The Compliance Fund: A New Tool for
Achieving Compliance under the Kyoto Protocol

Executive Summary

by Glenn Wiser and Donald Goldberg

For more information, contact Glenn Wiser at gwiser@ciel.org, or Craig Hart at chart@ciel.org.

How Annex I Parties to the Kyoto Protocol will achieve compliance with their substantive obligations, and how the Parties will collectively enforce those obligations, are two of many questions left unanswered by the Protocol's text. Parties may fear they could commit to obligations with which they are unable to comply, and they are concerned that their efforts may be undercut or their economic competitiveness undermined if other Parties "free ride" by failing to implement their own obligations adequately.

Parties legitimately need assurances that these concerns can be met as they negotiate rules that will determine how the first and subsequent commitment periods will be managed. During the first commitment period, domestic action to reduce emissions should be the centerpiece of each Party's compliance strategy. The cooperative mechanisms-joint implementation, emissions trading, and the Clean Development Mechanism-provide additional flexibility and cost-effectiveness to the Parties' implementation efforts.

After the commitment period ends however, the opportunity for a Party to meet its obligations for that period through domestic reductions will no longer be available to it. Annex I Parties with an overage at the close of the commitment period will thus effectively be bound to purchase credits from the cooperative mechanisms if they desire to comply with their substantive obligations. When the commitment period ends, Parties will "true-up" their greenhouse gas ledgers to ensure that their aggregate domestic emissions have not exceeded their assigned amounts, as required by Article 3.1. If a Party finds that its aggregate emissions are greater than its assigned amount, its only option for remaining in compliance will be to increase its assigned amount through cooperative mechanism purchases, until the amount is equal or greater than its emissions. Should it choose not to purchase sufficient credits, it will be out of compliance with its substantive obligations, and in turn will be exposed to an enforcement response.

However, there is no way of knowing in advance whether these mechanisms will provide the market with enough credits to satisfy the Parties' needs. If there are insufficient credits available on the market at the end of the true-up, or if speculators controlling available credits insist on prohibitively exorbitant prices, Parties could be faced with breaching their Protocol obligations, even if they have the will to comply.

Other Annex I Parties may decide that it makes political or economic sense to ignore their overages and risk the consequences of an enforcement response, or to delay honoring their commitments until an unspecified future time.

The first of these groups needs a mechanism that will enable them to stay in compliance with their commitments, should the cooperative mechanisms fail to provide the means. The second necessitates an enforcement response that will induce them to comply. The Compliance Fund, coupled with a binding arrangement for assessing and collecting contributions, provides a way to address both needs.

The basic idea of the Compliance Fund is uncomplicated. If a Party's emissions exceed its assigned amount at the end of the true-up period, and no cooperative mechanism credits are available on the open market, the Party has the opportunity to pay into the Fund a fee commensurate with its overage. Fees collected by the Fund are used to underwrite highly reliable GHG mitigation projects throughout the world. The Fund sets fees on the basis of actual estimated mitigation costs, plus a surcharge or "multiplier" to account for administrative costs, the risk of project failure, and other factors. The multiplier also serves to make the price of Fund credits high enough to dissuade Parties from relying upon them as a first choice for their commitment period implementation strategies.

Upon payment of the fee, the Party receives emissions credits equivalent to the amount of its overage. The Party adds the credits to its assigned amount, thereby ensuring that its aggregate emissions no longer exceed the amount and that it is in compliance with its substantive Article 3 obligations.

Because it requires an up-front payment from a Party with an overage, the Fund (1) provides an assured way of "making the climate whole" by balancing carbon ledgers for the commitment period, and (2) removes any economic advantage the Party might have received from failing to adequately mitigate its emissions during the period. The Fund is thus superior to "borrowing," or a "reduction of future assigned amount," the most oft-discussed proposals for allowing such Parties to avoid a declaration of non-compliance. These approaches neither make the climate whole nor remove a non-complier's economic advantage. They merely shift the responsibility of emissions reduction to future generations by allowing Parties to borrow portions of their assigned amounts from future commitment periods as a way to pay back their excess emissions in a current period.

For those situations in which cooperative mechanism credits are available during the true-up but a Party fails to honor its obligations by purchasing them, effective enforcement responses are essential to preserving the Protocol's integrity. Traditional responses-publicizing a Party's non-compliance, suspending its treaty privileges, or imposing trade measures or fines-can deter non-compliance. They should thus be part the Protocol's reserve of non-compliance consequences. However, none of them alone will guarantee that the twin needs of making the climate whole and neutralizing a non-complier's economic advantage are successfully addressed.

The Compliance Assessment can help accomplish both. Should an Annex I Party not correct its overage during the true-up, then a Compliance Assessment is levied against it. The amount of the Assessment is determined automatically, based upon the size of the overage. Parties satisfy an Assessment by making payment to the Compliance Fund, which uses the collected monies to underwrite highly reliable emissions mitigation projects.

The Assessment can become enforceable by applying traditional enforcement responses to secure its payment. However, a Compliance Assessments Recognition Agreement could provide a more efficient and reliable way to assure that Assessments are satisfied. Under this Agreement, Annex I Parties would consent to recognize Compliance Assessments as arbitral-type awards that can be collected in their domestic courts, where they are not subject to appeal or review. Countries have already accepted similar arrangements under the NAFTA Environmental Side Agreement and the New York Convention for the Recognition of Arbitral Awards.

For a full copy of this report, please send your publication request and mailing address to Cameron Aishton at caishton@ciel.org.