Corporate Corner: Carbon trading - the next big thing?

With environmental matters now officially being the most significant issue on the minds of Canadians, our political leaders are doing a lot of talking about the environment.

The Liberal party, saddled with a legacy of inaction except at the symbolic level, hopes to label the Conservative party as heartless polluters. The Conservatives are pointing out, with the aid of PowerPoint presentations, that effecting any serious change will be very expensive and take a long time.

While Canadians are large per-capita producers of carbon dioxide, our total output is negligible next to that of the United States and China, countries that have not signed the Kyoto Accord. Accordingly, Canadians could sacrifice mightily to reduce carbon emissions and it would have no significant impact on global warming.

Be that as it may, the phrases “climate change” and “global warming” have entered our vocabulary and we are all seeing unusual weather patterns that we are attributing to these causes, with or without any solid scientific basis. A significant plurality of Canadians now believe that global warming is real and serious and that their government should do something about. It will be pretty tough for any political party to get elected unless it has a concrete proposal to put before the Canadian public.

While it has not been discussed much in the current Canadian political environment, one mechanism proposed for the mobilization of private financial resources to fight the spread of greenhouse gases is carbon credit trading. This mechanism is specifically mentioned in the Kyoto Accord and forms part of the United Nations Framework Convention on Climate Change.

Carbon credit trading involves setting up a regime under which the traded commodity is the right to introduce one ton of carbon into the environment during a calendar year. Under the Kyoto Accord, participating governments are allocated a number of millions of tons of carbon per year, which they are permitted to introduce into the environment. If governments are in the position to actually emit less carbon, they can be allocated carbon credits, which they can then sell to countries that exceed their limits. This provides a monetary incentive for governments to meet and exceed their targets.

Similarly, within a country, the Kyoto Accord contemplates that a government would establish carbon emission targets for various industries and entities active in those industries that, if exceeded, would result in the issuance of carbon credits that could then be traded for profit. If the emission targets are not met, the offending entity must purchase credits to meet its targeted output. If secondary trading is introduced, it is possible to imagine that a great deal of economic activity would be generated both in the simple trading process and for the creation of devices and processes to limit carbon emissions.

The backbone of any such market is effective regulation and monitoring. If the emission targets are set too high there is no incentive to reduce carbon emissions. If the emission targets are set too low, entire sectors of economic activity can be strangled in a fruitless effort to achieve the impossible. If appropriate targets are set but there is no effective monitoring, the market will be perceived to be unfair and will be ineffective.

The European Union has attempted to establish such a market with the European Union Emission Trading Scheme. So far, the carbon reduction targets have been found to be largely elusory and the industry targets have not in fact required industry to reduce carbon output at all. Accordingly, the price for a carbon credit has steadily declined from the introduction of the system in 2004.

The Chicago Climate Exchange is a voluntary market where 200 companies have signed on to trade carbon credits with one another. However, this exchange thus far has been mostly seen as a public relations exercise as the standards set are not independent and the monitoring system is not well developed. There is a Montreal Climate Exchange, which is affiliated with the Chicago Climate Exchange, but it is not yet trading. Montreal is waiting for the federal government to make the rules.

It would be a very interesting thing for Canada to innovate in this area. It would undoubtedly be challenging to establish targets and to regulate and monitor the outcome, but Canadians are used to regulation, the government is capable of monitoring, and there are plenty of freely operating exchanges in Canada with the technical capacity to handle the trading activity.

In some ways, Canada is the ideal testing ground for a properly functioning carbon-credit-trading regime because we produce a lot of carbon but there are not many of us. We are relatively wealthy and we are relatively well educated, so the chances are good that there will be many innovative responses to the economic stimulus of a properly functioning market.

From a legal perspective, there are a lot of interesting and potentially difficult issues associated with the establishment of a climate exchange. The next column will identify and discuss a few of these.
Carbon trading is the kind of thing that could produce innovation and entrepreneurial responses that could mitigate and even profit from the economic costs of reducing greenhouse gases. The polls tell us that Canadians are ready to do something. Perhaps this is the thing to do.

Sam Billard is a partner at Aird & Berlis LLP practising primarily in the debt finance area.

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