Although China is a signatory to the Kyoto Protocol, it is listed as a "non-Annex I" country, meaning it is not under any legal obligation to reduce its greenhouse gas emissions. However, under the Protocol's Clean Development Mechanism, foreign entities either from or sponsored by an Annex I signatory can partner with non-Annex I countries, such as China, to carry out voluntary projects that reduce greenhouse gas emissions in those countries, yielding carbon credits, known as certified emission reduction units, or "CERs." Foreign entities can also acquire CERs generated through such CDM projects and use them to satisfy their home country's greenhouse gas reduction commitments.

CDM projects must follow the procedures under the Kyoto Protocol, Marrakesh Accords (U.N. Doc. FCCC/CP/2001/13/Add.2 Jan. 32, 2002), and the Montreal Accord (U.N. Doc. FCCC/CP/2005/8/Add.1 Mar. 30, 2006). Such projects must further the host country's sustainable development and produce greenhouse gas emission reductions that are additional to what would occur in the absence of the proposed activity.

A Major Source of CDM Opportunities. China is an attractive site for CDM projects, because Chinese projects generally offer the greatest carbon reductions for the least investment, and it is relatively easy to demonstrate "additionality." According to U.N. statistics, CDM projects in China constitute 41.79 percent of all registered projects and have produced 252,324,614 CERs, representing 52.92 percent of all CERs issued.

In 2010, China released its "Emerging Energy Industry Development Plan," which calls for an investment of RMB 5 trillion over the next 10 years, providing for investments in the clean technology and renewable energy sectors, along with measures for upgrading and transforming conventional energy sources. China has also established a CDM fund that reinvests money generated from its CDM projects in other domestic climate change initiatives.

China's CDM Approval Process. CDM projects in China are regulated by the Measures for the Operation and Management of Clean Development Mechanism Projects in China (Order No. 37 [2005], effective Oct. 12, 2005). Under these CDM Measures, CDM projects in China must be owned either by a wholly Chinese-funded enterprises or one in which at least 51 percent of the equity is controlled by a Chinese party. However, the CDM Measures permit foreign entities to acquire the CER credits generated through CDM projects in China.

Under the Kyoto Protocol, all proposed CDM projects must by approved by the host country's Designated National Authority, which in China is the National Development and Reform Commission ("NDRC"). The CDM application to the NDRC must include a floor price for the CERs that are to be generated during the life of the project. If this floor price is below the applicable minimum floor price, which is set by the NDRC and varies by project, the application will likely be rejected.

Upon acceptance by NDRC, the application will be submitted for expert review by the National CDM Board, which is made up of members from the NDRC, the Ministry of Science and Technology, the Ministry of Foreign Affairs, and various other ministries. Based on the Board's recommendation, the NDRC will then approve the CDM application and issue the project owner a letter of approval.

Next, the project owner must have its Project Design Document approved by a Designated Operational Entity, an independent auditor accredited by the U.N.'s CDM Executive Board, and have the project registered at the Executive Board. As the CDM project is implemented, the Designated Operational Entity will verify monitoring results, certify the exact amount of greenhouse gas emission reductions resulting from the project, and report the results to the Executive Board.

The Chinese owner of the CDM project and the foreign entity that is purchasing the CERs generated through the project should have in place an Emissions Reduction Purchase Agreement or similar arrangement. As the Designated Operational Entity reports the project's verified emission reductions to the CDM Executive Board, the Executive Board will, upon request, cause CERs to be issued to the registry accounts of the foreign entity. Under the CDM Measures, the Chinese government is entitled to collect from the project owner a "CER transfer benefit," ranging from 2 percent to 65 percent of the revenue from the transfer.