economic have robust environmental integrity safeguards, and impacts beyond GHG emissions reductions; and are aligned with policymakers’ crediting objectives. y helping to mobilize carbon finance in sectors and activities not directly exposed 4. DECIDING ON THE SCOPE to carbon pricing instruments. A key initial step of any crediting mechanism is In designing the crediting mechanism, policymakers determining what sectors, gases, mitigation activities, or should consider involving relevant stakeholders at project types are allowed, as well the scale (i.e., level of an early stage to increase understanding, trust, and aggregation) of mitigation activities. Policymakers also support for the crediting mechanism. The need for and need to define—often at the methodological level—which level of stakeholders’ involvement will likely vary from sources and sinks each mitigation activity includes, jurisdiction to jurisdiction. Generally, in domestic crediting where eligible activities can take place, and the mix of mechanisms, stakeholder engagement takes place at project-based and programmatic activities the program the program design and methodology approval stages. will incentivize. The appropriate scope will depend on the policy objectives, priorities, and constraints of the implementing jurisdiction. The scope should be outlined in transparent and objective eligibility criteria. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 4 Synthesis Policymakers also need to decide on the scale of eligible mitigation activities and the geographic scope. 6. DEVELOPING Most crediting mechanisms start with project-based METHODOLOGIES activities but can be scaled up to programmatic activities once they have built the appropriate knowledge and Methodologies are the foundation of any crediting capacity. This guide is limited to domestic crediting mechanism as they establish the rules for project eligibility, mechanisms that focus on activities within a jurisdiction’s demonstrating additionality, quantifying emissions, and boundaries. However, policymakers may also want project monitoring. Robust methodologies are needed to to focus on certain regions within their jurisdiction. safeguard the environmental integrity of carbon credits. Methodologies can employ either a project-specific approach that relies on analysis of an individual project’s 5. DECIDING ON THE characteristics and circumstances, or a standardized CORE ELEMENTS approach where key components, such as determination of the baseline scenario and additionality, are uniformly The core elements of crediting mechanisms include applied for specific classes of project activities. Often avoiding double counting, setting the crediting period, crediting mechanisms use a combination of both. avoiding environmental or social harm, promoting development benefits, and addressing non-permanence To ensure environmental integrity, methodologies risks. Effective crediting mechanisms have systems in can restrict projects’ eligibility based on criteria like place to avoid double counting. Public and transparent baseline technologies or project scale, and these registry systems with extensive monitoring, disclosure, decisions should be in line with the mechanism’s scope. and accounting requirements can guard against double Generally, crediting mechanisms employ a variety issuance, double use, and double claiming of carbon of tests to demonstrate additionality. These can be credits. Policymakers also need to decide on the length of determined on a case-by-case basis or for a whole the crediting period (i.e., the time during which a project is category of projects. Whatever approach is adopted, registered and for which credits can be claimed). During policymakers need to bear in mind that demonstrating this period, the quantification parameters for emissions additionality is key to ensuring the environmental integrity reductions related to regulatory conditions are fixed at of the crediting projects and the mechanism itself. the outset, although conditions themselves may change throughout the period. Policymakers must strike a balance GHG quantification and reporting should be in line with between periods that are short enough to respond to GHG accounting principles, such as ISO 14064-2 and changing conditions (e.g., technological or policy changes) the GHG Protocol for Project Accounting, to promote but also long enough to provide project proponents a environmental integrity and provide additional guidance sufficient level of investment certainty. Policymakers must to project proponents and auditors. Finally, monitoring also determine the rules for crediting period renewals. project performance over time is essential as many factors that affect emissions can change over the project life cycle. Necessary safeguards should also be in place to ensure crediting mechanisms avoid social and environmental harm, particularly if existing domestic safeguard 7. ADOPTING, REVIEWING AND requirements are not able to sufficiently address REVISING METHODOLOGIES these concerns. Related to this, policymakers may want to design their crediting mechanisms to promote Policymakers need consistent and clear rules for development benefits, like reduced air pollution or developing and approving new methodologies, as well as increased job creation. If this is an objective of the for revising existing ones to correct for earlier errors or mechanism, identifying and monitoring development update them to reflect changes in policy. Policymakers can benefits can help amplify them, but will come at a cost use methodologies from existing crediting mechanisms, to the project proponents. Finally, policymakers need to which can also be modified to suit the domestic context address non-permanence risk for carbon removal projects or specific policy goals. Alternatively, policymakers by defining a permanence period and putting mechanisms can develop and approve methodologies through a like buffer reserves in place to manage the risk of reversals. bottom-up process, where they are developed by third 5 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Synthesis parties (often project proponents) or a top-down (i.e., A streamlined project cycle determines the project’s internally developed) process—or a combination of both. final eligibility at the time of the first verification of its The best approach will be determined by how quickly emissions reductions. As this takes place after the methodologies are needed, available resources to support project’s implementation, a streamlined approach creates this process, and the level of control policymakers uncertainty for project proponents because they do want over the methodology development process. not know eligibility from the outset. On the other hand, a streamlined approach can significantly reduce costs Methodologies should be reviewed and updated regularly for project proponents and administrators. It works well to reflect changes to technologies, practices, and with clear and simple eligibility criteria, such as with policy goals over time and protect the environmental standardized approaches to methodologies, or where integrity of the crediting mechanism. Policymakers need the project type is relatively simple with low additionality to outline the types of changes that may occur, when and safeguards risks. The streamlined system may be they will occur, and how often they will be reviewed introduced in certain cases after program administrators and updated. The Partnership for Market Readiness’ and stakeholders acquire more experience. (PMR) Developing Emissions Quantification Protocols for Carbon Pricing: A Guide to Options and Choices for Policy Makers covers these processes in more detail. 9. OVERSEEING AUDITORS Project validation and verification uphold the credibility 8. DECIDING ON THE and environmental integrity of crediting mechanisms. Typically, these functions are performed by independent PROJECT CYCLE auditors rather than program administrators or project proponents. Policymakers need to make certain that The term “project cycle” refers to the phases and auditors are well qualified and can competently validate procedures a crediting project has to go through, which and verify crediting projects. Putting in place formal include the registration phase (i.e., project application, standards and procedures to accredit and approve review, validation, and approval); the implementation auditors, as well as validation and verification standards, phase (i.e., monitoring, reporting, verification, and credit can ensure the consistency and rigor of these activities. issuance); and the renewal phase. Policymakers can opt Policymakers also need rules in place to minimize the for a full or streamlined project cycle. The full project risk of any conflicts of interest between auditors and cycle is more time-consuming and resource intensive project proponents. Finally, policymakers should also but provides greater certainty about the environmental regularly review auditors’ performance. The PMR’s integrity of projects. Project proponents will also have Designing Accreditation and Verification Systems more certainty about the eligibility of their projects. provides more information on these issues. This can be useful for complex mitigation activities, projects that use project-specific methodologies, and the early phases of a crediting mechanism. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 6 Synthesis 10. ESTABLISHING Because of the financial and legal implications associated with the creation and transfer of carbon GOVERNANCE credits, it is important to assign liability for the quality AND SUPPORTING and quantity of the credits. This is especially important in cases where credits have been found to be invalid. FRAMEWORKS The mechanism also needs a process for project proponents to appeal decisions by the administrator. Policymakers need a governance framework in place to ensure the smooth administration of the crediting Finally, crediting mechanisms will need a registry. mechanism. What this looks like will be jurisdiction This provides the technical infrastructure for issuing, specific but often includes a range of bodies that can transferring, and retiring credits, as well as making handle the following functions: (1) policy authority information on credits and projects publicly accessible. and oversight, to provide general policy direction; (2) Key governance questions include how a registry will rulemaking to develop secondary rules and regulations, be built and operated and what types of functions it such as methodologies; (3) implementation to ensure must be able to support. The PMR’s Emissions Trading such rules are adhered to, as well as any general day-to- Registries: Guidance on Regulation, Development, day administrative functions; and (4) technical advisory and Administration covers this topic in more detail. functions for expert input into specific components of the crediting mechanism’s design and overall operation. Institutional and governance choices will affect transaction costs and the administrative burden on government. Policymakers will need to find an institutional arrangement that is efficient, transparent, and predictable. This will give confidence in the crediting mechanism and can streamline both management of and participation in the mechanism. Policymakers must also consider the roles and involvement of other stakeholders. GETTING I GETTING STARTED STARTED I. Getting started 7 1 Before you begin 9 1.1 Purpose of this guide 9 1.2 Fundamental concepts in carbon crediting 12 1.3 Scope of the guide 14 1.4 Outline of the guide 15 1.5 Evaluation criteria for assessment of design options 15 2 Understanding the domestic context 17 2.1 Policy rationale and objectives 17 2.2 Crediting in the policy mix 20 2.3 Stakeholders and the process for designing a crediting mechanism 20 3 Using existing crediting mechanisms 23 3.1 Spectrum of reliance 23 3.2 Using carbon credits issued by existing mechanisms 24 3.3 Outsourcing or replicating design elements 26 9 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 1 you begin Before 1 BEFORE YOU BEGIN At a glance Carbon crediting refers to the process of issuing emissions reduction units to project activities in recognition of quantified emissions reductions. These reductions are calculated as the difference between emissions from the project and emissions from a baseline scenario, which represents the scenario assumed to occur in the absence of the crediting mechanism. Carbon credits can be used for different purposes; most often they are used to offset or partly compensate emissions covered by mandatory domestic carbon pricing instruments (e.g., carbon taxes or emissions trading systems [ETSs]) and to help companies and other entities achieve voluntary emissions reduction goals. While there are various types of crediting, this guide only focuses on crediting single-project activities and programs of activities and is intended to be used by policymakers in jurisdictions considering carbon crediting to achieve domestic climate policy goals. Carbon crediting provides a framework to recognize activities that either reduce greenhouse gas (GHG) emissions or increase carbon dioxide removals. Emissions reductions are distinguished from carbon dioxide removals from the atmosphere: emissions reductions prevent emissions from entering the atmosphere, while carbon dioxide removals involve sequestering atmospheric carbon dioxide in either the biosphere (e.g., trees) or the lithosphere (e.g., soil and geological structures). However, to be effective, crediting mechanisms must only award emissions reduction units to projects that are additional: these activities must lead to emissions reductions that would not have occurred in the absence of the crediting mechanism. They must also avoid over-crediting, or overstating mitigation through inaccurate quantification methodologies or inappropriate assumptions. Policy options are assessed against three key criteria: environmental integrity, transaction costs, and administrative burden. The trade-offs between these criteria are such that they are likely to shape much of the structure of any crediting mechanism. For example, options that deliver a high level of environmental integrity may potentially lead to higher transaction costs and therefore fewer crediting projects. Section 1.1 outlines the purpose of the guide and Section 1.2 introduces a number of fundamental concepts that are used throughout the guide. Section 1.3 outlines the scope of the report, identifying the key areas of focus and specific exclusions. Section 1.4 presents the outline of the guide, while Section 1.5 describes evaluation criteria policymakers can use to assess design options presented throughout the guide. 1.1 PURPOSE OF THIS GUIDE how to tailor the mechanism to achieve domestic policy objectives. It identifies policy design options and, where This Guide to Developing Domestic Carbon Crediting possible, provides recommendations, drawing on Mechanisms (hereafter “guide”) provides an in-depth examples of practices in existing crediting mechanisms, introduction to designing domestic carbon crediting with a particular emphasis on domestic systems, when mechanisms. It provides guidance for national and available (see Box 1-1). Where policymakers have subnational policymakers considering whether and several viable options for a key design feature, the guide how to establish a carbon crediting mechanism in their highlights the trade-offs policymakers need to consider. jurisdiction. The guide provides insights into the decision points for designing a crediting mechanism and indicates A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 10 you begin Before Box 1-1. Carbon crediting mechanism categories As outlined in the State and Trends of Carbon Pricing regulation or international treaties. They are 2020,2 carbon crediting mechanisms can be classified administered by private and independent into three categories, based on how credits are third-party organizations, which are often generated and the way the crediting mechanism is nongovernmental organizations. Examples are the administered: Gold Standard and the Verified Carbon Standard (VCS). These largely supply the voluntary market. 1. International crediting mechanisms. International crediting mechanisms are those 3. Regional, national, and subnational crediting governed by international climate treaties and are mechanisms. Regional, national, and subnational usually administered by international institutions. crediting mechanisms are governed by their Examples are the Clean Development Mechanism respective jurisdictional legislatures and are (CDM) and Joint Implementation. usually administered by regional, national, or subnational governments. In 2020, there are 23 2. Independent crediting mechanisms. regional, national, and subnational carbon crediting Independent crediting mechanisms are mechanisms in operation or scheduled mechanisms not governed by any national for implementation (see Figure 1-1). Two developments have shaped the evolution of crediting The design, methodologies, and experiences of many mechanisms over the past decades: the CDM and of these mechanisms can also offer valuable insights corporate interest in voluntary credits. Firstly, practical to policymakers interested in designing a domestic experience with crediting mechanisms is largely dominated mechanism. While regional, national, and subnational by the CDM, an international crediting mechanism crediting mechanisms exist, many of these are found in established by the Kyoto Protocol in 1997. It has North America and it is only in recent years that developing generated more than two decades’ worth of experience countries have started to roll out, or consider, their own in crediting. With projects in over 100 countries, it is also crediting mechanisms (see Figure 1-1). This guide has tried responsible for over half of all issued credits.2 It has also to highlight domestic crediting examples where relevant; developed over 250 methodologies for crediting emissions however, much of the experience and lessons learned reduction activities and many countries have drawn to date stem from the CDM and independent crediting on their experiences with the CDM, its methodologies mechanisms and therefore have been used to demonstrate and templates to establish their own mechanisms. Its examples of implementation throughout this guide. sheer size and geographic reach means the CDM has exerted substantial influence on the design of crediting mechanisms. Secondly, a significant share of activity in the crediting market has been driven by companies interested in using carbon credits to meet corporate voluntary climate commitments. Independent crediting mechanisms, which have historically focused on servicing the voluntary market, were responsible for almost two-thirds of credits issued in 2019.2 Many of these mechanisms, like the Climate Action Reserve, Gold Standard, and VCS, have been operating for close to 20 years. 2 World Bank 2020. 11 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS you begin Before Figure 1-1. Existing regional, national, and subnational carbon crediting mechanisms British Columbia Alberta Emission Québec Offset Beijing Forestry Saitama Crediting Offset Program Offset Program System Offset Mechanism Mechanism, Saitama Forest Absorption Certification System Tokyo Offset Mechanism Fujian Forestry Offset Crediting Mechanism Guangdong Pu Hui Offset Nova Scotia Crediting Mechanism Washington State Crediting Mechanism Crediting Mechanism RGGI CO2 Offset Mechanism Canada GHG Offset System Switzerland CO2 Kazakhstan Crediting Attestations Crediting Mechanism Republic of Korea Mechanism Offset Program Spain’s Carbon Fund for a Sustainable Economy Joint Crediting California Compliance Mechanism Offset Program Mexico Crediting Mechanism China GHG Voluntary Emission Reduction Program Australia Emissions Reduction Fund South Africa Crediting Mechanism Implemented Under development Source: Adapted from State and Trends of Carbon Pricing 2020, World Bank 2020. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 12 you begin Before 1.2 FUNDAMENTAL CONCEPTS IN CARBON CREDITING For the purposes of the guide, carbon crediting is represents the scenario assumed to occur in the defined as the process of issuing emissions reduction absence of the crediting mechanism (see Figure 1-2). units to project activities in recognition of quantified emissions reductions. These reductions are calculated The subsections below introduce some concepts that as the difference between emissions from the project are fundamental to the crediting process. Key terms and emissions from a baseline scenario, which used throughout the guide are summarized in Box 1-2. Figure 1-2. Example of how carbon crediting works Business as usual (BAU) Emissions BAU Wastewater emissions plant; methane is being vented Time Implementation of emission reduction project Emission reduction project Emissions Emissions BAU levels Methane captured reductions eligible and combusted for crediting to generate Remaining emissions electricity Time Issuance of carbon credits Carbon credits Carbon credits can generation Crediting be sold as offsets Emissions mechanism Carbon Creation of carbon credits or to determine credits equal to results-based the emissions climate finance reduced in metric payments, for tons of CO2 instance. Time Source: World Bank 2020. 13 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Box 1-2. Key terms used in the guide you begin Different crediting mechanisms often use different Program administrator: The entity responsible for Before terminology to describe their system and the various administering the day-to-day functions of the crediting actors in the system. For consistency and clarity, this mechanism. Guide uses a common set of terms regardless of the specific mechanism considered, summarized below. Projects: The activity, group of activities, or programs undertaken to deliver emissions reductions. Crediting mechanism: Initiative that issues tradable credits to actors that voluntarily implement emissions Project proponents: The entities responsible for reduction activities that are additional to business-as- implementing the project. Other sources may use usual operations. Other sources may use “crediting the terms “project developers,” “project owners,” or program” or “offset program” to describe the same “project designers” to describe the same entities. initiative. Auditors: The entities responsible for undertaking Policymaker: The entity responsible for designing validation and verification activities. Other sources may the crediting mechanism (and/or other policies) in use “verifiers, validation, and verification bodies” or, in the jurisdiction. Other sources may use “program the case of the CDM, “designated operational entities” designer” to describe an entity with the same function. to describe the same entities. 1.2.1 Crediting at the levels of y Policy crediting involves estimating the effects of projects and programs specific policy measures, like an energy efficiency standard or feed-in tariff, on overall emissions levels Policymakers can take four different approaches and crediting the outcomes of such policies. to carbon crediting. The first two involve focus on specific activities, and the second two are Figure 1-3. Crediting at different levels and scope forms of “scaled-up” crediting (see Annex I): of this guide y Single-project crediting is are pursued by a Scope of this guide project proponent, normally in a single installation Single-project (i.e., facility or entity) or a set of installations, crediting applying a specific technology or process. y Programmatic crediting lets project proponents Programmatic generate credits from similar activities within crediting an overall program as described in the project methodology or protocol. Programs allow for some flexibility in that they need not identify clearly, before commencing activities, the specific installations Scaled up creditng or devices generating the required emissions Sectoral Policy reductions. These tend to be small and micro crediting crediting scale activities (e.g., at the household level). y Sectoral crediting aggregates emissions reductions across an entire industrial sector or subsector. It does not prescribe the types of activities undertaken within the sector. Credits are only generated if a predetermined aggregate target Additional detail on each of the four approaches to crediting, (e.g., sector-wide target or jurisdictional target in including examples of each, is provided in Annex II. the case of jurisdictional crediting) is reached. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 14 1.2.2 Emissions reductions versus This situation is referred to as over-crediting. carbon removal Credits can only have environmental integrity In most industrial and energy-related projects, reducing if the issued credits are additional and the you begin GHG emissions from the baseline scenario involves emissions reductions quantification methods are Before reducing (or avoiding) an emission that would have conservative, and therefore avoid over-crediting otherwise occurred. By contrast many forestry-related (see environmental integrity criteria below). projects, as well as carbon capture and storage projects, capture carbon dioxide from the atmosphere and store it in carbon sinks—the biosphere (e.g., in forests) or the 1.2.6 Voluntary participation lithosphere (e.g., in soils or in geological structures). Carbon taxes and ETSs adopt the “polluter pays principle,” whereby polluters face a carbon price that they internalize For simplicity of language, throughout this guide, into their decision-making. Instead of placing a cost on “emissions reductions” is used to cover both emissions, carbon crediting rewards emissions reductions. emission-reducing and sink-enhancing activities. As a result, project proponents and other actors participating in a crediting mechanism do so voluntarily— 1.2.3 Crediting versus offsetting even where mandatory obligations (e.g., for emitters under a carbon tax or ETS) drives demand for those credits. The terms offsetting and crediting are often used interchangeably. However, in this guide crediting refers to the process of providing recognition for emissions 1.2.7 The need for an external reductions, while offsetting refers to the particular use source of demand of a credit to compensate for (or “offset”) an emission Carbon crediting mechanisms are a type of carbon by an agent under either a mandatory or a voluntary pricing instrument that, unlike carbon taxes and ETSs, commitment. Similarly, a credit is the unit representing do not in themselves create a carbon price directly or an emissions reduction, whereas an offset represents indirectly. Instead, they complement initiatives that create the use of that unit in a particular policy context. For demand for emissions reducing activities, either at the instance, a credit is not an offset where it is used domestic or the international level. For carbon credits to support results-based climate finance through a to have value, crediting mechanisms require an external mechanism, like the Pilot Auction Facility of the World source of demand for the credits. For example, an ETS Bank. In this example, the Pilot Auction Facility could could allow regulated emitters to use credits as part of purchase credits as a proxy for mitigation, but such their compliance with the cap, corporations could use credits would not be used to compensate for any them to help meet their voluntary emissions reduction emissions. This guide uses the term “credit” wherever goals, or governments could purchase the credits the unit is involved, and only uses “offset” in contexts in recognition of the delivered emissions reductions involving compensation for other emissions. (otherwise known as results-based climate finance). 1.2.4 Additionality 1.3 SCOPE OF THE GUIDE Carbon credits should only be awarded to activities that are driven by the incentive provided from the crediting The guide’s primary target is policymakers aiming to mechanism—that is, if they demonstrate additionality. If develop domestic crediting mechanisms in support of an actor would undertake an activity even in the absence domestic mitigation goals. It does not include details on of the crediting mechanism, the activity is not additional developing an international crediting mechanism—such and the emissions reductions should not be recognized as the ongoing discussions on rules for Article 6.4 and by the crediting mechanism. There are a range of Article 6.2 of the Paris Agreement—and refers to these options to test whether a project activity is additional. only where there is a link to policy choices made at a These tests are described in Chapter 6. Additionality domestic level. International cooperation is approached is a fundamental part of crediting mechanisms and a only insofar as it may be relevant to discussions on mechanism’s environmental integrity is compromised if the design of domestic carbon crediting systems. carbon credits are issued to non-additional projects. This guide focuses on project-based and programmatic 1.2.5 Over-crediting crediting. In domestic contexts, scaled-up crediting may play less of a role and be less relevant because such Even if a crediting mechanism has deemed an activity mechanisms may be larger than the potential crediting additional, if the methodology applied to calculate demand in most domestic markets, and most national the emissions reductions overestimates baseline governments lack the capacity to administer them. In scenario emissions or underestimates project scenario addition, with the exception of reduced emissions from emissions, the resulting calculation will be inflated. 15 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Figure 1-4. Outline of designing a domestic crediting mechanism you begin 08 DECIDING ON THE PROJECT CYCLE BEFORE YOU BEGIN 01 Before 09 OVERSEEING AUDITORS UNDERSTANDING THE 02 DOMESTIC CONTEXT 10 ESTABLISHING GOVERNANCE AND SUPPORTING Governance and Getting USING EXISTING 03 CREDITING FRAMEWORKS assurance for started MECHANISMS domestic crediting mechanisms 06 DEVELOPING Designing a domestic DECIDING ON THE SCOPE 04 METHODOLOGIES crediting mechanism 07 ADOPTING, REVIEWING AND DECIDING ON CORE ELEMENTS 05 REVISING METHODOLOGIES deforestation and land degradation, which has been a viable and well-defined category of crediting mechanism, 1.5 EVALUATION CRITERIA sectoral and policy-based concepts have remained FOR ASSESSMENT OF at a pilot stage to date. Annex II provides additional information on sector and policy crediting, as does DESIGN OPTIONS the PMR’s technical note on Establishing Scaled-up Crediting Program Baselines under the Paris Agreement. The guide provides three evaluation criteria policymakers can use to assess design options or considerations presented at each step of the design process: 1.4 OUTLINE OF THE GUIDE y High environmental integrity. Promoting The guide summarizes the main decisions confronting environmental integrity in a crediting system means policymakers in setting up a crediting mechanism (see ensuring that aggregate emissions do not increase Figure 1-4). The first step in this process, before the as a result of the crediting transactions.3 This actual design of any program, is to clarify its policy requires consideration of multiple elements, including objectives. The following chapters cover the major ensuring that the activity is additional, the emissions decisions for designing a crediting mechanism once abatement is independently verified, there is no the objectives have been clarified. Rather than linear double counting of emissions reductions, and the steps in a decision-making process, these may be seen emissions reductions are permanent.4 Policymakers as building blocks. There is a typical order of issues— often use principles to promote environmental integrity deciding on scope before deciding on methodological in program development, project implementation, development rules, for example. Nevertheless, and sourcing of carbon credits.5 Ensuring genuine policymakers can also decide on issues simultaneously abatement also requires GHG emissions reductions or in a different order than envisioned here. to be quantified and reported in accordance with the GHG accounting principles to avoid over- crediting emissions reduction activities. Promoting ³ Schneider and La Hoz Theuer 2019. 4 Schneider and La Hoz Theuer 2019; Broekhoff et al. 2019. 5 See, for example, Broekhoff et al. 2019. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 16 environmental integrity is important for stakeholders y Minimal administrative burden. An important to view carbon credits, and the crediting mechanism criterion, given administrative capacity in many more generally, as a credible approach to reducing developing countries, is that the rules of the crediting emissions. A market that includes carbon credits that mechanism must not impose an unreasonable you begin Before have (or are perceived to have) low environmental administrative burden on the government. integrity can undermine investment certainty and Policymakers may consider whether specific choices reduce overall confidence. Further, the presence of might require significant additional analysis, review, low environmental integrity carbon credits will make or other action by government agencies, and it more expensive for jurisdictions to meet emissions whether this is worthwhile. There are several options reduction targets, because additional emissions to minimize the burden; for example, by utilizing reductions must be sourced to compensate for any the administrative infrastructure of international abatement that is not real. Chapters 5, 6, and 9 in crediting mechanisms or outsourcing some particular address these components in more detail. functions to third parties (see Chapters 3 and 10). y Low transaction costs. Transaction costs for At times, policymakers may have to decide how project proponents include costs of collecting and to balance competing criteria (see Figure 1-5). reporting program-specific data, fees charged by the crediting mechanism (e.g., for registering projects A classic trade-off will likely involve the balance between or issuing credits), and the costs of developing and environmental integrity and the administrative and auditing project documentation and performance. transaction costs. While a certain level of environmental They can also include the costs of the uncertainty integrity is necessary, additional rigor, tests, and and time required in the regulatory process or procedures may also increase the costs for program resulting from frequent or unexpected changes in the administrators and project proponents. Jurisdictions rules, procedures, and guidelines (see discussion of have developed a range of ideas on how to manage the project cycle in Chapter 8). Higher transaction transaction costs, including greater emphasis on costs may reduce participation in the market, both regulatory certainty; simplification through standardization because they affect the financial viability of projects of baselines, project cycles, and other methodological and because they create uncertainty for investors. components; development of standardized parameters and approaches (such as positive lists for additionality); and the introduction of concepts such as “materiality”  6 into the validation and verification procedures. Figure 1-5. Trade-offs between design criteria Low transaction costs Minimal High administrative environmental burden integrity 6 Materiality is a concept that auditors apply in verifications in order to detect errors, omissions, or misstatements in emissions reductions being claimed. Something is material when the statement, omission, misstatement, or erroneous reporting of it could change the registration or issuance of carbon credits. This may be defined, for example, in terms of a certain percentage of the emissions reductions impact. 17 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 2 2 UNDERSTANDING THE DOMESTIC CONTEXT Understanding the domestic context At a glance Carbon crediting does not stand alone in the policy mix; it requires mechanisms to create demand for credits. It also can complement other climate policy instruments, including regulation and other carbon pricing instruments. The policy objectives carbon crediting can achieve include: • reduce emissions at a low cost, leading to an overall increase in cost-effectiveness; • reduce businesses’ cost of compliance with other emissions reduction mandates; • deliver positive social, environmental, and economic impacts beyond greenhouse gas (GHG) emissions reductions; and • help to mobilize carbon finance in sectors and activities not directly exposed to a carbon price. In designing the crediting mechanism, policymakers should consider involving relevant stakeholders at an early stage to increase understanding, trust, and support. Stakeholders’ inputs will be needed at the design stage and particularly in the process of methodology and project approval. This chapter outlines the preparatory steps policymakers should consider before designing a domestic crediting mechanism. Section 2.1 looks at the rationale and objectives for crediting, highlighting the need for policymakers to prioritize their objectives from the outset. Section 2.2 discusses the role of crediting: a crediting mechanism cannot operate in isolation but can support and complement a broader suite of climate policies. Finally, Section 2.3 highlights the importance of identifying and engaging with stakeholders to build understanding and expertise for both stakeholders and the government. 2.1 POLICY RATIONALE 2.1.1 Reducing emissions and helping the jurisdiction achieve its targets AND OBJECTIVES If demand exists, crediting can contribute to emissions reductions and help governments achieve their emissions Policymakers must establish the objective(s) of the reduction targets (including, if appropriate, National crediting mechanism because these priorities will affect Determined Contributions [NDCs]). Under the Kyoto important design and policy decisions later on. Table 2-1 Protocol, for example, Germany, France, Portugal, and identifies the policy objectives that introducing a crediting Spain instituted domestic carbon credit procurement mechanism into the climate policy mix can achieve. schemes. These incentive programs were based on These objectives are not mutually exclusive, and, in the use of carbon crediting methodologies to advance some cases, the objectives may even be mutually carbon mitigation in sectors and activities climate supportive. For example, allowing credits from uncovered policy instruments did not otherwise cover. This can be sectors can reduce a business’s cost of complying with particularly useful for sectors that are not traditionally an emissions trading system (ETS), while mobilizing covered by an ETS or a carbon tax, like the forestry sector. additional investment to these uncovered sectors. Forestry credits are generated in domestic crediting mechanisms in several jurisdictions (for example, Alberta, Beijing, California, and Switzerland). Clearly defining the role of the crediting mechanism in a jurisdiction’s A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 18 Table 2-1. Potential policy objectives for crediting mechanisms Policy objectives Description Illustrative examples Reduce emissions/ Broadens access to emissions reductions Almost all national and subnational help achieve NDC options across the economy, increasing the crediting mechanisms have this goal. cost-effectiveness of achieving mitigation Understanding the domestic context targets, and can result in an increased level of ambition. Reduce domestic Adds additional flexibility to compliance Used for offsetting compliance obligations compliance costs options by allowing offsets in addition under carbon markets in the United States to allowances or tax payments. and Canada.7 Used for offsetting compliance obligations under South Africa’s carbon tax regime. Provide offset options Facilitates stronger voluntary commitments Costa Rica’s Carbon Neutrality to corporations to mitigation from corporations and other Program for companies. entities not subject to mandatory policies or emission constraints. Mobilize investment (including Directs private (or public) investment to Results-based climate finance international results- mitigation activities in possibly under- programs such as the World based climate finance) funded sectors/activities. Bank’s Pilot Auction Facility. Promote development benefits Delivers investment into sectors and Programs such as the Carbon Initiative for activities that may increase development Development and VCS methodology for benefits (employment/biodiversity, blue carbon credits. environmental health). policy mix and its contribution to achieving both current and implemented correctly, can lower the overall ETS and future emissions reduction targets will be critical compliance costs, and may theoretically result in components of the crediting mechanism design process. industry and government having a broader willingness to take on more aggressive mitigation. The Partnership 2.1.2 Providing flexibility and reducing for Market Readiness’ (PMR) Emissions Trading in domestic compliance costs Practice: A Handbook on Design and Implementation provides additional guidance on other options to improve The most common reason for introducing a domestic compliance flexibility and reduce compliance costs. crediting mechanism is to reduce the cost of compliance with a mandatory ETS or carbon tax that is already Similarly, some jurisdictions allow companies to use in place. However, almost all8 jurisdictions that allow credits to satisfy carbon tax obligations or as a way the use of offsets cap the amount that can be used of avoiding the requirement to pay carbon taxes, as is to meet an entity’s compliance obligation. Out of the the case in South Africa and Colombia, respectively. 21 ETSs in operation in 2020, only three systems Chile and Mexico are also in the process of developing (Nova Scotia, New Zealand, and Massachusetts) do domestic crediting mechanisms that will be linked with not allow for offsets. (However, a link to high-integrity their carbon taxes. Allowing a company to meet part international carbon markets is likely to form part of of its carbon tax obligation through credits can provide New Zealand’s 2030 strategy and Nova Scotia’s ETS greater flexibility for businesses in how they fulfill their tax legislation includes the possibility for a future offset obligations. The PMR’s Carbon Tax Guide: A Handbook system.9) Carbon crediting mechanisms, if designed for Policymakers provides additional guidance. 7 For instance, the British Columbia Offset Program, California Compliance Offset Program, Québec Offset System, and the Regional Greenhouse Gas Initiatives’ CO2 Offset Mechanism. 8 Kazakhstan, for instance, does not limit the use of domestic offsets in its ETS. 9 For more see the International Carbon Action Partnership’s ETS Map: https://icapcarbonaction.com/en/ets-map. 19 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 2.1.3 Providing offset options to Where credits are issued, they provide a tangible businesses and other organizations investment opportunity that can attract investments from a broad range of financial players. In this way, Carbon crediting mechanisms provide a source of carbon credits can be used as a metric of carbon credible emissions reductions that businesses and performance. This approach is used in results-based other organizations can use to voluntarily offset climate finance, which relies on the ability to measure, their emissions. Crediting mechanisms facilitate in a cost-effective way, actual GHG performance this by providing a source of high-quality units. Understanding the domestic context of a specific investment (i.e., decrease in GHG emissions or increase in carbon sequestration). 