Although only Annex I Parties that have made commitments under the Kyoto Protocol’s Annex B have quantified emissions limitations, all Parties have committed to take climate change considerations into account, to the extent feasible, in their relevant social, economic, and environmental policies and actions (UNFCCC, 1992, Article 4.1.f). It is recognized, however, that non-Annex I Parties’ efforts to take actions that contribute to national development and GHG emissions reduction may be limited by capital constraints, lack of knowledge, or other factors. The UNFCCC and the Kyoto Protocol, therefore, include several provisions that can help overcome such barriers, such as the provision that:

• All Parties are “committed to promote and co-operate in the development, application and diffusion, including transfer, of technologies, practices and processes that control, reduce or prevent anthropogenic emissions of greenhouse gases not controlled by the Montreal Protocol in all relevant sectors, including the energy, transport, industry, agriculture, forestry and waste management sectors” (UNFCCC, 1992, Article 4.1.c).
• Parties agreed to establish a financial mechanism “for the provision of financial resources on a grant or concessional basis, including for the transfer of technology” (UNFCCC, 1992, Article 11.1).

Additionally,

• “The CDM created by the Kyoto Protocol creates an incentive for (entities in and governments of) Annex I Parties to assist the development and implementation of climate change mitigation projects that contribute to sustainable development in, and are approved by, a non-Annex I Party” (UNFCCC, 1997, Article 12).

This section discusses the three Kyoto mechanisms: international emissions trading (IET) (Article 17) in Section 6.3.1 (for some clarifying remarks, see also Section 6.1.3), and JI (Article 6) and the CDM (Article 12) in Section 6.3.2. Thereafter, the section deals with international transfers (Section 6.3.3) and with the various other international policies, measures, and instruments (Section 6.3.4).

If the Kyoto Protocol comes into force Annex I Parties will have agreed to an allocation of AAs (here also called emission quotas) of GHG emissions for the first commitment period, 2008 to 2012. Article 17 of the Protocol allows them to trade part of these emission quotas among themselves in accordance with rules currently being negotiated.⁵⁹

IET implies that countries with high marginal abatement costs (MACs) may acquire emission reductions from countries with low MACs. In principle, such trading tends to equalize MACs across these countries, so that an aggregate emissions reduction can be attained cost-effectively.⁶⁰ Parties have not yet decided whether IET based on Article 17 will be restricted to governments or whether legal entities also will be allowed to participate with the approval of their national governments. To support compliance with their AAs after adjusting for trading, governments may use any of the domestic policy instruments discussed in Section 6.2 above.

Limiting all transactions to multilateral and potentially anonymous trade on an exchange would help IET move in the direction of becoming efficient and non-discriminatory. Bilateral trading cannot be relied upon to reveal to others the true full transaction prices (including undisclosed side-payments), which is required to give all participants equal access to gains from trade. Non-anonymous trading may eliminate transactions between Parties who are in conflict with each other, thus reducing market efficiency. Transparent, anonymous, and efficient trading would be possible on a continuous stock-exchange kind of market (Bohm, 1998). The scope for the exertion of market power is small on such markets, contributing to efficiency (Smith and Williams, 1982).

According to Article 17 in the Protocol, “any such trading shall be supplemental to domestic actions for the purpose of meeting quantified emission limitation and reduction commitments.” How to implement this provision is still under debate.⁶¹ A restriction on free IET as a result of binding supplementarity requirements could prohibit equalization of the MACs across participating countries, and hence increase aggregate abatement costs.⁶²

It has also been argued that constraints on the use of IET and the project-based Kyoto mechanisms (see also Section 6.3.2) might accelerate technological innovation in Annex I countries by increasing the relative price of alternative options for carbon mitigation. Limited analytical studies are inconclusive as to whether such constraints will induce significant innovation, but do suggest that they could reduce the flow of technology to other countries.

An initial quota allocation that turns out to exceed a baseline projection for a country’s emissions–possibly relevant for some signatories of the Kyoto Protocol with substantial changes in political and economic systems since 1990–implies that sales of AA units (AAUs) will exceed emission reductions because of active climate mitigation policies, sometimes referred to as “hot air”. Restricting trade of “hot air”, as some Parties have proposed, would force larger reductions in emissions by countries that would otherwise import emissions quotas during the first commitment period.⁶³ In addition, constraints on hot-air trading, other things being equal, would make the Protocol less beneficial for some countries with “hot air” allocations (Bohm, 1999).

Emissions trading creates a risk that sellers of AAUs might not undertake the emissions reductions that their sales require, in spite of the political costs of non-compliance and despite the sanctions to be instituted. Several options that provide Annex I Parties with an incentive to transfer only part of their AAUs that are surplus to their compliance needs are under consideration. Such options, called liability provisions, are discussed in Section 6.3.5.3. Liability provisions are intended to enhance environmental integrity and are also necessary for the functioning of the market.

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