Update on market progress

As our colleague Whitney Debevoise discussed in his article in the first edition of Latin Lawyer's The Guide to Environmental, Social and Corporate Governance, carbon markets in Latin America are poised for take-off. Since the date of that article, significant steps have been taken to develop the carbon markets in Latin America, and particularly in Brazil with the arrival of the new administration of President Luis Inacio Lula da Silva. Given the size of the Brazilian economy and the depth of Brazil's natural resources, such developments bring promise of substantial progress in the Latin American carbon markets. Our article below updates Whitney's previous discussion, including a summary of these new developments in Brazil.

The importance of Latin American carbon markets on the world stage

With a rich history of involvement in hydrocarbon production and huge natural carbon sinks, such as the Amazon, Latin America has tremendous potential in the creation of carbon credits. Further, a growing number of countries stand ready to activate trading in carbon credits, whether through voluntary or compliance markets, and a growing number of companies are announcing net-zero targets that will only be achievable through access to functioning carbon trading markets.

With concern about climate change increasing, many investors and the public at large have increased their scrutiny of companies and their greenhouse gas (GHG) emissions. Many companies are answering the call to establish net-zero emissions targets, as are the countries in which they work and are based, many of which have pledged to reduce emissions in the context of the Paris Accords.

Some 20 per cent of all carbon credits are being generated in Latin America, and many of these credits are being applied in jurisdictions outside the region. As the integrity of carbon credits continues to improve, the volume of credits generated in Latin America should continue to grow. Further, as more countries engage seriously with their national commitments under the Paris Accords, carbon markets in Latin America will continue to grow, whether that be in the compliance market or the voluntary market.

In short, these are markets whose growth will generate much activity both for governments and business, as well as for lawyers in both government service and the private sector. All have an important role to play in the further development of carbon credits in Latin America, and the growth in carbon credits and trading will make an important contribution towards achieving the emission reduction goals of the Paris Accords.

A range of policies

These factors drive demand for functioning carbon markets and the governments in Latin America have begun to respond. Not surprisingly, the regulatory frameworks vary across the region. Some governments (such as Colombia, Mexico and Chile) have imposed carbon taxes, whether at the national or subnational level to promote emissions reductions in Latin America. In Colombia, for example, revenue from the country's carbon tax supports the Sustainable Colombia Fund, which deploys the funds in sustainability projects in conflict areas. Chile introduced a carbon tax at the rate of US$5 per metric ton of emissions of CO2, but this level of taxation has been criticised as inadequate and Chile is considering an increase that could go as high as US$40 per ton. In September 2023, the Chilean government published regulations with respect to the use of offsets against the US$5 per metric ton carbon tax. Other policies adopted include subsidies promoting low-carbon technologies and promoting the development of carbon capture and storage technologies with their existing energy infrastructure. Colombia has developed a national emissions trading system (ETS) that envisages a system of carbon allowances and allocations, as well as credits for voluntary GHG reductions that are properly verified and certified.

The World Bank and other multilateral sources have provided strong support and technical assistance to these efforts. In particular, the World Bank's Partnership for Market Readiness (PMR) has worked with numerous countries, among them Argentina, Brazil, Chile, Colombia, Costa Rica, Mexico and Peru, to design and deploy carbon pricing instruments (CPIs), whether in the form of carbon taxes or cap-and-trade systems. In Colombia, for example, PMR has conducted an evaluation of ETS system design, an impact assessment of an ETS on sectoral competitiveness, and a study on design options for a mandatory GHG reporting programme.

Brazil to the fore

While markets across Latin America have been making steady progress, in 2023 developments in Brazil captured the most attention. As Brazil is home to two-thirds of the Amazon Rainforest, which is the world's largest absorber of GHGs, and has by far the largest economy in Latin America, developments in Brasilia have an outsized impact on Latin America's eventual success in promoting emissions reductions. (The total area of registered public forests in Brazil in 2020 corresponds to approximately 309.4 million hectares, representing 36 per cent of the Brazilian territory.) In light of this significant potential, the implementation of suitable regulations extends beyond their positive social and environmental development impacts. It also holds the promise of revitalising the Brazilian economy and catalysing the emergence of fresh business opportunities.

