Article 6 of the Paris Agreement establishes a framework for international cooperation on market mechanisms, including emissions trading -- commonly referred to as carbon credits. The United Nations Development Programme (UNDP) plays a crucial role in supporting countries to establish carbon markets through bilateral agreements between countries and private sector buyers. The UNDP acts as a facilitator, collaborating closely with governments and stakeholders to develop frameworks and mechanisms for carbon market transactions.
Currently, there is a noticeable trend where most carbon credits are issued by countries in the Global South but primarily sold to entities in the Global North. These credits, if bought by companies, often undergo trades in secondary markets within the Global North, resulting in profits for the initial buyers, while the original issuers in the Global South do not receive adequate compensation from profits gained in the value chain. This disparity raises concerns regarding equity and fairness in the carbon market system, emphasizing the need for reforms to ensure that the Global South is duly rewarded for their contributions to climate action, particularly as these regions endure the brunt of climate change consequences.
Secondary carbon markets hold untapped potential for creating funding streams to address Loss & Damage caused by climate change. By attaching a residual model to trading mechanisms and financial transactions, these markets can generate stable and significant financing to aid in the recovery, adaptation, and resilience-building efforts required for communities facing the adverse impacts of extreme weather events, rising sea levels, and other climate-related damages. By harnessing this potential, the financing gap can be bridged, ensuring that the most vulnerable populations receive the necessary support to mitigate and cope with the irreparable losses and damages resulting from climate change.
Addressing ‘loss and damage’ – key consequences of climate change
The impacts and projected risks – both economic and non-economic – of extreme (e.g., hurricanes) and slow-onset (e.g., droughts) events exacerbated by climate change that cannot be avoided through current adaptation and mitigation capabilities are referred to as “Loss and Damage”. This concept recognizes that some consequences of climate change are inevitable and that some communities and countries are more vulnerable than others. While mitigation and adaptation efforts can help to reduce the risks and impacts of climate change, they will not be enough to prevent all losses and damages.
In 2022, a severe heat wave with temperatures as high as 46°C (115°F) hit the South-Asian subcontinent. Forest fires swept India, and glaciers melted in Pakistan, leading to massive flooding, and wiping out essential infrastructure. Scientists have found that climate change has made such temperatures 30 times more likely. In December 2020, Cyclone Yasa devastated Fiji with 94 percent damage to crops, destruction of 8,000 homes, widespread loss of electricity and water, landslides, and coastal flooding up to 33 feet. In March 2019, severe flooding in Mozambique displaced over 100,000 people and destroyed almost 780,000 hectares of crops. Six months later, more than 1 million people still faced food insecurity.
Financial incentives for buyers and sellers
Funneling money to Loss and Damage is a net benefit to major companies. Recovery from climate change-induced disasters is essential to the global supply chain. The automobile industry, one of the largest purchasers of carbon credits, learned this the hard way in early 2022. In December 2021, a tropical depression hit Malaysia, causing flash floods, and displacing 125,000 people. The flooding caused severe damage to Klang, one of the largest ports in Asia, leading to a break in the semiconductor supply chain. Global semiconductor shortages caused car companies, including Toyota and GM, to reduce or pause production.
The role of carbon finance and secondary carbon markets
Carbon contracts currently signed for Article 6 transactions are future contracts in which a buyer and a seller agree to a fixed price and lock it in for a credit generated in the future. However, when credit is transferred to the primary buyer for the previously agreed price, market prices will inevitably go up. The price increase is anticipated for a commodity that is high in demand but limited in supply. The primary buyer now has an arbitrage opportunity -- they have the incentive to sell the credit for a higher price in the market and make a decent profit. With the expected price increase for future credits, other market participants such as banks, brokers, or individuals who voluntarily retire credits will likely participate in Article 6. As the cycle of countries’ Nationally Determined Contributions (NDCs) – that is, national climate action plans to cut emissions and adapt to climate impacts – nears its end, increased demands on compliance buyers and voluntarily committed companies make the secondary market an essential instrument for meeting commitments.
A residual model to increase the flow of climate finance
Using the residual model––primarily used in film and television––could increase the flow of climate finance to the Global South. Residuals are ongoing compensation for talent such as actors, directors, and writers. The model allows creative talent to participate in revenue generated when a project is used beyond its original scope.