2.1.4 Measuring benefits and mobilizing finance Domestic jurisdictions can attract additional international financial flows where foreign investors can make Crediting mechanisms can be used as tools to measure investments in specific projects to obtain carbon credits. the climate benefit of specific policies or investments As an example, the Clean Development Mechanism and/or mobilize climate finance. These benefits can be (CDM) under the Kyoto Protocol facilitated foreign realized even if carbon credits are not formally issued, financial flows by attracting private sector investment. as the methodologies used in crediting mechanisms The discussions on Article 6 of the Paris Agreement can be used by governments and private investors to date suggest a similar international transfer of to estimate the GHG emissions reduction value of a domestic credits may be allowed and recognized particular measure or understand the GHG emissions under the Paris Agreement framework (see Box 2-1). reduction impact of a financial investment. Box 2-1. Transferring domestically generated carbon credits under the Paris Agreement The direction of international climate policy may be domestic crediting mechanisms to align with them. particularly important if a country wants to allow the Similarly, Article 6.4, for which rules are also being “export” of domestic mitigation units (e.g., carbon negotiated, is intended to allow emissions reductions credits) in order to attract foreign financial flows to be transferred under a more centralized international through the purchase of these units. However, the mechanism that is directly under the guidance of the transfer of mitigation units to other jurisdictions, if Parties to the Paris Agreement. not well designed, carries the risk of exporting lower- cost abatement (i.e., the domestic carbon credits) Notwithstanding the absence of final rules on that the host country could otherwise use to reach implementation of Article 6, the Paris Agreement its own domestic mitigation goals. If countries sell has established the intent that only one Party can their domestic mitigation units abroad, they cannot count the same internationally transferred mitigation use those reductions to reach current and future outcome toward meeting its NDC target. Thus, climate goals. The Paris Agreement will regulate a Party that transfers the results of an Article 6 how participating countries (Parties) engage in the cooperation program cannot then count those international transfers of mitigation outcomes— emissions reductions toward achieving its own NDC including domestic credits. goal. Article 6.2 requires that Parties avoid “double counting,” which is discussed further in Chapter 5. Article 6 of the Paris Agreement establishes two Countries are beginning to develop their own policies potential opportunities for for Parties to voluntarily and procedures in anticipation of an agreement on cooperate to support meeting their NDC goals. Under principles and rules for Article 6 in the coming years. Article 6.2, Parties may transfer “mitigation outcomes” For example, Costa Rica has already developed credit to achieve their NDC targets; that is, they could export criteria and an approval procedure for such transfer domestic credits as mitigation outcomes to transactions. other Parties. The detailed rules for Article 6.2 are still being negotiated, and thus it would be premature to provide specific recommendations for the design of A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 20 2.1.5 Promoting development benefits Broad-based mandatory carbon pricing instruments, such as a carbon tax or an ETS, provide better tools to Carbon crediting mechanisms have the potential to incentivize reductions across the economy than crediting. promote additional benefits beyond emissions reductions. However, carbon crediting has its advantages in some They can provide incentives for specific technologies situations. For example, jurisdictions with an ETS or carbon or processes that have other sustainable development tax can use crediting in uncovered sectors to provide benefits. In many cases, climate change mitigation may additional compliance flexibility to regulated companies in go hand in hand with objectives such as improving air Understanding the domestic context covered sectors. In addition, a crediting mechanism could quality, protecting water resources, improving soil health be a useful option if there are barriers, for instance legal and biodiversity, and improving productivity. Other social hurdles or political resistance, to implementing an ETS or and economic benefits could include improved energy a carbon tax. In these cases, a crediting mechanism may access (e.g., off-grid lighting and electrification), providing be a good starting point to send a carbon pricing signal jobs implementing new technologies (e.g., retrofitting and build familiarity with market mechanisms. Additionally, of buildings), improving livelihoods, and assisting in the crediting may also be useful in sectors that have early commercialization of new emissions reductions diffuse emissions—such as emissions from agriculture technologies or products. Policymakers may choose and livestock—and for which appropriate emissions to narrow the scope of eligible projects or impose monitoring protocols have not yet been developed. additional requirements to promote specific benefits. See Chapter 5 and the PMR’s forthcoming report The Importantly, unlike a carbon tax or an ETS, carbon Development Benefits of Carbon Pricing for more detail. crediting cannot stand alone because it requires an external demand for credits. Demand for carbon credits 2.2 CREDITING IN could be generated through a number of options, such as from entities with compliance requirements under an THE POLICY MIX ETS or carbon tax; a government mandate for emissions reductions; and/or voluntary climate commitments. While a domestic crediting mechanism cannot be the Governments will need to consider whether there will only tool to decarbonize an economy, it can serve as a be sufficient demand before embarking on the crediting useful mechanism to incentivize emissions reductions and mechanism design process. Assessing demand for credits help deliver broader policy objectives. Determining the will usually rely on economic analysis of mitigation options role of crediting in a policy mix will require policymakers and economic modeling of supply-demand interaction. At to map existing and planned policies to see where a the same time, a variety of other policy instruments may crediting mechanism will be best suited. The answer to have a bearing on the effectiveness of carbon crediting, so the question of how carbon crediting should be used by their interaction also needs to be factored in. Overlapping a jurisdiction vis à vis other policy options is one that will or countervailing policies could undermine the additionality vary depending on jurisdictional context and is beyond of the crediting mechanism and its overall effectiveness. the scope of this paper. The PMR’s forthcoming guide on Carbon Pricing Assessment and Decision Making: A Guide to Adopting a Carbon Price provides a framework 2.3 STAKEHOLDERS AND THE for determining the role of a carbon pricing instrument. PROCESS FOR DESIGNING Looking at the interaction with other policy frameworks, A CREDITING MECHANISM crediting can help to develop appropriate monitoring frameworks that support policy development for other Involving stakeholders in program design and regulatory approaches or vice versa. In some early implementation has several key benefits, including cases, low-cost abatement opportunities identified (for the following:10 example, in the framework of the CDM), have led the way to inclusion of these opportunities in regulatory y Building understanding and expertise. Stakeholder instruments, post-crediting. Conversely, emissions or engagement gives policymakers access to additional technology regulations may provide benchmarks against sources of expertise and ensures stakeholder which to assess crediting activities. In most crediting concerns are considered as part of the crediting mechanisms, activities can be credited only if they are not design process. Stakeholders who were involved in mandated by law and thus crediting projects must achieve the design of the program will be better positioned a higher level of climate action than the law requires. to participate in it. Likewise, involving multiple well- 10 Based on Step 2 on engaging stakeholders in the forthcoming revised ETS Handbook. 21 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS informed stakeholders, such as potential project The nature of the stakeholder engagement will likely proponents, industry players, environmental be shaped by the statutory requirements, standard regulators, auditors, climate experts, and experienced practices, and norms for public engagement in authorities from other jurisdictions, in the design of the that jurisdiction. Broadly speaking, stakeholder mechanism will allow for smoother implementation. In engagement should take place at two levels, which addition, the program may need to allow extra time for are addressed in different places in this guide: stakeholders to consider particularly complex elements Understanding the domestic context of carbon crediting mechanisms, particularly if the y Program design. While a government entity country has little experience with market mechanisms. (national or subnational) leads the design process, Additional time may also be needed to engage with both technical review (e.g., by experts in the private the regulatory authorities of a carbon tax or ETS that sector, academia, and think tanks) and input may provide the domestic demand for the credits. from civil society on the socioeconomic and local environmental impacts of the crediting mechanism y Building credibility and trust. Giving stakeholders will benefit the design process. As an example, the chance to review and understand the rationale Mexico is currently developing a mechanism to allow and planned rules for a system tends to increase their mitigation credits to be recognized as offsets under its confidence in it. External, peer-reviewed research ETS. The development process started with internal will ensure that information and data are public and consultations with the main public institutions in that conclusions are as transparent as possible. charge of design and regulation and the support of Active engagement before and during implementation international experts. This was followed by a series will make it easier for stakeholders to anticipate of virtual technical workshops with stakeholders the approval processes for crediting projects. across several sectors to seek advice on alignment Transparent and clear stakeholder engagement can with other national policies and programs, as well also build trust, for instance, with civil society and as on the scope and approach of the crediting environmental nongovernmental organizations in the mechanism across several sectors. Once the first environmental integrity of the crediting mechanism. draft of the program is ready, it is expected that the government will consult with a wider stakeholder y Building acceptance and support. A successful group. The development of the crediting mechanism in crediting mechanism needs enduring social Mexico follows a much longer process of stakeholder acceptance and interest. Broad political support engagement on the ETS design itself. Policymakers will help ensure the viability of the system through in Mexico have therefore built on established political cycles and increase the system’s legitimacy. public consultation procedures generally used for new environmental regulations in the country. Policymakers should identify and map stakeholders before engaging with them. This includes not only y Methodology approval. Stakeholders may be project proponents and businesses from sectors likely invited to review and comment on proposed to participate in the crediting mechanism, but other crediting methodologies as part of the review and government stakeholders (including relevant ministries and approval process (see Box 2-2). Stakeholders political parties), academia and think tanks, the media, may have particular insight into technical aspects and the broader public. Other jurisdictions with similar such as the additionality of the project activities, domestic crediting mechanisms may also be consulted. availability of information, and the assessment of the Figure 2-1. Example of process for making policy decisions for a crediting mechanism Conduct Set Engage Approve technical objectives stakeholders design analysis Communication A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 22 Box 2-2. Example of stakeholder input on methodology approval: California The California Air Resources Board (CARB) governs • 45-Day Comment Period: provide at least the Compliance Offset Program for the state’s 45 days for the public to review the proposed ETS. CARB has a formal and extensive process Compliance Offset Protocol text and staff report and provide written comments to CARB. Understanding the domestic context for stakeholder input for all new proposed offset protocols:a • Public Hearing: present the proposed Compliance • Offset Protocol Announcements and Timing: Offset Protocol to the Board for its consideration. announce decisions to develop new offset The dates and agendas for each hearing are posted protocols in a public setting, open to on the rulemaking website. Stakeholders can all stakeholders. provide written and oral testimony to the Board. • Informal Development Activities: hold public • Summary and Response to Comments: workshops or technical meetings to discuss summarize and respond to all formal comments the development of a potential offset protocol. submitted during the 45-day comment Depending on the complexity of the project type, period, at the Board hearing, and during any CARB may hold a series of workshops or subsequent 15-day comment periods. technical workgroup meetings. • Submission of a Rulemaking Action to the • Issuing the Public Notice: initiate formal Office of Administrative Law for Review: rulemaking action by issuing a public notice of following final CARB approval, submit rulemaking proposed rulemaking, with a Board hearing date record to the Office of Administrative Law for posted at least 45 days prior to the Board hearing. review. Upon the office’s approval, the Board- This notice initiates a 45-day public comment adopted Compliance Offset Protocol is filed with period. the Secretary of State. • Availability of the Proposed Text and the Initial Statement of Reasons: Along with the public notice, provide the proposed Compliance Offset Protocol text and a staff report that includes Source: CARB 2013. a an explanation of why certain decisions were made https://ww2.arb.ca.gov/sites/default/files/classic//cc/capandtrade/ compliance-offset-protocol-process.pdf in the development of the proposed Compliance Offset Protocol. baseline and monitoring, reporting, and verification In terms of the process for designing a new crediting requirements. Their input can also ensure that the mechanism, governments may choose to seek input from program will address any local stakeholder concerns a wide range of stakeholders on the proposed design about potential adverse impacts. This could be options for the crediting mechanism (see Figure 2-1). particularly important for land-use change and This might follow a technical analysis of policy options forestry methodologies, as well as projects improving and be part of a process led by the principal ministry cookstove efficiency (for more detail see Chapter 7). for the crediting mechanism or an interministerial committee or board overseeing climate change policy. In addition, in some cases, there may be a need to More detailed guidance on stakeholder consultation consult as part of project approvals. While this was can be found in the PMR’s Carbon Tax Guide and the a large part of many international and independent PMR and International Carbon Action Partnership’s crediting mechanisms, it is uncommon for domestic Emissions Trading in Practice: A Handbook on Design programs. To promote transparent and effective and Implementation. The Guide to Communicating stakeholder management, policymakers should Carbon Pricing also offers relevant insights. compile, and provide public responses to, feedback and comments received, including criticisms or concerns. 23 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 3 3 USING EXISTING CREDITING MECHANISMS At a glance Building a domestic crediting mechanism can be a significant undertaking, requiring financial resources, technical crediting mechanisms capacity, and regulatory expertise. However, policymakers can save time by relying or building on existing Using existing crediting mechanisms. One option is to allow credits issued by existing crediting mechanisms to be used for domestic policy purposes. This can reduce time and effort, generating an immediate supply of credits consistent with other carbon market standards. Over time, policymakers could build up the necessary sectoral knowledge and monitoring, reporting, and verification (MRV) skills to develop their own domestic mechanism, if desirable. Another option is to model elements of a domestic crediting mechanism on existing mechanisms, or to choose to outsource specific functions to them. For instance, a domestic mechanism could base its own project cycle requirements on those of an existing mechanism (see Chapter 8) and rely on auditors accredited under an existing mechanism to perform domestic validation and verification functions (see Chapter 9). Relying on existing crediting mechanisms in this way can reduce the resource requirements to develop and implement a domestic mechanism but limits a jurisdiction’s control over specific design elements. These trade-offs need to be balanced by policymakers when considering if and how to use elements from existing crediting mechanisms. This chapter discusses both the options and the considerations for allowing the use of credits issued by existing mechanisms in a domestic context, as well as the options for, and possible advantages of, establishing an independent domestic crediting mechanism that outsources certain components or is modeled on existing mechanisms. 3.1 SPECTRUM OF RELIANCE y Using credits issued by existing crediting mechanisms. Options on the left side of As outlined in Chapter 1 (see Box 1-1), existing crediting Figure 3-1 simply require domestic policymakers mechanisms include international; independent; and to generally oversee and approve the use of regional, national, and subnational mechanisms. Reliance international credits, potentially based on additional on one or more of these mechanisms, either in full or in terms and conditions (i.e., gatekeeping). part, can greatly reduce the time and resources required to establish a domestic crediting market. The Partnership y Replicating design elements from existing for Market Readiness’ (PMR) technical note Options to crediting mechanisms. Options on the right Use Existing International Offset Programs in a Domestic side of Figure 3-1 require policymakers to play a Context 11 identifies a spectrum for using existing larger role. In these options, discrete elements, like mechanisms. This spectrum outlines four options that can auditing, are outsourced or components of other be allocated into two categories of international reliance, mechanisms, like emissions factors or methodologies, which are discussed further in the following subsections: are used as a basis for their own domestic design. 11 World Bank 2015a. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 24 Figure 3-1. Options for using existing crediting mechanisms in a domestic context RELIANCE ON DOMESTIC ADMINISTRATION RELI ANC E SP ECT RUM RELIANCE ON EXISTING MECHANISMS crediting mechanisms FULL RELIANCE GATEKEEPING OUTSOURCING INDIRECT RELIANCE Using existing Use credits from Conditionally Issue own credits Issue own credits existing crediting use credits from but outsource and replicate design mechanisms existing crediting certain functions elements/functions mechanisms Source: World Bank 2015a. The level of reliance can differ across design elements. where existing crediting mechanisms do not align with the The Korea Offset Program, for example, allows the use preferred scope of a domestic mechanism—for example, of some Clean Development Mechanism (CDM) carbon if they are not issuing credits for projects within the credits for domestic compliance (a type of gatekeeping) jurisdiction or they do not target priority project types. while also designing its own domestic program modeled on the CDM and allowing the use of CDM methodologies In most cases, domestic policymakers prefer to be (a combination of indirect reliance and outsourcing). selective about which credits are used. To facilitate this, policymakers can adopt “gatekeeping” criteria, which The level of reliance on existing crediting mechanisms are typically based on project type, vintage and location may change over time. For example, policymakers (generally domestic projects). This is similar to the could start out allowing the use of credits issued approach being used under the Carbon Offsetting and by existing crediting mechanisms, but transition Reduction Scheme for International Aviation (CORSIA) to locally administering a domestic mechanism as established by International Civil Aviation Organization administrative and MRV capacities are developed. (ICAO), which uses criteria to determine which credits airlines can use for offsetting purposes (see Box 3-1). Deciding whether and how to use existing international crediting mechanisms in a domestic context requires Other criteria are possible as well, though they may consideration of domestic constraints, opportunities, and require additional vetting by domestic policymakers policy objectives. It will also likely be influenced by the or program administrators. South Africa, for example, outcomes of negotiations relating to Article 6 of the Paris allows credits issued by certain international and Agreement and, in particular, the ongoing recognition of independent crediting mechanisms to be used to meet these programs in a post-Kyoto Protocol framework. domestic carbon tax obligations so long as the credits are issued for projects that are located in South Africa and are not covered by the carbon tax. South Africa’s 3.2 USING CARBON CREDITS program administrators must also check whether government subsidies are present since the existing ISSUED BY EXISTING crediting mechanisms do not check this directly. MECHANISMS Note that in practice, allowing the use of credits Domestic policymakers can permit the use of externally issued by existing crediting mechanisms almost issued carbon credits for domestic policy or regulatory always means relying on crediting mechanisms requirements. Full reliance would entail accepting all that operate internationally—and typically only if credits issued by an existing mechanism for domestic use. those programs operate within the country that Adopting this approach could be problematic, however, allows their credits to be used (see Table 3-1). 25 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Box 3-1. “Gatekeeping” criteria used in CORSIA CORSIA requires aircraft operators (that is, airlines) counted only once toward a mitigation obligation; to purchase and surrender carbon credits to offset and (8) do no net harm. greenhouse gas (GHG) emissions from international flights above a 2019–2020 baseline. Following the publication of the criteria, offsets programs were invited to apply to become eligible In 2019, the ICAO Council adopted program-level for the pilot phase of CORSIA. An independent body and credit-level criteria—the CORSIA Emissions was appointed to review applications and make Unit Eligibility Criteria—to assess existing crediting recommendations of eligibility to the ICAO Council.c mechanisms and their credits.a,b Existing crediting crediting mechanisms mechanisms must meet both sets of criteria in order As part of a first call for proposals, six existing Using existing for credits to be eligible for use under CORSIA. crediting mechanismsd were approved in early 2020 for use to comply with offsetting requirements during The program-level criteria include clear crediting the first phase of CORSIA. However, not all activities methodologies and development process, robust from the six approved crediting mechanisms were issuance and tracking processes, protection against assessed as being eligible. For instance, activities from double counting, and sound transparency and afforestation or reforestation under the CDM were not governance measures, including validation and approved for use under CORSIA. verification procedures. a https://www.icao.int/environmental-protection/CORSIA/Pages/ The credit-level criteria specify that emissions CORSIA-Emissions-Units.aspx. reductions must (1) be additional; (2) be based on b https://www.icao.int/environmental-protection/CORSIA/Documents/ a realistic and credible baseline; (3) be quantified, ICAO_Document_09.pdf c A group of 19 international independent carbon markets experts, the monitored, reported, and verified; (4) have a clear and Technical Advisory Board, was appointed to review applications and transparent chain of custody; (5) represent permanent d make recommendations on their eligibility to the ICAO Council. These programs are the American Carbon Registry, the China GHG emissions reductions; (6) assess and mitigate against Voluntary Emission Reduction Program, the CDM, the Climate Action potential increase in emissions elsewhere; (7) be Reserve, the Gold Standard, and VCS. Policymakers may want to allow the use of credits issued Limited resources by existing mechanisms in a domestic context for the One advantage of allowing the use of credits from following reasons: existing mechanisms is that it offers a way to source carbon credits without having to establish a domestic Urgency initiative that can be administratively burdensome. Depending on policymakers’ policy objectives, it may If governments do not have the internal capacity, be important to generate a readily available supply of whether it be sufficient staff or expertise, to build and credits in the near term—for example, to promote early run a domestic crediting mechanism, full reliance or action, increase market liquidity, attract investment, gatekeeping can be a particularly attractive option. or help reassure participants covered by a newly While domestic policymakers will still need to assess implemented emissions trading system (ETS) or carbon the suitability of these other crediting mechanisms and tax that the program has flexibility, which can help maintain some level of oversight, the effort and expertise contain compliance costs. If expedited implementation required is more manageable. Several of the countries is a priority, then allowing the use of credits issued by listed in Table 3-1 also developed and supplied CDM existing programs may be advantageous, given that it projects and this shift to a direct reliance model allows often takes years to establish a fully independent crediting the country to leverage its preexisting projects and mechanism. The Republic of Korea recognized this private sector experience without much additional work. when it developed the Korea Offset Program, allowing Allowing the use of external credits enables domestic for a gatekeeping option even as it developed its own policymakers to focus on policy priorities and avoids the administrative capacity, as described in Table 3-1. need to develop and oversee all the crediting mechanism elements described in Parts II and III of this guide. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 26 Table 3-1. Examples of countries allowing use of credits issued by existing mechanisms12 Jurisdiction Description Chile In February 2020, improvements to the green tax on stationary sources were adopted as part of the national tax code reform. Revisions to the green tax include allowing the use of carbon credits to meet green tax obligations from 2023 onwards. Policymakers have three years to set the offset rules, including setting the eligibility criteria for project activities and developing the MRV requirements for offset projects. It also includes the development of a carbon offset registry and transaction system. Colombia Allows the use of credits in specific circumstances. Taxable entities can use credits acquired from projects located in Colombia to fully or partially reduce carbon tax liabilities. Credits must be from a crediting mechanism that, among other things, has a public registry and methodology development crediting mechanisms procedures that include public consultation (such as CDM, Verified Carbon Standard [VCS] and Gold Using existing Standard). Other requirements currently include ensuring the credits were generated after January 1, 2010, and were generated by activities not mandated by law. Project activities must also be registered on Colombia’s National Registry for the Reduction of GHG Emissions and credits must be canceled in the originating crediting mechanism’s public registry to avoid double counting. Republic of Korea The Korea Offset Program has a gatekeeping element, where ETS-regulated companies are allowed to use CDM credits, provided those credits come from domestic projects that started after April 14, 2020. International CDM projects developed by Korean companies that generate credits after June 1, 2016, are also allowed from 2018. However, Korean companies need to meet certain conditions relating to ownership, project cost, and funding. All CDM credits need to be converted into Korean Credit Units before they can be used for compliance. New Zealand Until 2015, New Zealand allowed the use of CDM credits (Certified Emissions Reductions) with no restrictions for compliance in its domestic ETS (a rare example of full reliance). International units were not eligible for compliance as of June 1, 2015. Mexico Allows credits issued under CDM to be used to fulfil carbon tax obligations as long as they are sourced from projects located in Mexico. The initial draft of the offset mechanism for the ETS uses international standards as a main reference, adapting criteria and procedures to the national context. South Africa Allows credits issued under programs such as CDM and voluntary market standards including VCS and Gold Standard, to be used to fulfil carbon tax obligations as long as they are from projects that are located in South Africa, are not covered by the carbon tax, and do not receive certain government subsidies. Units are canceled in the standard’s registry and then transferred to a domestic registry for retirement against the tax liability of the covered entities account. Attracting international finance 3.3 OUTSOURCING OR If one objective for a domestic crediting mechanism is to attract international finance, then working with REPLICATING DESIGN existing mechanisms could be advantageous as a way ELEMENTS to offer consistency and familiarity to international credit buyers already familiar with such programs. Developing Domestic policymakers may prefer to directly administer a a domestic market can then focus on fostering demand domestic crediting mechanism. In this case, policymakers (international and/or domestic), while using existing will be responsible for making final decisions about infrastructure to generate carbon credit supply. registering projects and issuing credits. This entails greater effort to both design and administer the mechanism but gives policymakers greater control and, they can ensure the mechanism is more closely aligned with domestic policy objectives. In pursuing this approach, domestic policymakers do not have to reinvent the wheel. They can: 12 Assembled by the authors from personal knowledge as well as information from South African National Treasury 2019; MexiCO2; International Emissions Trading Association & Environmental Defense Fund 2018; and International Carbon Action Partnership 2020. 27 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS y outsource certain functions to existing International Organization for Standardization (ISO) crediting mechanisms; and/or 14065 to perform validation and verification. Alberta’s crediting mechanism outsources its registry functions y replicate design and functional elements to the Canadian Standards Association (see Table 3-2 of existing crediting mechanisms. and Table 3-3). The California Air Resources Board (CARB) has approved the Climate Action Reserve, Outsourcing can be done by incorporating the principles, American Carbon Registry, and VCS to serve as official standards (including methodologies), or other requirements “offset project registries” tasked with reviewing project of existing mechanisms into the domestic crediting applications, evaluating auditor reports, and issuing mechanism design. As an example, both the VCS and provisional credits. It thus effectively outsources the Gold Standard allow new methodologies to use these administrative tasks, but still performs its own methodological tools developed and maintained by the oversight and retains authority to make final decisions CDM (e.g., the CDM’s “Tool for the Demonstration and about converting provisional credits into compliance- crediting mechanisms Assessment of Additionality”); if the CDM revises or eligible Air Resources Board Offset Credits. Using existing updates these tools, the revisions automatically apply within the VCS and the Gold Standard. Similarly, the Alternatively, policymakers can use or build on what Korea Offset Program allows domestic projects to be existing mechanisms have done by replicating or adapting developed using CDM methodologies (see Table 3-2); their standards, governance structure, or procedural updates or additions to CDM methodologies also apply requirements. A wide range of options is possible within the Korea Offset Program. Such outsourcing here, including replicating or adapting methodologies can avoid the need to maintain technical capacity or methodology development procedures; adapting and administrative resources needed for some of auditor training and accreditation requirements; the more complex elements of crediting design. replicating registry design and functionality; replicating project cycle definitions and requirements; and so Another common approach is to outsource program on. The PMR’s technical note on Options to Use administrative functions. For example, policymakers may Existing International Offset Programs in a Domestic permit the use of auditors accredited and overseen by Context refers to this as “indirect reliance” since other crediting mechanisms (see Chapter 9). The Joint these elements are under the complete control Crediting Mechanism, a bilateral mechanism implemented of domestic program administrators, often with by Japan and partner countries, for example, allows modifications to better fit domestic circumstances. CDM-accredited auditors and entities accredited under Table 3-2. Examples of outsourcing crediting features or functions Jurisdiction Description13 California CARB has approved several independent crediting mechanisms (Climate Action Reserve, American Carbon Registry, and VCS) to serve as official “offset project registries” tasked with reviewing project applications, evaluating auditor reports, and issuing provisional credits. It thus effectively outsources these administrative tasks, but still performs its own oversight and retains authority to make final decisions about converting provisional credits (registry offset credits) into compliance-eligible Air Resources Board Offset Credits. Japan and 17 The Joint Crediting Mechanism allows validation and verification to be performed by auditors accredited partner countries either under the CDM (known under the CDM as “Designated Operational Entities”) or ISO 14065. Republic of Korea The Korea Offset Program allows domestic projects to be developed using CDM methodologies. The program is also modeled on many aspects of the CDM, including project cycle and monitoring procedures. The Korea Offset Program also has a gatekeeping element, where ETS-regulated companies are allowed to use CDM credits, provided those credits come from domestic projects that started after April 14, 2010. International CDM projects developed by Korean companies that generate credits after June 1, 2016 are also allowed from 2018. However, Korean companies need to meet certain conditions relating to ownership, project cost, and funding. All Certified Emissions Reductions need to be converted into Korean Credit Units before they can be used for compliance. 13 Assembled by the authors from personal knowledge as well as information from International Emissions Trading Association & Environmental Defense Fund 2018; International Carbon Action Partnership 2020. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 28 Table 3-3. Examples of replicating design elements of existing mechanisms14 Jurisdiction Description Alberta Alberta’s crediting mechanism provides flexibility to large, industrial facilities under the province’s baseline-and-credit system (Technology Innovation and Emissions Reduction Regulation). Crediting methodologies have been independently developed but have drawn on those from other existing mechanisms, including the CDM, Climate Action Reserve, the American Carbon Reserve, and resources from the Intergovernmental Panel on Climate Change, World Resources Institute, and the World Business Council for Sustainable Development. China The CCER program is largely based on the CDM, particularly the methodologies and project development framework. Unlike the CDM, though, MRV is largely carried out by local bodies rather crediting mechanisms than on the national level,15 which can reduce transaction costs. Policymakers also initially allowed Using existing CDM-registered projects to transition into the CCER. These projects can generate CCER offset credits generated before the date of registration (“pre-CDM projects”). This leverages the significant supply of carbon offset projects already in the country as a result of China’s involvement in the CDM. The extent to which they can be converted for compliance is likely contingent on the additional project type and geographic restrictions demanded by the respective ETS pilots and those that may be imposed by the future national carbon market. Republic of Korea The Korea Offset Program is modeled on many aspects of the CDM, including project cycle and monitoring procedures. For countries with experience hosting projects registered If so, then simply allowing the use of credits issued by under existing programs (e.g., CDM projects), drawing these mechanisms may not be feasible. Establishing a on this experience can be a natural starting point for domestic crediting mechanism—though it requires more designing a domestic mechanism. The Chinese Certified time and cost—gives policymakers more control over Emissions Reduction (CCER) Scheme is a national how the mechanism will function, the relative incentives it crediting mechanism that is largely based on the CDM, provides for mitigation activities in different sectors, and with some adjustments to reduce transaction costs. For the balancing of transaction costs with environmental instance, there is no request for review stage in the project integrity. If this greater level of control is desired, adapting cycle and no charge for project proponents (see Table 3-3). or outsourcing where appropriate can make the jobs Policymakers will need to assess which mechanisms of domestic policymakers and administrators easier. are most appropriate to draw from and a number of factors come to play here from scope and project type(s), Building up domestic mitigation capacity sufficient granularity, the level of familiarity and experience of the domestic private sector, and the crediting One goal for establishing a domestic crediting mechanism mechanism(s) and activity in neighboring jurisdictions. could be to build up technical capacity related to certain mitigation activities, as well as MRV capacities. Relying The main advantages of outsourcing and replicating on existing mechanisms by allowing the use of their design elements: credits can begin to develop some of these capacities (especially among domestic private actors) but offers fewer advantages in terms of gaining experience with Better alignment with domestic policy goals crediting governance, administration, and regulatory Because existing crediting mechanisms were developed oversight. Domestic policymakers may wish to begin with to serve a variety of different markets and policy contexts, (or transition to) the outsourcing and indirect reliance they may not always align well with domestic policy models as a way to build up their capacity to exert needs in terms of scope (e.g., locations and sectors greater control, in line with domestic policy objectives. targeted; see Chapter 4) or stringency, particularly related to environmental integrity (see Chapters 5 and 6). 14 Assembled by the authors from personal knowledge as well as information from International Emissions Trading Association & Environmental Defense Fund 2018; International Carbon Action Partnership 2020. 15 There are 12 CCER validation agencies approved by the National Development and Reform Commission. CCER projects must be validated by one of these 12 national agencies. DESIGNING AII DOMESTIC DESIGNING A DOMESTIC CREDITING MECHANISM CREDITING MECHANISM II. Designing a domestic crediting mechanism 29 4 Deciding on the scope 31 4.1 Avoiding overlap with other policies and regulations 31 4.2 Prioritizing sectors and types of mitigation activities 33 4.3 Scale of eligible mitigation activities 38 4.4 Geographic scope 38 5 Deciding on the core elements 39 5.1 Mechanisms to avoid double counting 40 5.2 Policies on crediting periods 41 5.3 Avoiding social and environmental harm 43 5.4 Promoting development benefits 46 5.5 Addressing non-permanence 49 6 Developing methodologies 53 6.1 Using project-specific and standardized approaches 53 6.2 Determining project eligibility 56 6.3 Demonstrating additionality 57 6.4 Quantifying emissions reductions 60 6.5 Monitoring project performance over time 65 7 Adopting, reviewing and revising methodologies 67 7.1 Approaches for adding new methodologies 68 7.2 Important procedural considerations for methodology development 70 7.3 Choosing an approach to methodology development 72 7.4 Procedures for reviewing, revising and updating methodologies 73 31 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 4 4 DECIDING ON THE SCOPE At a glance The scope of a crediting mechanism can be defined in terms of the sectors, gases, and mitigation activities or project types covered. Policymakers will also need to define—often at the methodological level—which sources and sinks each mitigation activity includes, where eligible activities can take place, and the mix of project-based and programmatic-based activities the mechanism will incentivize. The scope should be outlined in transparent and objective eligibility criteria and should avoid overlapping with existing carbon pricing instruments or regulations that mandate certain technologies or emissions reduction targets. Deciding on the scope Ultimately, the choice of scope will depend on the priorities and constraints in the implementing jurisdiction; however, the criteria outlined in Chapter 1 may help governments decide which sectors to prioritize in order to promote environmental integrity while keeping costs low. Apart from sector choice, policymakers need to decide on the scale of eligible mitigation activities and the geographic scope. Generally, starting with project-based activities and scaling up to programmatic activities could give policymakers time to build capacity. This guide is limited to domestic crediting mechanisms that focus on activities within a jurisdiction’s boundaries. In this context, policymakers may want to prioritize aspects for their jurisdiction, including • sectors and gases; • types of mitigation activities and the greenhouse gas (GHG) sources and sinks from those activities; • the scale, or level of aggregation, of eligible mitigation activities crediting; and • the locations in which projects may generate eligible credits. Sections 4.1 and 4.2 address, respectively, avoiding overlap with other policies in choosing sectors, gases, and mitigation activities and prioritizing types of mitigation activities. Section 4.3 addresses scale and Section 4.4 addresses geographic scope. 4.1 AVOIDING OVERLAP Chapter 4 of the World Bank’s State and Trends of Carbon Pricing report and the Partnership for Market WITH OTHER POLICIES Readiness’ (PMR) forthcoming report Carbon Pricing Assessment and Decision Making: A Guide to Adopting AND REGULATIONS a Carbon Price. These resources provide a framework for categorizing policies, as well as a range of tools and Crediting is premised on the idea of incentivizing modeling approaches to map out potential issues in the mitigation in activities that are not appropriately policy mix. However, the challenges of managing policy incentivized by existing policies. Thus, in general, the overlaps is a changing and ongoing process. As such, scope of the crediting mechanism should not include building in regular review and evaluation windows can entities, gases, or activities covered by mandatory GHG be a good opportunity to respond to any new issues. emissions reduction regulations. For more on managing policy overlaps with a carbon pricing instrument, see A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 32 Figure 4-1. Example of overlap with an ETS Policymakers should avoid creating situations where emissions reductions under one program, like an emissions trading system, can also be eligible for carbon credits. Crediting Emissions Trading System Mechanism Deciding on the scope 4.1.1 Overlap with other carbon However, identifying these risks is not always simple, pricing instruments because of indirect overlaps between covered and uncovered sectors, or types of mitigation activities Crediting emissions reductions in a sector covered by within those sectors. An example of this complexity an emissions trading system (ETS), for example, would occurs when the point of regulation for a carbon tax or undermine the environmental integrity of the crediting ETS is “upstream” of the point where GHG emissions mechanism.16 As the ETS already provides a price signal occur, such as the producer of a fossil fuel.17 In these to incentivize emissions reductions in those sectors, the cases “downstream” businesses (such as electricity additionality of credits generated from those sectors generators) face an indirect carbon price. So in this would be highly questionable (see Figure 4-1). Even if example, while an electricity generator is not directly the incentive from the carbon price was not sufficient to covered by a carbon tax or ETS (e.g., is not required to make the offset project viable, allowing offsets within a pay the carbon tax or surrender allowances), it faces covered sector creates the risk of double counting (see a carbon price that is included in the cost of the fuel. Chapter 5). For example, if cement manufacturing is This carbon price is passed through the supply chain, covered by an ETS and a covered cement plant could providing an incentive to reduce emissions (e.g., using also generate carbon credits from an energy efficiency less fuel or switching to a lower-carbon fuel). Allowing the project, then the emissions reductions could be counted electricity producer to also create a credit for reducing twice: first by lowering the GHG emissions of the cement emissions (e.g., through switching to lower-carbon plant (which is covered by the ETS) and second when the fuels) would raise questions about the additionality of credits are used (e.g., as an offset by another ETS entity). those credits and would double count the emissions reductions associated with the carbon tax or ETS. Without appropriate accounting adjustments between Box 4-1 presents some examples of how different the crediting mechanism and the ETS, this would jurisdictions address issues of overlap between crediting look like more emissions reductions are being mechanisms and other carbon pricing instruments. achieved than actually is the case. What is more, the cement plant owner would receive a double benefit: once by reducing its liability under the ETS and then again from the sale of the carbon credits. 16 Entities below the coverage threshold in an ETS (e.g., metric tons of carbon dioxid per year per facility in emissions) could be allowed to participate in the crediting mechanism market without risk of overlap. 17 Many jurisdictions place the point of regulation “upstream” (e.g., on fossil fuel producers or distributors) to simplify administration. 