Enter Lula

Under President Luis Inacio Lula da Silva, inaugurated on 1 January 2023, Brazil has increased its obligations under the Paris Agreement to cut carbons emissions by 2030 by 53 per cent compared to emissions in 2005. In demonstration of his commitment, on his inauguration date, President Lula signed numerous decrees and provisional measures to signal that climate change would be at the centre of his administration. Among other decrees and provisional measures, President Lula signed:

  • Provisional Measure No. 1,154, which changed the organisation of the Presidency and its ministries, transforming the Ministry of Environment into the Ministry of Environment and Climate Change;
  • Decree No. 11,372, which reinvigorated the National Environmental Fund (FNMA);
  • Decree No. 11,373, which defined certain environmental infractions and administrative sanctions and established the federal administrative process for investigating these infractions, and provided that 50 per cent of fines collected would be paid to FNMA;
  • Decree No. 11,367, which established the Permanent Interministerial Commission for the Prevention and Control of Deforestation, re-established the Action Plan for the Prevention and Control of Deforestation in the Legal Amazon (PPCDAm) and provided for the Action Plans for the Prevention and Control of Deforestation in the Cerrado, Atlantic Forest, Caatinga, Pampa and Pantanal;
  • Decree No. 11,368, which amended a previous decree to provide for the governance of the Amazon Fund, defining in its Article 2 that BNDES would collect donations on behalf of the Republic; and
  • Decree No. 11,369, which sought to correct distortions in the mining industry.

Taking a big step towards improving the robustness of the monitoring and implementation of the carbon credit market, and to help meet his goal of a more integrated governmental approach to climate change, on 2 March 2023, President Lula signed Decree No. 11,427. This decree created the role of Secretary of Green Economy, Decarbonization and Bioindustry within the Ministry of Development, Industry, Commerce, and Services, to coordinate the proposal of measures and norms for the implementation and improvement of the Brazilian carbon market.

Turning to legislative steps, aiming to expand opportunities for the creation and exchange of carbon credits linked to sustainable management of public forests by private entities, on 24 May 2023, the Brazilian Congress passed Law No. 14,590. This law modified the existing Public Forest Concession Law, which governs concession of public forests (Law No. 11,284). Under this new legislation, during the period of any concession to exploit public forests, any carbon credits generated could now be transferable by the concession holder, instead of only by the concession issuer (the public authority). In addition, the new law established the right to trade the related carbon credit certificates and related environmental services. These amendments to the Public Forest Concession Law have the potential to leverage Brazil's role as a global leader in combating climate change, by promoting the bio-economy and the implementation of nature-based solutions, yielding social, environmental and economic advantages.

On 5 June 2023, the Brazilian government celebrated Global Environment Day by enacting a series of decrees to fulfil its environmental agenda. For example, Decree No. 11,550 established the Interministerial Committee on Climate Change (CIM), through which guidelines and the definition of Brazil's strategies within the scope of the Paris Agreement would be decided. Approved on the same day, Decree No. 11,549 (which amended Decree No. 9,578/2018) created the National Fund on Climate Change and the National Policy on Climate Change. Among other provisions, the rule retains a recent amendment to Law No. 12.114/2009 (the National Climate Change Fund Law), which enables the Brazilian National Development Bank (BNDES) to qualify private agents to act in the financing operations of the National Climate Change Fund. The decree also added representatives of indigenous peoples and traditional communities to the Management Committee of the National Fund for Climate Change.

Further, the Lula administration, through Decree No. 11,548, created the National Commission for Reducing Greenhouse Gas Emissions. The Commission's membership includes representatives from various cabinet ministries plus the office of the president (Casa Civil), indigenous peoples and members of other traditional communities, as well as non-governmental organisations, higher education and research institutions, and private sector actors with activities in the socio-environmental area. This decree foresees the use of Reducing Emission from Deforestation and Forest Degradation (REDD+) credits for eventual transactions in carbon markets, to be regulated by an act of the Executive Branch.

