As adversity caused by climate change accelerates, the landscape of global macroeconomics and trade is changing. International cooperation is paramount, not only to achieve environmental stability but also for climate-smart economic and financial architecture.

The Paris Agreement, a landmark accord adopted by nearly 200 countries, aims to limit global warming to well below 2 degrees Celsius. A key mechanism in this agreement, Article 6.2, facilitates international carbon markets through the trading of internationally transferred mitigation outcomes (ITMOs). These ITMOs are similar to carbon credits.

Let’s understand the basics of Article 6.2, its benefits, challenges and its critical role in achieving nationally determined contributions (NDCs) and how developing countries can utilise this framework.

Article 6.2 of the Paris Agreement establishes a decentralised framework for countries to engage in cooperative approaches. These approaches allow for the transfer of GHG emissions reductions or removals - known as ITMOs - between countries. The primary purpose of the ITMOs is to enable countries to meet their NDCs cost-effectively and to promote GHG reduction commitments.

Approved during the 21st session of the Conference of the Parties (COP21) in 2015, Article 6.2 laid the groundwork for international cooperation on carbon markets. Detailed rules for its implementation were developed at COP26 in 2021 and COP27 in 2022, creating what is now referred to as the Article 6 Rulebook.

In COP28’s global stock-taking, many countries were found lagging on their NDCs. The COP29 in Baku will discuss the emission trading schemes and the need for cooperative approaches to fill the NDCs gap.

In ITMO transactions, the host country is the nation - typically in the Global South - where a project generating the GHG emissions reductions or removals takes place. These transactions bring significant benefits to host countries by attracting investments in low-carbon projects that contribute to sustainable development.

The receiving country, on the other hand, benefits by financing projects in regions where GHG reductions are cost-effective. This allowing it to achieve or exceed its NDC targets. The Article 6 Rulebook mandates several critical requirements to ensure the integrity of ITMO transactions, including corresponding adjustments to prevent double-counting of GHG reductions, adherence to social and environmental standards and verification that the ITMOs represent genuine and additional GHG reductions.

Cooperative approaches under Article 6.2 typically begin with bilateral governmental agreements, setting the framework for ITMO transfers. These agreements, often termed cooperation agreements or implementing agreements, outline the quality criteria, procedures for authorisation, verification and reporting.

Within the governmental framework, private sector entities can engage in ITMO transactions through commercial agreements. These agreements specify the commercial terms, including the number of credits, payment structures and pricing. A notable example is the agreement between Switzerland and Peru, where the Swiss Foundation for Climate Protection and Carbon Offset partners with Microsol SAS to support energy-efficient cook-stove projects in Peru.

For Pakistan, such projects make pure economic sense, the household energy portfolio is dominated by traditional fuels, transitioning households to cleaner fuels can not only generate the health benefits and reduced deforestation but also save foreign exchange.

The procedure for ITMO transactions typically involves several steps: authorisation by both the host and receiving countries; monitoring and verification by an independent third party; recognition of the transfer in national registries; and application of corresponding adjustments to GHG inventories.

Participating countries must also submit various reports, including initial reports, annual updates and biennial transparency reports. These reports are reviewed by a centralised technical expert panel overseen by the UNFCCC to ensure compliance with Article 6.2 guidelines.

Several countries have already engaged in ITMO transactions. Switzerland has agreements with Ghana, Peru, Senegal, Georgia and Vanuatu. Singapore has partnerships with Ghana, Peru, Papua New Guinea and Japan.

Sweden has transactions with Nepal and Cambodia through the Swedish Energy Agency. Ghana has emerged as a leader in implementing Article 6.2 projects. A notable initiative involves training rice farmers in sustainable agricultural practices to reduce methane emissions, showcasing Ghana’s commitment to leveraging ITMOs for sustainable development.

The rice initiatives make perfect economic sense for Pakistan, as upcoming Carbon Border Adjustment Mechanism will require emission offsetting at each point of supply chain, these projects will help Pakistan achieving low-carbon intensity in rice exports. These trading mechanisms require rigorous frameworks.

