As is the case in many industries, there are distinct groups of companies involved in the climate change market, each with a different focus. The fundamental distinction is whether a company focuses on the:

The primary market consists of project developers such as EcoSecurities, but also includes entities that manage and invest funds in climate change projects. The majority of the investments take place in the Clean Development Mechanism (CDM) (see box, Legal framework to the carbon markets below).

The secondary market is mainly populated by two classes of entity, namely:

The primary and secondary markets themselves are very different creatures. In the primary market, lawyers must advise on contracts and risks arising from project investments relating to:

Secondary market advice focuses much more on advice relevant to commodity trading activities, such as the delivery path and credit risks.

Despite the different character of these markets, the risks are so intertwined that a climate change practitioner is expected to be able to advise clients and have a good understanding of the risks and documents in both markets. Therefore, whatever part of the market a climate change lawyer is primarily involved in, there are certain elements they must be familiar with as practitioners, as well as the aspects of commercial practice common to all in-house counsel. As a result, the climate change sector demands an unusual mix of skill sets and poses a uniquely interesting and demanding environment for practitioners.

The remainder of this article introduces some of the practice areas which appear most frequently and highlights some of the live issues in the market at present.

One fact which sometimes seems to be forgotten by many non-lawyer participants of the carbon markets based on the Kyoto Protocol or the EU ETS, is that the market is a regulated system. Regulation is even more central to the carbon markets than in other regulated systems (such as energy, water and telecommunications). Whereas those markets existed before their regulators, the international carbon markets, and the allowances and credits traded therein, exist because of their regulated systems. Understanding this and the issues it poses is a significant part of providing effective legal advice in the sector.

A CDM project comes to life following its registration with the CDM Executive Board, the industry's regulator. In a purely regulatory sense, registration is the grant of permission for a CDM project to participate in the CDM scheme and a requirement that it complies with that scheme's rules.

If it can be established that the project's performance actually reduces emissions, the CDM Executive Board will issue carbon credits to reward compliance with the rules. As such, its decisions can have a huge impact on the profitability of investments. The issues arising in this context are similar to those under a national regulatory scheme.

A lawyer working in this field should be prepared to:

Giving advice in this area requires detailed knowledge of the CDM rules and knowledge of general administrative and regulatory law.

The need for an interest in regulatory law does not stop there. The EU ETS is currently the largest emissions trading scheme by far. It covers more than 11,000 major installations in heavy industry and energy generation and over 6.3 billion carbon units were traded in it in 2009 alone (see World Bank: State and Trends of the Carbon Market 2010 (May 2010)). For a company like EcoSecurities, this means the majority of its credits will be sold and traded in this scheme.

The EU Emissions Trading Directive (2003/87/EC) (as amended) regulates how carbon offset credits can be used in the EU ETS. National registry rules govern how to open accounts and how to transfer the credits from registry to registry. For more information on the EU ETS legislation in the EU, see Practice note, EU ETS Amending Directive 2009.

Being abreast of these rules is necessary, not only to facilitate trades, but also because they are a major factor in shaping the future business of a company. For example, from Phase III of the EU ETS (2013-20), there will be qualitative and quantitative restrictions on the use of offset credits (that is, credits from CDM or JI projects) for EU ETS compliance.

A lawyer understanding these rules, monitoring the changes to them and being able to facilitate discussion of them at board level is fundamental to whether or not a company will make effective decisions when:

As described above, the CDM is very much a top-down regulatory system created under a protocol (the Kyoto Protocol) to an international treaty (the UNFCCC), as opposed to a system administered by a sovereign state (see box, Legal framework to the carbon markets above). Despite this, the CDM also deals directly with private entities in the form of corporate participants in the international carbon market. As such, the CDM is very unusual and poses unique challenges. These challenges cannot be addressed without viewing them in the context of international public law. For more information on vertical international public law, see the Institute for International Law and Justice at the New York University School of Law: Global Administrative Law Programme.

For example, currently, a decision by the CDM Executive Board to refuse to register a project cannot be challenged. This is because the CDM Executive Board is the only authority with decision-making powers, and is the only authority which can review its own actions and decisions.

