Introduction of technical paper Funding adaptation in developing countries: extending the share of proceeds used to assist in meeting the costs of adaptation; and options related to assigned amount units of Parties included in Annex I to the Convention UNFCCC http//:unfccc.int Pres-sessional workshop on the second review of the Kyoto Protocol pursuant to its Article 9 22 – 23 October 2008 Athens, Greece

Outline | Background & Scope of note Overview of options - Extending share of proceeds on the basis of unit transfers unit issuance - Assigned amount units contribution from domestic auctioning revenues contributions from international auctioning revenues Monetization

Background & Scope of note | Mandate At its 28th session SBI requested secretariat to prepare a technical paper on: Extending the share of proceeds to assist in meeting the costs of adaptation to joint implementation and emissions trading Options related to assigned amount units of Parties included in Annex I to the Convention for funding of adaptation in developing countries Further it was requested to include information on the potential impacts on the carbon market; potential scale of the resources; options for operationalization and transfer to the Adaptation Fund SBI further requested secretariat to make the note available to Parties prior to this pre-sessional workshop Parties were invited to submit their views on the issue, which the secretariat has compiled in document FCCC/KP/CMP/2008/MISC.1

Background & Scope of note | Scope Presents an analyses of options for extending the share of proceeds and options related to AAUs of Annex I Parties Section II provides overview of available options Section III and IV explores the two sets of options in further detail, including scale and impact Final section explores a number of issues relating to Monetization of KP units for the Adaptation Fund

Overview of options | Two sets of options OptionBrief descriptionPotential scale a Extending the share of proceeds 1. Extending the share of proceeds on the basis of unit transfers A share of proceeds would be applied to the first international transfers of AAUs, RMUs and ERUs from the national registries which issued them 2008–2012: USD 25–130 million per year 2030: USD 30 million to USD 2.25 billion 2. Extending the share of proceeds on the basis of unit issuance A share of proceeds would be applied to the issuance of AAUs and RMUs 2008–2012: USD 5.5–8.5 billion per year (AAUs only) b 2013–2020: USD 3.5–7.0 billion per year (AAUs only) b Assigned amount units 3. Contributions from domestic auctioning revenues A percentage of the revenues from auctioning allowances to entities under domestic trading schemes would be contributed towards international adaptation activities 2013–2020: USD 1–2 billion per year 4. Contributions from international auctioning revenues A percentage of Annex I Party AAUs would be transferred to a central body, which would conduct auctions of the units and contribute the funds towards international adaptation activities 2013–2020: USD 3.5 to 7.0 billion per year (AAUs only) b a Based on funding levied at 2 per cent of the relevant basis for the option. b No estimate is provided for the share of proceeds on the issuance of RMUs, as estimates of issuance are not available.

Extending share of | basis of unit transfers proceeds Description and potential scale of funding Levying a share of proceeds on the 1 st time transfer of unit (AAU, RMU, ERU) not subsequent transfers ITL could monitor and enforce, ensuring units making up share proceeds transferred to Adaptation Fund account Assuming a 2% levy, potential levels of funding could be: 1 st commitment period: USD million By 2030: USD 30 million – 2.25 billion

Extending share of | basis of unit transfers proceeds Impact on market A small share of proceeds to 1st time transfers may act as small deterrent to international market activities and slightly reduce liquidity in the carbon market Would have a greater impact on JI than emissions trading Small share of proceeds would not affect the liquidity of national markets Overall demand would not be expected to change; sellers would primarily bear the costs of the share of proceeds as buyers would have other units/options However, there is some potential of sellers carrying over surplus into future commitment periods Overall impact on liquidity is not possible to determine, but likely to be small

Extending share of | basis of unit transfers proceeds Extending to either JI or emissions trading If extended to JI only, less funding would be raised than if extended to both, unless applied as a commensurately high rate Apply to one unit and not others, in general will lead to shifts in market activity from levied to non-levied mecanisms However, the magnitude can differ: In case of applying to emissions trading the affect could be small, since JI has higher transaction costs and mitigation activities that generate surplus AAUs may not lend themselves to JI projects; Likewise, if applied to JI, then affect would be higher.