Despite the progress, several challenges remain. The private sector entities acquiring ITMOs risk the possibility of governmental parties failing to execute corresponding adjustments. The ITMOs cannot be banked between NDC periods, potentially leading to liquidity issues near the end of NDC cycles.

The integration of ITMOs with existing emissions trading systems, such as the EU’s Emissions Trading System, remains uncertain. Macroeconomic trends, including rising borrowing costs and competition from fossil fuel projects, pose additional challenges to the expansion of ITMO transactions. However, cooperative approaches under Article 6.2 are expected to grow, driven by ongoing infrastructure development and procedural refinements.

Article 6.2 of the Paris Agreement will play a pivotal role in facilitating international cooperation on carbon markets through ITMO transactions. By enabling cost-effective GHG reductions and fostering sustainable development in host countries, particularly those where nature-based solutions are either constrained by land or engineering based solutions are limited due to financial and technological bottlenecks, ITMOs will contribute significantly to achieving and exceeding NDCs. As the global community continues to refine and expand these mechanisms, the potential for ITMOs to enhance global climate action remains promising.

Implementing this mechanism requires robust policy architecture and infrastructure, including various registries and platforms to ensure transparency, accuracy and accountability in the trading and reporting of emissions reductions. Each participating country must maintain a national registry to track ITMO transactions, recording the issuance, transfer and cancellation of ITMOs to ensure all transactions are accurately documented and corresponding adjustments are made to prevent double counting of emissions reductions.

An international registry serves as a centralised system to track ITMO transactions across borders, facilitating the accurate recording of ITMOs transferred between countries and ensuring that the mitigation outcomes are correctly attributed and accounted for in the respective national registries.

To support the reporting requirements under Article 6.2, a mechanism registry is needed to record the details of each ITMO transaction, including the project or activity generating the emissions reductions, the host country and the receiving country, ensuring that all necessary information is available for verification and reporting purposes.

The Article 6 Database (Art 6 DB) functions as a comprehensive database that stores all relevant data on cooperative approaches under Article 6.2, including information on ITMO transactions, corresponding adjustments and compliance with social and environmental standards, facilitating transparency and allowing stakeholders to access and analyse data related to ITMO activities.

The Centralised Accounting and Reporting Platform consolidates data from national registries, the international registry, and the Art 6 DB, providing a unified view of all ITMO activities, ensuring that all transactions are accurately recorded, corresponding adjustments are made, and compliance with Article 6.2 requirements is maintained.

Developing an emission trading scheme (ETS) in Pakistan requires a comprehensive policy roadmap that addresses the unique challenges and opportunities within the country. Establishing a federal body to oversee the development and implementation of the ETS, ensuring coordination between federal and provincial governments, and creating a multi-stakeholder task force that includes representatives from federal and provincial governments, industry, academia and civil society to guide the process are essential steps.

Developing and enacting legislation to provide the legal basis for the ETS, outlining the roles and responsibilities of all stakeholders and establishing clear rules for emissions reporting, verification and compliance to ensure transparency and accountability are critical.

Investing in data collection and management systems to develop a comprehensive national GHG inventory that establishes baselines for emissions across different sectors is necessary to ensure accurate and up-to-date information on emissions.

Detailed studies to develop marginal abatement cost curves (MACCs) for key sectors, such as energy, industry, agriculture and transportation are important to identify the cost-effectiveness of various emissions reduction measures. Prioritising sectors and measures for inclusion in the ETS based on MACCs, focusing on those with the highest potential for cost-effective emissions reductions will enhance a scheme's efficiency.

Providing incentives for early action and investments in low-carbon technologies to encourage participation in the ETS and developing financial mechanisms to support sectors and businesses that may face higher costs in transitioning to lower emissions are also important.

Keeping the global climate agenda in focus, the financing NDCs will be a paramount part of macroeconomic policymaking. Being a low emitter and having competitive advantage in developing nature-based high quality carbon credits/ ITMOs, Pakistan can potentially finance climate resilience through emission trading with China, EU and Middle Eastern fossil fuel based economies.

The writer has a doctorate in energy economics. He is a research fellow at Sustainable Development Policy Institute. He can be reached at khalidwaleed@sdpi.org and tweets @Khalidwaleed_