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By Nidhi Bothra

Vinod Kothari Consultants P Ltd


1012 Krishna
224 AJC Bose Road
Kolkata – 700017. India
Ph no – 91-33-22817715/ 1276/ 3742
Email: nidhi@vinodkothari com
nidhi@vinodkothari.com
` Concerns on ecological imbalances and global warming issues have
several times been addressed and discussed at various Summits in the
pastt
◦ Rio de Janeiro Summit or the Earth Summit in 1992
◦ Montreal Protocol
◦ Vienna Conference
◦ Kyoto Protocol
◦ Copenhagen Summit
` Six recognised GHG gases
◦ Carbon dioxide
◦ Methane
◦ Nitrous oxide
◦ Hydrofluorocarbons
◦ Perfluorocarbons
◦ Sulphur hexafluoride
` N
Need
d ffor reduction
d i iin GHG to maintain
i i ecological
l i lb balance
l and
d can b
be
done in two ways:
◦ Sequestration, to reduce the impact of emissions
◦ Offset the impact of emission of GHG by undertaking greener project

Understanding Carbon Credits by Nidhi Bothra


` The projected emissions growth are as below,
the need for mitigating global warming is
quintessential

Understanding Carbon Credits by Nidhi Bothra


` What were introduced as tradable rights to control pollution
y JJohn Dales,, economist from Canada,, in 1968 are today
by y in
vogue…
` A generic term to the attempt to mitigate the growth in
concentrations of GHG
` One carbon credit is equal to one ton of carbon dioxide
dioxide, it is
an “Entitlement Certificates” issued by the United Nations
Framework Convention on Climate Change (UNFCCC)
acknowledging reduction in emissions
` Certified Emission Reductions (CERs) or carbon credits earned
through the reductions in emission of greenhouse gases.
CERs are:
◦ self generated
x purchased through CER purchase agreements
◦ traded in the international carbon credit market
x trading on the stock exchanges
x bidding for tenders floated by several governments

Understanding Carbon Credits by Nidhi Bothra


Understanding Carbon Credits by Nidhi Bothra
` Carbon
C b footprint
f t i t – measure off the
th GHG
emissions caused by an entity. Carbon
footprint is a subset of ecological footprint
footprint.
Mitigation of carbon footprint is called carbon
offsets.
` For sustainable development people want to
stay carbon neutral by offsetting their carbon
ffootprints
t i t

Understanding Carbon Credits by Nidhi Bothra


` 187 countries by signing and ratifying the treaty
committed themselves to reduce the carbon
emission levels by at least 5% below the 1990
baseline emission levels by the commitment period
of 2008-2010.
2008 2010.
` Targets not applicable to developing and least
developed nations
` The Protocol spoke about ‘common
common but
differentiated responsibility, through the three
emission reduction mechanism :-
◦ Cl
Clean D l
DevelopmenttM h i
Mechanism (CDM)
◦ Joint Implementation (JI)
◦ Emission Trading

Understanding Carbon Credits by Nidhi Bothra


` JI are projects undertaken by one developed
country
t for
f theth benefit
b fit off the
th other
th
` Emission reductions are awarded as Emission
Reduction Units ((ERUs).) is a tradingg unit under
the Kyoto Protocol representing a reduction
of greenhouse gases under the Joint
Implementation mechanism
mechanism, where it
represents one tonne of CO2
equivalent reduced
` Th
The JJoint
i t IImplementation
l t ti projects
j t are
supervised by the Joint Implementation
Supervisory Committee (JISC)

Understanding Carbon Credits by Nidhi Bothra


` Kyoto Protocol introduced the concept of ‘cap and
trade
trade’ system
◦ carbon dioxide emissions should be capped
◦ Emission reductions quantified in real terms can be traded
` EU Greenhouse Gas Emission Trading System (EU-ETS) ,
UK Emissions
E i i Trading
T di G
Group (ETG)
(ETG), Chi
Chicago Cli
Climate
t
Exchange (CCX), and the New South Wales Greenhouse
Gas Reduction Scheme are offspring of the cap and
ttrade
ade syste
system.
` The EU-ETS is the largest greenhouse gas emissions
trading scheme in the world.
◦ 2.8 billion tons of carbon dioxide were traded in the EU-ETS in
2008
2008, accounting for nearly 60 percent of the world's
world s total
total,
compared to 94 million tons in 2005.
` More than 20 platforms for trading carbon in the world