The SBCE

Perhaps the most significant movement in terms of creating an active carbon trading market in Brazil is Bill No. 412/2022, which is working its way through the Brazilian Congress. If enacted, the bill would establish the Brazilian Greenhouse Gas Emissions Trading System (SBCE), a regulated framework designed to place constraints on greenhouse gas (GHG) emissions, and oversee the regulation of the carbon market in Brazil. The bill was approved by the Environmental Commission of the Brazilian Senate on 4 October 2023, and is the product of a collaborative effort with the Executive Branch, under the leadership of the Ministry of Finance. It further facilitates the exchange of assets that represent emissions, reductions or removals of such gases exclusively within Brazil's national boundaries.

The SBCE model is founded on a cap-and-trade approach, which model is widely used in Europe. This approach mandates a specific cap on carbon dioxide emissions, with companies that are subject to the law and that emit GHGs in excess of established limits being required to buy certified offsets from others. Under the bill, companies emitting more than 10,000 tons of carbon dioxide equivalent (tCO2e) annually would be required to submit a monitoring plan on a regular basis and report detailing their GHG emissions and removals. For those companies that exceed 25,000 tCO2e annually, an additional obligation is imposed: they must align with emission reduction targets outlined in the National Allocation Plan (PNA), established by the governing body of the SBCE. The PNA delineates emission limits for specific activities and allocates emission quantities to individual operators.

Each company's emission allowance is represented by Brazilian Emission Quotas (BEQ), where one BEQ is equivalent to 1 tCO2e. Companies would have the option to acquire these quotas from others, especially if they surpass their allocated emission limit. Under the proposed legislation, if a company's emissions exceed 25,000 tCO2e, it would be required to prove ownership of both BEQs and Certified Emission Reduction or Removal Verification Certificates (CRVE) corresponding to its emissions. The CRVE represents carbon credits generated through the effective reduction or removal of 1 tCO2e and are tradable or can otherwise be applied in international transfers under the Paris Agreement.

Entities subject to regulation would be required to furnish emission monitoring plans and reports to the governing body of the SBCE, which has the authority to impose penalties for violations. While the bill currently lacks specified penalties, it provides for the possibility of sanctions such as warnings, fines, embargoes, partial or complete activity suspension, loss of tax benefits and financial support, a three-year prohibition on public administration contracts, and even cancellation of its corporate.

The overarching goal of the plan is alignment with the National Policy on Climate Change (PNMC) and upholding Brazil's commitments under the United Nations Framework Convention on Climate Change, and the bill represents a noteworthy move towards Brazil's compliance with these commitments. That said, notwithstanding the progress it represents, the bill has its detractors, with many pointing out that Brazil's largest emitters of GHG – entities in the agricultural sector – are excluded from the bill. Without the inclusion of that sector, which is responsible for significant deforestation, plus additional emissions from livestock and crops, many commentators believe that Brazil's bill does not go far enough. Debate also revolves around the extent to which regulated industries can purchase carbon credits from the voluntary market to offset their unavoidable emissions. In any event, the bill must still be reviewed by Brazil's lower house, the Chamber of Deputies. But once established, the Brazilian regulated carbon market can be expected to provide specific conditions for offsetting, incorporating crucial socio-environmental safeguards.

REDD+

Finally, the election of President Lula created a substantial opportunity for the expansion of the supply of carbon credits in connection with avoided deforestation (REDD+) due to the significant forest resources in Brazil. Carbon credits associated with REDD+ projects already have a strong presence in the region. With a renewed emphasis coming out of the Glasgow COP26 on nature-based solutions, there is a real opportunity to integrate local communities into the carbon credit process for improved societal returns. Appropriate metrics for this dimension will need to be developed, together with an improvement in the standards for monitoring and verifying carbon credits for REDD+ projects, which have been criticised for lack of oversight and inaccurate accounting.

Originally published in Latin Lawyer, 03 April 2024

Gregory Harrington and Chris Willott are partners and Ana Carolina Ramazzotti is a Foreign Attorney at Arnold & Porter Kaye Scholer LLP.

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