“Requirements for activities involving removals under the Article 6.4 mechanism” - What does it all mean?
Last week the Article 6.4 Supervisory Body (“SB”) adopted the “Requirements for activities involving removals under the Article 6.4 mechanism”.
This was both a surprise move and an important development for the carbon markets.
Below, we outline:
What happened;
What this means;
How insurance/risk management fits in;
Kita’s viewpoint and how we can help; and
What’s next.
For project developers/activity participants and other market stakeholders who wish to understand how to address the insurance requirements referenced within this text, and wish to discuss more widely the risk assessment and scenario analysis outlined in the buffer requirements, please don’t hesitate to get in touch with the Kita team. We have deep expertise across this space and stand ready to help operationalise next steps.
What happened?
The UN Supervisory Body (SB) has the responsibility to operationalise the principles of Article 6. As part of this mandate, the SB has been working to elaborate and further develop recommendations on activities involving removals.
In a surprise move last week, The Article 6.4 SB adopted the “Requirements for activities involving removals under the Article 6.4 mechanism”. The objective of this standard is to set out the requirements for activities involving removals under the Article 6.4 mechanism. This version of the standard entered into force on 9 October 2024.
The SB decided to bypass the Parties to the Paris Agreement (CMA), in order to progress the development of this mechanism prior to COP29, meaning this document is now an adopted regulatory document.
What does it mean?
The objective of the Standard is to set out requirements for activities involving removals under the Article 6.4 mechanism.
“Activities involving removals and emission reduction activities with reversal risks under the Article 6.4 mechanism shall meet the requirements contained in the following sections, all the applicable standards and procedures of the Article 6.4 mechanism and any further requirements approved by the Supervisory Body in this regard.”
This standard (alongside a further adopted standard on methodology requirements) will help project developers create and submit methodologies for their projects, to allow them to be registered under the Paris Agreement Crediting Mechanisms. The SB has not yet developed approved methodologies nor have they released an exhaustive list of acceptable CDR activities. However, in theory, these methodologies could come from any source, including from existing voluntary carbon markets.
It can be assumed that once Article 6.4 methodologies are approved, this will shape methodologies and approaches used across the wider carbon markets, including the VCM.
How does insurance/risk management fit in?
Insurance is referenced in the text, as are wider risk management approaches. The standard adopted by the SB aligns broadly with the current risk management approaches within the VCM, rather than setting a new approach.
Key points include:
Buffer: There will be an Article 6.4 buffer pool mechanism that activity participants must contribute to, based on the risk profile of their project, which will remediate avoidable and unavoidable reversals. Reversals will be tracked and monitored, the buffer composition will be published annually, and the buffer itself will be regularly stress-tested (at least every 3 years).
53. The Supervisory Body shall establish a Reversal Risk Buffer Pool Account in the mechanism registry which serves to remediate avoidable and unavoidable reversals in full through cancellation of an equivalent amount and authorization status (authorized A6.4ER or Mitigation Contribution Unit) of Buffer A6.4ERs. The Reversal Risk Buffer Pool Account shall aggregate all contributions of Buffer A6.4ERs.
54. The Reversal Risk Buffer Pool Account shall be administered and shall only be accessed by the Article 6.4 mechanism registry administrator. The composition of the Reversal Risk Buffer Pool Account, including the share of A6.4ERs by vintage, region and country, type of activity, authorization status, risk rating, and methodology, shall be published annually.
60. The Supervisory Body shall oversee a regular stress-test of the Reversal Risk Buffer Pool Account to assess the resilience of the pool to a range of reversal risk scenarios and to consider and implement any potential remedial actions necessary to manage risks to the robustness of the Reversal Risk Buffer Pool Account.
61. The stress-test shall assess the resilience of the Reversal Risk Buffer Pool Account to a range of reversal risk scenarios based on, inter alia, the range of risk ratings as well as significant loss event(s), affecting the activities linked to the Reversal Risk Buffer Pool Account. The stress-test shall occur at least every three years and in an event of a significant loss event.
Buffer contribution risk assessment: Contributions to the buffer pool will be based upon a project level risk assessment, following a template that is yet to be published. It is our reading that the activity participants will conduct the risk assessment, as is currently seen on the VCM.
38. Activity participants shall conduct a risk assessment, which shall include a risk mitigation plan, for an activity involving removals, using the reversal risk assessment tool to identify, assess and mitigate reversal risks, and calculate an overall percentage-based risk rating (hereinafter referred to as risk rating) that accounts for both avoidable and unavoidable reversals, taking into account, inter alia, the nature, magnitude, likelihood, and duration of the risks.
39. The percentage-based risk rating calculated in paragraph 38 above shall inform: (a) The proportion of A6.4ERs to be transferred to the Reversal Risk Buffer Pool Account; (b) Identification of A6.4ERs with a negligible risk of reversal which shall be tagged in the mechanism registry.
Insurance for avoidable reversals: Projects must make good avoidable reversals and must have insurance in place.