33 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Box 4-1. Examples of how different jurisdictions avoid overlap between crediting and other carbon pricing instruments In California, sectors under the ETS are not eligible minimizing overlap, this ensures that credits can only to generate carbon credits to be used as offsets to be generated by small renewable power producers ensure additionality and avoid policy overlap. Indirect that might need additional support because they are coverage is also managed through restricting offset not viable at the available tariffs. uses. The state’s Compliance Offset Program is restricted to agriculture, forestry, land use, livestock Mexico allows entities to offset their emissions methane, and ozone-depleting substances, while the with carbon credits (limited to Clean Development California ETS covers electricity, industrial energy, and Mechanism [CDM] projects located in Mexico) under transportation. the carbon tax regime. In practice, because the value of carbon credits (and the carbon tax) is low, covered In South Africa, overlap with the carbon tax is avoided entities have not yet used carbon credits to meet by restricting which activities are eligible to generate their carbon tax obligation. Mexico also considered carbon credits. South Africa’s Carbon Offsets the interaction with renewable energy policy during Deciding on the scope Regulations exclude activities covered by the carbon the design of its ETS. To avoid double counting and tax. South Africa manages the overlap in renewable potential policy overlap, Clean Energy Certificates power regulations and the inclusion of the power (which are designed to promote renewable electricity sector under the carbon tax by imposing threshold generation, with an associated reduction in GHG limits. For instance, only large electricity generators emissions) cannot be used to meet compliance are covered by the carbon tax, meaning small obligations during the pilot phase of the ETS. generators are potentially eligible to generate carbon credits. Overlap with regulations like the country’s Renewable Energy Independent Power Purchase Sources: MexiCO2; International Emissions Trading Association Procurement Program, which provides a feed-in tariff, Environmental Defense Fund 2018; National Treasury 2019. is also managed through the use of thresholds: only a The carbon offset regulations only allow independent power producers in the Renewable Energy Independent Power Purchase small independent power producers, or technologies Program to generate carbon credits if they are smaller than 15 facing barriers due to higher production costs, are megawatts or if their generation cost is above ZAR 1.09/kilowatt- eligible to generate carbon credits.a In addition to hour (USD 0.06). 4.1.2 Other regulations pricing instruments at the level of sectors, types of mitigation activities within those sectors, and gases. If other regulations already mandate certain activities, The exercise would also identify other policies, like then crediting the emissions reductions from these same energy regulations, that mandate the implementation activities would raise issues of fairness and concerns of mitigation activities, as well as any incentives or about additionality. If the regulations provide incentives or support that might need to be considered later in subsidies, then it might be possible to reflect the impact of additionality and baseline assessments (see Box 4-2). these incentives in the analysis of projects in the crediting mechanism, but only if an investment additionality test was used and the incentives were fully reflected in the 4.2 PRIORITIZING SECTORS baseline and additionality assessment (see Chapter 6). For example, California policymakers deliberately excluded AND TYPES OF in-state landfill methane projects from the state’s crediting mechanism because the law already required MITIGATION ACTIVITIES methane capture and destruction at in-state landfills. The decision on whether and how to prioritize sectors To assess the potential overlap with existing and and types of mitigation activities in the crediting planned regulations, policymakers should undertake mechanism will depend on the priorities and constraints a policy-mapping exercise as part of the development in the implementing jurisdiction. The criteria outlined in of the crediting mechanism. This exercise would Chapter 1—environmental integrity, transaction costs, identify the coverage of existing and planned carbon and administrative burden—can guide jurisdictions, A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 34 Considerations of how to prioritize specific sectors, mitigation activities, and gases should address the Box 4-2. Interaction between carbon following questions: credits and certificates from clean energy programs y How large is the mitigation potential and how low are the mitigation costs? The starting point for many One potential area of overlap with a carbon mechanisms would be to include activities with a high crediting mechanism is with programs that issue potential to provide low-cost emissions reductions, tradable renewable energy certificates, such as long as they are not covered by another climate as renewable portfolio standards (also called policy instrument. Policymakers may prioritize the renewable energy targets), or energy efficiency most cost-effective mitigation options—including those programs that issue tradable “white certificates.” with low transaction costs—but will need to carefully While these program types have slightly different consider how to incorporate other objectives, such objectives—one to accelerate renewable energy as achieving sustainable development outcomes. Further, policymakers need to ensure that encouraging deployment and the other to provide an incentive high volumes of abatement does not compromise the for increased energy efficiency—each also could environmental integrity of the crediting mechanism. provide carbon benefits and potentially support a type of carbon crediting activity. y How significant are the additionality risks? Deciding on Demonstrating additionality is easier for certain the scope For example, a new renewable energy project activities or in certain sectors than others. As an could theoretically be issued with renewable example, studies of the CDM and Joint Implementation energy certificates for its contribution to a indicate that activities with significant non-carbon renewable energy target and also with carbon revenues—such as large-scale wind power and credits for generating electricity with lower hydropower, waste heat recovery and fossil fuel emissions to what otherwise would have been switching, energy-saving cookstoves and energy- generated. This overlap highlights the need for efficient lighting—had greater difficulty with policymakers to carefully consider the interactions demonstrating additionality.18 Focusing on project types that do not have high risks can help secure the with related policies and address issues relating environmental integrity of the crediting mechanism. In to additionality and/or double counting of the addition, because evaluating additionality and setting carbon benefits (see Chapter 6) in case such baselines for activities with low additionality risks are programs are also considered as a part of easier, prioritizing such activities can lower transaction crediting programs. costs and administrative burden on an ongoing basis. y What monitoring, reporting, and verification (MRV) skills does the country want to develop? Some along with their overall objectives for the crediting activities (e.g., agriculture) produce GHG emissions mechanism, in deciding the scope. In particular, with that are inherently more difficult to measure at the limited administrative resources available, there is a project level. As a result, it is particularly challenging need to prioritize resources, effort, and timing for those to cover these activities under a mandatory carbon activities and sectors that best meet the jurisdiction’s pricing instrument (e.g., carbon tax or ETS). In these objectives. Policymakers can prioritize sectors and cases, it may be advantageous to prioritize these activities by restricting a crediting mechanism’s project activities for inclusion within a crediting mechanism. types or by giving particular types preferential treatment, This could build the necessary MRV capacity in for instance, by providing simplified procedures and rules. the country in preparation for future coverage There are several ways policymakers might prioritize under a mandatory carbon pricing instrument. what to include in the crediting mechanism, which are largely dependent on the broader policy objectives of y Are there significant sustainable development the mechanism (as outlined in Chapter 1). Some are benefits? Policymakers may want to explicitly target mutually exclusive, while others can be complementary, activities that provide high sustainable development as they address different characteristics of mitigation benefits, such as improved air quality, or improvements activities that policymakers may choose to promote. to the local communities and ecosystems. For low- income countries, for instance, policymakers might prioritize energy access activities (e.g., improved cookstoves, rural electrification). A government 18 Cames et al. 2016; Warnecke et al. 2017; World Bank might identify the technology areas based on expert 2016; Kollmuss, Schneider, and Zhezherin 2015. judgement and sectoral expertise, or it might choose to 35 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Figure 4-2. Coverage summary of existing regional, national, and subnational crediting mechanisms LAND STATIONARY ENERGY TRANSPORT OTHER FORESTRY LAND USE CARBON WASTE CAPTURE INDUSTRIAL & STORAGE GASES INDUSTRY ENERGY EFFICIENCY MANUFACTURING SECTOR COVERAGE FUEL WASTE SWITCH Deciding on the scope Notes: Coverage is generally based on the TRANSPORT RENEWABLE availability of a methodology (as at 2020), ENERGY regardless of whether projects have been implemented or credits have been issued. FUGITIVE AGRICULTURE Forestry includes Québec’s Offset System as EMISSIONS their afforestation and reforestation methodology is expected to be completed in 2021. The agriculture sector includes activities that reduce emissions in crops and livestock, including methane destruction from manure treatment. undertake more detailed quantitative assessments of streamline the project approval process and reduce sustainable development impacts. More guidance on transaction costs. An example of this could be how to promote the sustainable development impacts project types where there are no incentives other of crediting projects is also provided in Section 5.3. than emissions reductions (e.g., methane or nitrous oxide destruction, or some livestock and agriculture y Is there potential for incentivizing new interventions) so that additionality assessment can technologies and long-term decarbonization? be standardized as part of a “positive list” of eligible Policymakers could promote crediting projects that activities. Another example would be project types are in line with the technologies and activities needed with homogeneous outputs (e.g., electricity, steel, for a net zero emissions economy. This could include, other heavy manufacturing or mining products), for instance, prioritizing projects that foster low- or which makes it possible to use a performance zero-emissions technologies and innovation rather benchmark for the baseline and reduce MRV costs. than projects that may lock in fossil fuel technologies.19 The challenge with the latter category, however, is While crediting projects that result in cleaner or that often these are the sectors already covered more efficient fossil fuels may reduce emissions in by mandatory carbon pricing instruments. the short term, the ramifications of locking in fossil fuel technologies will make a transition to a net zero Additional guidance on carbon pricing scope may also economy by mid-century increasingly challenging. be found in the PMR and International Carbon Action Partnership’s revised Emissions Trading in Practice: A y Is there a potential to use simplified or Handbook on Design and Implementation and the PMR’s standardized approaches for MRV? Focusing on Carbon Tax Guide: A Handbook for Policy Makers. For activities where the MRV process and additionality instance, some sectors may face greater MRV and assessment can be easily standardized could mitigation quantification challenges, or be less sensitive 19 Betram et al. 2015; Lazarus and van Asselt 2018; Höhne et al. 2015; Wright et al. 2018. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 36 Table 4-1. Sectoral and mitigation activity scope of some existing crediting mechanisms Crediting mechanism Sectoral and mitigation activity eligibility International and Independent American Carbon Fuel combustion, industrial processes, land use change and forestry, carbon capture and storage, Registry livestock, waste. CDM All except nuclear; some limits on forestry projects (i.e., only afforestation and reforestation are allowed). Gold Standard Energy efficiency, renewable energy, industrial waste handling, and land use change and forestry. Joint Implementation All except nuclear. VCS All CDM sectoral scopes. Regional, national, and subnational Alberta Agriculture, carbon capture and storage, energy efficiency, forestry, fugitive emissions, industrial gases, manufacturing, renewable energy, and waste. Deciding on the scope Australia Emissions All sectors. Reduction Fund British Columbia All sectors. California Currently approved activities are those relating to livestock, rice cultivation, forestry, coal mine methane, and ozone depleting substances. China Varies between the seven piloting regions allowing use of Chinese Certified Emissions Reduction credits. Regulation allows trading activities of GHG emissions from carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, and sulphur hexafluoride. All pilots exclude credits from large hydropower projects. Québec Sectors not covered under Québec’s ETS, such as waste, ozone depleting substances, agriculture, coal mine methane, forestry. Spain For the National Territory, sectors outside the European Union ETS. For International Territory, energy efficiency, renewable energy, and waste management projects will be prioritized. Switzerland Emissions from all GHGs. All sectors except for nuclear, carbon capture and storage, research and development activities, and fuel switch to natural gas in the transport and building sectors. Climate Action Livestock, rice cultivation, forestry, coal mine methane, and ozone depleting substances, landfill Reserve gas, livestock, nitrogen, and organic waste in the United States and Mexico. Regional Greenhouse Landfill methane, forest sequestration (including afforestation, reforestation, improved forest Gas Initiative management, and avoided forest conversion), and avoided methane from manure management practice. Source: Based on Michaelowa et al. 2019. to price signals, than others, making them less suitable summary of sectoral coverage for existing regional, to a carbon pricing approach. This may explain why, national, and subnational crediting mechanisms. for instance, there are very few transport credits issued to date and a high volume of credits from industrial As shown in Table 4-1, the scope of crediting emissions, renewable energy, and fugitive emissions mechanisms varies considerably, with some of those projects.20 Answering some of these questions may be focused on supplying credits for compliance purposes particularly challenging (e.g., potential for long-term having a narrower scope. In these cases, eligibility is decarbonization), yet important to promote environmental limited to those activities not covered under existing integrity and to ensure the mechanism meets the carbon taxes or ETSs and that may be encouraged long-term policy objectives. Figure 4-2 provides a with an incentive rather than by a cost. International and independent crediting mechanisms (e.g., CDM and Verified Carbon Standard [VCS]) tend to have 20 World Bank 2020. broader coverage than those with a domestic focus. 37 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Table 4-2. Scale of mitigation activity in some existing crediting mechanisms Crediting mechanism Scale of activities International and Independent American Carbon Registry Project-based CDM Project-based and programmatic Climate Action Reserve Project-based Gold Standard Project-based and programmatic Joint Implementation Project-based and programmatic VCS Project-based and programmatic Regional, national, and subnational Alberta Project-based Australia Emissions Reduction Fund Project-based Deciding on the scope British Columbia Project-based Californiaa Project-based China Project-based Japan (J-Credits) Project-based and programmatic Joint Crediting Mechanism Project-based and programmatic Québec Project-based Spain Project-based and programmatic Switzerland Project-based and programmatic Source: Adapted from Michaelowa et al. 2019. a California has also been exploring international offset credits generated through approved sector-based crediting mechanisms issued by a subnational jurisdiction in a developing country. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 38 4.3 SCALE OF ELIGIBLE 4.4 GEOGRAPHIC SCOPE MITIGATION ACTIVITIES Most domestic crediting mechanisms limit activities that take place within national boundaries. This ensures In terms of the scale of eligible mitigation initiatives, that both the value of the emissions reductions and crediting mechanisms might include multiple mitigation the sustainable development benefits of the project activities of the same type at a single site, a single implementation are captured locally. Some jurisdictions mitigation activity at a single site, or programmatic do allow for internationally generated credits, but a interventions (sometimes called “programs of activities”).21 detailed examination of the key elements associated with In this sense, “scale” is not so much about the size international crediting is beyond the scope of the guide. of a given installation (e.g., 1,000 megawatt versus Some subnational jurisdictions have extended the scope 100 megawatt power plant) but about the boundaries beyond their own borders. California allows for credits and number of different sites that might be part of the from a specified list of Compliance Offset Protocols. overall mitigation intervention. Allowing programmatic These can be generated from anywhere within the United activities, which then must define the eligibility criteria for States. However, starting in 2021, no more than half of the including specific sites or actions inside of the program quantitative limit that entities can surrender can come from for purposes of generating emissions reductions, requires projects that do not provide direct environmental benefits additional rules and procedures. Generally, most domestic to the State of California. Thus, while the geographic crediting mechanisms use project-based approaches, scope of the state’s crediting mechanism may go beyond Deciding on the scope while many existing international crediting mechanisms its territorial borders, the program requirements ensure also include programmatic approaches (see Table 4-2). that California accrues a share of the extra benefits Both approaches have a significant base of experience beyond the flexibility it offers regulated entities. in terms of the MRV requirements. Programmatic activities offer the added advantages of being able to Restricting geographic scope can be a way of incentivizing reach small and micro scale activities and can be more mitigation or technology developments and ensuring easily scaled to cover a large number of activities. enforceability against project proponents. For instance, the Regional Greenhouse Gas Initiative allows crediting projects in participating states or in jurisdictions where there is a memorandum of understanding in place.22 Box 4-3. Direct environmental benefits in California Assembly Bill 398 outlined the key features of with the statutory requirements (Section 95989[a] or California’s ETS beyond 2020, including, among Section 95989[b]) in order to be positively identified other issues, new limits and qualitative requirements as having a direct environmental benefit. While the on the use of offsets. As of 2021, no more than half process is easier for projects located in California, of the limit on carbon credits for compliance within projects out of state may also apply for a direct the ETS can come from credits that do not provide a environmental benefit determination. Projects that direct environmental benefit to the State of California. meet the direct environmental benefit requirements Such benefits are defined as any project that results will be flagged as such in the California Air Resources in “the reduction or avoidance of emissions of any air Board registry and the Offset Credit Issuance Table so pollutant in the state or the reduction or avoidance that they are easily identifiable by compliance offset of any pollutant that could have an adverse impact buyers. on waters of the state.” a Projects will need to comply a AB 398, Chapter 135. 21 While some crediting approaches are exploring different types of “scaled-up” interventions (e.g., sectoral or policy-based crediting), they remain preliminary and such experiments are outside the scope of this guide. 22 World Bank 2020. 39 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 5 5 DECIDING ON THE CORE ELEMENTS At a glance Effective crediting mechanisms need to avoid double counting, define an appropriate crediting period length, impose safeguards to avoid social and environmental harm, address non-permanence and, if desired, promote development benefits. This chapter looks at five key elements that directly impact the environmental integrity of a domestic crediting mechanism. Section 5.1 discusses design elements to avoid double counting: policymakers need to ensure that rules are in place to minimize the risk of double issuance, double use, and the double claiming of carbon credits. This includes public and transparent registry systems; requiring legal attestations from project proponents; monitoring to ensure claimed emissions reductions do in fact result from qualifying project activities; excluding any emissions reductions required by another regulation or policy; and avoiding double claiming between the Deciding on the crediting mechanism and jurisdictions. Without these, there is a risk that the same emissions reduction or core elements removal can be counted twice, inflating the climate impact of the crediting mechanism. Section 5.2 highlights the need to decide on the length of, and the ability to renew, the crediting period—the time period that a project remains registered and credits may be claimed. Regulatory conditions are also generally fixed during the crediting period. Accordingly, the period needs to be long enough to provide investment certainty to project proponents but short enough to allow jurisdictions to respond to changing climate targets and technological developments. Section 5.3 discusses approaches to avoid environmental or social harm resulting from the crediting projects. Policymakers may also wish to design crediting mechanisms to explicitly improve environmental and social outcomes. Existing environmental safeguards and domestic requirements for impact assessments may be sufficient but if there is concern, policymakers may need to impose additional requirements. Related to this, Section 5.4 looks at how governments can promote the development benefits of a crediting mechanism if this is an objective of the program. Requiring identification and/or monitoring of development benefits will add costs for both government and project proponents but increase positive sustainable development impacts. Finally, Section 5.5 discusses the potential for non-permanent emissions reductions and the possible risk that the emissions removals from a crediting project will be re-released. Policymakers need to assess the risk of non-permanence, decide on the most appropriate permanence period (generally between 25 and 100 years), and determine the most appropriate mechanisms to address this risk. Most existing crediting mechanisms to date have opted for a buffer approach alongside extensive monitoring requirements. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 40 5.1 MECHANISMS TO AVOID to them (and not emissions reductions that accrue to projects or activities upstream or downstream from DOUBLE COUNTING them). Finally, crediting mechanisms should mandate that project proponents attest, such as by signing legal Double counting occurs when a greenhouse gas forms, that they have not been issued with credits for the (GHG) emissions reduction is counted more than same emissions reductions under another program. The once toward achieving climate change mitigation.23 A mechanism should also disallow projects that overlap failure to address double counting can undermine the with an ETS (or require such projects to address the environmental integrity of the crediting mechanism. double issuance issue with the operator of the ETS). The subsections below explain and provide examples 5.1.2 Double use for the three types of double counting (double issuance, double use, and double claiming) and summarize the Double use occurs if the same credit is counted twice rules and requirements existing crediting mechanisms toward achieving climate change mitigation. This can have implemented to prevent each. Robust monitoring also be thought of as double selling and can be a type and accounting provisions within crediting registries of fraud. For example, a carbon credit might be sold can play an important role in avoiding double twice, or a singular GHG emission reduction might be counting, as the following subsections detail. certified under two carbon crediting mechanisms and sold under each. Measures, like proper serialization and tracking, that prevent double issuance can also prevent 5.1.1 Double issuance double use. However, double use relates to how actors Double issuance occurs if more than one carbon credit in the marketplace use credits. For example, double use or other emissions unit is issued for the same unit of could also occur if an unscrupulous seller represents to Deciding on the core elements GHG emissions reduction. If multiple carbon credits multiple buyers that the carbon credit was retired on their exist for the same GHG emissions reductions, then behalf. Preventing this kind of behavior requires buyers the sum of the carbon credits will be greater than the and other stakeholders to act. To encourage such action, actual emissions reductions the activity achieves. crediting mechanisms should implement registry systems Each of these scenarios involves double issuance: that are publicly available so that buyers can check the status of credits (e.g., whether they are active or have y Two entities claim credits for the same emissions been retired) to prevent double use in addition to the reduction, or a crediting mechanism mistakenly measures listed above that prevent double issuance. issues two credits for the same emissions reduction; for example, if both the producer and 5.1.3 Double claiming the consumer of a biofuel are issued a credit for the emissions reductions associated with Double claiming occurs when two different entities the same liter of fuel produced and used. claim the same emissions reductions as contributing to achieving climate change mitigation. Like other forms y A project is registered under two crediting of double counting, it results in the sum of the claims mechanisms and credits are issued under both exceeding the actual emissions reductions achieved, mechanisms for the same emissions reductions. which means mitigation is being claimed for emissions reductions that have not taken place. This issue typically y Emissions reductions receive a credit under a crediting arises when emissions reductions are claimed in multiple mechanism for emissions that are also covered by an jurisdictions or crediting mechanisms. For example, two allowance in an emissions trading systems (ETS). countries collaborating to reduce emissions through waste management and methane destruction toward To avoid double issuance, the crediting mechanism should Paris Agreement targets might result in both countries include stringent registry and accounting procedures. claiming the resulting emissions reductions. In a similar Registry systems should use serial numbers to record manner, there is also a risk that subnational entities and and transparently track carbon credits, to ensure that corporations working together could both claim credits only one credit is issued per emissions reduction. under a national program for a collaborative project. Registry procedures should also check for projects and issuances in other crediting mechanisms, to ensure that There is some debate as to what constitutes double projects do not issue credits for the same emissions claiming when it comes to the voluntary carbon market reductions under more than one program. Setting norms and the interaction with a jurisdiction’s targets (such as for project accounting boundaries can also help ensure a country’s Nationally Determined Contribution [NDC] that projects count only emissions reductions that accrue under the Paris Agreement). Some argue that if the host 23 This section uses definitions for double counting consistent with the CORSIA Avoiding Double Counting Working Group, Schneider et al. 2019. 41 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 5.2 POLICIES ON Box 5-1. Double counting: Paris Agreement and CORSIA CREDITING PERIODS • Paris Agreement: Article 6 recognizes A crediting period25 is the length of time for which credits the possibility for international cooperation are issued for a specific emissions reduction activity. through the transfer of mitigation outcomes. During this time, the parameters for calculating emissions It calls for avoiding double counting through reductions remain unchanged or only change under transfers of emissions reductions by robust very specific conditions. Crediting periods are meant to accounting methods. Specifically, it is ensure that projects do not continue to generate carbon envisaged that a transferring country must credits beyond a predetermined time frame for which make a corresponding adjustment to its the project activity has been assessed as eligible. This is reported emissions balance as part of its NDC particularly important for the assessment of additionality reporting to account for the reduction; the and establishing a baseline, which can change over time acquiring country can then reduce its reported because of changes to the regulatory framework, emissions balance based on the emissions technologies, or what is considered common practice in reductions that were generated in the an industry. Crediting periods are also important to provide transferring country’s boundaries. However, project proponents with a level of investment certainty. the rules and modalities around Article 6 have Accordingly, crediting periods need to balance the need not yet been agreed to. to provide investment security to the project proponent • Carbon Offsetting and Reduction with the need to ensure issued credits reflect market Scheme for International Aviation conditions, such as legal requirements, technology, Deciding on the core elements (CORSIA): While the rules under CORSIA or related factors. Thus, in setting the crediting period are not yet settled, the current working policymakers must balance environmental integrity assumption is that airplane operators will against administrative and transaction costs. likely need to secure a letter of assurance and The subsections below present guidelines for the three authorization from the host country before key decisions for policymakers: determining the length of applying any carbon credits in fulfilment of the crediting period and the need for any differentiation their obligations under CORSIA. Similar to the on length within the mechanism; whether and how often Paris Agreement process outlined above, it is the crediting period can be renewed; and whether and likely that host countries would need to apply how parameters may be updated during a given crediting corresponding adjustments for any credits period. Note that these decisions interact with each other transferred to airplane operators in fulfilment and are not mutually exclusive (for example, if changes are of CORSIA obligations. The International Civil allowed within a crediting period, a longer period would Aviation Organization will likely finalize these reduce the negative impact on environmental integrity). obligations based on the final Article 6 rules when negotiations are complete. 5.2.1 Length of crediting period To determine the length of the crediting period, jurisdiction counts the emissions reductions (e.g., toward policymakers should factor in how quickly market its NDC), a corporation should not be able to use the same conditions change. This includes changes to the regulatory emissions reductions to make a carbon neutrality claim. framework, project technologies, jurisdiction GHG Others argue that country-level and corporate-level GHG emissions reduction targets, and international policy. accounting represent different ledgers that cannot be This is critical because changes to these factors can compared (for more see Box 5-1).24 influence whether the baseline remains appropriate.26 Accordingly, changes to these factors can often require prompt updates to parameters to maintain environmental integrity.27 This may suggest adopting shorter crediting 24 Also see the International Carbon Reduction and Offset Alliance’s position on scaling private sector voluntary action after 2020; International Carbon Reduction and Offset Alliance 2020. 25 Crediting mechanisms may use different terms for this concept. For example, Québec Offset System uses “eligibility period.” 26 As discussed in Section 8.2.3, a project’s additionality is determined only once, at its outset, and is concerned with whether the project would have been implemented in the absence of the crediting mechanism. 27 Broekhoff et al. 2017. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 42 periods to allow for more frequent reassessments of the information technologies (by shifting to cloud-based project’s baseline. However, shorter crediting periods servers), because the technological development can reduce the return on the project investment and in IT is rapid and payback quick. Differentiation reduce investment certainty, which may reduce project on this basis is relatively simple to implement. development activity. In addition, the experience with Joint Implementation projects has suggested that shorter y Project-specific. Under this option, there is a crediting periods can significantly impact ambitious minimum project type-specific crediting period. In projects such as those deploying less mature technology addition, each project can apply individually for a or those with higher upfront costs (e.g., district heating). longer crediting period at registration (a maximum These projects often have longer lead times and certainty should also be defined). This option provides flexibility about crediting period and project payback are key for project proponents and places the burden on to their investment. Longer crediting periods can also the project proponent to justify a longer crediting decrease administrative and project development costs. period. As a drawback, project-specific differentiation requires the program administrator to assess each Ultimately, the decision on crediting period length project’s crediting period length claim, which may must balance environmental integrity against impede the standardization of rules and project cycle providing investment certainty to project proponents. processes. This approach is therefore administratively Importantly, the rules on crediting periods must be burdensome and increases transaction costs. While clear and changes should be avoided. The crediting it could make it easier to establish environmental period should not be so long as to ignore technology integrity if standard crediting periods are short, and policy changes, which are inevitable, but they any error when extending a crediting period can should not be so short (or changed after project undermine that effect. Such an approach has not been commencement) so as to discourage project investment. used yet in any existing crediting mechanisms.28 Deciding on the core elements Policymakers can opt to outline different crediting 5.2.2 Renewing crediting periods periods based on the project type or specific project. This more tailored approach can improve environmental All existing mechanisms include an option for renewing integrity, as projects more subject to change (e.g., a crediting period.29 Along with the choice of the due to technological innovations) are assigned shorter crediting period length, the possibility of renewal crediting periods to reflect these dynamics: determines the maximum time period during which a project may claim emissions reductions. During y Project type. Under this option, the length of the renewal, the eligibility of the project is checked (see crediting period can differ depending on the type Section 8.2.3). A project may be allowed to continue, of activity. Most existing crediting mechanisms may continue but with changed parameters, or may not differentiate by project type and use crediting periods be able to generate credits any longer. If, for example, of five to 10 years. Distinguishing by project type regulatory changes during the crediting period mean makes sense if a crediting mechanism has a broad the project activity is now mandated by law, then the scope, with project types that vary widely with respect project’s crediting period cannot be renewed. to the payback period and speed of change. For types with generally long payback periods (e.g., district Crediting period renewals should not be longer than the heating) and activities that require longer periods to initial crediting period, because whatever considerations deliver abatement (e.g., afforestation), the crediting or factors led to the initial decision on period length will period may need to be longer (in the Climate Action still apply. Most crediting mechanisms use equal length Reserve, for example, the crediting period for forest crediting periods at renewal. However, Switzerland has an projects is 100 years). For types where change is initial crediting period of seven years while renewals are rapid and a more frequent reassessment of eligibility only three years. Shorter subsequent crediting periods is required, the crediting period may need to be allow swift adjustment in case of technological progress shorter. For example, in Québec the crediting period or changes in the regulatory environment. Since project is 10 years for manure and landfill projects versus proponents base their investment decisions mainly five years for projects related to ozone-depleting on the length of the first crediting period, because the substances. Another example of a short crediting timing of this is certain but renewal is not, a shorter period is for projects implementing energy-efficient renewal period is unlikely to discourage investment. 28 For an overview of the implementation of crediting periods in existing crediting mechanisms see World Bank 2015, especially Table A8. 29 Some mechanisms use the word “extend” instead of “renew.” The difference is mostly semantic. Under the Emissions Reduction Fund, for example, a project cannot have more than one crediting period. However, the Minister is able to “extend” a crediting period by specifying a longer crediting period in a variation to an existing method. 43 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Most existing crediting mechanisms limit the maximum many countries, with varying degrees of local regulatory number of renewals. The total period, including renewals, development and enforcement capacity. Domestic may still be quite long (e.g., 21 years for all technologies crediting mechanisms therefore focus on promoting other than forestry in the Clean Development Mechanism compliance with the jurisdiction’s legal requirements, [CDM]). In addition, the administrator often defines like those mandating environmental impact assessments a maximum time period during which credits are and local stakeholder consultations. These requirements allowed to be created for a specific technology (e.g., can flag any potential social and environmental 15 years for a boiler based on its standard technical risks that project proponents may need to address. lifetime). Therefore, it is often this maximum time Policymakers may choose to guard against the risk of period rather than the crediting periods that limits harm by building on preexisting local regulations or credit generation. This is true in particular for those by defining the scope of project types eligible based, crediting mechanisms that do not limit the number at least in part, on social and environmental concerns of renewals at all (e.g., Switzerland and Québec). (e.g., only allowing project types with low risk of harm). Table 5-1 summarizes the existing safeguards used 5.2.3 Changes to parameters in some crediting mechanisms. It highlights that only during the crediting period independent mechanisms have specifically included social and environmental safeguards, to date. A crediting mechanism may allow for updates even during the crediting period. Such updates could increase The safeguard approaches of existing crediting environmental integrity because they account for new mechanisms vary in how they address social and information (e.g., new scientific evidence, economic and environmental harm, but almost all leave significant technological progress, or new regulations). Updates gaps—although these gaps may be less important for also provide for more consistency among projects. domestic crediting mechanisms in countries with strong Deciding on the core elements However, the prospect of frequent or significant local governance frameworks. In terms of international changes decreases investment security and therefore and independent crediting mechanisms, the Verified the willingness of proponents to design projects in the Carbon Standard (VCS) includes a no-harm principle first place. It may also be difficult to clearly define which and identifies risks but does not require follow-up unless parameters are subject to possible updates and which required by other “add-on” labels.31 Other mechanisms, are not. Ongoing monitoring of these parameters (e.g., including national mechanisms, address this by limiting based on periodic measurements) can help policymakers eligible project types. Switzerland’s CO2 Attestations determine when and how these metrics should be Crediting Mechanism, for example, excludes nuclear updated. Québec’s Offset System allows updates during energy, while the California crediting mechanism and the eligibility period, but as a general rule updates within Climate Action Reserve both consider potential negative the crediting period should be limited to extreme cases, impacts when considering which project types to allow. such as evidence of gaming or fraud. Policymakers may rather opt for shorter crediting periods as an option to Based on the approaches adopted in existing allow for more frequent updates of key parameters. crediting mechanisms, there are three options for avoiding social and environmental harm: 5.3 AVOIDING SOCIAL AND y Rely solely on existing domestic frameworks ENVIRONMENTAL HARM and regulations. National laws and permitting requirements (e.g., environmental impact assessments) Ensuring no net harm requires three components: (1) may be designed to ensure that the projects do publicly demonstrating a project’s ongoing compliance not cause harm. Using existing frameworks has with specific social and environmental safeguards; the advantage of keeping transaction costs and (2) an obligation on project proponents to identify, the administrative burden of the mechanism low. mitigate, monitor, and report on risks; and (3) local This is the practice in almost all of the current stakeholder consultations.30 However, domestic crediting domestic crediting mechanisms. While compliance mechanisms almost always rely on existing domestic with other national legislation is implied under the law and regulations to address environmental and social crediting mechanism, policymakers could mandate harm. A few independent crediting mechanisms have that proponents show evidence that their project put in place dedicated provisions on safeguards, since meets certain regulations and standards, like other these mechanisms may support project activities in environmental or public health requirements. 30 Schneider, Michaelowa et al. 2019. 31 For example, the Climate, Community & Biodiversity Standards (https://verra.org/project/ccb-program/) and the Social Carbon Standard (socialcarbon.org). A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 44 y Include safeguards within the crediting upfront testing to confirm a project’s eligibility and/ mechanism. Depending on the stringency and or ongoing requirements to monitor and report adequacy of these domestic social and environmental regularly on any identified risks to demonstrate that regulations, policymakers may want to explicitly harm was being avoided. The latter would ensure address no net harm in their crediting mechanism that harm is avoided but would obviously further rules. If existing regulations and consultation increase transaction costs and administrative burden. processes are less well developed, or if such environmental and social safeguards are the focus y Refer to third-party labels that include safeguards. of current policy, the jurisdiction may find that the The mechanism rules could require that project benefits of a more elaborate process are worth proponents use a third-party “add-on” label, the costs of implementation, although this would where the rules for that added certification raise both transaction costs and the administrative include safeguard provisions, similar to the burden on government. Safeguards could include VCS independent crediting mechanism. Table 5-1. Safeguards in some existing crediting mechanisms Crediting mechanism Safeguards against negative impacts Independent American Carbon Registry Impact assessment to ensure compliance with environmental and community safeguards best practices. Deciding on the core elements Climate Action Reserve Safeguards are based on compliance with all applicable laws, including environmental regulations; may also include criteria in protocols to ensure against harm. Gold Standard Safeguarding principles derived from the United Nations Development Programme’s Social and Environmental Standards, United Nations Environment’s Environmental, Social and Economic Sustainability Framework, and the World Bank’s International Finance Corporation Performance Standard. VCS Various provisions to protect against harm within agriculture, forestry and other land use (AFOLU) projects. International CDM No separate provisions for safeguards Joint Implementation No separate provisions for safeguards Regional, national, and subnational Australia Emissions Reduction Fund Negative list of projects that might cause adverse outcomes, but no separate provisions for safeguards. British Columbia No separate provisions for safeguards California Compliance Analysis on potential harm for specific project types under the California Offset Program Environmental Quality Act, but not project specific. China No separate provisions for safeguards Joint Crediting Mechanism Safeguard guidelines in place for projects reducing emissions from deforestation and forest degradation.32 Québec No separate provisions for safeguards Spain No separate provisions for safeguards Switzerland Negative list excludes potentially harmful project types, but no project specific provisions. Source: Adapted from Michaelowa et al. 2019; Climate Action Reserve website. 