One of the most interesting recent developments is the proposal for an appeals system to the CDM to overcome these shortcomings, and discussions on what the structure of an appeals process capable of direct access by private entities should be. At the 2009 international climate change meeting in Copenhagen (COP 15/CMP5), the parties to the Kyoto Protocol mandated the CDM Executive Board to introduce an appeals process. This would represent the first quasi-judicial review process with a commercial purpose within the UN system.

Lawyers from DLA Piper, Linklaters and EcoSecurities have been heavily involved in addressing the legal challenges to developing this review process. They have made a submission to the CDM institutions highlighting the minimum requirements for an appeals process. This work is ongoing and underlines that carbon trading still poses cutting-edge legal challenges for practitioners and theory in a market that sits at the crossroads of commercial, international, regulatory and public international law.

For more information on:

Production and delivery risks are among the most significant issues faced by entities in both the primary and secondary markets. The value of the project developers, the trading activities of financial institutions and the compliance of regulated entities under the EU ETS depend on the predictability of deliveries from the primary markets. Buyers in the secondary market hope to avoid short deliveries due to the market and the administrative risks these pose for their attempts to balance portfolios and comply with obligations to surrender emission allowances under domestic regulations.

As a result, the market has developed structured products to attempt to deal with these risks. One of the first examples of this was developed by EcoSecurities and is known as the EcoSecurities Carbon 1 transaction. For this product, Ecosecurities worked with a financial institution to create a special purpose vehicle that would deliver guaranteed volumes of carbon credits to European utilities from a portfolio of projects. This portfolio transaction bundled together projects managed by EcoSecurities from South America, Africa and Asia. Deliveries are made annually and certain minimum volumes negotiated with the buyers are guaranteed by an entity with an AAA credit rating. Other players in this field are investment funds that invest in companies and technologies related to low carbon economies.

The voluntary market is competitive and extremely bespoke. Buyers do not buy carbon credits or offset their emissions because they have to, but because they want to make a statement about their environmental responsibility and performance. For more information, see Practice note, Carbon offsets.

In this sector, a commercial sales team needs to be able to offer a variety of products. Some US buyers, for example, may want to purchase credits from voluntary projects in the US, whereas European buyers select emission reduction credits from different standards, host countries or technology types because these best suit their environmental and public relations goals.

Although there are more and more standardised voluntary carbon credits, there is always an appetite for bespoke products. For example, in 2010 the legal and commercial department at EcoSecurities developed a new product, which packaged a monitored emission reduction credit with co-benefits and other measurable conservation benefits. The combination was listed as a new product on an environmental market registry and allowed a buyer to have a double environment benefit in one transaction. These transactions require knowledge of the rules of the standards to ensure the correct transfer. Equally essential are high creativity and a good understanding of the risks involved and the expectations of the customer.

Working with CDM or voluntary projects in developing countries means being involved in infrastructure projects and industrial plants (for example, energy and chemical installations). This creates its own set of challenges. Many of these projects are related to local governments. For example:

Local environmental and corporate laws must be adhered to and may sometimes require an international investor to establish a local presence in order to participate in or operate the project.

Additionally, doing business in these countries requires stringent know-your-client, anti-money laundering and economic sanctions policies to help ensure compliance with regulations relating to the extraterritorial rules on bribery, terrorism prevention and money laundering.

Finally (as for any in-house lawyer), it is necessary to deal with contentious client relationships, potential disputes and litigation. The fact that a carbon markets project developer like EcoSecurities has projects in over 40 developing countries only serves to make these challenges more, rather than less, interesting.

Alexander Sarac is the General Counsel at EcoSecurities, an emission reduction project developer and carbon trading company.

EcoSecurities invests in projects in developing countries that apply a wide range of technologies on a diverse selection of projects including renewable energy, agriculture, waste management, industrial efficiency and forestry. The company has acquired a large portfolio of emission reduction credits which it sells and hedges in the carbon market. EcoSecurities became an indirect fully-owned subsidiary of JP Morgan Chase Bank in November 2009.