58. For avoidable reversals, for which A6.4ERs have been cancelled from the Reversal Risk Buffer Pool Account, activity participants shall be fully liable for replenishing the Reversal Risk Buffer Pool Account by forwarding the equivalent amount and type (authorized A6.4ER or Mitigation Contribution Unit) of A6.4ERs to the Reversal Risk Buffer Pool Account within a timeframe to be specified by the Supervisory Body.
59. Activity participants should obtain and maintain sufficient coverage under an insurance policy or comparable guarantee products to cover the risk that avoidable reversals occur.
Maintaining robustness of the buffer pool: The Supervisory Body will manage risks to the robustness of the buffer pool and consider alternative means to remediate reversals, including the use of insurance policies:
62. The Supervisory Body will consider and implement any potential remedial actions necessary to manage risks to the robustness of the Reversal Risk Buffer Pool Account, including ongoing consideration of measures to remediate reversals and ensure the resilience, sufficiency, and solvency of the Reversal Risk Buffer Pool Account, and other appropriate measures and procedures that may provide suitable alternative means to remediate reversals, including the following: (a) Requirements and approval procedures for the use of insurance policies, or comparable guarantee products, or third-party guarantee approved by the Supervisory Body to cover the risk that reversals occur; (b) Procedures for establishing, managing, and using a monetary permanence reserve enabling remediation of reversals through the direct or potentially centralized purchase and cancellation of A6.4ERs with negligible or no reversal risk.
Kita’s viewpoint
Overall we think this is an ambitious move to proceed at speed with Article 6.4, and we support the teams who worked hard to craft and execute this Standard.
That said, on the insurance side, we think there are considerations to take into account and potential actions to be taken:
Onus on Activity Participants: With regards to insurance, the onus appears to be on the activity participant to source and maintain insurance policies, particularly regarding reversal risk. We believe this can be challenging for smaller participants and/or those located in jurisdictions where insurance penetration is smaller. Coupled with wider market insurance requirements that are increasingly being put upon the Project Developers (such as corresponding adjustment protection), there is a chance that activity participants could de facto have trouble participating in the market if they can’t access insurance.
ACTION: Project Developers/Activity Participants - please get in touch to discuss your insurance requirements and how the Kita team can help.
Insurance for avoidable reversals: There is a requirement for activity participants to obtain and maintain insurance to cover the risk that avoidable reversals occur. Avoidable reversals have been defined as “reversals caused by factors over which the activity participants have influence or control.” While there are existing insurance policies that can address avoidable risks, implementing this type of insurance at the activity participant level could suffer from a high moral hazard risk, as insurers would be protecting an organisation against actions over which they have influence or control. As such, policies are unlikely to cover wholesale fraud/negligence at a company-wide level (vs the action of specific employees acting in isolation). Thus, there might still be a gap here that hasn’t been considered.
ACTION: We are happy to speak to Project Developers/Activity Participants and other market stakeholders who wish to understand suitable insurance policies, as well as possible gaps that could be mitigated via complementary policies for other parties.
Insurance to remediate reversals: We read clause 62 as reversal insurance for activity participants. However, we would argue that if insurance was implemented at a portfolio level it would be more cost-effective, and more well suited to providing comprehensive risk protection across both avoidable and unavoidable risks. This would also alleviate the onus and complications associated with directly insuring activity participants (as outlined above), enabling more robust and full-coverage protection across the entire Article 6.4 mechanism. Please see here for further information on how an insurance policy can work alongside the buffer to cover reversal risk across an entire standard.
ACTION: We are happy to speak to Project Developers/Activity Participants and other market stakeholders who wish to understand suitable insurance policies, as well as possible gaps that could be mitigated via complementary policies for other parties.
Risk management of the Buffer: The SB will be seeking to regularly stress test the buffer and assess its resilience to a range of reversal risk scenarios. This is an ongoing specialised task for the SB which could be managed by a qualified third-party. For example, Kita already provides an independent risk management service (Buffer as a Service) to standards within the Voluntary Carbon Market which helps to reduce risk and increase operational efficiency of their buffers. Therefore, the SB could use services such as this to outsource their buffer management.
ACTION: If any of the SB members wish to discuss Buffer as a Service with us further, please do reach out.
How can Kita help?
We have deep expertise across this space and are available to help operationalise next steps:
Activity participants: please get in touch to discuss new insurance requirements.
Project investors/financiers: please get in touch to discuss the types of insurance you should be assessing as part of investment DD.
Art 6.4 SB: check out Kita’s buffer as a service, relevant for the scenario analysis and risk assessments that will be part of this process and annual publicising of buffer composition.
What’s next?
COP29 next month will be a test. As per this summary, “Para 3 of the Annex to the CMA Decision at COP26 says that the Article 6.4 Supervisory Body shall supervise the Paris Agreement Crediting Mechanism “under the authority and guidance of the CMA and be fully accountable to the CMA.””
Thus, arguably, the CMA can block this outcome at COP29. However, according to the Kita teams’ chats with market insiders, current market sentiment seems to be that the CMA will let it pass.
We look forward to tracking these developments.
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