32 For example, https://www.jcm.go.jp/opt/kh-jp/rules_and_guidelines/download/reddplus/file_24/JCM_KH_GL_SG_REDD+_ver01.0.pdf. 45 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Figure 5-1. Types of development benefits of carbon crediting projects Generate employment Stimulate Improve technological Contribute economic change to political Improve performance stability democratic governance ECONOMIC Contribute to fiscal Trigger sustainability Improve POLITICAL & private interregional INSTITUTIONAL investment collaboration Enhance energy Deciding on the core elements security POTENTIAL BENEFITS OF CREDITING Promote MECHANISMS biodiversity Enhance energy access ENVIRONMENTAL Support Protect ecosystem environmental services Reduce resources poverty SOCIAL Improve Reduce soil quality air pollution Reduce Increase stressors food and water security Improve health Note: Original figure included climate benefits. Source: Mayrhofer and Gupta 2016. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 46 The decision on how to approach safeguards and avoid Starting in 2021, no more than half of quantitative limit harm will depend on policy priorities, resources, and for offsets can come from projects that do not provide the availability of an existing robust domestic system for direct environmental benefits to the state (see Box 4-3).36 addressing safeguards and ensuring public participation This is in part because this mechanism is one of the few under other regulations (such as environmental and social domestic or subnational crediting mechanisms that allows impact assessments). project activities outside of its jurisdiction to generate carbon credits. In addition, California policymakers wanted to have more projects developed in the state such that 5.4 PROMOTING DEVELOPMENT residents could enjoy the benefits of those projects. These benefits include not only the reduction or avoidance of BENEFITS GHG emissions but also the benefits associated with reduced air pollution in the state. California deems any The importance of the sustainable development impacts project located within the state as one that has direct or “development benefits” of emissions reduction projects, environmental benefits, although other projects will have particularly in the context of developing countries, has to present evidence that they benefit the state based been widely acknowledged.33 Such positive impacts on “scientific, peer-reviewed information.” However, could include a wide range of environmental, social, and California does not provide methodologies for measuring economic impacts (see Figure 5-1). More information on the or monitoring these development benefits, and there broader benefits of carbon pricing instruments more broadly will be no requirement to monitor them on an ongoing can be found in the Partnership for Market Readiness’ basis. Table 5-2 provides an overview of how crediting forthcoming The Development Benefits of Carbon Pricing. mechanisms have dealt with development benefits. The extent that development benefits have been explicitly As the table reflects, most national and subnational recognized in crediting mechanisms to date has largely Deciding on the core elements crediting mechanisms do not address development been dependent on the most common use for those benefits directly. This is in part because domestic credits. While independent crediting mechanisms crediting mechanisms often serve compliance buyers, supporting voluntary offsetting requirements have which place less emphasis on development benefits prioritized development benefits, this has not been a than buyers in the voluntary markets, which are generally major focus of international, national, and subnational served by independent crediting mechanisms. In the crediting mechanisms supplying to compliance markets.34 voluntary markets, buyers often prioritize the development Even among the independent crediting mechanisms, benefits and in some cases value credits with significant Gold Standard is the only one that requires identification, development benefits more than those without. Voluntary measurement, and monitoring of development benefits. buyers are often procuring offsets to meet their No national or subnational crediting mechanisms have environmental and social goals. Because of this, they similar requirements (see Table 5-2). These are often often seek to invest in projects where they can highlight more focused on cost-effectiveness, or—in the case not just the carbon benefit but also the suite of associated of domestic crediting mechanisms—rely on the choice social benefits. If targeting development benefits is a of project types to promote development benefits. priority for a domestic crediting mechanism, policymakers may not necessarily have to start from scratch. They However, as demand grows for carbon credits that may be able to use labels or standards from international recognize development benefits, some crediting and independent crediting mechanisms that address mechanisms are beginning to incorporate various forms of development benefits, like the Climate, Community & recognition, even if these are not requirements for credit Biodiversity Standards37 or the Social Carbon Standard.38 issuance. For example, the Australian government has These provide detailed monitoring, reporting, and updated the Australian National Registry of Emission Units verification (MRV) rules for specific development benefits, to allow it to include additional information for specific as well as guidelines on stakeholder engagement and projects, where available. This is intended to help buyers avoiding harm. Equally, as another potential tool that make informed decisions on the additional benefits could be applied in domestic crediting mechanisms, delivered by specific projects.35 California is also moving the Gold Standard Foundation now provides dedicated toward incorporating development benefits more explicitly. 33 Zhang and Wang 2011; Spalding-Fecher et al. 2012; Sven, Olsen, and Verles 2019; Mayrhofer and Gupta 2016; Gold Standard 2014. 34 Boyd et al. 2009; Nussbaumer 2009; Karakosta, Doukas, and Psarras 2011. 35 http://www.cleanenergyregulator.gov.au/ERF/Pages/News%20and%20updates/News-Item.aspx?ListId=19b4efbb-6f5d-4637-94c4- 121c1f96fcfe&ItemId=753. 36 https://ww2.arb.ca.gov/our-work/programs/compliance-offset-program/direct-environmental-benefits 37 https://verra.org/project/ccb-program/. 38 http://www.socialcarbon.org/. 47 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Table 5-2. Development benefits in some existing crediting mechanisms Development benefits Program requirements Independent American Carbon Projects may disclose positive No requirement, but the registry can be combined with Registry contributions to Sustainable Development the Climate, Community & Biodiversity Standards Goals, but no particular tool or protocol Climate Action Program manual establishes the avoidance Only for forestry projects Reserve of negative social and environmental outcomes Gold Standard Sustainability is a core requirement Sustainability assessment to be performed both before and after VCS No specific sustainability objective Only reports from environmental impact assessment International CDM Stated as one of the two main No United Nations Framework Convention on Climate objectives of the mechanism Change rules; requirements established by host country Joint Requirements set by the host party Not required for project approval; set by the host party Deciding on the core elements Implementation Regional, national, and subnational Australia Stated objectives of protecting the natural Decided on a project type basis by the Minister Emissions environment and improving resilience to (based on advice from independent committee) Reduction Fund the effects of climate change; registry allows tracking of additional information British Columbia Mentions the program as part of No specific sustainability requirement their sustainability targets California Forest protocol requires sustainable Requirement that no more than one half of the offset management and a return to native quantitative usage limit can come from projects that do species, among other criteria not provide direct environmental benefits in the state China Contribution to sustainable Contribution to sustainable development development is an approval criterion is an approval criterion Joint Crediting Part of the Joint Crediting Some participating countries have guidelines to evaluate Mechanism Mechanism’s purpose projects’ contribution to sustainable development. In those countries, project participants are required to conduct analysis before project implementation (as part of registration) and an evaluation after implementation (before credit issuance). Québec No specific sustainability objective No specific sustainability requirement Spain No specific sustainability objective No specific sustainability requirement Switzerland No specific sustainability objective No specific sustainability requirement Source: Adapted from Michaelowa et al. 2019; Australia Clean Energy Regulator; California Air Resources Board. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 48 Box 5-2. The Gold Standard for Global Goals The Gold Standard was the first independent carbon provides quantification methodologies for other market standard to prioritize development benefits sustainable development impacts. For example, two in its actual rules and methodologies. Only projects separate standards have already been included for demonstrating development benefits are eligible under air quality impacts (i.e., “Methodology to estimate the standard. The early versions of the Gold Standard and verify Averted Disability Adjusted Life Years from included a “sustainable development assessment cleaner household air”) and water efficiency impacts matrix” with a wide range of indicators, which an (i.e., “Sustainable sugarcane initiative methodology auditor had to validate prior to registration. The to quantify water efficiency outcomes from seedling auditor also verified any changes to these qualitative nurseries”). The Gold Standard will start piloting indicators during verification. After the adoption of the additional activity-specific Sustainable Development Paris Agreement and the United Nations Sustainable Goals impact measurement tools in 2020. This is Development Goals, the Gold Standard launched an example of a tool or add-on label that could be the Gold Standard for Global Goals, which expands referenced by a domestic crediting mechanism. the development benefits MRV framework. It also Source: Gold Standard 2020. impact measurement standards for some sustainable to include only project types with high development Deciding on the development impacts as well through the Gold Standard benefits in the scope of the crediting mechanism, rather core elements for Global Goals (see Box 5-2). The CDM also provides than using project-specific requirements or MRV. a voluntary tool to track development benefits.39 This includes a wide range of potential benefits to air quality, Implicit recognition without specific rules. natural resources, soil health, job creation, balance of Not having any development benefits rules keeps payments, and more. The tool allows project proponents transaction costs and the administrative burden low, to use a template report that provides a detailed and it is possible that implicitly valuing development description of the specific development benefit. However, benefits (e.g., through the definition of the scope of the there is no requirement for verification or methodologies program or because of experience with climate change for quantifying the impacts. To date, 69 projects and mitigation actions more broadly) will have an impact. programs, out of more than 8,000, have applied the tool. Once finalized, Verra’s Sustainable Development y Implicit recognition through geographic and Verified Impact Standard (SD VISta) for assessing and regional limitations. Limiting the use of credits based reporting sustainable development benefits may provide on where they are developed can help ensure that another source policymakers can draw upon to adapt project benefits accrue to that specific region, even these standards to local conditions and priorities.40 if specific reporting of those development benefits is not required. The Alberta program, for example, Some options that policymakers could use to promote only allows offsets from Alberta projects to be used sustainable development outcomes appear below. in its system, in part to ensure that the full benefits The options are presented in order of increasing (including the economic benefits) accrue to residents regulatory effort and increasing transaction costs for of Alberta. Similarly, the Regional Greenhouse Gas project proponents. As with safeguards, the approach Initiative, which includes 10 (soon to be 11) US to development benefits depends on both the policy states, allows offsets from participating regions. objectives of the program and the robustness of the Projects outside the region are allowed if there is existing domestic regulatory environment. Policymakers a memorandum of understanding in place with need to assess whether targeting development benefits another jurisdiction. California’s direct environmental through additional requirements in the crediting benefits requirement was also put into place in part mechanism justifies the increase in cost for the to help ensure that benefits, including reduction of government and project proponents. Notably, all options air pollution, occurred within the state. A downside are flexible in that the policymaker can decide on the of regional restrictions is that lower-cost mitigation priorities and tools for assessing development benefits. As opportunities outside of the region may be foregone. discussed in Section 4.2, policymakers could also choose 39 United Nations Framework Convention on Climate Change 2020. 40 https://verra.org/project/sd-vista/. 49 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS y Require project proponents to identify Figure 5-2. Possible reversal risks for biological development benefits. This approach, similar to sequestration projects how California requires projects to demonstrate direct environmental benefits, can be used to target particular development benefits. Policymakers could require project proponents to submit a report outlining the specific benefits, which could then be assessed and verified by the government or by certified independent experts. This would increase the chance that projects would deliver development benefits without requiring extra ongoing costs for monitoring. y Require use of an independent development benefits standard. Rather than creating a new development benefits MRV approach within the crediting mechanism, the rules could require that projects use an independent label or standard (e.g., Climate, Community & Biodiversity Standards, Gold Standard for Global Goals, or the SD VISta program) to demonstrate development benefits on an ongoing basis. Complying with these independent standards RISKS TO FORESTS would be an add-on to the other GHG-related requirements under the crediting mechanism. Deciding on the core elements y Identify, measure, and monitor development 5.5.1 Risk of non-permanence benefits using a domestic standard. The crediting Risk of non-permanence is the risk that an event will mechanism could not only have its own rules, result in the release of stored emissions back into the procedures, and tools for quantifying certain types of atmosphere. For example, if a forestry project that development benefits but could also specify how these sequesters carbon in tree and soil biomass were to should be monitored on an ongoing basis. These rules suffer a fire event, some or all of this carbon could be could specify the protocols for quantifying, reporting, released back into the atmosphere (see Figure 5-2 for and verifying development benefits impacts. This examples of reversal risks). In addition to fire, tree and soil would be similar to the approach the Gold Standard biomass face threats from pest and disease outbreaks adopts—albeit in a domestic crediting system. and extreme weather events (e.g., hurricanes, floods, droughts, or winter storms). Humans also pose a direct 5.5 ADDRESSING threat through poor management, overharvesting, illegal logging, and encroachment for fuelwood collection. NON-PERMANENCE Similarly, a geological storage reservoir that contains Carbon credits are typically used to compensate for captured carbon dioxide from industrial processes, emissions that will increase radiative forcing in the electricity generation, or through direct air capture could atmosphere for a very long time—in the case of carbon also suffer non-permanence. For example, an injection dioxide, thousands of years. Reflecting this, carbon well might not be capped appropriately, and subsurface credits need to represent emissions reductions that pressure could cause stored carbon to be pushed to are effectively permanent. The issue of permanence the surface and leak over time. For both biological and applies to projects that store or sequester emissions geological storage projects, there are several options in ways that could be reversed over time, such as in that can be used by policymakers to manage non- biological systems (e.g., forests and soils) or through permanence risk. As a starting point, policymakers need geological storage (e.g., carbon capture and storage). to identify the minimum time period necessary to deem an Reversing this storage or re-releasing those emissions emissions reduction or sequestration activity permanent. into the atmosphere increases global GHG emissions and undermines the climate benefits of the crediting project. The following sections discuss the risks of non- permanence and options to addresses these risks. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 50 5.5.2 Permanence period Project monitoring requirements will need to cover the entire permanence time period. This is important and Deciding on the appropriate permanence period from a generally will require project proponents to notify the policy perspective can be challenging. Most regulatory program administrator if an event has occurred that systems and even commercial contracts are challenged may result in a reversal of stored carbon. Policymakers by long-lived duration requirements where those may also impose more stringent MRV requirements for setting the rules will no longer be in place to assure the those projects with a higher risk of non-permanence. requirements are met. Longer time frames, however, are California’s US Forest Protocol mandates monitoring, required because carbon dioxide emissions effectively an annual submission of Offset Project Data Reports, raise atmospheric concentrations for many thousands third-party verification, and site visits at least every of years.41 International policymakers have adopted 100 six years. In Australia, the Emissions Reduction Fund years as a standard benchmark for evaluating the climate also requires project proponents to take reasonable impacts of mitigation actions.42 This time frame matches steps to protect the stored carbon in their projects. the 100-year time horizon for global warming potentials. Proponents need to develop a permanence plan outlining the steps they have taken—or will take—to Crediting mechanisms, however, have varied in the ensure permanency, including the risk of reversal from permanence period they have imposed. California, for fire where proponents are encouraged to work with example, uses 100 years, which reflects its estimated local fire authorities to identify appropriate action. carbon dioxide residence time. The American Carbon Registry, however, applies a 40-year project length, Policymakers can draw from existing domestic legal which it stipulates is not a proxy for permanence frameworks to support the permanence requirements but rather an attempt to “strike a balance between within the crediting mechanism rules. This could include, incentivizing broad participation” and long-term storage for example, requiring insurance or even requiring Deciding on the across its program.43,44 The Tree Canada Afforestation core elements project proponents to provide legal guarantees on the and Reforestation Protocol further reduces this and permanence of stored carbon. For example, the Regional identifies that projects must last a minimum of 30 years,45 Greenhouse Gas Initiative’s forestry protocols require and Australia’s Emissions Reduction Fund allows landowners to obtain permanent land conservation project proponents to opt for a shortened permanence easements, which ensure that the project is maintained requirement of 25 years—although opting for a 25-year for a long period of time—often longer than a crediting permanence period requires credits to be discounted period. However, requiring legal guarantees has not been by 20 percent. This discount is intended to cover the adopted by many existing crediting mechanisms, as the potential future cost to the Australian government additional legal restrictions on land use can lower land should it have to replace any emission releases after the values and discourage landowners from participating. project ends (discussed more in the following section). The Québec Offset System is considering a novel approach as part of a new protocol being developed for 5.5.3 Approaches to address afforestation and reforestation on private lands. To avoid non-permanence risk including a permanence period requirement, the Québec There are four main approaches to address non- Offset System is considering a “ton year” approach to permanence risks. Policymakers can also apply a recognize the climate benefits achieved at the time of combination of these approaches. They are: credit issuance, based on radiative forcing. The rules for implementing this approach are still being developed.46 y buffer reserves, In deciding the appropriate length, policymakers will y temporary crediting, need to balance the risk of reversal and securing y discounting, and environmental integrity with the need to provide a manageable time frame for landowners to monitor y insurance. and guarantee the permanency of the reductions. Each of these is outlined in turn below. 41 Mackey et al 2013. 42 Fearnside 2002. 43 American Carbon Registry 2019. 44 https://americancarbonregistry.org/carbon-accounting/old/carbon-accounting/ACR%20Forest%20Carbon%20Project%20Standard%20 v2.0%20-%20peer%20review%20summary%20and%20responses.pdf. 45 Tree Canada 2015. 46 http://www.environnement.gouv.qc.ca/changements/carbone/credits-compensatoires/index-en.htm. 51 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Box 5-3. VCS AFOLU pooled buffer account South Africa and Colombia accept VCS as a completes a loss event report (using the VCS compliance program within their respective domestic templateb) and submits it to Verra, the VCS carbon tax systems. VCS’s pooled buffer account administrator. Verra places credits equal to the manages the risk of reversal across the entire portfolio reported loss “on hold” until the auditor reviews the of AFOLU projects. Project proponents use the event. Reflecting the auditor’s findings, credits equal AFOLU non-permanence risk toola to analyze the risk to the loss event are canceled from the pooled buffer of reversal and determine the number of credits to account. Any credits sold by the project remain valid deposit in the pooled buffer account, which includes verified carbon units, as the cancelation of buffer a portfolio of credits from projects from across the credits from the pooled buffer account compensates VCS. Auditors assess this analysis and pooled buffer for the project’s loss event. account contribution. a Credits are non-tradable and are used to compensate See https://verra.org/wp-content/uploads/2019/09/AFOLU_Non- Permanence_Risk-Tool_v4.0.pdf for project reversals that have occurred. When b See https://verra.org/wp-content/uploads/2018/03/VCS-Loss-Event- a project reversal occurs, the project proponent Report-Template-v3.2.doc. Deciding on the core elements Buffer reserves and submit a verified estimate of current stocks within 23 months of the discovery of the reversal. Based on this, Under the buffer reserve approach, projects that are CARB assesses whether offset credits need to be retired subject to non-permanence or reversal risk contribute from the pooled buffer account. However, for intentional a portion of their emissions reductions and removals to reversals, this is not done through the buffer. Rather, the a pooled buffer account that the program administrator project proponent must submit a verified report within a manages. Some programs, like the Gold Standard, require year of the reversal and compensate for this change by projects to contribute 20 percent of their emissions submitting a corresponding number of valid instruments reductions or removals to the buffer account. Others, (such as carbon credits) for retirement.49 Policymakers like California’s US Forest Protocol for carbon credits, should also consider the level of diversification of require projects to conduct a project-specific reversal activities included in the pooled buffer. For example, risk assessment and contribute an amount to the buffer the American Carbon Registry buffer accepts any account based on the reversal risk associated with the type of credit in its pool, which ensures that if a forest project (see Box 5-3, which discusses this concept for accidently reverses its carbon stock, other types of domestic crediting mechanisms that use the VCS). emissions reductions can compensate for that loss. If an unintentional47 reversal event occurs, the amount of Buffer reserves have proven to be an effective and least- carbon released into the atmosphere is estimated and cost way to compensate for reversals when necessary. In a corresponding number of buffer credits is canceled the long run, a buffer reserve supported with a requirement from the pool. This accounts for the fact that projects that project proponents hold commercial third-party will not all suffer reversal events simultaneously and the insurance could be an option to address the residual buffer reserve will be able to absorb a certain number of non-permanence risk not covered by buffer reserves. reversal events that may occur. Thus, the buffer needs to be geographically dispersed to a degree that a rare, Buffers can however present a “moral hazard” problem, if large-scope event would not affect the entire pooled used to compensate for human-caused reversals, such as buffer.48 For instance, in California, forest owners need intentional harvesting. If a landowner faces no penalty for to notify the California Air Resources Board (CARB) harvesting trees for timber other than through contracting within 30 days of identifying an unintentional reversal provisions—because reversals caused by harvesting 47 Intentional reversals are not typically allowed and if they do occur, project proponents are generally required to compensate for them. 48 For further considerations relating to stocking a buffer reserve, refer to the Canadian Council of Forest Ministers n.d. 49 See Sections 95983(b) and (c) of Article 5, Title 17, California Code of Regulations. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 52 would be compensated out of the buffer reserve—then the Discounting landowner may face an incentive to harvest. Such perverse A third option is to apply a discount factor to emissions incentives must be mitigated through oversight and penalty reduction calculations based on the risk of non- enforcement to cover intentional or avoidable reversals. permanence. Australia’s Emissions Reduction Fund applies this approach in addition to a buffer. Under While setting up a buffer reserve may impose additional the fund, project proponents can opt for either a 25- costs, the approach of South Africa and Colombia or a 100-year permanence period. If the former is chosen, highlights that mechanisms can also build on, or outsource the number of credits issued is reduced by 20 percent. to, other mechanisms, such as VCS. When addressing This discount is intended to cover the potential cost to non-permanence risk, policymakers should follow the the government in the event emissions are re-released following guidelines: from the project after the project has ended. This is on y To determine the appropriate buffer pool contribution, top of the 5 percent reduction that goes into the buffer. risk estimates should be conservative and cover To date, Australia is the only region to use an explicit the permanence period. It can be assessed discounting approach. Establishing a conservative at the methodology or the project level. baseline and applying a buffer pool contribution, however, could be viewed as forms of implicit discounting. y Buffer accounts need to maintain a sufficient number and diversity of buffer credits to Insurance cover any losses; this includes rare but large Through the liability and insurance approach, policymakers events that could destroy the entire buffer. decide who will compensate for reversals (project proponents, the government, or other parties); the y Risk assessment should reflect the fact that, as time period of that liability; and whether to provide or Deciding on the core elements climate change progresses, the reversal risk for most require a form of insurance to help cover the liability. project types increases. For instance, climate change Insurance would typically be provided by third-party is a contributing factor to increasingly severe and commercial insurers and could serve as an alternative, frequent forest fires, as well as bark beetle outbreaks. or as a supplement, to other risk management options, such as buffer reserves. Many insurance companies y The buffer reserve also needs to be designed, offer forest insurance for protection of commercial through monitoring and enforcement, to counter forest assets from fires and pests and extending this to moral hazards such as landowners intentionally forest carbon is logical. To date, however, forest carbon overharvesting trees without being liable for the insurance has not been widespread and obtaining resultant carbon loss (such as by imposing penalties). insurance is not a requirement under any existing crediting mechanisms. However, it has been a suggested Temporary crediting approach to mitigate permanence risk in several US The CDM uses the temporary crediting approach, in pieces of legislation, including the latest comprehensive which projects that are subject to non-permanence climate bill (the Waxman-Markey Bill) in 2009. risk are issued credits that expire after a predefined period. However, temporary crediting has not gained traction, primarily because the approach transfers risk from the project proponent to the credit buyer by requiring buyers to replace their temporary carbon credits. Buyers have not been prepared to accept this liability and the market for temporary credits has therefore been nonexistent. In addition, temporary credits add significant administrative complexity because of the need to track timing and replacement of credits, which can increase program administrative costs. 53 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 6 6 DEVELOPING METHODOLOGIES At a glance Methodologies provide the detailed rules, standards, and procedures that a project proponent must apply to their project to generate carbon credits. They are an essential component of a crediting mechanism as they set the rules for project eligibility, quantifying greenhouse gas (GHG) emissions, demonstrating additionality, safeguards against environmental or social harm, and project monitoring. Policymakers need to establish standards to guide methodology creation and ensure the environmental integrity of carbon credits. Methodologies can employ either a project-specific approach that relies on analysis of an individual project’s characteristics and circumstances, or a standardized approach where key components (additionality and the baseline scenario and emissions) are uniformly assessed or determined for specific classes of project activities. This chapter covers the essential elements of methodologies that crediting mechanisms must establish to ensure both environmental integrity and program efficiency. Section 6.1 highlights the differences between project-specific and standardized approaches. A standardized approach, where practicable, can reduce transaction costs for project proponents by simplifying project development and auditing. However, standardized approaches can be resource-intensive to establish and maintain for program administrators and methodologies are not suitable for all project types. Existing crediting mechanisms use a combination of both standardized and Developing project-specific approaches. Section 6.2 covers project eligibility (i.e., which activities are allowed under the crediting mechanism). High level eligibility can be program-wide but specifics about how projects within a crediting mechanism’s scope are assessed are generally set out in a methodology. Section 6.3 covers additionality, a crucial part of demonstrating the environmental integrity of carbon credits. Typical additionality tests are outlined. Section 6.4 looks at GHG quantification and reporting, which should be in line with GHG accounting principles, such as with ISO 14064-2 and the GHG Protocol for Project Accounting, to promote environmental integrity and provide additional guidance to project proponents and auditors. Monitoring project performance over time is essential, as many factors that affect emissions can change over the project life cycle. This is covered in Section 6.5. 6.1 USING PROJECT-SPECIFIC This section introduces both approaches and provides a comparison of their relative merits. AND STANDARDIZED Where possible, a standardized approach is preferable APPROACHES because it offers efficiencies and can reduce costs, particularly for project proponents. However, standardized Methodologies provide the detailed rules, standards, approaches are not always possible. Accordingly, and procedures that a project proponent must apply to when developing methodologies, policymakers need to their project to generate carbon credits. It is important determine whether additionality and baselines can be that the format and content of methodologies is standardized, or whether a project-specific approach is consistent within and across mitigation activities. required. Importantly, standardized and project-specific Policymakers can opt for a project-specific or a approaches are not binary alternatives—policymakers standardized approach for demonstrating additionality may incorporate a combination within a methodology or and determining the baseline scenario and emissions. different methodologies across the crediting mechanism. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 54 6.1.1 Project-specific approaches Similarly, adoption of different transport modes varies from region to region and developing standardized This approach analyzes each individual project’s approaches for the transport sector can be challenging. characteristics and circumstances. For example, to Standardization also has higher upfront administrative demonstrate additionality a project proponent developing costs for policymakers and can require significant data to a hydroelectric power plant in a remote location might develop. Some of these upfront costs can be reduced if be required to identify the barriers that had previously policymakers can use approaches from existing crediting prevented the project from being implemented. mechanisms. However, as highlighted in Chapter 3, the These barriers might include the fact that the project approach taken from the existing crediting mechanism requires construction of a new road and electricity needs to be adjusted to appropriately reflect the transmission lines because of its remote location. domestic context. This can make it difficult to adopt Barriers will vary across projects depending on a range standardized approaches used in existing crediting of factors, including the project size, location, and other mechanisms, since their standardized components local social or economic factors, such as electricity may only be valid in specific circumstances (e.g., tariffs. Similarly, monitoring and the quantification of predefined geographic regions). Policymakers must emissions reductions may also depend extensively on also periodically review the standardized approaches unique, project-specific parameters and contextual in a methodology to ensure that they continue to factors. Most existing carbon crediting mechanisms provide an appropriate basis for demonstrating rely heavily on project-specific approaches. additionality and determining the project baseline. 6.1.2 Standardized approaches Standardization provides a generic process for specific classes of mitigation activity to demonstrate Box 6-1. California US Forest Projects additionality or establish a baseline scenario. This Protocol—an example of standardized streamlines the development and assessment process approaches for individual projects. The performance of individual activities can be evaluated against predefined criteria The California US Forest Projects Protocol determines or thresholds to determine eligibility. It provides a clear additionality by using both the legal requirement test methodologies Developing set of requirements that—if followed and met—will and a performance standard evaluation. result in activities that are deemed to be additional or simplify baseline emissions quantification. Note, these The legal requirement test evaluates whether a standardized approaches are distinctly different from the project exceeds the obligations required by any use of uniformly applied parameters or defaults (such law, regulation, or other mandate. Modeling of the as default grid emission factors) within a methodology. baseline for forestry projects also has to factor in any While existing crediting mechanisms widely use legal constraints. Finally, if the project is for avoided project-specific approaches, standardized approaches conversion, project proponents need to demonstrate are increasingly being applied (see Box 6-1).50 the anticipated land use is allowed (e.g., forestry owners have obtained all necessary approvals). 6.1.3 Comparing the two approaches Generally speaking, project-specific approaches are The performance standard evaluation is a more flexible and impose a lower upfront administrative standardized approach, which applies a common burden for the policymaker. However, they require practice test for evaluating the project’s impact more work from the project proponent in terms of data based on the US Forest Service Forest Inventory and collection and analysis. Project-specific approaches also Analysis data at the regional level. This approach require more effort from auditors, who verify the project uses activities and average forest growth rates in data and documentation. Standardized approaches can help eliminate the need for unique project-specific the region where the project is located to establish a analyses, which can reduce costs. However, such conservative business-as-usual baseline. A project’s an approach is not always possible, as some project impact is calculated against this uniformly applied activities may be heterogenous or have complex systems, performance standard metric, with growth beyond making them difficult to standardize. For example, the national average considered additional. This agricultural practices vary widely across regions, so eliminates the time-consuming task of establishing a practice that might be considered additional in one a model of forest growth that accurately reflects region might be business as usual in another region. the forest and its management practices before the project was implemented. 50 World Bank 2016. This trend has continued from 2016 to this guide’s publication in 2020. 55 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Table 6-1. Project-specific versus standardized approaches Project-specific approaches Standardized approaches Applicability Provides a flexible approach if the May be difficult to apply to some sectors or project crediting mechanism has a wide sectoral types; for example, heterogeneous activities (e.g., coverage and scope (i.e., may include land-use projects) or activities involving complex project types for which standardized systems (e.g., transportation). Often can only approaches would be difficult). Can take be used in a particular geographic region. project-specific conditions into account. Development time Methodologies can be developed Methodologies take longer to develop, because and data needs more rapidly, because existing tools additionality and/or baseline scenario for the class can be referenced for determining of project activities must be established up front. additionality and baseline scenario. Extensive (typically sector-wide) data collection and analysis is required to evaluate common practices across a geographic area, define performance standards, and determine conditions or thresholds that distinguish additional from non-additional activities. Burden on project Increases cost of producing project Simplified, more transparent and streamlined proponents documents (e.g., project-specific process. Requires less project-specific data, which data and more exhaustive analysis is can reduce costs and streamline project reviews. required), thereby increasing project development costs. In addition, because of the heterogeneous nature of projects, auditing costs are typically higher. Burden on Requires more effort from program Requires more upfront effort to develop approaches methodologies Developing program administrators and an ongoing in-depth that are standardized but can reduce the level administrators project evaluation is necessary for of ongoing effort required for review because each individual project. Project reviews additionality and/or baseline scenario is determined often have subjective components. up front in the methodology. Can also reduce the subjective nature of project reviews. Certainty Gives less certainty to project proponents Provides greater certainty to project proponents and investors because project additionality and investors by making eligibility easier to and/or the baseline scenario must be determine. In addition, when baselines can be determined on a case-by-case basis. standardized, the volume of carbon credits and return on investment are easier to assess. Frequency of Methodologies should be periodically Methodologies must be updated on an ongoing basis methodology reviewed and updated but may occur on to reflect changes in practices and technologies. revisions a more ad hoc basis than methodologies adopting standardized approaches. Table 6-1 above compares the two approaches. baseline and quantification assumptions, while still prescribing project-specific additionality determinations. Generally, standardized approaches may make the most Conversely, other crediting mechanisms, such as sense where the crediting mechanism has a narrow scope, California’s Compliance Offset Program (COP), apply covers mitigation activities with similar or consistent standardized additionality tests (as well as project- contextual factors (e.g., like electricity, which has a specific approaches) but also have project-specific homogenous output), or where a top-down methodology requirements associated with baseline, monitoring, development approach is preferred (see Chapter 7). and quantification methods. The most significant distinction between methodologies is often whether they In practice, methodologies need not be exclusively require standardized or project-specific additionality either project-specific or standardized (see Box 6-2). For determinations, because additionality can be difficult to example, some Clean Development Mechanism (CDM) demonstrate yet is important for environmental integrity. methodologies employ at least some standardized A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 56 y Baseline technologies or practices: activities that displace certain technologies Box 6-2. Combined project-specific (e.g., diesel generators to produce electricity) and standardized approaches or practices (e.g., clear-cutting a forest). Australia’s Emissions Reduction Fund provides y Baseline conditions: proposed projects with two soil carbon methodologies. One adopts specific preconditions (e.g., for reforestation, no a project-specific approach, whereby project commercial logging may occur in the 10 years proponents undertake soil sampling to evaluate prior to project initiation). Such applicability the accumulation of carbon. A separate conditions can guard against moral hazard, such methodology applies a standardized approach, as clear-cutting a forest and immediately beginning adopting a default carbon accumulation rate in carbon credit generation through reforestation. tons of carbon per hectare per year for a given region and land management activity, derived y Project technologies or practice: certain from the Australian national GHG inventory.a technologies (e.g., solar photovoltaic panels) or specific practices (e.g., selective timber a Australian Government 2018. See https://www.legislation.gov.au/ harvest) employed by the project. Latest/F2018C00126. y Project scale: minimum or maximum project size (e.g., hectares of project area 6.2 DETERMINING or megawatts generation capacity). PROJECT ELIGIBILITY y Legal right and ownership: require that project proponents demonstrate they have the legal right The conditions set out in a methodology outline the or consent to undertake the project. This criterion limits and restrictions under which a specific activity can can be particularly relevant to land-use activities, be registered and receive credits under the crediting where legal title over the land or right to operate mechanism. Methodologies may restrict projects based the project and accrue its benefits (including methodologies on the following aspects (summarized in Figure 6-1): Developing carbon credits) may not be clear.51 Policymakers operating within a jurisdictional context where Figure 6-1. Considerations for project eligibility identifying legal ownership presents challenges should review existing good practice guidance.52 BASELINE CONDITION y Geographic region: specific jurisdictions or other geographical areas. Such geographic BASELINE PROJECT limitations can ensure project development TECHNOLOGY TECHNOLOGY OR PRACTICES OR PRACTICE benefits accrue to targeted populations. y Certification requirements: activities that have received specific independent certifications (e.g., Forest Stewardship PROJECT Council certification). Such applicability CERTIFICATION PROJECT conditions leverage established certifications REQUIREMENT ACTIVITY SCALE to achieve development benefits or avoid duplicating the evaluation work performed in pursuit of a certificate, thereby saving time and effort for the program administrator. GEOGRAPHIC LEGAL RIGHT REGION AND OWNERSHIP 51 Australia’s Emissions Reduction Fund experienced challenges with this issue and enacted legislation explicitly to address carbon rights in 2011. 