Emissions Trading System: An Instrument to Drive the Reduction of Greenhouse Gas Emissions

To achieve the target, Mexico has implemented a three-pronged approach. This approach consists of: holding auctions for the development of solar, wind, and geothermal energy generation projects; the issuance, by the Energy Regulatory Commission, of clean energy certificates attesting to the production of a given amount of electricity from clean energy sources; and an amendment to the General Law on Climate Change which, among other things, requires the Mexican government to create an Emissions Trading System (ETS). An ETS is a GHG emissions reduction mechanism that operates in accordance with the "cap and trade" principle. This means that the government sets a cap on GHG emissions in certain sectors of the economy that will decrease over time so that, as a result, those emissions are reduced. Companies must hold permits for each ton of GHG emissions they release into the atmosphere and, if they do not have enough to cover their emissions, they must either reduce them or purchase permits from other companies, which in turn must reduce their own by the amount of the permits or rights sold. Prior to the ratification of the Paris Agreement in 2016, various GHG emissions reduction mechanisms already existed in Mexico, such as the tax on fossil fuels based on carbon content, approved by the Federal Congress in 2013 and applied since January 2014. Nevertheless, the rationale behind the mandate to create an ETS is that this system offers the possibility of "promoting emissions reductions at the lowest possible cost, in a measurable, reportable, and verifiable manner, without undermining the competitiveness of participating sectors vis-a-vis international markets." In other words, although in recent times it has become a trend to be a "sustainable" company, the reality is that companies look for real and measurable incentives to move away from the use of fossil fuels, which in most cases are far cheaper than green ones. Thus, the implementation of an ETS is one of the Mexican government's tools for meeting the goals of the Paris Agreement by requiring and incentivizing companies in Mexican territory to use green fuels or to modify their operations in order to reduce their GHG emissions. As part of the country's sustainability policies, the ETS is an effective and binding instrument for driving companies in Mexico to implement measurable strategies to reduce their carbon footprint. Currently, the ETS is in a pilot phase in which only facilities that carry out activities in the energy and industry sectors, and whose annual emissions are equal to or greater than 100,000 tons of direct carbon dioxide emissions, participate. It is worth noting that the pilot program has been delayed because the Ministry of the Environment and Natural Resources is still in the process of allocating emission allowances. For this reason, it does not yet have economic consequences (fines or payment for emission allowances), since its purpose is for market participants to learn how it works. However, since the ETS to be implemented in Mexico is based on international models,8 it is anticipated that penalties and fines will be established for GHG emissions in excess of those authorized. The criticism the ETS has received in Mexico stems from the alleged impact that the obligation to reduce emissions will have on the Mexican market and economy. This is interesting because these types of systems have been successfully implemented around the world since 2005, when the European Union implemented the first ETS. Furthermore, it is important to mention that combating climate change from the private sector also has consequences for organizations' ability to attract new talent. Companies with high emissions have found it more difficult to recruit personnel. By participating in the ETS, reducing emissions, and selling allowances, companies not only ensure compliance with the law and eliminate the risk of fines and penalties, but also foster good environmental practices and acquire an unmatched reputation in the market. Thus, the implementation of the ETS in Mexico should be seen as an area of opportunity for companies in the energy sector and the various industrial sectors. The Paris Agreement has led the vast majority of national and international investors to incorporate environmental aspects into the risk assessments they carry out to evaluate future investments in a company. For the investor, this has the advantage of knowing the company's environmental policy and the possibility of investing in a sustainable company that is genuinely carrying out a measurable mechanism to reduce its carbon footprint. For companies, it translates into an alternative that will allow them to comply with applicable regulations with measurable environmental standards that favor the sustainable development of their business, in pursuit of attracting more and better investments and clients. For further information on the subject of this note, please contact our experts: Edmond Grieger, Partner: +52 (55) 5258-1048 | egrieger@vwys.com.mx Rebeca Márquez, Associate: +52 (55) 5258-1048 | rmarquez@vwys.com.mx

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