(a) Inter-system linkage

The emergence of independent trading systems raises the possibility of joining these systems through the concept of ‘linkage.’ Formal linkage occurs when one trading system enables its regulated entities to use allowances (direct linkage) or offset credits (indirect linkage) from another system in order to meet emissions reduction obligations.1 These linkages can be one-way (one system recognizes another system’s credits) or reciprocal for complete integration. Linkage theoretically carries the benefits of lowering overall abatement costs and increasing liquidity by broadening the market for allowances.2 Linking systems may also mitigate leakage, or the migration of industrial sources of emissions to areas not subject to emissions caps.3

Despite these benefits, design differences among systems pose problems for effective linkage, and the technical, administrative and political hurdles associated with linkage can be prodigious, particularly for direct linkages involving mutual recognition of emission allowances for compliance purposes. For example, differences in design features may raise environmental integrity and competitiveness concerns if there is not general parity in the stringency of emissions reductions requirements, enforcement rules, standards for recognition of offsets (ie, emissions reductions outside of the cap), and allowance distribution or allocation systems.4 There are considerable economic implications associated with linkage as well, including the possibility that costs could increase for facilities in areas with the lower relative abatement costs.

Whether and how to link the various emerging sub-national trading schemes with one another, and how to link those programs or a federal cap-and-trade system with foreign emissions trading or emissions ‘credit’ systems (such as the CDM market), is thus a key issue in the US emerging compliance markets. It is also predominantly a policy question rather than a legal question. As a non-party to the Kyoto Protocol, for example, the United States faces comparatively fewer treaty law restrictions on its ability to recognize credits from other regimes, unlike Kyoto Protocol parties which cannot use US credits for compliance purposes. Linkage arrangements can in theory be worked out after a trading regime is established. Because many of these market dislocations are best addressed through harmonization, however, linkages ideally should be considered during the establishment of new emissions trading mechanisms so they can be factored into the overall architecture of the new market.

Fortunately, US policymakers and legislators have been conscious of these considerations. Linkage issues have arisen at all levels in the emerging emissions trading programs in the United States: between two or more sub-national programs (eg, between RGGI and WCI); between sub-national programs and international regimes (eg, between RGGI and the EU ETS); between sub-national programs and a future US federal program; and between a US federal and international regimes. Although the resolution of many of these issues remains in flux, several key developments are in place already.

  1. Linkages between sub-national regimes

With respect to linkages between sub-national regimes, the emergence of The Climate Registry (TCR) as a common reporting platform appears to offer a solution to one of the primary technical issues that must be resolved in linkage, namely the need to identify a common trading and recordkeeping platform to avoid double-counting.5 Although TCR was initially a purely voluntary program designed to ensure consistent and transparent GHG reporting, it has taken on a quasi-official status as states have increasingly endorsed it as the registry they intend to use in their GHG reduction programs. In addition, as part of its effort to publish a mandatory GHG reporting rule, the US EPA is working with TCR to harmonize reporting and recordkeeping practices among jurisdictions.6

  1. Linkages between sub-national and international regimes

At least one sub-national program currently provides for the unilateral recognition of overseas credits for purposes of compliance. The RGGI program allows covered entities to ‘link’ with external programs outside of the United States to import external credits for recognition under the RGGI offset compliance requirements. If the average price of carbon exceeds $10 in the RGGI trading market, covered entities will be able to use CO2 offset allowances for the permanent retirement of GHG allowances or credits that have been issued pursuant to ‘any governmental mandatory carbon constraining program outside the United States that places a specific tonnage limit on greenhouse gas emissions’, CERs, or other emissions reduction credits issued under ‘protocols adopted through the UNFCCC process’.7 The current Western Climate Initiative design recommendations similarly contemplate unilateral indirect linkages through the recognition of offset credits from North American markets and the CDM. The recommendations provide, however, that WCI participants may impose additional qualifying criteria and

specify that offset credits will not be accepted for GHG reductions in developed countries from sources that are covered by the WCI cap and trade program.8 These one-way recognition provisions, which do not require the consent of the regime exporting the carbon credit, would appear to sidestep questions about the compatibility of sub-national linkage mechanisms that might otherwise arise under the US Constitution’s Compact Clause (discussed further below).

By contrast, even one-way linkages may raise novel constitutional questions to the extent that they involve an agreement (eg, as an eligibility criterion) with a foreign state. California’s Scoping Plan under AB 32 contemplates the adoption of agreements with developing countries ‘to work jointly to develop minimum performance standards or sectoral benchmarks, backed by appropriate monitoring and accounting frameworks. Such agreements would encourage early action in developing countries toward binding commitments, and could also reduce concerns about competitiveness and risks associated with carbon leakage’.9 As discussed further below, these one-way linkages are arguably more constitutionally suspect to the extent that they depend on active entanglements between sub-national authorities and foreign governments.

Similar issues arise with respect to sub-national programs, like the WCI, that contemplate the future development of mutual recognition linkages for allowances traded under other programs, based on agreements to be negotiated.10 For example, California gave significant attention to the potential establishment of such two-way linkages between its cap-and-trade system and the EU ETS.11 Indeed, in late 2008 Governor Schwarzenegger hosted a summit with various countries, including China, India, Mexico, Brazil, and Indonesia, to explore these linking relationships. Although such mutual recognition schemes maximize the policy benefits of linking trading schemes, they are also potentially more vulnerable to constitutional challenge when they involve sub-national entities engaging in bilateral or multilateral binding legal agreements, particularly with foreign countries.

  1. Linkages between US federal and sub-national regimes

With respect to linkages between federal and sub-national regimes, it is likely that most of these issues will be resolved through the absorption of sub-national schemes by the federal program.12 Nevertheless, one key issue that must be resolved in designing the

federal program is whether it will reward (ie, give credit for and thereby effectively link to) early action taken by covered entities under a state program.

  1. Linkages between US federal and international regimes

More generally, legislative proposals at the federal level have addressed a wide range of linkage models with other trading systems as well as the CDM and offset credit markets. The various cap and trade bills introduced in the last Congress differ widely on how they treat various linkage opportunities. For example, some permit use of foreign allowances only and exclude the use of CERs; others would give recognition only to foreign offset credits including CERs; yet others give recognition only to foreign offsets that allow forest credits but exclude CERs, etc. These linkage issues, which will have a significant impact on the pricing of the global carbon market given the potential size of US demand, are thus merely one more open issue in the large mix of policy and political questions that lawmakers are addressing.

There is one common element across nearly all of these bills, however: non-US originating credits and allowances, to the extent they are recognized at all, would generally be permitted for compliance purposes only up to a quantitative limit (eg, 15% of a covered entity’s compliance obligation).13 Another common issue is that (unlike the California regime), these laws are generally not being drafted in a way that is calculated to increase the possibility of closely aligned regimes with significant two-way linkages. Those opportunities, if they are feasible at all, will likely require complex negotiations and efforts to graft together the US system with its international analogues.