52 For instance, see United States Agency for International Development 2012. 57 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Box 6-3. Positive and negative lists to filter for additionality A crediting mechanism can filter out activities that are likely to be additional (e.g., off-grid renewables in a less likely to be additional or focus on those activities region with identified barriers to uptake). that are more likely to be additional. This can be done through positive or negative lists. Project types under Positive list a positive list are automatically deemed additional, VCS and Gold Standard methodologies for off-grid whereas negative lists outline what is not allowed and renewable activities would therefore establish eligibility excludes project types that are deemed to be harmful criteria to ensure only off-grid activities qualify to apply or undesirable. Negative lists are often implemented at the methodology. This is often referred to as a positive the program-level and positive lists at the methodology list because the project must satisfy the stated criteria level, through eligibility criteria to ensure that a (e.g., that it is not connected to a centralized distribution methodology applies only to projects that meet certain grid). Another example of a positive list applicability requirements. condition relates to baseline technology and practice. For many off-grid renewable energy projects, the Negative list baseline scenario is likely to be diesel generators This is used in the Verified Carbon Standard (VCS) and (for electricity) or kerosene lamps (for lighting). Thus, Gold Standard to exclude certain renewable energy applicability conditions could restrict the eligibility of projects. Both crediting mechanisms exclude grid- the methodology to projects that can demonstrate connected renewable energy projects and any projects that in the absence of the project, diesel generators that are above 25 megawatt capacity in specified or kerosene lamps would be the likely scenario and regions. These program-level eligibility restrictions limit therefore represent the baseline. renewable energy projects to activities that are more methodologies Developing As these aspects suggest, eligibility conditions not only affect scope but can be adopted to filter for additionality 6.3 DEMONSTRATING or achieve other policy objectives, such as through the ADDITIONALITY adoption of positive or negative lists (see Box 6-3). A proposed project activity is considered additional if it Eligibility conditions can be used to prioritize crediting would not be implemented in the absence of the crediting projects that deliver specific development benefits. mechanism (e.g., the price signal from the carbon credit Eligibility conditions under the Gold Standard market), holding all other factors constant.54,55 Additionality methodologies, for instance, consider the project’s is an essential element to ensure carbon credit quality. community impact as part of the project design in order to However, determining additionality can be challenging as maximize development benefits and reduce any unintended it requires an assessment against a counterfactual (that is, harm. The small-scale methodology “thermal energy what would have happened in the absence of the crediting from plant oil for the user of cooking stoves” requires, mechanism). This is both challenging and has an element for instance, that plant oil be produced with sustainable of subjectivity. Additionality risk refers to the possibility management practices and not sourced from existing that a project is not additional. The policymaker must plantations to the detriment of other existing uses.53 determine how much risk is acceptable. Good practice is to use informed assumptions and ensure there is sufficient evidence to have a high level of confidence in a proposed project’s additionality. A summary of typical tests is provided in Box 6-4, noting that these tests are not mutually exclusive and in practice crediting mechanisms generally use a combination of tests to demonstrate additionality. This is the approach taken in California (see box 6-5). 53 Gold Standard n.d. 54 Gillenwater 2008. 55 A note on the applicability of additionality: additionality is not exclusive to crediting mechanisms; additionality considerations are used also for some subsidies and development cooperation projects, to ensure that scarce public resources are used effectively where they are most needed and not to support business-as-usual activities that are commercially viable even without support. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 58 Box 6-4. Typical additionality tests Additionality tests adopted by existing crediting • A common practice test or technology/practice mechanisms include: penetration level test that considers the proposed project’s technology or practice within its context • A regulatory surplus test that asks whether the (e.g., sector, region, and industry). If the technology project activity is required by law, mandate, court or practice is established common practice and order, or regulation. Required activities are deemed would likely occur even without the crediting non-additional. Exceptions may be made when a mechanism, then the project or program is deemed policy or regulation is generally not widely followed to be non-additional. or enforced. Additionality tests may be applied to individual • A financial or investment test that analyzes activities (such as through eligibility criteria) or at the whether the project activity is economically program level, such as automatically classifying types and financially viable. If the proposed project of activities, practices, or technologies as additional in question is economically viable without the carbon credit revenue, it would be deemed non- (for example “positive lists”), or conversely excluding additional. This test is often operationalized in certain project types deemed unlikely to be additional. the form of an estimated internal rate of return In practice, crediting mechanisms typically use a for the proposed project relative to a contextually combination of tests to provide a robust method relevant investment benchmark. Another option is for assessing additionality. For example, a landfill to compare the net present value of the project to methane capture and destruction project activity a reference level. The project is considered non- might pass a regulatory surplus test (because it is in additional if the internal rate of return is above the a jurisdiction that does not require implementation benchmark or the net present value of the project of this technology) and a financial or investment is higher than the reference level. additionality test (because it did not make sense to methodologies Developing install this technology from an economic perspective), • A barrier test, whereby project proponents but it could still fail a common practice test if in the need to identify obstacles to implementation. Additionality is demonstrated if the incentive surrounding region 90 percent of similar landfills have from the crediting mechanism helps the installed the technology without the additional financial project proponent overcome defined financial, benefits from carbon credits. technological, institutional, or regulatory barriers, which otherwise are preventing the project activity. The difficulty of demonstrating additionality varies among applicability conditions to filter out project activities project types. For example, it is generally easy to show that are likely to be non-additional; and that industrial gas destruction projects are additional, as only legal mandates or carbon credits provide practical y intensive project reviews at the point incentives to undertake them. By contrast, renewable of registration request. energy and energy efficiency projects require careful As previously discussed, additionality can be determined scrutiny, as they may be undertaken even in the absence on a case-by-case basis using a project-specific of the crediting mechanism (e.g., because of revenues approach, or for a whole class of projects using a from energy sales). See Section 4.2 for a further discussion standardized approach. In practice, the effect of a of approaches to avoid low-additionality project types. crediting project or program is typically context specific. For example, a crediting mechanism may incentivize a Crediting mechanisms have several options to increase mitigation activity in one location or context (meaning the likelihood that activities are additional. This can be it is additional there) but not in another. Furthermore, done through the additionality assessment will change over time y program-wide requirements (e.g., by excluding project (meaning an activity may be additional at present but activities unlikely to be additional, often called a not in five or ten years). This highlights the benefits of a “negative list”—like those described in Box 6-3); project-specific approach to determining additionality and is one reason why standardized approaches y methodologies that carefully specify their to additionality have been difficult to develop. 59 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Box 6-5. Multiple additionality tests: California In California, projects must comply with two tests Cultivation Compliance Offset Protocol focus on for additionality. The first is a requirement to show specific regions, which mitigates against the risk that legal additionality. This ensures that only project certain practices and activities may be common in one activities that are not required by law are eligible. If, part of the country and not in others. for instance, the project is generating credits for one program, like a voluntary carbon offset program, it For each of California’s Compliance Offset Protocols, cannot also generate compliance offset credits for the the performance standards are outlined for specific California cap-and-trade program. The second test activity types. For instance, the protocol on mine applies performance standards that vary according methane capture distinguishes between active to the project type. This evaluation provides an underground mine ventilation air methane activities, assessment of the level of common practice of a active underground mine methane drainage activities, specific technology or process and its technological active surface mine methane drainage activities, and parameters, as well as considering the prevalence of abandoned underground mine methane recovery barriers to development of the project. For example, activities. the additionality requirements for California’s Rice 6.3.1 Project-specific approaches and measured and technologies and fuels do not have widely varying emissions rates. Standardized approaches Project-specific approaches determine additionality may only be feasible for certain sectors or activities through a tailored analysis that typically uses a (e.g., grid-connected energy generation, fuel switching combination of tests to demonstrate that the project for specified technologies) determined by contextual would not have been implemented without the factors for potential projects within the designated methodologies crediting mechanism. In the project-specific approach, Developing sector or activity type. The PMR’s Guide to Greenhouse additionality tests are used as the basis for developing Gas Benchmarking for Climate Policy Instruments has an additionality tool, such as CDM’s “Tool for the additional detail on developing GHG benchmarks.56 demonstration and assessment of additionality.” For more information on how to use additionality tests to One way of implementing standardized approaches is develop additionality tools and methodological tools, through a “positive list” (see Box 6-3), which identifies see the Partnership for Market Readiness’ (PMR) Carbon specific activities that are deemed to be additional and Credits and Additionality: Past, Present, and Future. eligible to use certain methodologies.57 For instance, the Climate Action Reserve US Livestock Project 6.3.2 Standardized approaches Protocol employs a technology-specific threshold Standardized approaches determine additionality by based upon an evaluation of manure management applying conditions, requirements, a performance practices in applicable project locations. Further standard, a performance benchmark, or any combination applicability conditions constrain the types of projects of these tools. Projects must meet stated conditions that are eligible to use the methodology, such as specific and requirements, or outperform the performance baseline conditions (e.g., technologies or practices standard or performance benchmark, to be considered present in the baseline scenario) and minimum time additional. A performance standard is typically a list that the baseline conditions were operational. of technologies or practices, and projects will need to implement one or more of these to pass the standard. A The standardized approach accepts that some performance benchmark is an emissions intensity–based non-additional projects will meet the applicability approach whereby projects need to achieve a specific conditions and be deemed additional (false positives) emissions rate per unit of product or service (e.g., tons and that some additional projects will not meet the of carbon dioxide equivalent per metric ton of clinker conditions and therefore be deemed non-additional produced for a cement sector methodology). Benchmark (false negatives). The risk of false positives and false standards are best suited to sectors or activities where negatives can be minimized, but not eliminated. Regular standard outputs or services can be easily identified review, evaluation, and refinement of the methodology (particularly the additionality tests) reduces this problem. 56 https://openknowledge.worldbank.org/handle/10986/26848 57 See, for example, https://verra.org/wp-content/uploads/2018/03/VCS-Guidance-Standardized-Methods-v3.3_0.pdf A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 60 Issuing credits to non-additional activities can result in an overall increase of emissions, because the recipient 6.4 QUANTIFYING EMISSIONS would otherwise implement alternative mitigation actions. REDUCTIONS Non-additional credits also dilute the value of other credits in the market. If buyers factor in this risk, it may Methodologies set out rules, procedures, lower the price, dampening the mitigation incentive of the and formulae so proponents can quantify crediting mechanism. Using non-additional carbon credits GHG emissions reductions through: would displace the use of additional credits or the direct emissions reductions by the compliance entity/buyer. y specifying the GHG accounting boundary; As highlighted in Chapter 1, the presence of non-additional y establishing the baseline scenario and credits makes it more expensive for jurisdictions to meet estimating baseline emissions; their emissions reduction targets, because the government would need to incentivize or mandate emissions y estimating project emissions; and reductions elsewhere in the economy to achieve its target. This undermines the role of crediting mechanisms y quantifying net GHG emissions reductions. in achieving cost-effective emissions reductions.58 This is illustrated in the two scenarios below:59 6.4.1 GHG accounting boundary The GHG accounting boundary describes the GHG y Carbon tax scenario. Use of a non-additional sources, sinks, and reservoirs (SSRs) either directly credit, in part, to meet an entity’s compliance or indirectly impacted by the activity that should be obligation, would reduce the carbon tax included in the quantification of emissions reductions. revenue otherwise paid to the government. The GHG accounting principles (see Box 6-5) of y ETS scenario. Use of a non-additional credit relevance and completeness should inform the approach to meet an emissions compliance obligation to developing methodological guidance to define a effectively results in emissions covered project’s accounting boundary. Appropriately defining by the ETS exceeding the ETS cap. the GHG accounting boundary through programmatic methodologies guidance and methodological requirements ensures Developing The decision of how to approach additionality depends that all SSRs are considered when GHG impacts on the crediting mechanism’s objectives and scope are quantified. This is discussed in Chapter 4 on and the national context. Based upon the discussion determining the boundaries in the PMR’s Developing in this chapter and the factors to consider when Emissions Quantification Protocols for Carbon Pricing: determining the level of standardization (Section 6.1), A Guide to Options and Choices for Policy Makers. policymakers must determine whether additionality can be standardized effectively for each project type. Key to Methodologies should ensure the project this determination is whether resources are available to boundary appropriately accounts for the project support the development of a standardized approach activity’s SSRs. Specifically, methodologies and maintain it over time. Existing crediting mechanisms, like the CDM, California, and VCS, among others, provide y should specify the relevant SSRs for the project a substantial body of methodologies that policymakers activities to which they are applicable; could draw from. If standardization is not feasible, the project-specific approach may be preferable, at least y should address data monitoring and reporting in the early stages of the crediting mechanism. requirements (see Section 6.5) that may be specified for types of SSR or specific SSRs within individual project methodologies; y may exclude SSRs below a prescribed threshold of significance (the “de minimis threshold”) to reduce the burden on project proponents and auditors; and y should account for leakage emissions (see Box 6-7) in the estimate of net GHG emissions reductions, if significant. 58 Broekhoff et al. 2019. 59 World Bank 2016. 61 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Box 6-6. GHG principles GHG accounting principles underpin and guide • Consistency. Enable meaningful comparisons in all aspects of quantification and reporting of GHG GHG-related information. emissions reductions. They are therefore an important element in ensuring carbon credit quality. The • Accuracy. Reduce bias and uncertainties as far as principles serve as a guide to project proponents and is practical. auditors, particularly where the rules and requirements • Transparency. Disclose sufficient and appropriate of the crediting mechanism provide flexibility or where GHG-related information to allow intended users to there is uncertainty. Note that these accounting make decisions with reasonable confidence. principles apply to quantification and reporting only. Two foundational documents set out the GHG • Conservativeness. Use conservative accounting principles used by crediting mechanisms— assumptions, values, and procedures to ensure ISO 14064-2 (Specification with guidance at the that GHG emissions reductions or removal project level for quantification, monitoring and enhancements reporting of greenhouse gas emissions reductions are not overestimated. or removal enhancements) and the GHG Protocol for Project Accounting. The six principles are: The application of principles is a core element of ensuring carbon credit quality. Crediting mechanisms • Relevance. Select the GHG emission sources a , should establish principles in line with ISO 14064-2 data, and methodologies appropriate to the and the GHG Protocol for Project Accounting and specific project type. require project proponents and auditors to follow these principles. • Completeness. Include all relevant GHG emissions and removals; include all relevant a World Resources Institute and World Business methodologies Developing information to support criteria and procedures. Council for Sustainable Development 2005. If methodologies fail to account for leakage emissions, The baseline scenario is an important part of quantifying projects will overestimate net GHG emissions reductions. emissions reductions because the emissions under the Therefore, methodologies must estimate leakage project scenario are compared to emissions in the baseline when leakage is an issue and make the necessary scenario to determine the emissions reductions generated deductions when net GHG emissions reductions are by the project. For this reason, it is critical that the calculated. Leakage is most common in forestry and baseline scenario emissions are conservative—baseline land-use projects. For example, VCS has developed scenarios should err towards underestimating emissions. a tool (the “VT0004 JNR Leakage Tool v1.0”) for quantifying leakage from reduced emissions from Estimates of GHG emissions under the baseline scenario deforestation and land degradation projects. Furthermore, are generally a product of two factors: the level of methodologies typically provide procedures for leakage activity associated with a process that generates GHG quantification specific to the project activity(ies) emissions (which could be expressed using a variety included in the methodology (if applicable). It is of metrics) and the GHG intensity of technologies or advisable to review similar methodologies to support practices involved in that process (commonly expressed development of leakage quantification procedures. as an emissions factor). Estimates of GHG emissions under the baseline scenario are generally produced 6.4.2 Baseline scenario and emissions as part of the project proposal. Baseline emissions must be set conservatively so as not to overstate The baseline scenario is a prediction made before the them, as overstating could lead to over-crediting, project begins of what would have occurred in the undermining the environmental integrity of the credits. absence of the project (for example, installed equipment or technology). The baseline scenario should thus be based There are three key issues that must be considered on evidenced assumptions of behavior and technology. when determining the most appropriate approach for baseline setting: A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 62 y determine the level of standardization; project-specific approaches for baseline emission calculations for afforestation and reforestation y define baselines on either an absolute activities because activities can occur in diverse or intensity basis; and geographies with varying baseline considerations. y determine an appropriate method for Standardized approaches to determining baseline developing a baseline scenario. emissions are established using sector-wide data. They can be applied to certain types of activity, provided Each of these issues is considered below. Policymakers activities have homogenized contexts to ensure accuracy. must evaluate and determine the best-fit approach for In cases where the baseline scenario involves a technology estimating baseline emissions and set out the approach with an industry or performance standard, this standard in the project methodologies. For a more detailed look may be used to establish a baseline emissions level. at baseline setting, refer to the PMR’s technical note on For example, an existing industry standard for natural Options and Guidance for the Development of Baselines.60 gas boilers indicates the baseline emissions for a renewable heating project that reduces carbon dioxide Level of standardization emissions through displacing such boilers. Alternatively, Approaches to determining the baseline scenario a single generic reference technology or practice can can adopt various levels of standardization. serve as a baseline scenario (for example, a livestock anaerobic digester project that will capture and destroy Taking project-specific circumstances into account methane may establish the standardized baseline means conducting an individualized assessment to scenario for an uncontrolled anaerobic system).61 determine the most appropriate baseline practice California’s COP applies a standardized baseline for its or activity for a proposed project, or configuring US Forest Projects Protocol because the methodology baseline modeling parameters using project- constrains project activities to a geographic region specific data and information. The CDM stipulates across which baseline considerations are similar. methodologies Developing Box 6-7. Leakage Increases in GHG emissions outside the project’s providers or users of an input or product react GHG accounting boundary that occur as a result to the change. For example, an improved forest of the project’s implementation are called leakage management project activity might reduce the emissions.a Leakage, sometimes referred to as harvesting frequency of a forest plot, thus reducing “secondary effects,”  b can be categorized as follows: supply of wood products. The market demand signal leads an adjacent forest owner to increase • Upstream or downstream effects are harvesting to meet unmet demand. associated with the operating phase of a project activity—either the inputs used (upstream) or the • One-time effects result from construction, products produced (downstream) of the project installation, and establishment, or decommissioning activity. For example, a biomass energy project and termination, of the project activity (for example, might increase demand for biomass. This in turn a reforestation project may require clearing of increases biomass harvesting frequency by timber the existing non-forest land cover prior to forest companies, and the increased use of harvesting establishment). equipment increases emissions. a Offset Quality Initiative 2008. b • Upstream or downstream effects involving The GHG Protocol for Project Accounting highlights that the definition of leakage varies from context to context and can be defined with market response occur when a project activity respect to a range of factors, including physical project boundaries or changes market supply and demand and alternative responsibility for GHG emission sources.62 60 Broekhoff and Lazarus 2013. 61 See Chapter 8.1 in https://openknowledge.worldbank.org/handle/10986/21824 62 World Resources Institute and World Business Council for Sustainable Development 2005. 63 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS As outlined above, a project-specific approach to Methods for estimating baseline emission baselines will produce a more accurate outcome 63 but A variety of methods can be used to project baseline require more detailed project-level data and information. emissions, including simple extrapolation from historical For instance, project proponents would need to identify data, more detailed modeling of future trends, the use and calculate all baseline scenario SSRs. A standardized of comparison groups, or some combination of these. approach will increase the upfront burden on policymakers Existing crediting mechanisms typically allow for each but can reduce the costs for project proponents. However, of these methods depending on the type of mitigation because a standardized approach to baseline setting activity involved. Additional detail on each of these essentially adopts an average across all applicable project approaches and their advantages and disadvantages activities, there is a potential for inaccuracies in a specific is available in the PMR’s technical note on Options project’s baseline emissions calculation. This increases and Guidance for the Development of Baselines. the importance of using conservative assumptions when adopting a standardized approach to baseline setting. 6.4.3 Project emissions The crediting mechanism’s objectives, scope, and Project emissions are the emissions associated with the local context should act as a guide. For example, the implemented project activity. In this way, project emissions Québec Offset System applies standardized baselines are quantified in a very similar way to those required for to selected sectors to make project development mandatory GHG emissions reporting programs. The and emission calculations easier. Québec looked PMR’s Developing Emissions Quantification Protocols at targeted sectors against data availability and the for Carbon Pricing: A Guide to Options and Choices for program administrator’s capacity. As Québec had Policy Makers provides specific guidance on calculating key industry-wide data, it could establish uniformly project emissions. Two key issues are discussed applicable baseline scenarios for activities within below: functional equivalence between the project and these sectors. Furthermore, the provincial government baseline scenario, as well as avoiding underestimation. had sufficient capacity to develop the standardized baselines for each applicable scenario for project Functional equivalence means equal goods or methodologies and had allotted time for this process. services are produced. Project SSRs, as identified by methodologies, must propose a project scenario that methodologies Developing Absolute or emissions intensity is functionally equivalent to the baseline scenario. For example, a facility that implements energy efficiency Baseline emissions may either be absolute or based process improvements must still provide the equivalent on emissions intensity. The project activity type lighting, heating or cooling, or processing capacity usually dictates which approach is appropriate. to that assumed to have occurred in the baseline Absolute baselines, for example, are appropriate where scenario. If the project results in the addition of new mitigation activities affect the activity level of a process, direct or indirect SSRs to the project boundaries, such as reducing landfill methane or industrial gas it may still provide functional equivalence, and the emissions, or reducing emissions from deforestation. program administrator evaluates the overall system Intensity baselines are applicable where a mitigation function for equivalent function. The project’s GHG intervention is unlikely to (significantly) change activity accounting boundaries must reflect functional levels, but instead reduces emissions per unit of activity, equivalence of the project and baseline scenario. such as in renewable energy or energy efficiency Project emissions must be based on conservative projects. Most existing crediting methodologies employ assumptions so as not to underestimate them (or some form of intensity baseline. Additional detail overestimate the amount of emission removals). is available in the PMR’s technical note on Options An underestimation of project emissions would and Guidance for the Development of Baselines. lead to over-crediting the project activity, just as would overstating baseline emissions. Both would contribute to an overestimation of GHG emissions reductions, undermining the environmental integrity. 63 Standardized baseline emissions will likely result in under- or over-crediting compared to the project’s actual impact. This is because the standardized baseline is essentially an average across all applicable project activities. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 64 6.4.4 Net GHG emissions reductions Dealing with negative abatement The project’s net GHG emissions reductions result from It is possible that emissions during the project period subtracting the project emissions from the baseline may be greater than those in the baseline, especially emissions. This is often done on an annual basis, but the for absolute emission baselines. Depending on period can potentially be shorter or longer to align with how this is addressed, it can result in “negative the monitoring requirements, as set out in Section 6.5. abatement” (meaning more emissions actually occur through the project compared to the baseline). For example, Project X’s estimated baseline emissions are 50,000 metric tons of carbon dioxide equivalent This concept is demonstrated in Figure 6-2, which (tCO2-e)/year and estimated project emissions are presents an illustrative example of a project with an 38,500 tCO2e/year. This can be calculated as: established baseline of 100 tCO2e and project emissions that vary from year to year.66 If credits are only allocated in years when project emissions are lower than the baseline, Baseline emissions – project emissions = the project would receive credits for merely achieving net GHG emissions reductions business as usual with annual variation.67 There are two main approaches to address negative abatement: 50,000 (tCO2-e/year) – 38,500 (tCO2-e/year) = 11,500 (tCO2-e/year) y Zeroing. Where any negative abatement at the end of a reporting period is disregarded and no adjustments are made to total abatement calculations. Any potential leakage emissions must be incorporated Zeroing is a simple approach that lowers risks into the calculation of net GHG emissions reductions by to project proponents but it increases the risk adding leakage emissions to the left side of the example of over crediting (see example in Figure 6-2). equation above. A range of tools can be used to capture various aspects of leakage and policymakers can draw y Netting out. Where the amount of negative abatement from tools used by existing crediting mechanisms. For in a reporting period is recorded and accounted for— example, the VCS has a specific module to quantify usually by reducing abatement in subsequent reporting methodologies market leakage 64 and a specific module to quantify periods. This is a more conservative approach that Developing activity-shifting leakage 65 for land-based projects. would lead to higher environmental integrity. After net GHG emissions reductions are calculated The potential for negative abatement is often associated for each project, programs may require contribution with land sector projects due to the natural variation that of credits to the buffer reserve or make other risk-of- can occur with these projects (e.g., climatic and seasonal reversal or discounting subtractions from the net GHG variation). Such variability is also present in nonbiological emissions. The remaining emissions reductions are systems (e.g., increased heating in the winter and cooling issued by the crediting mechanism as carbon credits. in the summer). Economic conditions, such as interest rates, foreign exchange rates, and international demand for products, can dramatically shift production as compared to forecasts. There are also examples where economic variability can result in negative abatement. This can occur where improvements in emissions performance are directly linked to changes in underpinning economic conditions.68 Negative abatement should be treated consistently across all project types and sectors. 64 See VCS Agriculture, Forestry and Other Land Use Project Market Leakage Module (https://verra.org/methodology/afolu-project-market- leakage/). 65 See VCS module on the Estimation of Emissions from Activity-Shifting Leakage (https://verra.org/methodology/vmd0032-estimation-of- emissions-from-activity-shifting-leakage-v1-0/). 66 Note that the average project emissions over the 10-year period is 100. 67 In this example, the project would be allocated over 60 credits in total, as any negative abatement in a given reporting period is disregarded (zeroing). 68 For example, if a methodology awards credits for improving emissions intensity, negative abatement may result where a baseline has been established during a period of high production (perhaps due to strong economic growth) and there is a sharp fall in production during a reporting year (perhaps due to economic downturn). Negative abatement would result where the emissions intensity is highly correlated to the level of production (e.g., due to economies of scale). 65 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Figure 6-2. Over-crediting annual variation through zeroing negative abatement 140 35 120 30 Number of credits allocated Project/baseline emissions 100 25 80 20 60 15 40 10 20 5 0 0 1 2 3 4 5 6 7 8 9 10 Credits Allocated Baseline Project (avg=100) methodologies 6.5 MONITORING PROJECT Developing Methodologies must also supply instructions relating to cleaning instruments, inspection, field check, and PERFORMANCE OVER TIME calibration activities, including the role of individuals performing these duties, and quality assurance or quality Monitoring project performance ensures the project control provisions to ensure that data acquisition and continues to meet the eligibility requirements, and it meter calibration are carried out consistently and precisely. generates data to quantify baseline, project, and leakage emissions. Monitoring helps to safeguard against social Examples of project monitoring parameters include and environmental harm and track development benefits as discussed in Chapter 5. Methodologies describe y inputs (including fuel, electricity, waste); the data and parameters that need to be monitored, y outputs (including fuel, electricity, waste, by-products); including the sources of data and units of measurement, as well as the procedures for monitoring including y operations data (including quantity of steam, monitoring frequency and measurement techniques. temperature, moisture, hours of operation); Collecting data is essential to supporting monitoring y equipment is operated consistent with objectives. For instance, projects that estimate emissions manufacturer recommendations; reductions from installed renewable energy that displaces grid electricity must collect activity data (kilowatt hours of y emissions factors for power sources (e.g., grid electricity generated) in the form of a meter reading. In this electricity, generators, alternative fuel types); example, the methodology would specify the frequency y project size (e.g., area of forest under of collection and acceptable types of activity data (e.g., improved management); and monthly meter readings) and the frequency of emission factor checks (e.g., annual checks of emission factors). y sample plots and growth rates (e.g., biological sequestration projects). A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 66 Monitoring procedures cover estimation, modeling, Guidelines for Completing the Project Design Document and direct measurement calculation approaches and (CDM-PDD) and the Proposed New Baseline and guide project proponents in managing data quality. Monitoring Methodologies (CDM-NM), for example, Methodologies should also include specific guidance to provides further explanation of the elements that should monitor for potential leakage emissions—see the VCS be included in a monitoring methodology (Chapter III) and Validation and Verification Manual for an example.69 In guidance for developing a monitoring plan (Chapter B.7). some cases, crediting mechanisms provide supplemental guidance to assist auditors in ensuring that monitoring To help promote transparency, assist with verification, has been conducted appropriately. For example, the and help prevent procedural errors, policymakers VCS Manual describes information on monitoring may include requirements for project proponents to requirements that auditors must assess in their project develop a monitoring plan. Monitoring plans describe reviews. The PMR’s Designing Accreditation and the procedures for obtaining, recording, compiling, Verification Systems: A Guide to Ensuring Credibility for and analyzing monitored data and parameters. This Carbon Pricing Instruments provides further guidance. should include, among others, the roles, responsibilities, and competencies of the personnel who conduct Monitoring may extend beyond the project crediting project monitoring; procedures for recording and period for projects that have non-permanence storing data; quality assurance and quality control risk (e.g., forest projects, carbon capture, and procedures; and any sample approaches used. storage as discussed in Section 5.5). Alternatively, some crediting mechanisms, like in Australia, outline minimum requirements in the The methodologies should provide sufficient information methodology rather than mandate a monitoring plan. for the project proponent to conduct monitoring and for the auditor to assess whether monitoring has been performed appropriately. For uncertain parameters, conservative values should be selected. The CDM methodologies 69 https://verra.org/wp-content/uploads/2018/03/VCS_Validation_Verification_Manual_v3.2.pdf. Developing 67 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 7 7 ADOPTING, REVIEWING AND REVISING METHODOLOGIES At a glance The processes for developing and maintaining methodologies are an important consideration for policymakers. Policymakers should establish consistent and transparent rules for how methodologies can be added to the crediting mechanism, including procedures for developing and approving new methodologies. In addition, crediting mechanisms need clear procedures for revising methodologies (for example, correcting errors or adjusting parameters) and updating them (including expanding their scope or modifying methodological procedures). Options for adding new methodologies include replicating them from existing crediting mechanisms—either with or without modification to suit the domestic context and program goals—or developing and approving them through “bottom-up” or “top-down” processes. Policymakers can also adopt a mix of these approaches. Section below outlines these approaches in more detail. Section 7.2 discusses important procedural considerations that may arise depending on which approaches are chosen. Section 7.3 summarizes the three main considerations policymakers will need to factor in: (1) how quickly new methodologies are needed, (2) available program resources, and (3) how much control policymakers need over methodological choices and project types. Section 7.4 discusses considerations for reviewing and changing methodologies over time in order to keep them current and aligned with program goals. Policymakers should clearly communicate what types of changes are allowed, when they may be required, how frequently they may occur, and whether (and for how long) older versions of methodologies may continue to be used and under what circumstances. Additional guidance on Adopting, reviewing and the process for developing, reviewing, and revising quantification methodologies is given in the Partnership for revising methodologies Market Readiness’ (PMR) Developing Emissions Quantification Protocols for Carbon Pricing: A Guide to Options and Choices for Policy Makers. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 68 7.1 APPROACHES FOR ADDING methodology development and promote consistency, it is good practice for policymakers to provide NEW METHODOLOGIES guidance on the required contents and structure of methodologies, along with minimum requirements A crediting mechanism should adopt methodologies for meeting environmental integrity criteria (see for all mitigation activities falling within its scope (as Chapters 5 and 6). The Verified Carbon Standard defined in Chapter 4). There are three main ways that (VCS) Methodology Requirements v4.0, for example, methodologies can be added to a crediting mechanism: outlines general requirements for methodologies along with essential methodology components.70 In y Adopt methodologies developed by existing addition, some mechanisms provide methodological crediting mechanisms. Under this approach, tools to help develop and promote consistency project proponents are allowed to use methodologies across methodologies. The CDM, for example, has developed by an existing crediting mechanism. established multiple generic tools covering different Policymakers can allow project proponents to methodology components, including additionality directly use these methodologies or modify them determinations and methods for quantifying different to suit domestic circumstances. Policymakers may sources of emissions. Although guidelines and tools prioritize certain methodologies above others in line require upfront cost to develop, once adopted they with the crediting mechanism’s scope and policy can make bottom-up methodology development objectives. Where appropriate, this approach can far more efficient. The majority of existing crediting be a fast and cost-effective option for policymakers. mechanisms allow some form of bottom-up Even if adjustments are required, building on methodology development (see Table 7-2). the existing methodologies can still expedite methodology adoption. Both the Chinese Certified y Have program staff directly develop new Emissions Reduction CCER Pprogram and Korea methodologies (top-down). Under a top-down Offset Program have followed this approach, either approach, policymakers or program administrators allowing the domestic use of Clean Development develop methodologies that are then formally adopted Mechanism (CDM) methodologies or designing by the crediting mechanism’s rulemaking authority methodologies based on CDM methodologies. (see Chapter 10). The burden of methodology development is mostly borne by the jurisdiction itself, y Allow bottom-up development of new although external experts and stakeholders may help methodologies by external parties. Under this guide development. Under a top-down approach, approach, external parties, usually prospective project policymakers can prioritize which methodologies proponents, develop methodologies and submit them to develop first and when they will be approved. In Adopting, reviewing and revising methodologies to the domestic crediting mechanism for review and addition, although it is always good practice to be adoption. The costs of developing a methodology transparent about general methodology requirements are largely borne by the external parties, although (see Chapters 5 and 6), crediting mechanisms program administrators will need to expend some time that rely exclusively on top-down development and effort to review and approve their submissions. do not need to develop extensive methodology Independent reviewers (see Chapter 9) can do an guidance and tools, as is beneficial when using a initial review of submitted methodologies to reduce bottom-up approach. Several existing crediting the technical burden on program administrators. mechanisms exclusively use a top-down approach External demand largely drives when and which for developing and adopting new methodologies, methodologies are developed and submitted. including the California Carbon Offset Program, the However, program authorities have an important role Climate Action Reserve, the Québec Offset System, in reviewing methodologies to ensure that they are Australia’s Emissions Reduction Fund and the US sufficiently robust, promote environmental integrity, Regional Greenhouse Gas Initiative (see Table 7-1). and align with program objectives and criteria before they are finally adopted. To streamline new 70 https://verra.org/wp-content/uploads/2019/09/VCS_Methodology_Requirements_v4.0.pdf. 69 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Table 7-1. Approaches to developing methodologies and key actors involved Approach Typical methodology development procedure Examples of this approach Use 1. Policymakers or the program administrator determine which China’s CCER program; methodologies methodologies to recognize and approve from external Korea Offset Program; from existing programs. VCS; Gold Standard mechanisms 2. (Optional) external stakeholders are invited to review and comment on methodologies selected. 3. The program’s rulemaking authority makes a final decision about which methodologies to formally approve, with modifications as appropriate to reflect domestic circumstances. Bottom-up 1. External actors (e.g., project proponents) develop and submit CDM; VCS; Gold a methodology for approval. Standard; American Carbon Registry; China’s 2. (Optional) independent auditors conduct an initial review of CCER program; Alberta the submitted methodology. Emission Offset System 3. (Optional) an advisory panel of technical experts provides technical input and advice on the methodology. 4. (Optional) external stakeholders are invited to review and comment on the methodology. 5. The program administrator reviews the methodology and makes a recommendation on whether to approve or reject. 6. The program’s rulemaking authority approves or rejects the methodology or sends it back for modification. Adopting, reviewing and revising methodologies Top-down 1. Program administrators develop a methodology. Climate Action Reserve; California Carbon Offset 2. (Optional) advisory panel(s) consisting of external Program; Québec stakeholders and/or technical experts are convened to advise Offset System; Regional on methodology development; this may be done concurrently Greenhouse Gas Initiative; with the work of program staff, or after they have completed a Australia Emissions draft of the methodology. Reduction Fund 3. (Optional) external stakeholders are invited to comment on a penultimate draft of the methodology. 4. The program’s rulemaking authority formally approves and adopts the methodology developed by staff, after final revisions reflecting stakeholder comments. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 70 Crediting mechanisms can incorporate all critical as it helps ensure that methodologies are robust three of these approaches. For example: and effective. Moreover, if methodologies are developed as part of a formal regulatory process, some form of y China’s CCER program, VCS, and the Gold Standard public consultation may be legally required before they all use CDM methodologies (or modified versions are finalized and adopted. Stakeholder consultation of these methodologies) and also adopt new may also be useful when adopting methodologies are methodologies using a bottom-up approach. developed under existing programs, as a way to check their applicability in a domestic context. More information y The Korea Offset Program uses CDM methodologies on stakeholder consultation can be found below. and has also adopted new domestic methodologies through both bottom-up approaches (submitted Soliciting stakeholders’ input can help ensure their by project proponents) and top-down approaches concerns are heard and adequately addressed, facilitating (developed by government for high-priority domestic eventual approval and implementation of projects. project types). As of the end of 2017, the government Soliciting input from experts familiar with technical, had approved 34 methodologies (31 developed legal, and policy aspects of project development, by governments and three developed by project implementation, quantification, and monitoring can proponents) and adopted 211 CDM methodologies. help to ensure the technical rigor of methodologies. Stakeholder and expert input may also be required when y All methodologies under the CDM were initially methodologies are updated (see below). The extent and developed in a bottom-up fashion; however, nature of their involvement—if any—will likely be shaped over time CDM staff have also applied a top- by jurisdiction-specific norms and rules on the regulatory down process of combining methodologies for process. Two broad options for policymakers include similar project activities into single “consolidated” methodologies with broader applicability. y Involving stakeholders and/or experts throughout the methodology development process. This option engages experts and stakeholders (such 7.2 IMPORTANT PROCEDURAL as environmental groups, project proponents, CONSIDERATIONS industry experts, and academics) in the process of methodology development from start to finish. FOR METHODOLOGY This allows for a robust process that can anticipate challenges and increases the likelihood of having DEVELOPMENT a usable methodology that satisfies stakeholder concerns about quality but also works for project Adopting, reviewing and revising methodologies Several procedural questions are important to proponents. This option is typically used in top-down consider when deciding on how methodologies will processes of methodology development (though it be developed and adopted. For all approaches, it is could be used voluntarily in a bottom-up approach, it important to specify rules for external stakeholder is rarely if ever required; for adoption of methodologies engagement in the process of methodology development from existing programs, it is largely irrelevant). and approval. If a bottom-up approach is used, However, these kinds of working group processes can policymakers should decide how methodology review require significant resources and can be quite lengthy. and validation will be performed, as well as whether California, for instance, has an extensive stakeholder to allow concurrent approval of a methodology and an consultation process in line with general legislative associated project when they are submitted together. and regulatory requirements. This includes publicly accessible meetings, soliciting public comments on 7.2.1 Involvement of external stakeholders draft documents, and a Compliance Offset Protocol in methodology review (all approaches) Task Force. The task force is composed of a wide Both bottom-up and top-down approaches typically array of stakeholder groups, including scientists, tribal require some form of expert or stakeholder input into representatives, environmental justice, and labor methodology development. Even where policymakers and workforce advocates, as well as carbon market decide to simply incorporate methodologies from existing and sector-specific experts. They will provide a final crediting mechanisms, some stakeholder consultation report with recommendations to the California Air on whether to do this and which methodologies to Resources Board on new potential offset protocols. adopt may be beneficial. This step adds time to the The task force members and charter were officially development process, along with some incremental approved on January 23, 2020, and will provide the work for program administrators or policymakers, but is final report with recommendations in early 2021. 71 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Table 7-2. Choosing an approach for methodology development Methodologies from existing A bottom-up approach is typically A top-down approach is typically crediting mechanisms are typically used in the following circumstances used in the following circumstances used in the following circumstances • it is important to rapidly adopt • appropriate or desired • policymakers intend to adopt a portfolio of methodologies, methodologies are not available standardized approaches including methodologies from existing mechanisms; to methodologies; for priority project types; • program administrators lack • program administrators have • methodologies from other sufficient resources or capacity; sufficient capacity and resources; mechanisms are (a) aligned with domestic crediting mechanism • targeting specific project • there is no urgent need to criteria and requirements and types is less important; or quickly develop (a large (b) appropriate to national number of) methodologies; • policymakers do not intend to circumstances (e.g., based rely exclusively on standardized • policymakers desire a high on assumptions or default approaches to methodologies. degree of control over parameters) or (c) can be methodological choices; or adapted with minimal effort; or • targeting specific project • program administrators lack types is a high priority. sufficient resources or capacity. y Consulting stakeholders and experts before 7.2.2 How methodologies are reviewed final revision and adoption. This typically involves and assessed prior to adoption soliciting public comments and responding to those (bottom-up approaches) comments prior to the final revision and adoption of Where a bottom-up approach is adopted, the methodology a methodology. It can provide an important check on approval process should use independent technical a draft methodology to ensure it meets stakeholder reviewers to assess proposed methodologies and make Adopting, reviewing and revising methodologies expectations and requires a less intensive engagement a recommendation about whether program authorities process. A number of existing crediting mechanisms should approve or reject them. Some existing crediting employ this form of consultation, including Alberta’s mechanisms (e.g., CDM) make this an optional step, Offset Program, the British Columbia Offset Program, while others have relied heavily on technical reviews in the Joint Crediting Mechanism, the Gold Standard, making approval decisions. Relying on technical reviewers and VCS. Expert consultations, by contrast, generally to assess proposed methodologies can help reduce take the form of a formal review by a panel of experts administrative costs, but it may also have implications for familiar with the type of mitigation activities involved. quality control if program administrators fully delegate The CDM Methodologies Panel, for example, this responsibility and do not exhaustively review performs this function for the CDM. A potential methodologies themselves. Alternatively, policymakers drawback to this approach is that it can make it or program administrators could do the review entirely more difficult to anticipate stakeholder concerns or on their own, without external expertise. While this would technical issues early in the development process, give policymakers or program administrators greater potentially leading to larger revisions and delays. control over methodology reviews and approvals, it requires more resources and a greater level of internal technical capacity. A third option is a combined approach, whereby reviews are undertaken by both external experts and policymakers or program administrators. Most existing crediting mechanisms that allow for bottom-up methodologies use a combined approach. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 72 7.3 CHOOSING AN APPROACH or the need to channel investment into specific sectors, may make it important to prioritize TO METHODOLOGY methodologies for certain project types. If methodologies for those projects already exist under DEVELOPMENT existing crediting mechanisms, then simply adopting those same methodologies can be expedient. The preferred approach to methodology development Otherwise, a top-down approach affords the most will depend on a crediting mechanism’s specific needs. control over methodology adoption for specific project Key factors in this decision include the speed with which types. A bottom-up approach will give policymakers methodologies need to be adopted, program resources, less control as to whether methodologies can be and whether policymakers have specific priorities in terms adopted for specific project types, since it depends of the scope or methodology specification (see Table 7-2). on external parties to develop and propose them. Most existing crediting mechanisms combine a number of approaches to methodology development. Equally, y How important is control over methodological these approaches may change over time; policymakers choices and approaches? To ensure environmental may use existing methodologies at the outset, giving them integrity and achieve other policy objectives, time to develop their own methodologies, if desirable. policymakers may prefer greater control over methodological requirements, methods, and criteria. The answers to the questions below should guide the Typically, top-down approaches provide the greatest selection of an approach. control over methodological choices. Replicating methodologies from existing mechanisms offers (a) Timing the least control, though if these methodologies y How important is it to rapidly establish are already aligned with domestic priorities this methodologies covering a range of activities? may not be an issue. It is also possible to adapt Adopting methodologies developed under other other methodologies to align them with domestic crediting mechanisms is typically the quickest requirements before allowing their use. However, approach. If this is not feasible (for example, if depending on the scope of changes needed, the existing methodologies are not aligned with the scope resources required to do this may be similar to what is or policy requirements of the domestic program), involved in a bottom-up or even a top-down approach. a bottom-up approach is typically the second- best alternative. A top-down approach affords the y Is there a preference for using standardized greatest control over methodology development approaches in methodologies? Standardized but is generally slower than other options because approaches allow for the determination of additionality Adopting, reviewing and revising methodologies it relies on program staff to do most of the work.71 and baselines using performance standards and other predefined rules or criteria (see Chapter 6). (b) Program resources Developing these standards is typically a data- y What resources can jurisdictions devote to intensive and time-consuming process. Standardized methodology development? Adopting methodologies approaches are therefore typically developed using a from existing mechanisms typically requires the top-down approach. Although some existing crediting least amount of time and effort for policymakers and mechanisms allow standardized approaches in administrators. A top-down approach is typically more bottom-up methodologies (e.g., CDM and VCS), the resource intensive and higher cost for policymakers. pace of such submissions has been slow. In addition, The bottom-up approach is typically less of a burden it is difficult to adopt standardized approaches on program administrators; however, policymakers used in existing crediting mechanisms, since their should not underestimate the resources and other standardized components may only be valid in costs associated with reviewing and assessing specific circumstances (e.g., predefined geographic methodologies developed by external parties. regions). Adapting them for use in a different context therefore requires additional work and calibration. Priorities for methodology scope (c) For several project types, for example, the Climate and specifications Action Reserve maintains separate methodologies y How important is it to have methodologies for (“protocols”) for projects based on whether they are specific types of projects? Stakeholder concerns, located in the United States, Mexico, or Canada. 71 One qualification here is that under a bottom-up approach, prospective project proponents may be reluctant to be the first to propose new methodologies, since it is less costly for them if they can simply use a methodology that others have developed and proposed. This can be a disincentive to rapid methodology development. In practice, however, crediting mechanisms with bottom-up approaches have been able to adopt more methodologies more quickly than those using only top-down approaches. 73 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 7.4 PROCEDURES FOR y Updates. Methodology updates include changes to the scope of eligible mitigation activities (for REVIEWING, REVISING example, expansions to the list of eligible activities or project configurations), or major changes to how AND UPDATING emissions reductions are quantified, monitored, METHODOLOGIES and verified. They can include, for example, new requirements or additional options related to It is important for policymakers to review, revise, and additionality tests, methodological procedures, update methodologies over time to ensure they continue measurement or monitoring methods, and to align with the program goals. Chapter 8 of the PMR’s verification practices. The process for undertaking Developing Emissions Quantification Protocols for a methodology update is usually similar to the Carbon Pricing: A Guide to Options and Choices for process required for new methodology development Policy Makers contains detailed guidance on this step. and approval, including external consultation with It is good practice to establish rules regarding (1) the experts and stakeholders, and formal approval types of changes that may be made to methodologies by the program’s rulemaking authority. and associated procedures for making them; (2) how When a methodology is updated, one question is whether frequently changes to methodologies may (or must) be projects that have already registered under a prior version made, and what circumstances may trigger a review are required to transition to the updated version. Typically, and revision or update; (3) whether, and under what such projects are permitted to continue using the older conditions, the changes apply to existing projects (e.g., version of the methodology, at least until the end of their immediately, or when crediting periods are renewed). current crediting period. As highlighted in Chapter 5, Existing crediting mechanisms typically distinguish this provides policy certainty to project proponents, between two kinds of methodology changes reducing investment risk in mitigation activities. Projects (though their terminology for each may differ): may be required to use an updated methodology if the previous version had major methodological flaws, as it y Revisions. Methodology revisions include would otherwise undermine the project’s environmental clarifications, corrections, minor technical changes, integrity. However, such cases are rare. Policymakers and parameter updates. Program administrators can need to establish clear rules on when (and for how typically undertake these types of changes without long) older versions of a methodology may continue formal external consultation or formal approval to be used, and when new versions are required. by the program’s rulemaking authority. Usually, these types of changes are routine or will not have Crediting mechanism documentation should clarify the Adopting, reviewing and revising methodologies a material effect on mitigation activity design or rules and criteria that program administrators will use to the quantification of emissions reductions. One distinguish between these two types of revisions. They exception may be fixing clerical errors that do have should also indicate how revisions and updates will be a material effect, such as correcting a misplaced communicated, including announcements for when decimal or an incorrect numerical constant in a they are initiated, procedures for making them, notice formula. Program administrators should use their before the changes apply, and any opportunities for judgment in determining how to proceed with such public consultation and input (often in line with domestic corrections. In most cases, a methodology revision requirements for regulatory administrative procedures). (of whatever sort) will apply to all projects using the methodology, including projects that have already Policymakers should also provide an indication of the been registered (that is, existing projects are not timing and frequency expected for revisions and updates. allowed to continue using an unrevised version). Options here include 72 Hayashi and Michaelowa 2013b. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 74 y Revising or updating on an ad hoc basis. A common approach is to make revisions or undertake updates as issues with existing methodologies are identified or new data become available. Policymakers should establish clear rules indicating the circumstances that may trigger an ad hoc review and revision or update process. Typically, these circumstances include corrections or concerns submitted by external parties, or issues that come up as program administrators apply a methodology to different projects. For example, the VCS provides general guidance and indications for when methodologies (including those using standardized approaches) may, or must, be updated in its Methodology Requirements program document. y Conducting periodic reviews and revising or updating as necessary. Periodic reviews of methodologies occur on a regular basis. Methodologies adopting standardized approaches, for example, typically need to be updated on a regular basis because they employ default criteria, parameters, and performance standards that need to be updated over time to maintain their accuracy and applicability.72 If periodic reviews are required, program administrators should communicate the expected schedule for such reviews in advance. For example, the CDM requires standardized baselines to have a predefined “validity” period (with a default of three years) after which they must be updated in order for a methodology to continue to be used. GOVERNANCE AND ASSURANCE II GOVERNANCE AND ASSURANCE FOR FOR DOMESTIC DOMESTIC CREDITING CREDITING MECHANISMS MECHANISMS III. Governance and assurance for domestic crediting mechanisms 75 8 Deciding on the project cycle 77 8.1 Project cycle overview 77 8.2 Using a full project cycle 79 8.3 Streamlined project cycle 83 8.4 Considerations for project cycle approach 84 9 Overseeing auditors 85 9.1 Accrediting and approving auditors 85 9.2 Developing standards and guidelines for validation and verification 88 9.3 Managing conflicts of interest between auditors and project proponents 89 9.4 Reviewing auditor performance 92 10 Establishing governance and supporting frameworks 93 10.1 Program governance and regulatory systems 93 10.2 Enforcement, liability, and appeals 97 10.3 Registry infrastructure 99 77 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 8 8 DECIDING ON THE PROJECT CYCLE At a glance The term “project cycle” refers to the various phases and procedures relevant to a crediting project, including the project application, review and approval, monitoring and verification, and credit issuance. Two different models are in use among existing crediting mechanisms: a full project cycle and a streamlined project cycle. A full project cycle has distinct steps for determining and validating a project’s eligibility and the verification of its emissions reductions. In contrast, a streamlined project cycle incorporates the validation of a project’s eligibility into the initial verification of its emissions reductions after it has started implementation. A full project cycle imposes higher costs and administrative burden, but provides greater assurance about environmental integrity and can give project proponents more initial certainty about the eligibility of their projects. A full project cycle is recommended for complex mitigation activities, projects using project-specific methodologies (see Chapter 6), and the early phases of a crediting mechanism. A streamlined project cycle assesses and validates a project’s eligibility after it has started implementation. This can create uncertainty for project proponents, because they will not know until after a project starts whether it will be approved by program administrators. However, it can significantly reduce their transaction costs, and can reduce administrative burdens for program administrators. A streamlined approach is most suitable where eligibility criteria are clearly defined and simple, such as when standardized approaches to methodologies are used (see Chapter 6), or where the project type involved is relatively simple with low additionality risks. As a general rule, newly implemented crediting mechanisms are potentially subject to greater risks to environmental integrity, as project proponents, auditors, and program administrators gain familiarity with the rules and requirements and their respective roles. As a result, it may be prudent for newly implemented crediting mechanisms to start with a full project cycle. After program administrators and stakeholders acquire more experience, the streamlined system may be introduced where appropriate—for example, for small-scale, standardized mitigation activities or those that otherwise face a low environmental integrity risk. Regardless of the choice, it is important for policymakers to identify and communicate the project cycle to all Deciding on the project cycle parties, particularly potential project proponents. A well-documented process, with a clear set of criteria that lead to the issuance of credits, is key to enhancing trust in a crediting mechanism. This chapter describes the project cycle options and their procedural requirements, as well as any advantages and disadvantages (Sections 8.1 to 8.3). Section 8.4 then discusses considerations for selecting the most appropriate option, noting the potential trade-offs between governmental burden and transaction costs on the one side and environmental integrity on the other. 8.1 PROJECT CYCLE OVERVIEW Policymakers must decide whether project proponents need to comply with a full project cycle or a streamlined one. Figure 8-1 provides an overview of the various components of these two approaches. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 78 Figure 8-1. Project cycle options FULL PROJECT CYCLE STREAMLINED PROJECT CYCLE Project Description Project Description (Standardized/Simplified) REGISTRATION PHASE Stakeholder Consultation Validation Review Project Design and Validation Eligibility Check Registration Preliminary Registration Monitoring Report Monitoring Report (Standardized/Simplified) IMPLEMENTATION PHASE First Subsequent First Subsequent Extended Verification Verification Verification (Incl Validation) Verification Review Review and Final Registration Review Credit Issuance Credit Issuance RENEWAL Reassessment of Project Repetition of Eligibility Check Deciding on the project cycle Source: Based on World Bank 2015b. Project Proponent Independent Auditor Program Administrator Optional Step A project cycle consists of three different phases: a The key difference between the two approaches is the level registration phase, an implementation phase, and a renewal of independent checks, especially during the registration phase. The specific requirements for each of these phases process. Full project cycles require a detailed validation differs depending on the type of project cycle. Under a by a third-party auditor during registration. In contrast, full project cycle, for example, projects are fully approved streamlined project cycles require only an eligibility check and registered at the end of the registration phase. Under by the administrator (resulting in a preliminary registration). a streamlined project cycle, only a preliminary registration Because this initial registration is only provisional, under is provided at the end of this phase (sometime called streamlined project cycles, project proponents carry the listing or provisional approval to distinguish this from risk that their project will be deemed ineligible after it has full registration). The implementation phase requires been implemented. submission of regular monitoring reports along with verification of those reports. For each type of project cycle Box 8-1 provides examples of the type of project cycle there is the potential for renewal once a project reaches used in various crediting mechanisms. the end of its crediting period (see Section 5.2). 79 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Box 8-1. Use of full versus streamlined project cycles in existing crediting mechanisms The Clean Development Mechanism (CDM) has A number of national, subnational, and independent served as a blueprint for the full project cycle. crediting mechanisms use a streamlined project Under the CDM’s project cycle, a project proponent cycle, as validation is performed simultaneously with drafts a description of their project in line with the the project’s first verification. These mechanisms requirements of an applicable methodology. An include the Australia Emissions Reduction Fund, independent auditor then validates that the project California Compliance Offset Program, Québec Offset meets the methodology’s eligibility criteria, based System, and Climate Action Reserve. Consultation on on the description. In conjunction with this, the CDM specific projects are not required in these crediting requires a local stakeholder consultation. The project is mechanisms, except for the Climate Action Reserve, registered after a positive validation and final check by which requires stakeholder consultations for projects the administrator. After the project’s implementation, located in Mexico. the project proponent drafts a monitoring report, which must be verified by a second independent Under the Joint Crediting Mechanism and VCS, project auditor. Similar project cycle approaches are used by proponents have the option to pursue either a full or the Switzerland Offset Program, the China Certified a streamlined project cycle. Both require stakeholder Emissions Reduction Program (CCER, Korea Offset consultation on specific projects. Program, Verified Carbon Standard (VCS), and the Sources: World Bank 2015a, 2015b, 2020. a Gold Standard.a However, stakeholder consultations Under the Gold Standard, however, “micro scale” projects (those that reduce less than 10,000 metric tons of carbon dioxide on the specific project are not required under the equivalent per year) can opt to forgo independent validation and Switzerland Offset Program. verification and instead submit their own validation and verification reports that are directly checked by program administrators. The relative advantages and disadvantages of the help promote consistency and a level of standardization, two approaches are outlined in Section 8.4. Existing it is good practice for the policymaker to clearly define the international and independent crediting mechanisms, requirements and procedures—along with documentation including the CDM, provide documentation templates for templates75—for each of the phases outlined below. each phase of the project cycle (for example, templates for project descriptions, monitoring reports, validation 8.2.1 Registration phase: Project design, and verification reports, renewal applications, etc.). These validation, and registration templates can be leveraged by domestic policymakers.73 In addition, the Partnership for Market Readiness’ Under a full project cycle, the registration phase (PMR) Options to Use Existing International Offset takes the project from the initial concept and Programs in a Domestic Context 74 provides more development by project proponents up to the formal approval for inclusion in the crediting mechanism. Deciding on the information on the project cycle and options used project cycle in various existing crediting mechanisms. Development of a project description The project cycle begins with the project proponent 8.2 USING A FULL drafting a project description in a standardized PROJECT CYCLE format. To do this, the project proponent must follow whatever minimum requirements are set out in a Most existing international and independent crediting methodology appropriate to the project type (see mechanisms employ a full project cycle. The main steps Chapters 6 and 7). The project description must include for a full project cycle were developed under the CDM, a detailed description of the project and all information and these steps have largely been replicated in other necessary to assess whether the project is eligible crediting mechanisms adopting a full project cycle. To to use the methodology. This typically includes 73 For example the CDM (https://cdm.unfccc.int/), the Gold Standard (https://www.goldstandard.org/project-developers/standard-documents), or the Verified Carbon Standard (https://verra.org/project/vcs-program/). 74 World Bank 2015a. 75 For an example of such templates, see the CDM webpage: https://cdm.unfccc.int/Reference/PDDs_Forms/index.html. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 80 y a description of the mitigation activity (including regulatory requirements and programmatic stakeholder the applied technology or practice); consultation is not deemed sufficient, project-level stakeholder consultation may be advisable. y details on the project boundary, including the greenhouse gas (GHG) accounting Validation boundary and included GHG sources; Validation is the process by which an independent y a description of the baseline scenario; auditor (see Chapter 9) assesses a project’s eligibility y details on how the project meets the and its conformance with an applicable methodology methodology’s additionality requirements; and other rules of the crediting mechanism. Having an independent auditor validate the project description is y a description of how the methodology will good practice, as it imposes an additional, objective be applied to calculate baseline emissions, assessment of the project before it is implemented. project emissions, and leakage; Validation should be in-depth, systematic, independent, and follow a documented process. The auditor y a description of how emissions reductions will should identify any potential errors or ambiguities be calculated, according to the methodology; that the project proponent may need to resolve. y the project’s expected lifetime; Specific requirements for validation should be provided y a monitoring plan, which defines measurement in each program-approved methodology (see Chapters methods, data collection procedures, and 6 and 7). In addition, policymakers should outline the calculations that will be used to determine process for validation, along with general guidance a project’s emissions and prescribes the for auditors conducting validations (see Section 9.4). contents of future monitoring reports; and Typically, project proponents choose an auditor to y an estimate of emissions reductions. perform validation and pay them for their services; however, only fully accredited and certified auditors Optional: Stakeholder consultation should be allowed to perform validation (see Chapter 9). Prior to validation (see next step), existing international Auditors provide a professional opinion on the eligibility of and independent crediting mechanisms generally require a project and only projects receiving a positive validation project proponents to consult with stakeholders potentially opinion can progress through the registration process. affected by their project. This involves outreach to local communities or other parties to solicit their feedback and Project review and approval by program input on project design and implementation. This adds administrators time and cost to project development but can increase public acceptance and environmental integrity and ensures In the next step, the project proponent submits the any relevant concerns can be factored in at an early stage, project description and accompanying validation opinion including those related to sustainable development or to the program administrator. Under most crediting equity. Fixed deadlines for consultation, objections, and mechanisms, this submission must occur either before the appeals can help minimize any time delays (see Chapter 10 project’s implementation or within a short time thereafter for more details). Any accommodations in project design (typically three to six months). This is because, if a project Deciding on the project cycle to address concerns raised by stakeholders should be commences well before it registers to receive carbon incorporated in the project description prior to validation credits, there is a higher risk of it being non-additional.76 by an auditor. A variety of different crediting mechanisms all require stakeholder consultations for projects, including The program administrator reviews all documents and the CDM, VCS, Gold Standard, and China’s CCER. makes the final decision as to whether the mechanism’s requirements have been met. This is an important step. For many regional, national, and subnational domestic The environmental integrity of the crediting mechanism crediting mechanisms (for example, in Alberta, depends on the ability of the program administrator Australia, California, Quebec, the Republic of Korea, to reject projects that are non-additional, could lead and Switzerland), this step is seen as unnecessary, to over-crediting, or are based on faulty evidence. typically because projects are already subject to existing domestic regulatory requirements that The decision of the program administrator is typically included significant stakeholder consultation in based on the project’s validation report, but it may be the program or mechanism design. Where existing that the program administrator rejects a project even if it received a positive validation opinion (for example, 76 A long period of operation without being issued any credits would suggest the project did not require carbon credits as an incentive, and therefore is not additional (see Chapter 6). 81 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Table 8-1. Typical elements of a monitoring report Content Calculation/metrics Emissions The claim results from calculating baseline emissions, project emissions, and leakage. Those elements reduction claim are determined with data collected in line with the GHG Accounting Principles (see Chapter 6). Monitoring The required frequency, accuracy of measurement, calibration of the monitoring equipment equipment, and responsibilities as determined in the monitoring plan. Implementation Description of how the project activity is implemented. Location Geographic location of the project activity. Key dates Documentation of relevant dates such as the implementation date (e.g., first significant financial commitment), the start of the actual emissions reduction activities, or the monitoring period. Any changes If the project has not been implemented in line with the project description, this needs after registration to be documented in the monitoring report alongside any other operational or legal issues. If there are substantial deviations (such as using a different technology from that outlined in the original project documentation), a revalidation may be required. if the independent auditor missed relevant aspects). If 8.2.2 Implementation: Monitoring, reporting, the program administrator approves the project, it can and verification (MRV) progress through the registration process. If it is rejected, Following a successful registration, the project proponent the project proponent may choose to either discard the can implement and monitor the project. If a project has project or repeat the preceding steps after updating the not already commenced implementation at the time of its design, depending on the reason(s) for the rejection. registration, it should begin soon thereafter. Typically, for example, projects are given a time limit of six months to Registration commence (with a possibility for an extension), although Once a project is approved by program administrators, this can depend on the project type.77 Different crediting they formally register the project by marking it as mechanisms define the start of implementation in approved in the crediting mechanism’s registry system different ways, with some variations based on the type (see Chapter 10) and making the final project description of activity involved. A common milestone for crediting publicly available. The latter is important to promote mechanisms using a full project cycle is to use the date transparency. It also allows subsequent projects to build of the first significant financial obligation (for example, on methodological details implemented in approved the date of contract with a construction company).78 projects, where those details are not prescribed in the methodology. This may include the method used for Monitoring report data collection, assumptions on materiality thresholds, After a certain operational period (often called a reporting or evidence used to demonstrate additionality. Deciding on the period), the project proponent develops a monitoring project cycle Transparency requirements should include provisions report, using a predefined format, that collates all of the to allow project proponents to remove commercially monitoring data for that period.79 The maximum length sensitive information, such as financial data. of a reporting period will depend on the project type and is typically defined in project methodologies (see Chapter 6). Too long of a reporting period can make it more difficult for auditors to credibly verify monitoring data. For example, if too much time passes between when the data were generated and when the auditor can check 77 Such a time limit is required because circumstances determining project eligibility can change over time; if project owners wait indefinitely before beginning a project, this can call into question the validity of the initial eligibility decision, including the project’s additionality determination. 78 Note that this is usually not the point at which the project starts generating emissions reductions. For crediting mechanisms using a streamlined project cycle, project start dates are more typically linked to the commencement of emissions reductions, largely because projects are not typically registered until after this date. 79 For more guidance on how to monitor, report, and verify emissions and set up MRV frameworks see the PMR’s Developing Emissions Quantification Protocols for Carbon Pricing: A Guide to Options and Choices for Policy Makers. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 82 a project’s measurement systems, it may not be possible their opinion in an official verification report. Program to provide assurance about the accuracy of older data. administrators should only issue credits to a project An appropriate reporting period also helps to manage based on monitoring data that have been successfully risks that projects are being implemented correctly, since verified to the mechanism’s required level of assurance. monitoring reports provide a useful checkpoint for the program administrator. At the same time, it is important The verification of a project’s first monitoring report to allow project proponents to manage cash flows is usually more complex and time consuming than and administrative costs. To balance these objectives, subsequent verifications, in part because issues existing crediting mechanisms typically require a first may arise that were not anticipated during project monitoring report within one year of the date on which design and registration (such as problems measuring the emissions reductions started; subsequent reports some parameters), such that certain aspects of the are typically required within one to three years after the project description have to be revised. Subsequent preceding one.80 In most cases, project proponents have reports usually do not face these challenges and, in the option to generate and submit monitoring reports addition, can build on the first monitoring report. more frequently, but must get special exemptions from program administrators to submit them less frequently. Review Table 8-1 lists typical elements of a monitoring report The program administrator reviews all documents, (for further details on monitoring see Section 6.5). conducts a final check, and finally approves each monitoring report, conditional on a positive result for each of the preceding steps. Verification Verification is the process by which an independent Credit issuance auditor (see Chapter 9) reviews a project’s monitoring reports, confirms that the project has been implemented The program administrator issues credits in the registry for in accordance with the crediting mechanism requirements emissions reductions that occurred during the period(s) (including any methodology requirements), and confirms covered by each verified and approved monitoring report. that GHG reductions have been correctly quantified The policymaker may reserve the right to revoke or and reported according to the project’s applicable invalidate credits if the registration or issuance was based methodology. In most cases, every monitoring report on false claims, or in the case of fraud (see Chapter 10). for a project should be individually verified.81 8.2.3 Renewal/extension of crediting periods Verification of project monitoring reports is an essential Most existing crediting mechanisms allow crediting procedure for all crediting mechanisms. Specific periods to be renewed after the first crediting period verification requirements should be provided in each has expired (see Section 5.2). The number of allowable approved methodology (see Chapters 6 and 7). In renewals should be outlined in the mechanism’s rules. addition, policymakers should outline the process for For a renewal, project proponents must repeat the steps verification, along with general guidance for auditors of the registration phase (validation and reapproval). conducting verifications (see Section 9.4). Typically, However, policymakers typically reduce the requirements project proponents choose an auditor to perform for what must be assessed as part of crediting period Deciding on the verification and pay them for their services; however, project cycle renewals because many elements of a project will only fully accredited and certified auditors should be remain unchanged. Stakeholder consultations, for allowed to perform verification (see Chapter 9). example, are typically not required for renewal. Auditors should provide a professional opinion about The most important aspect of a project to assess whether a monitoring report provides a fair and at renewal is whether its original baseline scenario accurate representation of a project’s performance remains valid. This can include an evaluation of how and its associated emissions reductions and indicate the regulatory environment has changed (for example, the level of assurance (see Section 9.4) provided by whether new laws or policies have made the project 80 The period will depend on the nature of the project and its data collection systems. For industrial gas projects, for example, it can be important for auditors to regularly check the calibration of measurement instruments. For forestry projects, longer reporting and verification periods are typical, given the rate at which trees grow and the measurement methods involved. 81 Some crediting-type mechanisms, such as Australia’s Emissions Reduction Fund, use a risk-based approach that allows explicit verification of only a subset of a project’s monitoring reports, as long as a project meets certain criteria (for example, projects are small scale, homogeneous, and/or rely on digital verification technologies with few sources of uncertainty). This introduces greater uncertainties, however, and introduces risks to environmental integrity. As a result, such an approach is only suitable in specific circumstances. 83 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS activity mandatory) and any changes in baseline eligibility criteria, there is no independent validation. If the parameters or technology assumptions. The full scope criteria are met, the administrator preliminarily registers of what should be evaluated is typically specified in the the project and it may proceed to implementation. project’s applicable methodology. Once the baseline is reassessed, a new baseline may be established for the Project eligibility must still be validated by an auditor next crediting period. In some cases, this may reduce—or during the implementation phase in conjunction with even eliminate—the possibility for the project to generate verification of the project’s first monitoring report. creditable emissions reductions. For example, if the Registration is finalized by program administrators project concerns an activity that is now required by law, after the project demonstrates eligibility as part the baseline and project will be effectively the same, of its first verification (see Figure 8-1). The other meaning it cannot generate creditable reductions.82 implementation-phase steps in a streamlined project cycle—monitoring, reporting, verification, review, and credit issuance—are not substantively different 8.3 STREAMLINED from those same steps in a full project cycle (though monitoring and reporting may be somewhat simplified if PROJECT CYCLE standardized approaches to methodologies are used). As noted above, a streamlined project cycle can be A streamlined project cycle works best where the more efficient for both project proponents and program eligibility criteria for a project—including additionality administrators, as the project proponent provides only requirements—are unambiguous and require little analysis a simplified project description during the registration or interpretation, as is the case when standardized phase. This may be implemented, for example, by using a approaches to methodologies are used (see Chapter 6). standardized form that includes a list of eligibility criteria California, Québec, and the Climate Action Reserve, (for example regarding technology, availability of data for example, all use streamlined project cycles for to calculate emissions reductions, geographical region, methodologies that adopt standardized approaches. project scale, or confirmation that activity has not yet commenced). While the program administrator checks the Box 8-2. Digitizing MRV and automating project cycle management Traditionally, MRV has required substantial manual When the entire project cycle management is moved collection and data reporting, such as reporting the to digital systems, in combination with blockchain amount of power generated by a wind farm or survey and smart contracts, verification may be automated information for transport or community projects. by embedding the monitoring rules, for example in These means of data collection are well established, smart contracts on a blockchain. In this approach, but there remain issues related to time and cost measurements, such as those provided by power or required, precision and completeness of data, and gas meters, are directly fed into cryptographically safe even potential corruption, which undermines trust.a and tamper-proofed digital systems and subsequently Deciding on the project cycle recorded in trusted databases (such as blockchain or Digitization and automatization have progressed a trusted governmental database). Once a third party significantly in recent years and it is now possible verifies the entire MRV system and the related rules in to digitize many steps and procedures in the project smart contracts, data verification can be automated, cycle. This may include all aspects of data collection, leading to considerable efficiency gains and savings including the systematic use of electronic power and in transaction costs. gas meters to the use of sensors, or the Internet of Things. Also, the combination of remote sensing and artificial intelligence may provide new low-cost and trusted approaches on tracking, such as land-use a See Climate Ledger Initiative 2019, Section 2.2, for further detail. changes.b b See Climate Ledger Initiative 2019, Section 3.1, for further detail. 82 This is sometimes interpreted to mean the project is “no longer additional.” Technically, however, it is some or all of the project’s emissions reductions that are no longer additional (relative to the baseline). A project’s additionality is determined only once, at its outset, and is concerned with whether or not the project would have been implemented in the absence of the crediting mechanism. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 84 There are two reasons why clear and unambiguous The renewal of a crediting period in a streamlined eligibility criteria are important. First, since final registration approach includes a revalidation of the project’s eligibility. of the project is postponed to the implementation Typically, this occurs in conjunction with verification phase, the project proponent faces the risk that the of the project’s first monitoring report under the new project may not be approved, even after investments crediting period. If a standardized baseline approach are made and implementation has commenced. has been used, the crediting period renewal may require Objective and transparent eligibility requirements updated baseline parameters, as well as a check can help minimize this risk. For risk-averse project against legal requirements and other conditions. proponents, policymakers can also let them opt for a full project cycle that includes validation. The Climate Action Reserve, for example, effectively allows project 8.4 CONSIDERATIONS FOR proponents to request a “desktop verification” (resulting in “de facto validation”) prior to project implementation PROJECT CYCLE APPROACH in order to validate a project’s eligibility.83 Policymakers should specify detailed project cycle The second reason relates to potential conflicts of requirements, including whether project proponents interest on the part of auditors. This is because the must follow a full or a streamlined project cycle (or same auditor usually validates a project (i.e., during the whether they may be allowed to choose between the two verification of the first monitoring report) and verifies options based on the type of project and methodology its emissions reductions. Accordingly, this auditor may involved). Table 8-2 lists the respective advantages have an interest in offering a positive validation opinion and disadvantages of these options and identifies the in order to secure future verification business. This conditions under which each may be appropriate. perverse incentive can be countered by requiring less judgment, analysis, or interpretation when determining Ultimately, in deciding between a full or streamlined project eligibility. Under a full project cycle, policymakers cycle, policymakers face a trade-off between higher typically address this perverse incentive by requiring transaction costs and governmental burden or a higher separate auditors for validation and verification. level of environmental integrity. Environmental integrity This can be done under a streamlined project cycle risks can be reduced under a streamlined cycle if project but increases transaction costs (see Chapter 9). eligibility criteria are clearly specified and require little judgment or interpretation on the part of auditors. Table 8-2. Full cycle versus streamlined cycle Advantages Disadvantages Suitable for Full project cycle Greater certainty for project Higher transaction costs, Complex projects. proponents once project is registered. especially for the developer. Project-specific approaches Deciding on the More experience from existing crediting to methodologies. project cycle mechanisms. Initial phase of crediting mechanism. Streamlined project cycle Lower administrative costs for project Project proponent risks not obtaining Small-scale projects. proponent (especially in the registration final approval after implementation has Standardized approaches phase) and program administrator. begun. to methodologies. Integrity depends on having clear and Well-established project types objective eligibility criteria, which may with low additionality risk. not easily accommodate unique or unusual project configurations. 83 http://www.climateactionreserve.org/wp-content/uploads/2017/02/2017-Verification-Program-Manual.pdf. 85 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 9 9 OVERSEEING AUDITORS At a glance Project validation and verification are important functions that are essential to the credibility and environmental integrity of crediting mechanisms. Typically, these functions are performed by independent auditors rather than program administrators. It is essential for crediting mechanisms to ensure that auditors are well qualified and perform validation and verification functions competently. Policymakers should establish formal qualifications for auditors, define how they must perform validation and verification activities, and establish procedures that program administrators will use to oversee auditors and ensure the consistency and rigor of validation and verification. This chapter discusses the key responsibilities for policymakers. The first section looks at standards and procedures for accrediting and approving auditors (Section 9.1), followed by developing standards for validation and verification (Section 9.2). Section 9.3 outlines rules and requirements for managing conflicts of interests between auditors and project proponents before concluding with a final section on rules and procedures for regularly reviewing auditors’ performance (Section 9.4). The Partnership for Market Readiness’ (PMR) guidebook Designing Accreditation and Verification Systems provides detailed guidance related to implementing verification systems and establishing accreditation procedures for ensuring auditor competence. 9.1 ACCREDITING AND accrediting and approving auditors may involve ensuring that auditor staff are properly trained and certified. APPROVING AUDITORS Accreditation is the process of formally assessing the To ensure that validations and verifications are performed competence of an auditor to carry out project validations rigorously, consistently, and competently, crediting and verifications according to the crediting mechanism’s mechanisms should only permit qualified firms and standards. Accreditation typically looks at firm-level organizations to perform these services (see Box 9-1). qualifications and processes, such as data management Typically, crediting mechanisms will approve only firms systems, internal procedures, and appropriate staffing or organizations that are professionally accredited to needed to conduct validations and verifications. perform project validation and verification. Policymakers Most existing crediting mechanisms accredit firms or must establish rules and standards for accreditation organizations rather than individuals. This is because it and for formally approving entities allowed to perform is more difficult for individuals to possess the breadth of validation and verification services for project proponents. expertise and the systems necessary (e.g., record keeping Overseeing auditors and data management) to validate or verify emissions In this guide, “auditor” refers to firms and organizations reduction projects that can be technically complex. In that are accredited and approved to perform validation addition, accrediting firms or organizations can provide and verification services. Among existing crediting for a greater level of accountability. Auditors, for example, mechanisms, these entities are sometimes referred to as are typically required to carry insurance to cover potential “verifiers” or “validation and verification bodies.” Auditors liability for errors or omissions in verification opinions; typically employ multiple staff to validate or verify a project; individuals may lack the resources to maintain this employees are referred to here as “auditing staff.”  84 Part of liability coverage. However, crediting mechanisms should 84 In other contexts, individual personnel performing auditing tasks are sometime referred to as “auditors.” This guide uses “auditing staff” to clearly distinguish between firms or organizations (“auditors”) and their personnel. In rare cases, crediting mechanisms may approve individuals to perform auditing tasks rather than firms or organizations. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 86 Box 9-1. Using auditors to perform validation and verification Validation is the process by which an auditor assesses In principle, program administrators could conduct a project’s eligibility and its conformance with an project validation and verification themselves. In applicable methodology and other crediting rules. practice, all existing crediting mechanisms outsource Verification is the process by which an auditor reviews these tasks to independent auditors. Validation and a project’s monitoring reports, confirms that the verification of projects involve a potentially large— project has been implemented in accordance with and variable—volume of work. Supporting technical the crediting mechanism’s requirements (including capabilities for program administrators to perform any methodology requirements), and confirms that these functions is expensive, and potential fluctuations greenhouse gas (GHG) reductions have been correctly in carbon credit demand and supply could result in quantified and reported according to the project’s significant periods of underutilized capacity. Thus, applicable methodology. Validation and verification policymakers have found it more efficient to delegate are important procedural steps to ensure that projects validation and verification to independent auditors, adhere to methodological requirements for quantifying while putting in place systems to ensure the quality of emissions reductions and meet all relevant criteria. their work and avoid potential conflicts of interest. consider auditing staff-level certification in addition Many existing crediting mechanisms use the International to firm-level accreditation (as discussed below). Organization for Standardization (ISO) 14065,85 which is a general accreditation standard specific to auditors As outlined in Chapter 3, one option for policymakers of claims involving GHG accounting, including for GHG is to rely on existing crediting mechanisms for auditor mitigation projects. ISO 14066 covers competency accreditation. In this case, the policymakers would requirements for auditing staff (i.e., individuals within simply allow projects to be validated and verified by an organization), which can also be useful as part of auditors accredited (and specifically identified) under overall accreditation (see below). Alternatively—or an existing crediting mechanism. For instance, auditors in addition—policymakers can establish their own approved under the Clean Development Mechanism accreditation rules and procedures or tailor the (CDM) are eligible to undertake verifications under China’s principles and requirements of these standards for Certified Emissions Reduction (CCER) mechanism domestic purposes. This would ensure the standards and the Joint Crediting Mechanism. Relying on these meet the specific needs of the crediting mechanism accreditations could generate administrative savings, but but can be time-consuming and resource intensive. domestic crediting mechanism methodologies, policies, and procedures must closely align with those of the 9.1.2 Defining scopes for accreditation crediting mechanism accrediting the auditors, as the (optional) auditors might otherwise lack the expertise and training For smaller crediting mechanisms with a narrower scope, appropriate to the domestic crediting mechanism. it is often sufficient to define general accreditation requirements for auditors. For mechanisms that cover If accreditation is not outsourced, policymakers a wide range of different project types, however, it will need to establish a domestic accreditation may be important to distinguish accreditations for process. Key considerations for doing this are auditors based on competencies with respect to certain outlined in the following subsections. Overseeing kinds of mitigation activities. The competencies and auditors management systems needed to verify industrial gas 9.1.1 Deciding on an accreditation standard destruction projects, for example, may be different Policymakers must specify an applicable accreditation from those needed to verify forestry projects. Likewise, standard for auditors that defines, for example, the given the importance of accurate validation to promote principles that auditors are expected to uphold or environmental integrity and the additional expertise and demonstrate; general eligibility requirements (including judgment needed to perform validations, some crediting legal status, governance arrangements, and liability mechanisms distinguish between auditors accredited coverage); required competencies; requirements for to perform both validation and verification, and those internal systems to manage communications; data accredited only for performing verifications. The Climate retention; and conflicts of interest. Action Reserve, for example, defines different scopes of accreditation based on these competencies and an 85 https://www.iso.org/standard/60168.html. auditor’s expertise related to different project types. 87 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 9.1.3 Deciding on auditing staff-level 9.1.5 Deciding who is responsible certification requirements (optional) for accreditation Firm-level accreditation improves confidence in the Accreditation can be managed by program administrators, capacity of auditors and promotes consistency across professional accreditation bodies, or a combination of audits by ensuring they have appropriate internal policies, the two: standards, and management systems. However, relying on firm-level accreditation can raise issues in organizations y Program administrators. This option affords greater with high staff turnover, which can result in inconsistencies control but is also more costly and administratively in the skills and experience of individual auditing staff. burdensome. Having program administrators Policymakers should therefore consider whether to provide accreditations could make sense, however; establish certification and training requirements for if crediting mechanism requirements are highly auditing staff and make accreditation and approval of specialized, policymakers should ensure that auditors auditors conditional on having professionally certified staff. are fully acquainted with them. The California Air Resources Board (CARB) performs its own Certification of auditing staff focuses on an individual’s accreditation, for example, to ensure that auditors skillset and experience, rather than the systems are competent to perform verification activities and processes of an auditing firm. As with firm-level specific to California’s unique methodologies. This accreditation, policymakers can rely on existing ensures a robust pool of qualified auditors, including standards for personnel certification, such as the ISO/ smaller companies who may not have membership International Electrotechnical Commission 17024:2012 in a more costly national accreditation body. Standard,86 and elaborate on these standards with requirements specific to their jurisdiction. y Professional accreditation bodies. Multiple independent and domestic crediting mechanisms 9.1.4 Deciding on training requirements, rely on professional accreditation bodies to formally procedural requirements, and renewals accredit auditors for their programs. In North America, for example, the American National Standards Many crediting mechanisms require auditing staff to Institute and the Canadian Standards Association undergo training to ensure they possess the appropriate perform accreditation of auditors and certification qualifications and skills. This also helps the auditing of auditing staff for the Climate Action Reserve, staff become familiar with the mechanism’s validation the American Carbon Registry, and the Alberta and verification. Crediting mechanisms typically provide Offset Program. Where professional accreditation training—and administer examinations—related to bodies are available to provide these services, specific project types and methodologies, as well this can be a cost-effective option. Such bodies as any general requirements. Alternatively, trainings should be vetted by policymakers to confirm that may be outsourced to professional training firms. they have the expertise to oversee and accredit auditors according to the specific standards and Before the final accreditation some crediting mechanisms requirements of the domestic crediting mechanism. also require a witnessed assessment of the auditor in order to evaluate whether it has the appropriate internal y Hybrid approach. Policymakers can rely on systems in place and that auditing staff have appropriate professional accreditation bodies while also imposing skills. This is true for the Climate Action Reserve and additional requirements for formal qualification under California, for example. Under the Chinese national the domestic crediting mechanism. For example, crediting mechanism, the Ministry of Ecology and auditors could seek generic accreditation from a Environment approves and registers auditors or auditor professional accreditation body, then register with firms based on an assessment that looks at both on– program administrators to become eligible to perform Overseeing auditors site performance and a review of relevant documents. auditing services under the mechanism. To register, auditors could be required to demonstrate particular Finally, auditors should be required to renew proficiencies or meet other eligibility requirements. accreditation periodically and to take appropriate This option entails some higher administrative costs for (re) training regarding new crediting mechanism program administrators, but also affords more control policies or requirements. Policymakers should establish and oversight. For example, program administrators clear rules that outline how frequently renewals are would retain the ability to de-register auditors who required and what is required for reaccreditation. no longer meet the jurisdiction’s requirements. 86 https://www.iso.org/standard/52993.html. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 88 Regardless of which approach is used, once auditors and what an auditor can confirm. Materiality thresholds are formally accredited they should be officially may be qualitative, quantitative, or both. A qualitative approved by program administrators to perform audits materiality threshold defines material misstatements in accordance with the scope of their accreditation. as any statement that does not conform with the Crediting mechanisms typically provide a list of eligible, prescriptive requirements in a relevant methodology. accredited auditors for project proponents to consult For example, if a project fails to gather monitoring when seeking validation and verification services. data in accordance with the methods prescribed in a methodology, this would constitute a material For further information on designing accreditation nonconformance. A quantitative materiality systems for auditors, see the PMR guidebook threshold is a numeric cap on the magnitude of Designing Accreditation and Verification Systems. the error. Many existing crediting mechanisms define graduated numeric thresholds based on the size of mitigation activities (see Table 9-2). 9.2 DEVELOPING STANDARDS y Required level of assurance. Policymakers AND GUIDELINES FOR should establish a required “level of assurance” for VALIDATION AND auditors’ validation and verification opinions. The level of assurance prescribes to the depth of detail VERIFICATION and rigor that an auditor must use in identifying any material errors, omissions, or misstatements Crediting mechanisms should establish validation in project descriptions or monitoring reports (see and verification standards. The main goal here is to Chapter 8). It indicates the degree of confidence an ensure consistency across projects under the crediting auditor is able to provide regarding the accuracy mechanism. Detailed, relevant procedures ensure the of reported information and data. For example, the quality of the validation and verification. A standard level of assurance can be “limited” or “reasonable,” approach helps streamline review and reduces in line with the definitions of these terms in financial overall transaction costs for project proponents. assurance auditing.88 A limited level of assurance requires less detailed verification activities but carries Key elements of validation/verification standards a higher risk that a misstatement or noncompliance and guidelines include the following: will be missed. Most existing crediting mechanisms require a reasonable (or “positive”) level of assurance. y Procedural and substantive requirements. Procedural requirements detail the steps involved y Rules for when validation and verification in validation and verification and how they must must be conducted. These include whether be conducted. A commonly used reference for validation must be performed prior to implementing procedural requirements is the ISO 14064:3 Standard 87 the mitigation activity (as is typically required (see Table 9-2). Typical requirements also include under a full project cycle; see Chapter 8), and designating the required composition of auditing whether events (like natural disturbances) may teams. The Alberta Offset Program, for example, trigger a required (additional) verification. requires teams to have a lead auditor, subject matter expert(s), peer reviewer, and independent y Rules for the required frequency of verification. reviewers. Substantive requirements could include Crediting mechanisms typically specify the maximum general requirements for reviewing all monitored length of time allowed between verifications,89 along data, appropriate methods for conducting reviews, with what recourse is available if a project does not and requirements for the format and content of meet the required schedule or project proponents Overseeing verification reports (for example, requirements choose to forgo verification for some periods. For auditors for reporting on both methods and results). many types of mitigation activities, programs typically require verification every year at a minimum. Crediting y Specification of a “materiality threshold.” The mechanisms will typically refrain from issuing credits materiality threshold for verification indicates the for mitigation that is not verified within this time frame, crediting mechanism’s tolerance for any discrepancies unless project proponents request and are granted an between a project proponent’s reported information extension (for example, for extenuating circumstances). 87 https://www.iso.org/standard/66455.html. 88 See, for example, http://www.iaasb.org/. 89 The maximum time length/minimum frequency can vary by type of project, with specific requirements spelled out in individual methodologies. The required time between verifications can be longer for forestry projects, for example, than for methane capture and destruction projects. 89 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Modifications to the standard rules and processes please project proponents and secure future business for validation and verification may be made to with them. The effects of this can be insidious, as more manage transaction costs. For instance, auditors can rigorous auditors may find it hard to acquire clients or bundle small-scale projects together for verification may lose existing ones, leading to a “race to the bottom” under China’s CCER as a way to manage costs in the quality of validation and verification services. This for small and mid-size entities or projects. can compromise a crediting mechanism’s effectiveness and environmental integrity. Policymakers should therefore To develop these rules, it can be helpful to consult establish robust standards and procedural requirements established standards and guidelines in existing that limit the potential for conflicts of interest. crediting mechanisms. For example, many existing mechanisms have adopted rules similar (or identical) to A conflict of interest can occur between individuals those established under the ISO 14064, Part 3 standard. within an auditing firm or on a project team, or at the Because of this, many auditors who are accredited organizational level, between an auditor and the project under existing crediting mechanisms are already familiar proponent or its parent company or organization. with these rules and can apply them easily within a new Thus, it is good practice to address potential conflicts domestic crediting mechanism, even if they have been of interest at multiple levels. Common measures tailored or modified for domestic purposes. As Table 9-2 employed by existing crediting mechanisms include indicates, most mechanisms follow common high- level validation and verification standards, but differ in y Requiring auditors to have robust internal policies details related to materiality thresholds and verification for managing conflicts of interest as a condition frequency. Again, the PMR guidebook Designing for accreditation. As part of the auditor accreditation Accreditation and Verification Systems provides detailed process, it is important to ensure that auditors have guidance on defining requirements for auditors. adequate internal procedures and management systems in place for assessing and avoiding conflicts of interest with prospective clients. This is a common 9.3 MANAGING CONFLICTS requirement across existing crediting mechanisms. The ISO 14065 Standard on Accreditation, for OF INTEREST BETWEEN example, addresses procedures and practices AUDITORS AND PROJECT auditors can put in place to ensure impartiality. PROPONENTS y Requiring evaluation of conflict of interest risk and appropriate risk mitigation for all auditing services. Since audits are typically paid for by project proponents, It is good practice for program administrators to conflicts of interest can arise for auditors because of a require auditors to perform self-assessments of any financial incentive to maintain a business relationship with conflict of interest risks before validating or verifying a a project proponent. This can compromise, or appear project and to take steps to mitigate these risks where to compromise, an auditor’s ability to perform a fully possible. Program administrators should then review independent validation or verification. For example, an these self-assessments. If risks are high and cannot auditor may be incentivized to give positive opinions to be effectively mitigated, auditors should be barred Table 9-1. California’s auditor conflict of interest risk assessment guidelines Risk is high if… Risk is medium if… Risk is low if… Overseeing auditors The auditor and project proponent share (or recently The conflict of No circumstances shared) senior management staff or directors. interest risk is not indicating a high risk deemed to be high have been identified, Auditing staff members have performed certain types of consulting or low, and/or there and any non- or other services for the project proponent within the last five years. are personal or verification services familial relationships provided in the past The auditor has provided any kind of incentive to the between the auditor five years are valued project proponent in order to win its business. and the project at no more than 20 The auditor has provided verification services more times than is proponent. percent of the current allowed under program rules. verification contract. Source: Adapted from Title 17, California Code of Regulations, Section 95979. Table 9-2. Validation and verification standards among selected existing crediting mechanisms Validation Validation Verification Verification Program Materiality threshold Frequency of verification performed by… standard performed by… standard CDM Designated CDM Designated CDM Depends on quantity of A first verification is required at the operational entity validation operational entity verification emissions reductions latest one year after registration or manual (DOE) (different manual, ISO or removals reported the starting date of the crediting from the one 14064:3 and project type, ranges period; subsequent verification is that performed from 0.5% to 10%. decided by project proponent. validation) Joint Accredited CDM Accredited CDM 5% for projects that A first verification is required at the Implementation independent entity validation independent entity verification average less than 100,000 latest one year after registration or manual (can be the same manual, ISO metric tons of carbon the starting date of the crediting entity as the one 14064:3, dioxide equivalent period; subsequent verification is that performed ISO14065 (mtCO2e) per year; 2% decided by project proponent. the validation) for projects that average more than 100,000 mtCO2-e per year. Québec ISO-accredited ISO 14064:3 ISO-accredited ISO 14064:3 5%; all errors identified Verification required for the first auditor VVB must be corrected. reporting period, some flexibility allowed subsequently, but any project for which credits are issued must be verified. California* California Air N/A ARB-accredited Cap-and- 5%; all errors that Annual verification for non- Resources auditor (same trade can be identified sequestration projects; six years Board (CARB)- as validation) regulation must be corrected. for sequestration projects; and accredited auditor two years for projects reporting less than 25,000 mtCO2e. Climate Action American National N/A ANSI-accredited Verification 5% for projects reporting Annual verification for non- Reserve* Standards auditor (same Program 25,000 mtCO2e; 3% for sequestration projects, six years Institute (ANSI)- as validation) Manuals, projects reporting greater for sequestration projects, and accredited auditor ISO than 25,000 mtCO2e two years for livestock projects. 14064:3, but less than 100,000 ISO14065 mtCO2e; 1% for projects greater than 100,000. VCS ANSI accredited Verified ANSI-accredited VCS 5% for projects less A first verification is required at the auditor or Carbon auditor or DOE program than 300,000 mtCO2e latest one year after registration or designated Standard manual, ISO and 1% for project more the starting date of the crediting operational entity program 14064:3, than 300,000 mtCO2e. period; subsequent verification is manual, ISO ISO14065 decided by project proponent. 14064:3 Alberta* ANSI, Standards Standard for ANSI, Standards ISO 14064:3 5% for projects reporting First verification required at the end Council of Canada, Validation, Council of Canada, and Canadian less than 500,000 mtCO2e of the first monitoring period and International Verification International Auditing per year; 2% for projects is submitted prior to serialization; Accreditation Forum and Audit Accreditation Standards reporting more than subsequent verifications are at the accredited auditor V5.0 Forum accredited 500,000 mtCO2e per year discretion of program administrator. auditor * No separate validation step is required; validation is effectively performed at first verification. Source: Modified United States Agency for International Development 2014. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 90 91 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS from validating or verifying the project. California’s y Limiting the number of repeat verifications for a Compliance Offset Program (COP), for example, project by the same auditor. Many mechanisms limit classifies conflict of interest risks as high, medium, the number of verifications an auditor may conduct for or low depending on certain standardized criteria a project proponent. This reduces the risk of auditors (see Table 9-1). Auditors with a high risk of conflict developing a long-term business relationship with a may be barred from a particular project. Where there particular proponent. It also has the benefit of enabling is a medium risk, the auditor must implement risk multiple auditors to review the same mitigation mitigation measures specific to the type of conflict activities, thus providing an additional check on the that might be present. Where there is a low risk of consistency and appropriateness of the emissions conflict, validation or verification can proceed. reduction claims. Requiring different auditors may not be viable, however, if there is an insufficient number y Requiring the use of different auditors for of eligible auditing firms. Alternatively, policymakers validation and verification of the same project. may require audit firms to change auditing staff for Under a full project cycle (see Chapter 8), validation subsequent verifications for the same project. occurs separately from verification. Existing crediting mechanisms that employ a full project cycle frequently Some additional options for limiting the financial require the use of separate auditors for validation and relationship between project proponents and auditors verification. The CDM requires this, for example, for include the following. To date, however, no existing all large-scale projects (those that exceed certain crediting mechanisms have employed these options. size thresholds in terms of capacity or total emissions reductions). This reduces the risk that an auditor will y Having the crediting mechanism pay for auditing. provide a positive validation opinion in order to secure Making the program administrator the “client” rather future verification business for the same project. than the project proponent removes a source of However, this approach also increases transaction financial leverage project proponents may have costs for project proponents. Under a streamlined over auditors. Costs could be covered, for example, project cycle, the same auditor validates a project through the collection of fees from project proponents, at the same time it performs the project’s initial based on standard cost estimates for validating and verification, which creates an inherent conflict of verifying the type of projects they propose (auditing interest. However, existing crediting mechanisms using costs can vary significantly by project type and a streamlined project cycle typically try to establish size). However, if project proponents can still choose very clear and unambiguous eligibility criteria for which auditors are used for their project, this may projects, reducing the need for auditor discretion in not fully address potential conflicts of interest. validation opinions and therefore reducing the potential risk of a conflict of interest. y Limiting the ability of project proponents to choose auditors. Program administrators could assign auditors to proponents or allow them to select auditors from a predefined subset of eligible auditors. Overseeing auditors A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 92 9.4 REVIEWING AUDITOR consider the type of mitigation activities being verified and where the most risk to the program is (for example, PERFORMANCE in terms of the potential for over-crediting). Policymakers should establish criteria for selecting mitigation Crediting mechanisms should regularly review the activities for review, such as the type of activity being performance of auditors to ensure adequate quality verified and whether the auditor conducting the work control. Reviews are typically performed by having is experienced. If program administrators suspect an program administrators conduct an in-depth evaluation auditor is performing poorly, they may need to examine a of a sample of each auditor’s validation and verifications. greater number of verification reports to establish where The specific audits to be reviewed are chosen at random and why there is an issue and how it can be rectified. (and should be identified with little or no advance notice to the auditors). The review process can also allow Finally, it is important to establish clear penalties and program administrators to observe the implementation sanctions for poor performance by auditors. These of methodologies in order to inform future revisions can vary depending on circumstances and the type of or improvements to them (see Chapters 6 and 7). shortcomings involved (for example, carelessness or incompetence versus deceptive practices). Sanctions can Typically, the review process involves observing all include, for example, fines, suspensions, requirements aspects of validation and verification processes and starts for retraining, revocation of the ability to provide auditing when an audit commences. The individual conducting services, or even revocation of accreditation (if the the review participates in initial meetings, site visits, program administrator serves as the accreditation body). reviewing all project documentation, and conducting data checks. The reviewer then provides feedback to If administrators suspect an auditor is performing the auditor regarding instances of nonconformance poorly, they may need to examine a greater number with methodology requirements or verification of verification reports to establish where and why procedures and makes suggestions for improvement. there is an issue and how it can be rectified. It is typically not necessary to review every validation or verification performed by auditors, but program administrators must conduct enough reviews to provide an accurate picture of overall (program-wide) performance and to review the performance of every auditor. To capture a representative sample of the work, they must 93 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 10 10 ESTABLISHING GOVERNANCE AND SUPPORTING FRAMEWORKS At a glance Regulating and administering a carbon crediting mechanism requires institutions that can execute policy authority, provide oversight, and deliver rulemaking and implementation functions. The institutions responsible for these functions will vary and likely be jurisdiction specific. However, they often include a high-level decision body with overall authority to design and oversee the mechanism, an executive body that develops rules based on the overall regulatory environment and mandate, and an administrator to execute the rules and guidance. These institutions are often supported by technical advisory bodies. Institutional and governance choices will affect transaction costs and the administrative burden on government. Section 10.1 looks at the general governance structure for crediting mechanisms. Policymakers will need to find an institutional arrangement that is efficient, transparent, and predictable. This will give confidence in the crediting mechanism and can streamline both management of and participation in the mechanism. In deciding the role of civil society and the private sector in governance, key considerations will be the potential for conflicts of interest versus the benefits of more inclusive governance and diverse perspectives. Because of the financial and legal implications associated with the creation and transfer of carbon credits, it is important to assign liability for the quality and quantity of the credits (e.g., to deal with cases of errors, omissions, or fraud that lead to the cancellation or revocation of credits). In addition, crediting mechanisms should have clear processes for appealing decisions and for resolving any disputes. The assignment of liability and an appeals process are outlined in Section 10.2. Finally, many crediting mechanism functions are implemented through online registries, which provide the technical infrastructure for issuing, transferring, and retiring credits, as well as making information on credits and projects publicly accessible. Key governance questions on the registry infrastructure are outlined in Section 10.3. This includes how a registry will be built and operated and what types of information it must be able to support. The Partnership for Market Readiness’ (PMR) Emissions Trading Registries: Guidance on Regulation, Development, and Administration covers the design options and requirements of registry systems in more detail. 