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Liability provisions prescribe how quotas transferred by a party that subsequently is not in compliance with its emissions limitation commitment are treated. Since the developing country hosts of CDM projects do not have emissions limitation commitments, this is not an issue for CERs once they have been certified and issued by the operational entity or the Executive Board. However, this does not deal with the question of what happens if the certification has not been undertaken to acceptable standards or if there are other significant irregularities in issuance procedures. Since both JI and IET involve only Parties with emissions limitation commitments, treatment of quotas traded using these mechanisms must be addressed if the issuer does not achieve compliance.
With regard to JI, Article 6.4 of the Kyoto Protocol specifies that if compliance by an Annex I country is questioned under Article 8, any ERUs acquired from that country cannot be used to meet the buyer’s commitments under Article 3, until the question of non-compliance by the originating country is satisfactorily resolved (UNFCCC, 1997).
If the ERUs issued for JI projects are determined by an international review process, they reflect corresponding reductions of the host country’s emissions and hence do not contribute to its non-compliance. However, if the decision on the quantity of ERUs issued is left to the host government and the penalties for non-compliance are weak or not effectively enforced, JI projects could contribute to non-compliance by the host country. Since any ERUs transferred must be deducted from the party’s AA, they could be made subject to the liability provisions for IET.
Article 17 does not include any provisions to deal with quotas that have been transferred by a country that subsequently fails to meet its emissions limitation commitment. A number of options and variants have been proposed in the literature (Goldberg et al., 1998; Grubb et al., 1998; Haites, 1998; Baron, 1999; Zhang, 1999b). The proposals reflect various strategies, including seller and (its opposite) buyer liability, eligibility requirements for buyer and sellers, limits on the quantity of quota that can be sold, limiting sales to quantities surplus to estimated or actual compliance needs, or restoration of default. These approaches can be grouped into those that aim to prevent or limit the risk of non-compliance, and those designed to provide sufficient deterrence (either requiring the defaulting party to face the regimes’ non-compliance system or else harnessing the market to discount quotas from those Parties considered to be most at risk).
These liability proposals differ in terms of their environmental effectiveness, impact on compliance costs of Annex I Parties, and market liquidity. The proposals can change the ratio of domestic reductions to purchased quotas used for compliance and the mix of quotas purchased. In this way they can change the distribution of costs across countries, including non-Annex I countries through the volume of CDM activity. In policy terms, it is likely that the most effective strategy would aim to combine one or more of them. Details of how this may be undertaken, as well as on how many of the proposals would be implemented in practice, are currently subject to international negotiations.79
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