Understanding Carbon Credits by Nidhi Bothra


` A voluntary carbon market exists outside the
compliance market; i.e
i e outside the Kyoto compliant
mechanism.
` These are voluntary initiatives by socially
responsible companies and individuals wanting to
become carbon neutral
` The Chicago Climate Exchange, is a member based
exchange
g for voluntaryy GHG reductions for the
United States.
` The carbon credits generated outside the
compliance mechanism are verified and traded in
the
h global
l b l over the
h counter marketk as wellll ffor
greenhouse gas emissions and are called verified
emission reductions (VERs)

Understanding Carbon Credits by Nidhi Bothra


` A very active market
` The two prime categories of carbon instruments that
can be traded in the marketplace are:
◦ carbon allowances or the offset credits
◦ allowance derivatives
x swaps, options & futures allowing companies to lock in pricing on
carbon units
x Leading to price discovery and liquidity however since the financial
crisis there is a lot of hostility with regard to trading in carbon
derivatives terming it as “ineffective”
ineffective
` Major Exchanges trading CERs
◦ European Exchange Climate (ECX)
◦ Nymex
y Green Exchange
g
◦ Nordpool
◦ Powernext
◦ OTC markets using bilateral trade agreements

Understanding Carbon Credits by Nidhi Bothra


` There is a recent surge in the carbon trading
activities in Europe
` With the growing need for curbing pollution
levels in developed nations
nations, carbon trading
has emerged as a multi-billion dollar market
in global emission trading

Source: Commodity Insights Yearbook 2009, MCX

Understanding Carbon Credits by Nidhi Bothra


` Article 12 of the Protocol defines Clean Development Mechanism
` Purpose
◦ assist Parties not included in Annex I in achieving sustainable development
◦ to assist Parties included in Annex I in achieving compliance with their
quantified emission limitation and reduction commitments under Article 3.
` The CDM allows emission
emission-reduction
reduction (or emission removal)
projects in developing countries to earn certified emission
reduction (CER) credits, each equivalent to one tonne of CO2
` One of the flexibility mechanisms
` CERs earned since 2000 to the end of the first commitment
period can be used for the purpose of achieving compliance in
the first commitment period
` CDM registry ensures that there is accurate accounting of
issuance, holding, transfer, acquisition and cancellation of CERs
in all the projects

Understanding Carbon Credits by Nidhi Bothra


` Buyers of CERs – Developed nations or Annex I
countries
i as under
d theh Kyoto
K Protocol
P l
` Suppliers of CERs – Developing nations like India,
China Brazil etc or Non-Annex
China, Non Annex I countries
` Parties involved in a project activity
◦ Project Participant
◦ Project Design Document
◦ Designated Operational Entities
◦ g
Designated National Authority
y
◦ Executive Board (CDM – EB)
◦ CER – Certified Emission Rights

Understanding Carbon Credits by Nidhi Bothra


Source: http://cdm unfccc int/Projects/pac/index html
Source: http://cdm.unfccc.int/Projects/pac/index.html

Understanding Carbon Credits by Nidhi Bothra


` Project Design – basic framework of a project activity estimating
emission reduction to be submitted with EB
p
◦ Set a “baseline” which would represent p g
the anthropogenic emissions that would
occur in absence off the proposed project activity
◦ Demonstrate essence of “additionality” and the project should contribute to
sustainable development
◦ Determining Monitoring methodology
` Third party validation report
` PDD along with the validation report has to be submitted to the
Designated National Authority (DNA) for the host country approval and
the project proposer shall commit to provide an annual report for
monitoring, certification and issuance of CERs. Then the DNA shall issue
a letter
l off approvall for
f the
h project
j
` The project is submitted for registration with the CDM Executive Board,
which shall make the documents public for comments.
` implementation and the monitoring stage
` O i verification
On-site ifi i andd verification
ifi i report b
by iindependent
d d DOE
` Issuance of CER
` Record of issued CER is CDM registry

Understanding Carbon Credits by Nidhi Bothra


` Typically negotiation for the sale of CERs starts once the
PDD is finalized.
finalized The Term Sheet is duly prepared and
then parties enter into an Emission Reductions Purchase
Agreement (ERPA) which will duly spell out the purchase
price,
i ti
time period
i d off d
delivery,
li amountt off CER
CERs tto b
be
transferred etc.
` Key features for a CDM project to qualify:
◦ Development funds should not be involved in implementation
◦ They should have a well defined measurable baseline
◦ CDM projects should be measurable real time
◦ Should support sustainable development
◦ Should conform to UNFCCC approved methodologies
◦ Additionality should be established

