Bridging the transatlantic divide: legal aspects of a link between regional carbon markets in Europe and the United States

Bridging the transatlantic divide: legal aspects of a link between regional carbon markets in Europe and the United States
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  Sustainable Development Law & Policy   Volume 7Issue 2 Winter 2007: Climate Law Reporter 2007   Article 181-1-2007 Bridging the Transatlantic Divide: Legal Aspects of a Link Between Regional Carbon Markets inEurope and the United States Michael A. Mehling  This Article is brought to you for free and open access by the Washington College of Law Journals & Law Reviews at Digital Commons @ AmericanUniversity Washington College of Law. It has been accepted for inclusion in Sustainable Development Law & Policy by an authorized administrator of Digital Commons @ American University Washington College of Law. For more information, please Recommended Citation Mehling, Michael A. “Bridging the Transatlantic Divide: Legal Aspects of a Link Between Regional Carbon Markets in Europe and theUnited States.” Sustainable Development Law & Policy, Winter 2007, 46-51, 83-84.  Bridging the Transatlantic Divide: Legal Aspects of a Link BetweenRegional Carbon Markets in Europe and the United States Keywords European Union, EU, greenhouse gas emission, GHG emissions, European Community, International treaty  This article is available in Sustainable Development Law & Policy:  46 W INTER  2007 I NTRODUCTION European Union (“EU”) Directive 2003/87/EC establishes ascheme for greenhouse gas (“GHG”) emission allowance trading(“EU ETS”) within the European Community (“EC”). Under Article 25(1) of this directive, the European Commission has amandate to negotiate and conclude agreements with third coun-tries establishing a link to national or regional GHG emissionstrading schemes. 1 Aside from increased market liquidity and, byconsequence, reduced compliance costs, such a link promises tolessen competitive distortions between the participating states,counteract the threat of leakage, and potentially improve the prospects for a truly global carbon market. 2 With variousregional trading schemes currently under development in theUnited States, 3 the concept of linking emissions-trading marketsattracts attention on both sides of the Atlantic. Accordingly, theEuropean Council of Environment Ministers, which essen-tially decides on the adoptionof environmental legislation inthe EU, recently expressed “itscommitment to developing astrong global carbon market bylinking the EU ETS with other emissions trading schemes atnational or regional level.” 4 Meanwhile, an Executive Order adopted by the Governor of Cal-ifornia explicitly calls for thedevelopment of a “program that permits trading with the Euro- pean Union (. . .) and other juris-dictions.” 5 Indeed, the subject of linkages between GHG emissionstrading has become a widely discussed issue in climate negotia-tions and among climate experts. In his review of the economiccosts of climate change, for instance, the acclaimed economistSir Nicholas Stern considered linking national, regional, and sectoral carbon markets as an international priority and a valu-able opportunity to define a global price for carbon. 6 Unsurpris-ingly, several studies have addressed this issue by outliningconceptual issues and assessing the mutual compatibility of trad-ing schemes, 7 although few have specifically addressed the legalchallenges raised by such a market link. As a survey of existingscholarship reveals, a great majority of the conceptual chal-lenges identified thus far are largely political in nature and rarelyinvolve legal considerations. While essential for the operation of a trading link, for instance, the mutual recognition of allowanceshas been ultimately declared a “political issue,” and monitoring,reporting, and verification requirements mainly considered vitalfor their effect on confidence in the market. 8 In the end, rela-tively few design elements need to be compatible for a link to become legally viable, 9 with a high degree of harmonization between connected markets arguably desirable for political and economic reasons, but not essential as a matter of law.When considering a market link between emissions tradingschemes, questions of law are likely to emerge in two respects:  first  , during the process of implementation, which invariablynecessitates recourse to recognized sources of law and legal pro-cedures, and,  second  , during actual operation of the market link,where the latter may conflict with substantive norms and princi- ples of international, regional, or domestic law. Questions per-taining to the operation of a future trading link cannot beaddressed in a comprehensivemanner at this stage, given thecurrent uncertainties about itsultimate design. 10 Drawing onthe example of a link betweenthe current market in the EU and evolving markets in differentregions of the United States, thisarticle will provide an overviewof legal challenges apparent inthe preparatory process, focus-ing on the legal nature of a link-ing arrangement and the procedural constraints imposed on its adoption. L EGAL N ATURE OFA L INKING A GREEMENT As one scholar succinctly described it, “[t]wo national emis-sions trading schemes are linked if one country’s allowance can be used, directly or indirectly, by a participant in the other coun-try’s scheme for compliance purposes.” 11 In other words, sepa-rate trading schemes can be considered linked if allowances canflow between the respective schemes. As a result of such a link  B RIDGINGTHE T RANSATLANTIC D IVIDE : L EGAL A SPECTSOFA L INKBETWEEN R  EGIONAL C ARBON M ARKETSIN E UROPEANDTHE U  NITED S TATES by Michael A. Mehling* * Michael A. Mehling is a Research Fellow at the Faculty of Law and Economics,University of Greifswald, Germany, and an Associate with Ecologic — Institute for International and European Environmental Policy, Berlin, Germany. In hisdoctoral thesis, he evaluates competing approaches to energy and climate policy,with a focus on market instruments and emissions trading. Comments are wel-come at Separate trading schemescan be considered linkedif allowances can flow between therespective schemes.  