The 1997 Kyoto Protocol to the UNFCCC resolved to reduce emissions of greenhouse gases (such as carbon dioxide and methane) on a global scale. One strategy within the protocol for achieving this is the Clean Development Mechanism - or the CDM. The CDM allows industrialized countries with emission reduction commitments to meet part of their commitments by investing in projects that reduce emissions in developing countries. These projects need to support sustainable development in the host countries and must lead to emission reductions that are real, measurable and long term.

Image: Clean Development Mechanism

Many developing countries already have experience in projects relevant to climate change mitigation such as energy efficiency, cleaner production, fuel switching and forestry. These projects typically use equity and debt to raise capital and produce financial returns for the investor. CDM projects are different because they include another type of input - carbon investment. The project generates carbon credits with a monetary value. Additional financial resources flow to the project to gain carbon credits. This finance is distinct from the equity investments made for financial returns - even if they are made by the same investor.

The mechanism itself was established under Article 12 of the Kyoto Protocol [PDF, 65.2KB]. The Marrakesh Accords [PDF, 666KB] later established the 'rules and modalities' of the CDM (including its operating procedures, eligibility criteria, roles and responsibilities of parties and role-players and definitions) and established the requirement for a 'Designated National Authority' (and stipulated its role) in a host country.

How will carbon trading via the CDM help reduce global warming?

Greenhouse gases mix uniformly in the earth's atmosphere. Unlike sulphur dioxide or low level ozone, carbon dioxide and other greenhouse gases have the same impact on climate everywhere in the world. It does not matter, therefore, where one begins to reduce net emissions. This fact provides the economic justification for international cooperation on climate change projects and project-based emissions trading. International cooperation makes economic sense because emissions reductions in developing countries generally costs less than in industrialized countries. The difference between marginal reduction cost for the investor (industrialized country) and the host (developing country) is the 'surplus'. The host country and the investor country can share the surplus so that both benefit - the investor by reducing emissions more cost effectively than could be done in the investor's home country and the host by receiving additional finance that allows it to implement a greenhouse gas reduction project that would otherwise not be viable.

What opportunities can the CDM bring to South Africa?

South Africa is classified as a developing country for the purposes of the UNFCCC and the CDM.

From the developing country perspective, the CDM offers the following opportunities:

• It can attract capital for projects that assist in the shift to a more prosperous but less carbon-intensive economy;
• It encourages and permits the active participation of private and public sectors;
• It can be an effective tool of technology transfer if investment is channeled into projects that replace old and inefficient fossil fuel technology or create new industries in environmentally sustainable technologies; and
• It can help developing countries define investment priorities in projects that meet their sustainable development goals.

In South Africa, the CDM may provide additional investment for the development of activities that reduce the combustion of fossil fuels (particularly coal, oil, gas and paraffin), reduce methane emissions (from landfill sites for example) and improve land use patterns (such as reforestation). This investment, which is directly related to the extent to which emissions are reduced could make some businesses in South Africa more viable.

How does the CDM work?

The industrialised country starts by keeping a regularly updated inventory of its emissions. A national target for reduction of these emissions is set within the Kyoto Protocol. The industrialised country may then chose to allocate its national target across a number of domestic emitters.

The domestic emitter can then meet these targets through one of three methods:

• Mitigation activities within the country;
• Through the Joint Implementation Mechanism (another carbon trading mechanism within the Kyoto Protcol); and
• Through the CDM - where the emitter can invest in a project in a developing country (thus gaining Certified Emissions Credits for themselves) or buy CERs from someone who has invested in such a project.

Requirements on the host country are fairly straightforward. For a host country to be eligible to participate in the CDM, it must:

• Ratify the Kyoto Protocol; and
• Designate a national authority to provide official host country approval of a project.

Read more about the role of the DNA

With the DNA in place, the CDM can start to operate in a host country. It is a project-based mechanism and is driven by market forces - relying on potential investors finding suitable investment opportunities (projects) in host countries. The DNA of a host country will be able to assist the matching of investors with suitable CDM project opportunities developed within the host country.

Steps to be followed for a project to be considered as a CDM project

Specific processes must be followed for a project to become an official CDM project which is eligible for the issuance of certified emission reduction (CERs), or carbon credits.

See CDM Project Cycle and the DNA approval process.

Administration of the CDM and the main role players

Under the rules of the Kyoto Protcol, the CDM is administered by two bodies: the Conference of Parties, serving as the Meeting of Parties, and the CDM Executive Board.

The Conference of the Parties (COP), serving as the Meeting of the Parties (MOP), is the supreme body of the CDM and is constituted by those parties that have ratified the protocol. The COP/MOP provides guidance to the executive board and elaborates modalities and procedures with the objective of ensuring transparency, efficiency and accountability. The COP/MOP also reviews the regional distribution of designated operational entities to promote equitable distribution.

The Executive Board supervises the CDM and is fully accountable to the COP/MOP. It is responsible for accrediting operational entities, defining modalities and procedures for the CDM, approving new methodologies and guidelines related to baselines, monitoring plans and project boundaries. It also maintains the CDM registry and database.

The executive board is comprised 10 members from parties to the Kyoto Protocol as follows:

• One member from each of the five United Nations regional groups;
• Two other members from parties included in Annex 1 of the protocol;
• Two other members from parties not included in Annex 1; and
• One representative of the small island developing states.

More information on the roles and responsibilities of the Executive Board and COP/MOP can be found on the UNFCCC website.

The other main players (other than the DNA) are:

• Project developer
  Develops, owns and operates the project and is the original owner of any CERs generated. The project developer can be private sector, NGOs or Government and can be from the host country or elsewhere (including an Annex 1 country). The only requirement on 'location' is that the project itself must be physically based in a developing country.

• Project investor
  Party from the developed (Annex 1) country wishing to purchase CERs. Can be private sector, NGOs, Government or multilateral funds (e.g. the World Bank).

• Host country
  The developing country in which the project occurs.

• Operational entities
  Accredited firms ("auditors") responsible for validation, monitoring and certification. These are generally referred to as the Designated Operational Entities (DOEs) and perform a quality control function.

Read more about the role of each of these in the section on the CDM project cycle.