Residuals are union-negotiated payments that follow a formula whereby performers, directors, and other creative professionals receive a percentage of their original payment for each use of the project, such as reruns of a television show. For example, if an actor that was paid $100,000 to star in an episode of television, the second time that episode airs, the actor will receive 40 percent of their original payment ($40,000). The third airing of the episode brings a 30 percent ($30,000) residual check. These payments continue diminishing until the 13th airing of the episode, after which the actor will receive a 5 percent ($5,000) residual payment for all subsequent airings of the episode in perpetuity.
Secondary carbon markets have the potential to generate revenue and profit on carbon credits for the original sellers. Unlike the residual structure that ensures the creative talent that contributed to a television project receives compensation, at present, the original issuer of a carbon credit receives no such revenue stream. If India sells a carbon credit to an American car company and that car company re-sells to their benefit on the secondary market, India will receive no compensation. However, adopting the residual structure into India and the car company’s forward contract would provide India with a sustainable income stream to help recover from loss and damage caused by last year’s heatwave or other climate-induced events.
UNDP’s Carbon Payment for Development Facility as a facilitator to strengthen nascent carbon markets
Established in 2021, UNDP's Carbon Payments for Development Facility acts as a robust catalyst for innovative public-private partnerships aimed at reducing carbon emissions and advancing the Sustainable Development Goals (SDGs). It operates under the guidance of Article 6 of the Paris Agreement and catalyzes innovative public-private partnerships to uncover and invest in opportunities that provide products or services, and also contribute to a country's NDCs or GHG reduction targets.
To implement a residual structure, terms and conditions of the sale of credits for secondary market profit will be defined in standardized contracts supported by UNDP or other multilateral partners that detail the requirement to transfer a percentage of the profit generated through the sale in the secondary market to the original seller from the first event. This can be as small as a 2 percent Loss & Damage deduction from the price obtained in the secondary market and act as a foreign currency revenue stream to the carbon project host country. Blockchain instruments, where available, can further contribute to the transparency of such transactions and enhance transfer safety as they secure a chronological chain of information that cannot be changed ex-post or controlled by any single party.
In early 2023, Ghana decided to engage in unilateral approaches with the private sector as part of their voluntary cooperation through Public Private Partnerships. In Ghana, UNDP supports the establishment of bilateral, financial agreements with stringent enforcement structures and modalities. The bilateral agreements under Article 6.2 will address business and legal risks of public-private cooperation through contractual enforcement mechanisms that provide legal certainty for the investors against the potential risks related to the change of the authorized use of ITMOs.
In the current absence of a global enforcement structure under Article 6.4 of the Paris Agreement, there is also the opportunity for a foreign national regulator to impose the secondary market levy and add a layer of commitment to market participants. UNDP’s involvement and support to establish standardized contracts such as in Ghana, will facilitate the replication of similar modalities across countries engaged in Article 6 of the Paris Agreement.
Since these transactions will have to be transparently tracked to enhance the success for them to be implemented without a global enforcement mechanism in place, metadata platforms such as the Climate Action Data Trust will facilitate the tracking of the Loss & Damage residuals.
Such mechanisms will allow countries in the Global South to receive adequate compensation from profits gained in the value chain, further global fairness, and create financing streams to ensure that the most vulnerable populations receive necessary support to mitigate and cope with the irreparable losses and damages resulting from climate change.
About the authors
Alexandra Soezer is the Carbon Technical Advisor at UNDP, where she manages the Carbon Payment for Development initiative, including the Article 6 Readiness Programme and Article 6.2 Development Services for Internationally Transferred Mitigation Outcomes (ITMO) generations and transfers. Previously she managed MDG Carbon, UNDP’s corporate framework for carbon finance and served as a technical expert responsible for the negotiation of Emission Reduction Purchasing Agreements for the Austrian government’s carbon purchasing program. She tweets at @ASoezer and is available on LinkedIn.
Kate Zabinsky is a Strategic Communications Fellow at Nairobi-based Antara Health. She recently graduated with an MPA in Environmental Science and Policy from Columbia’s School of International and Public Affairs where she worked with organizations such as the World Resource Institute on their African Forest Landscape Restoration Initiative (AFR100). Prior to Columbia, she was a television producer, developing shows at Carousel Television and First Look Media. She has a BFA in Film & TV from NYU’s Tisch School of the Arts and an MBA from Duke University’s Fuqua School of Business. She is available on LinkedIn.
For more information on UNDP’s CP4D Facility, click here.
The views and opinions expressed in this think-piece are those of the authors and do not necessarily reflect the official policy or position of SIPA or Columbia University.