Understanding Carbon Credits by Nidhi Bothra


` Can either be a domestic legal entity or an international
organisation which has been accredited and designated by EB
and is responsible
p for;;
◦ Validation and registration of a proposed CDM project activity which will
be considered valid after 8 weeks if no request for review was made
◦ It verifies emission reduction of a registered CDM project activity, certifies
as appropriate and requests the Board to issue Certified Emission
Reductions accordingly. The issuance will be considered final 15 days after
the request is made unless a request of review is made
◦ There is procedure of accrediting operational applicant entities which is
being carried out by accreditation panel (CDM – AP) along with
assessment team (CDM – AT)

Understanding Carbon Credits by Nidhi Bothra


` After the project participants submit the project design
document, the DOE needs to be get the project activity validated
and registered with the CDM - EB. DOE may
◦ Submit a new baseline methodology and/ or monitoring methodology prior to
validation and registration for CDM Executive Boards approval, prior to
validation along with draft CDM – PDD or;
◦ Use an approved existing methodology
` Validation
V lid i - The
Th DOE needs d to validate
lid that
h the
h project
j attains
i
additionality and then registration is a formal acceptance of the
project by the Executive Board. Registration is the prerequisite
for the verification,, certification and issuance of CERs related to
that project activity.
` Verification – Independent periodic verification / monitoring of
the reductions in the emissions as a result of the registered CDM
project
` Certification – written assurance that the project has achieved
the reduction in the emissions, during the specified time period,
as verified

Understanding Carbon Credits by Nidhi Bothra


` The Conference of Parties serving as a
meeting for the parties to the Kyoto Protocol
mentioned in the modalities and procedures
for CDM –
◦ "29. Parties participating in the CDM shall designate
a national authority for the CDM.”

Understanding Carbon Credits by Nidhi Bothra


` To avoid giving credits to projects that would
have happened anyway ("freeriders"), rules
have been specified to ensure additionality of
the project
` There is a lot of ambiguity on qualification of
a project as additional.

Understanding Carbon Credits by Nidhi Bothra


Understanding Carbon Credits by Nidhi Bothra
` Broad categorization of methodologies
◦ Methodologies for CDM project activities
◦ Methodologies for afforestation and reforestation CDM project activities
◦ Methodologies for small scale CDM project activities
` The modalities and the procedures lay down
◦ Role of the executive board
◦ Accreditation and designation of operational entities
◦ Designated operational entities
◦ Participation requirement
◦ Validation and registration
g
x Role of Designated operational entities
◦ Monitoring
◦ Vertification
◦ Issuance of CERs
◦ Indicates how the Project Design Document should be
x Economic/ Socio-economic impact of the project
x Baseline methodology
x Procedures to be followed

Understanding Carbon Credits by Nidhi Bothra


` CERs issued are first transferred to the pending account
of CDM Registry from where they get forwarded to the
national
i l registry
i account
` Project participant of Annex I Party to the Kyoto
Protocol whose national registries are not yet connected
t th
to the International
I t ti l Transaction
T ti L
Log (ITL) may apply
l ffor
a temporary holding account in the CDM registry
` Project participant of Non - Annex I Party to the Kyoto
P t
Protocoll may applyl for
f a permanentt holding
h ldi accountt in
i
the CDM Registry at the time of the first issuance of
CERs from their project activity and may be forwarded
directly to a national registry account thereafter
` Registry does not accept emission trading between
accounts

Understanding Carbon Credits by Nidhi Bothra


Expected CERs
Annual Average until end of
CERs*
CERs 2012**
2012

CDM project
pipeline:
p p > 4200 N/A > 2,900,000,000
, , ,
of which:
--- 2315 are
375,520,755 > 1,810,000,000
registered
--- 65 are requesting
4,903,027 > 10,000,000
registration
* Assumption: All activities deliver simultaneously their expected annual average emission reductions
** Assumption: No renewal of crediting periods

Understanding Carbon Credits by Nidhi Bothra


Source: Commodity Insights Yearbook 2009, MCX

Understanding Carbon Credits by Nidhi Bothra


Title Number of CERs
Issued CERs 428,469,271
Total CERs Requested 452,465,339
Understanding Carbon Credits by Nidhi Bothra
Understanding Carbon Credits by Nidhi Bothra
Understanding Carbon Credits by Nidhi Bothra
Understanding Carbon Credits by Nidhi Bothra
Understanding Carbon Credits by Nidhi Bothra
Number of
Region
projects
NAI-Africa 45
NAI-Asia and the
1790
Pacific
NAI-Eastern
13
Europe
NAI-Latin
NAI L ti AAmerica
i
and the 474
Caribbean

