A literature review of the vulnerabilities to fraud in the EU ETS and the CDM : how does the environmental context affect fraud in the market?

Abstract

The Kyoto Protocol uses financial incentives to reach the environmental goal of reducing greenhouse gas emissions. This environmental context facilitates certain frauds, namely scams, bribery and corruption and fraud through structural flaws. This thesis investigates the vulnerabilities of fraud of the European Emission Trading System (EU ETS) and Clean Development Mechanism (CDM). In particular, the purpose is to examine current literature and cases to understand the effect of the environmental context on fraud. Fraud is the outcome of deceitful intentions (Collins Dictionary of Law, 2006). Based on the fraud cases and literature I found that the main factors facilitating fraud are the complexity of measuring atmospheric gases, their intangibility and alienability, the flawed assumption of perfect interchangeability of credits, the conflicting incentives in a financial market with an environmental goal and the legal vagueness and information asymmetries caused by the structure’s uncertainty. Through the analysis of market players, I found that the incentives of numerous stakeholders make regulating the market difficult. The problem is that good incentives may lead to environmentally undesirable outcomes, while fraudulent incentives may not do so. Through analysing the cases, the environment is found to be a central victim in scams, bribery and corruption and fraud through structural weaknesses. This means that distant, defenceless or unaware victims cannot sufficiently protect themselves against fraud due to the environment’s non-excludability. Through my findings, I found that most fraud cases that negatively affect the environmental objectives are associated with the CDM, while the other cases were largely associated with the EU ETS. This supports the idea of limiting the trade between the markets to limit fraud. Instead of replacing the system, I recommend that the know-how should be used to improve the current system, for example by excluding projects with questionable environmental benefits like carbon sinks (Martin & Walters, 2013). A limitation is that malicious fraudulent behaviour and good intentions with unexpected results were not always possible to distinguish.