10.1 PROGRAM GOVERNANCE mechanism is governed. Policymakers need to outline the roles and responsibilities of various agencies and AND REGULATORY SYSTEMS departments and establish new bodies or institutions where necessary. Together, this can ensure robust Having effective and transparent governance decision-making, protect the integrity of the mechanism, arrangements is important for any policy. Efficiency is and boost confidence in the crediting mechanism from and supporting frameworks important for both project proponents and administrators both project proponents and the broader public. It can Establishing governance to ensure the crediting mechanism runs smoothly. also minimize the potential for politicizing decisions, In finding the appropriate solution, policymakers will resulting in more predictable decisions and processes. need to balance the efficiency of pooling functions and minimizing unnecessary bureaucracy against the A jurisdiction’s specific circumstances will influence what importance of separating powers and responsibilities to these institutional arrangements look like in practice. promote the integrity of the mechanism. Transparency Constitutional or other legal arrangements, for instance, relates not only to the crediting rules (as discussed may already delineate areas of responsibility or tasks to in previous chapters) but also to how the crediting specific bodies. If a crediting mechanism is put in place to A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 94 offer flexibility for a carbon tax or emissions trading system expertise and input required if they were to draft these (ETS), policymakers may want to consider whether the methodologies from scratch. Yet, even if there is a high same authorities could run the crediting mechanism. While level of reliance on existing crediting mechanisms, this would have efficiency gains, those authorities may some domestic institutions will be needed for general not have the capacity and technical expertise to manage policy coordination, oversight, and rulemaking. both policies. In California and Switzerland, the ETS and the crediting mechanism are run by the same body 10.1.1 Institutional arrangements (the California Air Resources Board and Federal Office and administrative elements for the Environment, respectively). However, in South Africa and Colombia, different ministries run the carbon Designing effective institutional arrangements requires tax and the crediting mechanism. For jurisdictions with an understanding of the functions needed for a experience in the Clean Development Mechanism (CDM), crediting mechanism. These can be divided into four the country’s Designated National Authority could be a categories: policy authority and oversight; rulemaking; possible candidate for taking on many of the administrative implementation; and technical advisory (see Figure 10-1). functions of the domestic crediting mechanism, given This section addresses each of these in turn. the similarities in the skills required. This is the case for South Africa, where the Designated National Authority Policy authority and oversight in South Africa’s Department of Mineral Resources These functions focus on the macro decisions for the and Energy administers the crediting mechanism. crediting mechanism, like the coverage and level of reliance on existing crediting mechanisms. As these Equally, as discussed in Chapter 3, the extent to which decisions determine the general policy direction, policymakers rely on, or outsource to, other crediting they are generally undertaken by high-level political mechanisms will also affect the governance arrangements. decision-makers, like a government minister or For instance, if a domestic crediting mechanism uses agency chief executives. These functions will likely methodologies from an existing international crediting draw on existing governance arrangements, including mechanism, then policymakers would only need to assess those established by existing constitutional and the suitability of the international crediting mechanism legal frameworks, including those for climate policy. at the outset. They would not need the level of technical Figure 10-1. Governance functions for crediting mechanisms POLICY AUTHORITY & RULEMAKING FUNCTIONS OVERSIGHT FUNCTIONS • Agree on scope sectors, technologies, • Approve methodologies, technical project types, methodologies standards, and guidelines • Agree on use of elements of existing • Approve accreditation rules for crediting mechanisms independent auditors • Allocate all other functions • Review implementation decisions, if appropriate • Address grievances and appeals IMPLEMENTATION FUNCTIONS TECHNICAL ADVISORY FUNCTIONS and supporting frameworks • Accredit auditors to carry out validation • Review international methodologies, technical Establishing governance and verification guidelines, default factors • Review and register eligible projects • Oversee development of new methodologies, • Certify and issue emission reduction units technical guidelines, default factors by third parties • Maintain a registry of projects and emission reductions and international links • Develop new (top-down) methodologies Source: Adapted from Spalding-Fecher et al. 2017, 2018. 95 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS Figure 10-2. Key institutions in domestic crediting mechanisms Decision Overall authority to design and (e.g., Parliament, Minister, or Inter-ministerial body) oversee the mechanism Executive Develop rules based on the overall (e.g., ministry/department, multi-departmental regulatory environment and mandate board or agency, or multi-stakeholder group) Administrative Execute the rules (e.g., department, government agency, and guidance regulating agency, or independent third party) Technical Provide technical advice and (e.g., committee, specialized inputs to other bodies consultants, or technical experts) These functions will generally establish the high-level on the technical and policy skills of existing institutions framework for the crediting mechanism, including policy (such as those in existing government departments). objectives, any necessary primary legislation, and rules Though not covered in this guide, if policymakers are for compliance and enforcement (such as penalties considering linking, for instance through Article 6 of for noncompliance). The responsible institution may the Paris Agreement or through the Carbon Offsetting also be required to make final decisions regarding and Reduction Scheme for International Aviation, the scheduled reviews of the crediting mechanism and institutions responsible for rulemaking need to be aware implementing any broad design adjustments (e.g., in of the international policy frameworks being established scope) to the mechanism. The responsible institution to ensure the details of the crediting mechanism are will generally allocate subsidiary functions to other consistent with international rules and requirements. executive or administrative bodies. Figure 10-2 provides an indication of the types of institutions Implementation required to deliver all the functional requirements. A focus on implementation ensures that the rules and regulations of the crediting mechanism are adhered Rulemaking to, as well as overseeing the mechanism’s day-to- Rulemaking functions focus on all the secondary rules and day administration. These functions are generally regulations needed to flesh out the crediting mechanism in carried out at a lower administrative level and will line with the high-level policy direction. This can range from require greater technical capacity to understand developing methodologies under a top-down approach; the application of the crediting rules and sector- or to approving methodologies, standards, and guidelines technology-specific issues, in order to properly review for the crediting mechanism; to reviewing decisions by and register projects. A specialized agency could, for the administrator and addressing any grievances and instance, be established or adapted within an agency, appeals. For the latter, this body will need to have the department, or ministry to exercise these functions. ability to properly enforce its decisions. Though some Other functions include certifying and issuing credits, and supporting frameworks Establishing governance understanding of the sectors covered by the crediting accrediting auditors, and managing the registry. mechanism and a familiarity with carbon pricing may be needed here, the responsible institution(s) will often draw A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 96 Technical advisory government. Over time, as these gaps close, governments can reconsider whether they want to move these functions This refers to the technical capabilities that are not in-house. While no existing crediting mechanisms traditionally held within the government or can benefit from adopt this outsourcing approach, other carbon pricing being delivered by independent experts. This will consist instruments have. For example, partners in the Regional of experts with the appropriate sector, business, technical, Greenhouse Gas Initiative, an ETS consisting of 10 (soon or legal expertise needed to help ensure the rules and to be 11) states in the United States, contract third-party general direction of the crediting mechanism are robust, private companies to monitor the market, track allowances, tailored to local conditions, and implemented correctly. run the auctioning platform, and register offsets. Technical advice could be sourced from committees set up to serve other climate policy functions, such as Stakeholder involvement must also be considered as part those focusing on emissions reduction target progress of policy design and the project cycle. As discussed in tracking or United Nations Framework Convention on Chapter 2, involving stakeholders as part of policy design Climate Change reporting. Alternatively, there may (for example, during comment periods and hearings) be bodies serving sectoral functions—for instance, can help ensure a transparent and robust crediting advising on energy policy development—that may have mechanism. Having these other voices feed into the relevant insights for the crediting mechanism. Depending technical advisory functions may be helpful and a means on the coverage and complexity of the mechanism, of establishing ongoing stakeholder engagement on policymakers may need to draw on experts across the mechanism. In addition, it is possible to incorporate several departments, as well as consider the involvement stakeholder input as part of the project approval process, of external experts, like academics or consultants. as discussed in Chapter 8. While this is not common in This function can interact with multiple aspects of the regional, national, and subnational crediting mechanisms crediting mechanism, such as reviewing or developing (in most cases because they would duplicate existing methodologies, standards, guidelines, and default factors. requirements in national law on public participation), international and independent crediting mechanisms Functions for key institutions often include stakeholder consultation as part of the There is a range of options for different institutions to project approval process. Multi-jurisdictional crediting provide the necessary functions to successfully govern mechanisms include this type of engagement to and administer a crediting mechanism. Ultimately, the choice of specific institutions delivering those functions y draw out technical knowledge that can inform is dependent on jurisdiction-specific circumstances, project design to ensure implementation success, including the ability and desire to rely on existing institutions and the level of reliance on existing crediting y identify and reduce risks and build mechanisms. Figure 10-3 illustrates the flexibility in the community acceptance, and range of functions covered by specific institutions. y e nsure that projects meet social and environmental safeguards and promote development benefits. 10.1.2 Stakeholder engagement in project approval However, as noted in Chapter 8, this adds time and cost Policymakers must also consider the roles, involvement, to project development, and should only be included and inclusion of other stakeholders. Certain functions may where the jurisdiction does not already have a robust be outsourced to overcome capacity or knowledge gaps in framework for approving new investment projects. Figure 10-3. Example of range of functions for key institutions Key institutions Function Decision Executive Administrative Technical and supporting frameworks Establishing governance Policy authority and oversight Rulemaking  Implementation Technical advisory 97 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 10.2 ENFORCEMENT, invalidation. With this in mind, the risk of invalidation is relatively low. In California, for instance, only 0.3 LIABILITY, AND APPEALS percent of credits issued have been invalidated.91 Like other carbon pricing instruments, a crediting Given the multiple actors involved in an invalidation mechanism needs to ensure the administrator has situation, it can be challenging to assign responsibility for sufficient powers to enforce rules and obligations mistakes. To illustrate this, consider the following scenario: and impose any required penalties. The reporting and A proponent of a mitigation activity overestimates validation/verification steps in the project cycle (see emissions reductions. An auditor reviews the calculations Chapter 8), as well as the use of auditors (see Chapter 9) but fails to catch the mistake. Program administrators are core components of the enforcement and compliance also do not notice the error when reviewing the auditor’s regime. In some cases, penalties may be required to verification report, and issue credits based on the promote compliance. For instance, in cases of non- faulty estimation. A buyer conducts due diligence permanence (see Section 5.5) or over-crediting (see below) under the assumption that the proponent, auditor, or where auditors are performing poorly (see Section 9.4). and administrators executed their duties appropriately Penalties can range from naming-and-shaming (e.g., and also fails to identify the error, and purchases and publishing the name of noncompliant entities), to retires the credits. The original proponent committed deregistration (e.g., revoking auditor accreditation or a the error. The auditor did not meet the obligation of project’s eligibility status), or to fines or more serious identifying it. The program administrator bears ultimate criminal charges (e.g., in cases of fraud). The exact nature responsibility for issuing credits. The credit buyer’s of these penalties should be sufficiently strict to incentivize due diligence did not identify the error, either. compliance but not overly punitive to deter participation. Clear policies are needed to assign responsibility for A related governance aspect is how policymakers errors, omissions, accidents, or fraud. This allows elect to manage the financial and legal implications of disputes to be resolved efficiently, and all parties a crediting mechanism. Liability needs to be assigned understand their risks and responsibilities. Programs for both the quality and the quantity of the credits (note: can select seller, buyer, or program liability. A tiered liability in the case of emissions removals is addressed approach to such policies can also be used. Policymakers in Chapter 5). Liability can be attached to sellers, need to decide whether the credit seller or buyer or buyers, the program, or a combination approach. This the jurisdiction is better equipped to evaluate the will be important in cases where credits are found to be credit quality and deal with potential invalidation. invalid or over-crediting occurs. To correct these cases, policymakers generally require credits to be canceled or Seller liability is the most common among existing revoked, or mandate the retirement of additional credits. crediting mechanisms to date. Seller liability assigns The possibility of credits being revoked or invalidated responsibility for the mitigation activity to the first should also force low-quality credits out of the market. recipient of the credits: the project proponent. If, for example, a case of over-issuance occurs, then the 10.2.1 Assignment of liability project proponent is responsible for obtaining and retiring extra credits equal to the over-issued credits in In terms of potential liability, the most common types question. This compensates for the over-issuance and are for (1) over-crediting, where project proponents safeguards the environmental integrity of any credits that received more credits than the program’s requirements have already been issued. In most mechanisms, the only and methodologies allots them; (2) double issuance exception is cases of gross negligence in verification (also addressed in Chapter 5); and (3) noncompliance, activities, at which time the auditors are at fault. where projects may have violated other legislation (e.g., health and safety, air quality permits). All these can The primary advantage of seller liability is that it result in issued carbon credits becoming invalid.90 effectively means that, from a buyer’s perspective, any credit issued is free from risk. This can facilitate a Ultimately, all the policy design elements discussed more liquid market, supporting secondary transactions and supporting frameworks in the preceding chapters are intended to promote Establishing governance and reducing transaction costs. A more liquid market environmental integrity and reduce the risk of can help channel greater investment into mitigation 90 As discussed in Chapter 5, a reversal of an emissions removal is generally not grounds for invalidation. 91 For a livestock project in violation of health and safety regulations in Michigan, a livestock project in Wisconsin which was not in compliance with pollutant discharge permit requirements, and an ozone depleting substances project, which was in breach of a federal operating permit. For more see https://ww2.arb.ca.gov/sites/default/files/classic//cc/capandtrade/offsets/final.determination.svd.01.30.20.pdf, https://ww2.arb.ca.gov/sites/default/files/2020-09/Final_Determination_Central_Sands_Dairy_Offset_Investigation.pdf, and https://ww2.arb.ca.gov/sites/default/files/classic//cc/capandtrade/offsets/ods_final_determination.pdf respectively. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 98 Box 10-1. Buyer liability: California Policymakers in California viewed carbon credits Contrary to some early expectations, California has primarily as regulatory compliance instruments and a fairly robust market for carbon credits. Credit use facilitating market liquidity was not identified as a has actually increased under the California ETS, with major priority. California’s ETS allows credits to be regulated entities using offsets to meet 6.4 percent of generated anywhere in the United States, but it would their compliance obligation from 2015 to 2017 (second be challenging to have regulatory oversight outside compliance period), compared to 4.5 percent from its jurisdiction. By placing the liability on regulated 2013 to 2014.92 Various players have stepped in to entities (that may use credits for compliance), California provide insurance guarantees for certain credits, which could still have offsets outside of the state, ensuring protects buyers against invalidation. A tiered market sufficient supply, while having regulatory oversight over for credits has developed, where “gold” credits, which the companies under the California ETS. have guarantees against revocation, sell at a higher price than credits that still carry risk. activities. The disadvantage as compared to buyer Program liability assigns liability to the crediting liability is that it puts more onus on proponents, mechanism itself; however, no crediting mechanism auditors, and program administrators to ensure the currently uses this approach. In effect, this means the validity of credits. Seller liability reduces the risk program administrator guarantees the validity of credits to everyone else, and as a result credit prices may and, if an over-issuance occurs, agrees to compensate be higher than under a buyer liability approach. for the over-issuance to maintain environmental integrity. To make good on this commitment, policymakers Buyer liability assigns responsibility to any party that could establish a “buffer” account of credits used to holds credits at the time an over-issuance is identified. compensate for over-issuance or hold professional Program administrators cancel affected credits from liability insurance that would pay the mechanism any accounts that hold the credits. If affected credits to obtain and retire compensating credits. were retired against a compliance obligation, then the entity that retired the credits would be responsible for The advantage of program liability is that it relieves replacing them. Depending on the compliance due program participants from any direct risk, which in dates, the amount of time needed for replacement can turn could facilitate a more robust credit market. also mean buyers will have to pay a higher price for The disadvantage is that it imposes costs—in the replacement credits. This is the approach adopted in form of either a buffer set-aside requirement or Alberta and California (see Box 10-1 on California). additional program fees needed to pay for insurance— that would reduce revenues for mitigation activity While buyer liability theoretically encourages buyers to proponents and/or raise costs for credit buyers. conduct due diligence procedures, it can be challenging for buyers to do this, as the information necessary to A tiered approach could also be adopted that uses a undertake such an assessment is not always available. combination of seller, buyer, and/or program liability. In Buyer liability also encourages buyers to insert key this approach seller liability might generally apply but contracting provisions with sellers that effectively other models would apply under specific conditions. The reassign potential liability. The disadvantage of this Québec Offset System adopts a tiered approach, whereby approach is that it can dampen demand by creating seller liability is applied but the government provides higher transaction costs, as buyers must implement additional protections to guarantee carbon credits and stronger review mechanisms or negotiate legal ensure buyers bear no risk. The government protections agreements that protect them from revocation risk. This would only be used in situations where the project and supporting frameworks may in turn reduce demand in the secondary market, proponent was not able to satisfy its liability obligations Establishing governance as agreements must be reassigned to successive (e.g., the project proponent no longer exists). The Québec buyers. At the same time, buyer liability can result in Government has established an Environmental Integrity greater market transparency about the relative quality of Account to fund any future liabilities, which is funded by credits, with credits selling at different prices based on the automatic withholding of 3 percent of all offset credits differences in the perceived risks associated with certain issued. The government has not yet had to replace any mitigation activities (or types of mitigation activities). credits. 92 Sutter 2020. 99 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS The advantage of a tiered approach is that it could main functions required of crediting mechanism registries, more fairly balance responsibilities and avoid some along with key design choices and requirements. potential transaction costs associated with negotiating risk allocation in legal contracts. For example, project Registry systems for crediting mechanisms serve three proponents would not necessarily need to negotiate interrelated purposes: with auditors about who bears responsibility for any ultimate errors or omissions. A tiered approach could y to promote transparency by providing also reduce ambiguity in determining liability and reduce publicly accessible information on mitigation risk to buyers. The disadvantage is that it requires activities involved in the program; policymakers to describe in detail all the possible scenarios for risk and to clearly assign responsibilities y to facilitate the issuance, transfer, and use of uniquely under each. Furthermore, program administrators would identifiable credits that are clearly linked to, and need to apply and interpret these rules whenever over- convey a claim to emissions reductions or removals issuance or invalidation occurs and disputes arise. achieved by, registered mitigation activities; and y to help prevent double counting and double 10.2.2 Establishing an appeals process issuance of emissions reductions and removals. Policymakers will need to outline an appeals process and Linking to other registries can also reduce clearly set out which decisions are subject to appeal and the risk of double issuance and use. which are not. Elements of the appeals process include These three functions are essential for ensuring credits y How the overall appeals process will work, including are tradable emission-reduction assets that can be procedures for submitting an appeal, provision of used in conjunction with a carbon tax or an ETS—or in legal standing (who can submit an appeal and on carbon markets more generally. To achieve these goals, whose behalf), permitted justifications for appeals crediting mechanism registries generally have two main (appeals based on misinterpretation or misapplication components: of methodology requirements are typically allowed), and the rules for accepting or rejecting them. y a credit tracking registry system, used to issue, transfer, and cancel credits; and y The parties involved in hearing the appeal. This typically includes program staff and/ y a mitigation activity database system, used to record or the program’s governing authority. and make publicly available information on individual mitigation activities involved in the program. y Time frames for the appeals process. The appeals process should have specific timelines tied to These two components may be maintained and it so that project applicants can build the time administered separately, but together are commonly frame into project development planning. referred to as the program registry. If administrators have already established (or will establish) an emission trading registry (for example, for a domestic ETS), this 10.3 REGISTRY may also serve as a credit tracking system for a domestic INFRASTRUCTURE crediting mechanism. In this case, the only additional system needed is a mitigation activity database. However, Operating a crediting mechanism requires the administrators should make sure that the emissions establishment of basic administrative systems, including trading registry has all the necessary functionality to meet information systems needed to track implementation and the crediting mechanism requirements, including any verification of mitigation activities; providing for public tracking and information requirements needed to avoid transparency; and creating, transferring, and retiring double counting of emissions reductions or removals. carbon credits. The IT infrastructure needed to perform these functions is commonly referred to as a “registry.” The 10.3.1 Credit tracking functions and supporting frameworks PMR guidance document Emissions Trading Registries: Establishing governance A credit tracking system is essential for creating a Guidance on Regulation, Development, and Administration tradable carbon asset and (related to this) ensuring an covers the design options and requirements of registry exclusive claim to emissions reductions by avoiding systems in detail. This section provides a summary of the double counting (see Section 5). At a minimum, a crediting mechanism’s registry should93 93 For further discussion of these requirements and their relation to avoiding double counting, see Centrum Wiskunde & Informatica, Meridian Institute, and Stockholm Environment Institute 2019 and Schneider, Broekhoff et al. 2019. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 100 y be capable of securely and transparently basic documentation, like project design documents and effectuating the issuance, transfer, and verification reports, available to outside stakeholders. cancellation of carbon credits; The project database should use the same unique y allow the tagging of each credit with a unique identifier for each project used in the credit tracking identifier (typically a serial number) so that system. At a minimum, a project database should contain the following information and documentation: – each credit is clearly associated with a specific issuance and vintage related to quantified and y a description of the project, including information verified emissions reductions or removals and on the mitigation activity involved; – each credit can be connected to other y the emission sources, sinks, and greenhouse information relevant for potential buyers gases included in the calculation of the project’s or needed to avoid double counting; emissions reductions or removals, along with the location(s) of all relevant sources and sinks; y make relevant information on credits available to registry users and the public (e.g., details about y the geographic location where the the projects to which they were issued); and project is implemented; y incorporate credit cancellation procedures that y any other information needed to ensure that cancellation is clearly indicated, unambiguously identify the project; and irreversible, and unambiguously designated for an intended purpose, such as y details of the project proponents and/or developers. – meeting an entity’s offsetting requirement It is good practice for crediting mechanisms to under a domestic carbon tax, ETS, or require this information from project proponents other regulatory requirements; prior to project registration and to make it publicly available, generally on the mechanism’s website. – achieving voluntary offsetting goals; The PMR’s Emissions Trading Registries: Guidance on – compensating for excess issuance; Regulation, Development, and Administration identifies three primary design decisions for registries: deciding – addressing non-permanence; or on a legal framework; establishing an institutional framework and administrative structure; and deciding – removal from the registry for the purpose of on IT system procurement and development. re-issuance by another mechanism or entity. Carbon credits issued by a crediting mechanism and 10.3.2 Mitigation activity database functions tracked in a registry will have financial value corresponding to their eligibility for meeting regulatory compliance A mitigation activity database is a centralized repository obligations for fulfilling market demand. One function of information on all mitigation activities reporting under of a registry is to sustain this value, in part by legally the crediting mechanism. Such a database is essential defining a credit as an asset, including how it may be for making information available to participants about held, transferred, and used. Basic options include mitigation activities and their status. Information on each project’s stage in the project cycle and any credits y Supporting basic crediting mechanism functions issued should also be made available. The project (register model). A register can support basic database can also be used to manage the project cycle, crediting mechanism functions (such as transfer as project proponents should be reporting progress and use of credits for regulatory compliance) in the system. Finally, a project database can serve an but lacks the full functionality of a transaction important function for outside stakeholders, including and supporting frameworks registry. A standalone crediting mechanism Establishing governance voluntary credit buyers. At a minimum it can provide them may find a register approach sufficient without information about the quantity and types of activities having to legally address, for example, aspects of that are registered with the mechanism and allow them financial regulation and criminal enforcement. to identify projects that align with their preferences. If a buyer had a preference to support projects in a specific y Supporting broader market functions (transaction geographic region or of a specific type, like renewables registry model). A transaction registry has a or forestry projects, this information can be easily legal framework that fully supports consideration identified in the registry. It is good practice to also make of credits as financial assets. In most cases, 101 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS crediting mechanisms require a legal framework providers. Alberta’s Emission Offset Registry is operated, that incorporates at least some elements of a for instance, by the Canadian Standards Association in transaction registry—especially if policymakers coordination with the Alberta government. Alternatively, envision a robust market with trading among policymakers can rely on existing mechanisms to oversee different types of account holders. A transaction registry operations (see Section 2.1.5). Outsourcing can registry model is most appropriate, for example, save on costs but removing program staff from day- if a crediting mechanism is linked to a domestic ETS. to-day oversight could make it more difficult to monitor registry functions and identify problems as they arise. Other design decisions related to a registry’s legal framework include account holder classifications Another primary consideration is whether a fee should and specifications. Options include be charged for registry use and what the fee structure should be for different users. Typically, crediting y Defining accounts for basic regulatory functions. mechanisms charge fees for establishing and maintaining A crediting mechanism designed primarily as a registry accounts, as well as for issuing credits (often tool for regulatory compliance might distinguish applying a standard charge for each credit issued). between two types of accounts: those for project The fee structure will depend on overall administrative proponents (into which credits are issued), and costs, funding sources, and overall financial viability. those for regulated entities (from which credits are retired to meet compliance obligations). 10.3.4 IT procurement and development y Defining multiple account types to support Registries require various IT systems to operate. market functionality. A full transaction registry There is a range of options for establishing the might allow for additional account types, including technical infrastructure of a registry and providing accounts for intermediary buyers (traders/brokers), registry services. Key decisions include voluntary buyer accounts, and even observer accounts (which external stakeholders use to y Whether to develop, adapt, share, or access market data within the registry system). In outsource registry information systems. a transaction registry, it is important to implement Different options will have different advantages know your client procedures to ensure that entities and disadvantages in terms of cost, degree of with accounts are legitimate and to safeguard control, and customization to a domestic crediting against fraud. This can add to administrative costs. mechanism’s needs and requirements. Further, there is the question of accessibility. In general, y Anticipating needs for linking and interoperability. registries should be publicly accessible to maintain Interoperability of registry software with the systems transparency to support market and environmental of other crediting, carbon taxes, or ETSs may be integrity. The legal framework for a registry should desired if linkages with those programs are expected. define the terms under which different types of data and information may be accessed (in both the credit tracking y Defining functional specifications. These can and project database components of a registry). include, among others, specifications for the functionality of different account types; implementation of credit issuance, transfer, cancellation, and 10.3.3 Registry administration retirement actions; and various accessibility options. Administrators must oversee and monitor registry activity. Required administrative structures and procedures y Technical specifications. These include will depend on the registry’s legal framework, the requirements for the technology infrastructure governance and administrative structure for the crediting needed to support registry functions. mechanism as a whole, and cost considerations. A primary consideration is deciding who performs day- Establishing robust IT systems early and in conjunction to-day registry operation, including credit issuance, with developing the design of the crediting mechanism and supporting frameworks authorizing transfers, approving retirements, and can help streamline implementation and promote Establishing governance implementing cancellations. Some mechanisms handle the overall success of the crediting mechanism. all of these functions in-house—that is, assign them to administrators. Others outsource some or all of these functions. Those that use partial outsourcing typically delegate subsidiary functions like approving the transfer of credits, while administrators perform primary functions like project registration, or credit issuance and retirement. Outsourcing may involve independent registry service A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 102 ANNEX I: TYPES OF CREDITING APPROACHES There are various types of carbon crediting approaches. They work at essentially different scales and scopes of aggregation and range from individual project-based crediting to sector or policy crediting. Table A-1 provides a summary of the four main types of crediting approaches, including examples of each type. Strengths are marked in green and weaknesses are in red. Table A-1. Types of crediting approaches Objective Methodology Strengths/weaknesses Examples Project-based Support individual Baselines and Relative simplicity Clean Development investment projects monitoring, reporting, Mechanism (CDM) Allows for pure private and verification (MRV) sector transactions Australia Emissions based on technology Reduction Fund assessment Limited opportunities to scale up California Compliance Offset Program American Carbon Registry Example: Capturing the landfill gas that would have been vented into the atmosphere and flaring the methane, which then reduces methane emissions to the atmosphere. If there is no regulatory requirement to flare the gas and no other source of revenue other than carbon credits, then the most likely alternative would be to continue venting the gas. Programmatic Support a larger number Baselines and MRV Relative simplicity Programmatic CDM of similar projects, often based on technology Allows scaling up Standardized small and micro scale, assessment through replication crediting framework mostly by not requiring Often associated with identification upfront Allows reaching small and an incentive program of specific locations micro scale activities Example: Developing a program for distributing solar cookstoves to families in a region before knowing how many cookstoves will be distributed and/or where they will be used. Emissions reductions result from the decreased burning of biomass in conventional firewood stoves. Estimates of emissions reductions are often based on default use rates, and sampling is mostly used for monitoring. The program additionality is based on the argument that solar cookers are more expensive than alternatives and would therefore not be accessible to low-income families in the region in the absence of a similar incentive to the one provided by the program. Policy Support a policy Baselines and Large scale Transformational intervention (e.g., MRV based on High transformative effect Carbon Asset Facility energy subsidy removal, economic modeling carbon pricing) High complexity High preparation costs Limited role of private sector Example: Supporting fossil fuel consumption subsidy removal (for example, eliminating gasoline pump-price subsidies for consumers) through a policy package that includes targeted alternatives to low-income families who are hurt by the removal of that subsidy. Emissions reductions result from comparing emissions in the subsidy-supported sector before and after the removal of the subsidy. Sectoral/ Support overachieve- Sectoral/jurisdictional Large scale Jurisdictional and jurisdictional ment of sectoral/ baseline nested reduced Low risk of leakage and jurisdictional mitigation emissions from Crediting only at perverse incentives benchmarks/targets deforestation and aggregate level Low incentive for private land degradation sector participation High delivery risk Example: setting a target at jurisdictional level for the carbon sequestration resulting from the maintenance and increase of carbon stocks (e.g., protecting or restoring an existing native forest). Source: Adapted from World Bank n.d. 103 A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS ANNEX II: SCALED-UP CREDITING Scaled-up crediting mechanisms focus on a large in a different facility, increase its emissions without number of projects or even whole sectors of a country’s the project accounting reflecting this harm. economy instead of individual projects.94 Examples of scaled-up crediting include policy crediting, sectoral By supporting both policy and programmatic crediting, and jurisdictional crediting. Key features that levels, scaled-up crediting holds the potential distinguish scaled-up approaches from project-based to support transformative change and increase or programmatic crediting include the following: in climate ambition (see Box A-1). y Baseline emissions are established on a policy, At the same time, scaled-up crediting involves sectoral, or jurisdictional level. Credits are issued or interventions that are usually more complex than recognized based on aggregate reductions achieved single projects. Given the focus of the assessment across all included greenhouse gas (GHG) sources. is the policymaker, using the monitoring, reporting, and verification (MRV) protocols of project-based y Actions that reduce GHG emissions can be diverse, methodologies is generally impossible. Designing reflecting the actions of multiple entities responding to MRV protocols for sector-wide interventions is a incentives, rather than a single implementing entity. significantly different challenge than project-level MRV and usually requires a different set of tools and skills, y Government bodies instead of single- including economic modeling and policy analysis. project proponents may receive credits. Scaling-up crediting also may not be an option for Scaled-up crediting is in part a response to the domestic crediting approaches but rather for international limitations of project-based crediting. While the latter crediting. It may well require levels of carbon or climate supports discrete projects that can easily be predicated finance that domestic sources cannot generate. Given on the will of a single agent, scaled-up crediting can that limitation, interest in crediting at sector or policy support policy implementation and sectoral reform. level will typically come both from governments that wish to increase more effectively their purchase of Project-based crediting has often been criticized credits and generate more transformational, systemic for rewarding the best performers without taking change and from initiatives that seek to make carbon into consideration the evolution of an entire sector crediting a more effective tool in a more carbon- or industry. In other words, a program could be constrained world. See Box A-1 for examples. awarding credits to a facility in relation to a project, but the same operator of that facility could elsewhere, 94 Partnership for Market Readiness 2017. A GUIDE TO DEVELOPING DOMESTIC CARBON CREDITING MECHANISMS 104 Box A-1. Example of piloting scaled-up crediting Transformative Carbon Asset Facility Standardized Crediting Framework pilots Transformative Carbon Asset Facility is an innovative The Standardized Crediting Framework is a new facility that supports ambitious policy or sectoral approach to crediting emissions reductions owned mitigation programs in developing countries. Larger and managed by the potential transferring country, programs create greater momentum for sustainable which allows for more comprehensive geographic development and economy-wide transformation, coverage, flexibility, lower transaction costs, and as well as low-carbon development. By mobilizing increased private sector engagement. The framework international climate finance for results-based is important for several reasons. First, it proposes a payments and transfers of mitigation outcomes under systematic approach to quantifying carbon credits. Article 6 of the Paris Agreement, the facility supports Second, simplification and standardization improve middle-income countries in scaling up their climate the transparency of the carbon market and reduce commitments and accelerating socioeconomic growth. transaction costs. Finally, country-driven frameworks Working with national policymakers, it helps shape like the Standardized Carbon Framework support domestic environmental, energy, and climate change capacity building of transferring country institutions, policy to reach meaningful scale and create a lasting, improve coordination among domestic entities, and transformative social impact. 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