Extending share of | basis of unit issuance proceeds Description and potential scale of funding Levying a share of proceeds on the issuance of AAUs and RMUs would cover JI, as ERUs are obtained from converting AAUs or RMUs; applying a share to ERU issuance would be double taxing of JI This implies a significantly higher number of units being levied than with 1 st transfer levying, as all units would be levied whether traded or not; unlike CERs, not all issued AAUs/RMUS are likely to be transferred ITL could monitor and enforce as with 1 st transfer approach Assuming a 2% levy, potential levels of funding could be: 1 st commitment period: USD 5.5 – 8.5 billion By 2020: USD billion

Extending share of | basis of unit issuance proceeds Impact on market Applying levy to issuance could have a greater impact on the market than 1 st transfers approach Share of proceeds would represent a significant increase in supply, but less AAUs would also result in some increase in demand However, if roughly equal, then likely to be limited market impact

Extending share of | basis of unit issuance proceeds Extending to either JI or emissions trading If extended only to JI, then the amount of revenues raised would be small relative to that generated under the CDM Reductions from JI projects are expected to be 10-20% of that of CDM during the first commitment period Thus applying such a levy would most likely result in a shift to other activities/units (green investment schemes, emissions trading, CDM) from JI Levying a share of proceeds on issuance of AAUs and RMUs to extend to emissions trading would automatically cover JI

Description and potential scale of funding Several Parties are considering the use of revenues from auctioning of domestic allowances to fund adaptation Could be considered to agree a mandatory requirement for Parties implementing domestic emissions trading schemes The scale could be significant per year, but would depend on a number of variables (level of commitments, Parties implementing emissions trading, coverage of schemes, prices, etc. -- in paper estimate of USD 1-2 billion Funds generated in this way would decrease with expected fall in emission levels in Annex I Parties Options related to | Contributions from domestic AAUs auctioning revenues

Impact on market Using a proportion of domestic revenues from auctioning of allowances would not change the supply and demand of allowances, therefore not expected to impact market prices and traded quantities If option included the share of national emissions to be covered by domestic trading schemes and the shares to be auctioned, then it could increase the quantity of allowances to be auctioned Under such an approach the total demand and supply would not change, and market prices should not be affected, but liquidity may increase owing to greater volumes of units auctioned Options related to | Contributions from domestic AAUs auctioning revenues

Description and potential scale of funding Proposals for a percentage of the AAUs of each Annex I Party to be auctioned to raise revenues In such an approach when issuing into national registries, a share would be issued directly to the Adaptation Fund Levels of annual funding could be USD 3.5 – 7 billion during the period The costs of compliance for Annex I Parties would increase with such an approach (removing 2% of assigned amounts can be equivalent to an increase of several percent in required emission reductions e.g. if 20% reduction, 2% equivalent to 10% increase) Could have impact on stringency of reduction commitments to be taken by Annex I Parties Options related to | Contributions from international AAUs auctioning revenues

Impact on market A centralised international auctioning of share of AAUs could have an impact on the market Share of proceeds of 2% of AAUs could amount to million AAUs per year, which could be a significant share of expecting trading at least under a low-demand scenario In such a low-demand scenario it would mean these AAUs are a significant part of the annual supply, but with fewer AAUs left to Annex I Parties, for some Parties there would be an increasing demand However, to the extent they are roughly equal, then likely to be limited market impact Options related to | Contributions from international AAUs auctioning revenues

The options discussed require the units being contributed to the Adaptation Fund to be sold – “monetized” – before revenues can be used Where the Adaptation Fund is the recipient of the units, if not too significant an amount more than they already will receive from CDM, they could simply monetized them Where the amounts could be significant, a different approach may be needed e.g. issuance or centralized international auctioning approach could result in significant numbers of units in a short period of time and care would have to be taken not to disrupt the market Auctioning at regular intervals in cases where large quantities could allow for a more easy inflow of units into the market Where share of proceeds are direct financial resource transferred to Adaptation Fund monetization would not be required e.g. funds from domestic auctioning approaches Monetization | Issues

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