The goal of the CPR Scheme is to reduce Australia’s emissions in a cost-effective manner by harnessing the innovative legal instrument of the carbon trading market. However, the effectiveness of this innovative approach could be seriously undermined by the absence of adequate legal reform to support the operation of the carbon trading scheme.

One key concern in the proposed CPR Scheme is the lack of proposed legal reform to address the specific rights and legal protections that will be associated with the new carbon permits.

The establishment of clearly defined property rights — in the form of tradeable emission instruments — is a key prerequisite for an effective carbon market system. In order to be of value to the holder, carbon permits must be recognised and protected as property by the legal system in which the permit is held.

These instruments must be capable of unambiguous identification, protection, assignment and banking and should be able to be made the subject of a mortgage or charge. The presence of such legal characteristics will enhance confidence in the market, resulting in increased demand for the limited numbers of carbon permits with a resulting increase in the market price of carbon permits. This increased carbon price should, in turn, influence the behaviour of consumers, leading to overall reductions in greenhouse gas emissions.

The use of tradeable carbon permits to incentivise domestic greenhouse gas emission reductions stems from the Kyoto Protocol to the United Nations Framework Convention on Climate Change. The international climate market has resulted in the creation, and trade, of a diverse range of transferable international carbon instruments including Assigned Actual Amount units (AAUs), Certified Emission Reduction units (CERs) and Emission Reduction Units (ERUs).

The specific legal characteristics and rights associated with those critical instruments have not been defined by the nation parties to the Kyoto Protocol. Similarly, the European Union Emissions Trading Scheme established tradeable allowances but has not defined the specific legal characteristics associated with those instruments.

In both instances, the standard form contracts for the purchase and sale of these credits merely refer back to the Kyoto Protocol or the European Emissions Trading Scheme for definition — leaving this critical legal issue to be determined in the future. As a result, the recognition and protection of these instruments must be dealt with in an ad hoc fashion within the domestic civil law and common law systems in which the credits are created, traded or held.

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Understandably, the ability of the traditional legal principles within those systems to recognise and extend rights and protections to these novel artificial constructs will vary significantly across these jurisdictions.

This uneasy situation is exacerbated within Australia with its already fragmented approach to the treatment of property rights generally — and carbon rights specifically — across the various states and territories. The Australian states have all introduced legislative frameworks for the separate identification of forestry and carbon rights in land, and the legal characterisation and associated treatment of those carbon rights varies dramatically across the differing statutory schemes.

The Green Paper for the CPR Scheme confidently states that the scheme is intended to establish carbon permits which are personal property. However, there is no new legal framework proposed in the CPR Scheme to ensure that these permits possess the necessary features to be fully characterised and protected as personal property.

The Green Paper merely comments that the legislation for the CPR Scheme would not prohibit commercial transactions such as the creation of equitable interests in permits or taking security over permits. No additional legal reform is proposed.

This lack of reform will mean that the processes for dealing with these carbon permits will depend on the application of existing property law principles within the states and territories. Those disparate property law systems were not created with these novel concepts of carbon trading in mind.

Consequently, although the intention may be for these permits to be treated as property, they may not be characterised as such within the relevant jurisdiction. It is likely that this will affect the inherent financial value of these instruments within the carbon market. This, in turn, will undermine the overall effectiveness of the carbon market system.

It must be accepted that the use of the innovative market mechanism to reduce greenhouse gas emissions is very much in the experimental stages. All of the existing overseas carbon trading markets are still in their early phases with many important legal lessons still to be learnt.

The design of the Australian scheme is intended to be a world-best example. However, if this innovative carbon market is to operate effectively, and actually reduce our national greenhouse gas emissions within the necessary timeframe and in a cost-effective manner, it must be supported by an appropriate legal framework.

The proper legal characterisation of the tradeable carbon credit is but one of the many critical legal issues with which lawyers must grapple when advising in relation to the development of this scheme.

For related coverage, see our in-house feature on carbon trading on page 23.