Understanding Carbon Credits by Nidhi Bothra


• Huge demand for carbon credits in the developed
nations brought immense opportunity for developing
nations like India
• Estimates are - one third of the total CDM projects
registered with UNFCCC are from India
• India claims 31% of the total world carbon credit trade
• Future forecasts - a CRISIL research report issued in
May, 2010, states that carbon credits generated from
emission reduction projects undertaken in India, will
triple over next three years and the numbers are
expected to increase from 72 million in November 2009
to 246 million by December 2012

Understanding Carbon Credits by Nidhi Bothra


• In India, NCDMA is the Designated National
Authority (DNA) that evaluates and approves
the CDM projects as per the guidelines and
general criteria laid down in the relevant rules
and modalities pertaining to CDM in addition
to the g
guidelines issued by y the Clean
Development Mechanism Executive Board and
Conference of Parties serving as Meeting of
P
Parties
ti tto th
the U
United
it d N
Nations
ti F
Frameworkk
Convention on Climate Change.

Understanding Carbon Credits by Nidhi Bothra


` Seventh conference of Parties to UNFCCC decided
that the Parties participating in CDM should
designate a National Authority for the CDM
` Every CDM project needs written approval from
the DNA stating that the project activity assists
the host country in achieving sustainable
development.
p
` Business Standard News –
◦ The Indian government has approved more than 1,400
projects as part of the Clean Development Mechanism
(CDM) attracting around $6 billion (Rs 28,000 crore) into
the country by 2012 through sale of Certified Emission
Reduction (CER) certificates

Understanding Carbon Credits by Nidhi Bothra


• Purpose
– to assist developing country Parties in achieving
sustainable development, thereby contributing to the
ultimate objective of the Convention
– to assist developed country Parties in achieving
compliance
li with
i h part off their
h i quantified
ifi d emission
i i
limitation and reduction commitments under Article 3
• Eligibility Criteria
– Emission Additionality: The project should lead to real
real,
measurable and long term GHG mitigation. The
additional GHG reductions are to be calculated with
reference to a baseline.
– Fi
Financial
i l Addi
Additionality:
i li Th
The procurement off C
Certified
ifi d
Emission Reduction (CERs) should not be from Official
Development Assistance (ODA)

Understanding Carbon Credits by Nidhi Bothra


• Baselines
The p j
project p p
proposal y and transparently
must clearly p y describe
methodology of determination of baseline. It should confirm to
following:
• Baselines should be precise, transparent, comparable and
workable;
k bl
• Should avoid overestimation;
• The methodology for determination of baseline should be
homogeneous and reliable;
• Potential errors should be indicated;
• System boundaries of baselines should be established;
• Interval between updates of baselines should be clearly
described;
• Role of externalities should be brought out (social
(social, economic
and environmental);
• Should include historic emission data-sets wherever available;
• Lifetime of project cycle should be clearly mentioned;

Understanding Carbon Credits by Nidhi Bothra


` A recent Press Information Bureau, press release, stated
that:
◦ India has 520 registered CDM projects, out of the total 2313
projects registered by the CDM Executive Board of the UNFCCC
◦ The projects have the potential to generate 43 million Certified
Emission Reduction Units ((CERs)) p
per annum amounting g to 12%
(approx) of the total annual CERs generated by registered CDM
projects globally
◦ As on date 79 million CERs have been issued to Indian projects
◦ The value of actual CER issued to Indian p projects
j amounts to US$
790 million, assuming a conservative price of $10 per CER
◦ Indian solid waste management market is valued at around
$155.56 million (Rs 728 crore) and is expected to grow at a rate
of around 20 to 25 per cent in the next three to five years.
◦ Thi
This iis iindicative
di i off the
h hhuge potential
i l iinflow
fl off fforeign
i di
direct
investments into India

Understanding Carbon Credits by Nidhi Bothra


` India, being one of the leading generators of CERs
through CDM,
CDM has a large scope in emissions trading
` Forward Markets Commission granted trading
permission to carbon credits and has been included
in the list of commodities - ‘others’ category
g y
` Multi Commodity Exchange of India limited (MCX)
launched carbon credit futures trade in 2008 and was
Asia’s first Commodity Exchange to launch futures
trading in carbon credits to be in league with Chicago
Climate Exchange and European Climate Exchange.
MCX has been honored with India’s first green
exchange
` Indian commodity exchange does not allow direct
participation of foreign institutions in India restricting
trade where buyers are largely overseas buyers