47 S USTAINABLE D EVELOPMENT L AW & P OLICY  between trading programs in the United States and the EU, for instance, participants in the North American market could buyallowances in the EU ETS for compliance with their domesticreduction targets, and vice versa. However, a trading link doesnot necessarily have to operate in both directions. Rather, one jurisdiction may choose to create a unilateral link to other mar-kets, especially if the latter allow any legal or natural person toown allowances with the option of having these retired or can-celled. To this end, the jurisdiction in question could simplydecide to recognize allowances purchased and cancelled in a for-eign trading scheme for compliance purposes at home. 12 Although a trading link could also be construed to encompassthe transfer of credits through an overarching framework, suchas the Clean Development Mechanism (“CDM”) set out under the Kyoto Protocol, 13 this article will disregard such indirectapproaches to focus on arrangements suitable for the establish-ment of a direct bridge between the EU ETS and regional tradingschemes in the United States.While a unilateral link between trading schemes can beestablished through a simple legislative amendment specifyingthe conditions for recognition of foreign allowances, a bi- or multilateral link will typically require negotiations between thelegislators of all affected tradingschemes, resulting in some formof mutual understanding. Con-ventionally, this understandingcould be reached by way of: (1)a purely political arrangement;(2) a binding internationaltreaty; or (3) mutual recognitionof allowances by way of recipro-cal rules in the domestic lawof participating jurisdictions.Another approach could involvetransboundary contracts entered individually or collectively under private law, although thisoption is unlikely to offer the certainty and political acceptanceneeded for a comprehensive market link. P OLITICAL A RRANGEMENTS A political solution based on informal consultations has the benefit of obviating lengthy negotiation and ratification proce-dures. Aside from mere declarations of intent, for instancethrough joint statements at political summits, a more formal wayof documenting a convergence of will can lie in the conclusionof a Memorandum of Understanding, documenting a desired line of action, but lacking the binding power of a legal commit-ment. Adding to the less cumbersome procedure, such informalarrangements are also easier to modify and adapt than bindingtreaties. However, given the economic ramifications of a tradinglink and the importance of certainty and transparence for smoothmarket operation, pressure from stakeholders in the market willlikely prompt legislators to opt for a more reliable, legally bind-ing solution. B INDING I  NTERNATIONAL T REATIES Article 25(1) of Directive 2003/87/EC has chosen to followthis latter path by referring to the procedure in Article 300 of theTreaty Establishing the European Community (“EC Treaty”), 14 which specifies the adoption of international treaties by theEuropean Community. A treaty is one of the recognized sourcesof international law. 15 Its binding force follows from the custom-ary maxim of   pacta sunt servanda , 16 which ultimately reflectsstate sovereignty limited through voluntary consent. 17 The viola-tion of duties under a treaty counts as a breach of internationallaw, incurring state responsibility and the possibility of sanc-tions, often defined in the treaty itself as part of a negotiated compliance mechanism. While offering a high degree of cer-tainty, the adoption of an international treaty entails a lengthyand often contentious ratification process. Likewise, subsequentamendments to the treaty or a withdrawal from it are again sub- ject to sophisticated rules of international law. 18  Nonetheless,due to the formal nature and the transparency they offer, interna-tional treaties are likely to be the instrument of choice for afuture linking agreement. Still, it bears restating that suchtreaties can only be concluded by formal subjects of interna-tional law, a limitation of major relevance for any transatlanticlinking agreement betweenregional trading markets. R  ECIPROCAL C OMMITMENTS Rather than approving aninternational arrangement with binding force, different tradingmarkets could also enter a polit-ical commitment to adopt recip-rocal legislation within their respective jurisdictions, therebyensuring the mutual recognition of emission allowances. Such anarrangement would ultimately entail an adaptation of the respec-tive registry systems and thus derive its authority from domesticlaw, although it would result from formal or informal negotia-tions and preparatory meetings between states. Relative to aninternational treaty, of course, such a construction would nothave the capacity to bind participating jurisdictions, allowing for unilateral amendment or termination of the trading link without prior consent of other parties. In certain situations, this aggre-gate solution might be the only available means to connect sepa-rate markets while offering the legal certainty and transparencyof formal law. In that instance, unilateral digression is unlikelyfor as long as participants retain the common interest in an oper-ational trading link. C ONTRACTUAL A RRANGEMENTS A final vehicle for the implementation of a linking arrange-ment is private law, that is, the law governing the mutual rela-tions between natural and legal persons, notably the law of contracts and torts as it is called in the common law, or the law of obligations as it is called in civil legal systems. Different The concept of linkingemissions-trading marketsattracts attention on bothsides of the Atlantic.  48 W INTER  2007 approaches are conceivable under private law, although thesewill all involve some form of contract, either to establish alonger contractual relationship or purely negotiated  in casu togovern individual transactions. Whether a formal link has beencreated or not, transactions leading to a transfer of allowanceswill generally involve a contract specifying the terms of a partic-ular transaction, such as the price and volume of allowances, thedelivery date, a  force majeure clause, and default or liability pro-visions. 19 Even in the absence of a formal link, market partici- pants could use private law to create a bridge between otherwiseseparate trading systems by establishing a system for the conver-sion of permits. An example of this would be a system of private brokers leveraging arbitration opportunities. Such arrangementsare legally viable due to the fact that many trading schemes,including the ETS, impose no restrictions on account ownership,allowing virtually anyone to open an account an thereby enter the market. Moreover, there is a vital difference between trade inallowances, which is theoretically open to everyone, and actualtransfer, which is usually limited to market participants. 20 In thevoluntary sector, private transactions across trading schemeshave already occurred. 21 Unlike public internationallaw and the rules adopted by theEC, private law is not a body of norms adopted across nationalfrontiers. Instead, it differs fromstate to state, often with vast dif-ferences between historicallyseparate regulatory traditionssuch as the common law, whichis based largely on judicial precedent, and civil law, whichis based largely on codified rules. Of course, the United  Nations Convention on Con-tracts for the International Sale of Goods 22 has gone some way toestablish a uniform law of sales, but its application to emissionsallowances — the legal nature of which, while not entirely clear,rules out classification as a good or service 23  — is questionable. 24 In the absence of a harmonized normative framework, thecontractual arrangements for a trading link will thus be governed either by the private law of a particular state as specified in thecontract, the most likely case, or by the private law of the statedetermined by way of international private law. This latter set of rules, also known as conflict of laws, merely helps regulatetransboundary relations between private law subjects by deter-mining which of the competing legal systems is applicable. Thechoice of law in contractual relationships is typically selected  based upon either the place where the transaction physicallyoccurred ( lex loci actus ) or the doctrine of the proper law, whichis the law with the closest connection to the facts of the case.Altogether, this allows for great flexibility in the development of a trading link based on private law, although the scope of appli-cation will tend to remain limited to individual transactions or trading on a smaller scale. As mentioned earlier, market partici- pants are likely to insist on a transparent, legally binding frame-work for transactions between their respective trading schemes,favoring the predictability of formal legislation over a contrac-tual solution based on private law. P ROCEDURAL C ONSIDERATIONS OFA L INKING A RRANGEMENT As stated in the preceding section, the use of different link-ing arrangements can trigger differing formal procedures. Whilea political solution and contractual arrangements will generally pose no major challenges in this regard, both internationaltreaties and domestic legislation mandating the mutual recogni-tion of foreign allowances may only be adopted in accordancewith sophisticated provisions of legislative procedures and theinstitutional distribution of powers. With a view to the expressreference contained in Article 25(1) of Directive 2003/87/EC,this section will begin with an assessment of the proceduralframework for international agreements linking the EU ETSwith other emissions trading schemes. P ROCEDURAL I SSUESUNDER  E UROPEAN C OMMUNITY L AW First and foremost, themandate set out in Article 25(1)of Directive 2003/87/EC limits participation in a linking agree-ment to “third countries listed inAnnex B to the Kyoto Protocolwhich have ratified the Proto-col,” a limitation which, for thetime being, precludes an inter-national treaty with the United States because it has withdrawnfrom the Protocol. Thus, theusefulness of the Directive inguiding a transatlantic linkingarrangement is limited and the foregoing restriction will have to be repealed by way of a legislative amendment. A review processthat may result in an amendment is scheduled to conclude byJune 2007. In this connection, the European Commissionrecently indicated its intention to link with trading schemes cur-rently under development in the United States. 25 Although a transatlantic market link based on Article 25(1)of Directive 2003/87/EC may be ruled out for now, the proce-dure mandated therein may still serve as a likely model for future arrangements. Given that Directive 2003/87/EC is onlyderived legislation, without prejudice to the powers conferred onthe EC under its constitutive treaty, it is conceivable that theCouncil would move forward without observing the constraintsimposed by the foregoing mandate. Article 25(1) does not evenspecify the legislative procedure itself, but instead refers to Arti-cle 300 of the EC Treaty, a general provision setting out the process for adoption of international agreements with third states or international organizations. A sophisticated procedure,Article 300 involves several stages and participation by theEuropean Commission, the Council, and the Parliament.  A trading link to theEU ETS would notviolate the CommerceClause of the U.S.Constitution.
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