Understanding Carbon Credits by Nidhi Bothra


` How to account for CERs?
◦ Government Grants
◦ Intangible Asset
◦ Inventory
` No separate
p standard dealing
g with CERs
` International Accounting Standards Board (IASB) had
issued an interpretation IFRIC 3 on Emission Rights
but later withdrew, continuing debate on the
appropriate treatment for CERs.
CERs
` Institute of Chartered Accountants of India (ICAI) has
issued an Exposure Draft of the Guidance Note on
Accounting for Self-generated
Self generated Certified Emission
Reductions in 2009.
` ICAI has laid more emphasis on CDM as relevant to
India

Understanding Carbon Credits by Nidhi Bothra


` Expenses in the research and development phase
◦ Any cost incurred on development should be accounted for under AS 26 for
intangible assets.
` CERs held with the CDM Executive Board
◦ Where CERs are in the approval stage, these should be accounted for as per the
provisions of AS 29 as Contingent Assets (Para 30 of AS 29 says that an enterprise
should not recognize a contingent asset)
◦ Once approved should be recorded in the books as an intangible asset.
x identifiability
id tifi bilit
x control over resources
x expectation of future economic benefits flowing to the enterprise.
` CERs held for sale
◦ CER which are to be traded in the ordinary y course of business,, i.e asset held as
‘available for sale’ - accounted for as Inventory under provisions of AS 2.
` Cost at which CERs to be recorded in books
◦ in case intangible asset expenses are to be capitalized
◦ in case CERs treated as inventory, costs relating to consultant fees, levies imposed by
UNFCCC for approving of CERs are to be inventorised and are to be recorded as lower
or cost or net realizable value
x other incidental cost taken to the profit & loss account
` Any other tangible or intangible asset generated in the process is to be
recorded as per the existing accounting standard governing them, i.e AS
10 and AS 26 respectively
respectively.

Understanding Carbon Credits by Nidhi Bothra


` Reliance was placed on judgment of the Hon’ble Supreme Court
p
in the matter of Vikas Sales Corporation & Another vs
Commissioner of Commercial Taxes & Another , JT 1996 (5) SC
482. In the present case, it was held that:
◦ REP licenses conferred upon the transferee choate right that was
exercisable immediately
◦ licenses
li had
h d intrinsic
i t i i value
l off their
th i own which
hi h was independent
i d d t off the
th
value of the goods which could be imported
◦ licenses were bought and sold freely in the market, i.e they had a ready
market for trade
` In another case of Tata Consultancy Services vs.
vs State of Andhra
Pradesh and BSNL vs UOI [2006] 152 Taxman 135/ 282 ITR 273/
145 STC 1, it was held that anything that has the following
attributes will qualify to be goods:
◦ Utility
y
◦ capable of being bought and sold, and
◦ capable of being transmitted, transferred, delivered, stored and
possessed.
` CER by virtue of fulfilling the above mentioned attributes
qualifies
lf to be
b considered
d d as ““goods.”
d ”

Understanding Carbon Credits by Nidhi Bothra


` Ambiguity in treatment
◦ Actionable claim or security
x Claim to debt or beneficial interest in the moveable property
whether existent, accruing, conditional or contingent
◦ Service
x Rationale being CERs are exported to developed countries or
are traded like securities on the stock exchanges
exchanges, hence
attracting service tax
◦ Good
x Notification issued by the Government of the National
C it l T
Capital Territory
it off D
Delhi
lhi for
f carbon
b credits
dit are tto b
be ttreated
t d
as “goods”
x CER were explained as tradable commodity having
x market value
x ready market
x willing buyers and sellers
x freely transferable as marketable commodities

Understanding Carbon Credits by Nidhi Bothra


` Notification No. 256/CDVAT/2009/43 dated 13.01.2010 issued by
the Government of the National Capital Territory of Delhi,
Delhi concluded
that Certified Emission Rights (Carbon Credits) are taxable under
DVAT Act, 2004 and the rate applicable is 4% as the said item is
covered under Entry No.3 of IIIrd Schedule appended to the DVAT
A
Act, 2004 (I
(Intangible
ibl goods)
d )
` Entity engaged in the activity of sale or purchase of carbon credits is
a “dealer” in terms of the definition of dealer as contained in Section
2(1) of the DVAT Act,
Act 2004
` Service tax will be applicable on account of dealing in CERs on the
exchange platform and in case of contracts resulting in delivery VAT
will be applicable.
` Sale of CERs to overseas buyers should qualify as exports, and no
VAT applicable however there is no clarification rendered in this case

Understanding Carbon Credits by Nidhi Bothra