Emissions trading under the Kyoto Protocol: NAFTA and WTO concerns

I.

In response to international concern surrounding the effects of global climate change, the Kyoto Protocol1 to the United Nations Framework Convention on Climate Change2 was drafted in 1998 at the third meeting of the Conference of Parties (COP-3). Global warming is caused by the presence and continued release of large quantities of greenhouse gasses into the atmosphere, and the Kyoto Protocol is aimed at reducing emissions of these gasses.

The Kyoto Protocol requires nations that are party to the treaty to reduce greenhouse gas emissions to approximately five percent below 1990 levels by the year 2012. The Kyoto Protocol is currently undergoing a continued drafting process with anticipated ratification by 2007. In light of the negotiations surrounding the ratification of the Kyoto Protocol, a number of concerns are arising surrounding the associated emission reduction credit trading mechanism contained therein.

The North American Free Trade Agreement (NAFTA) or the World Trade Organization (WTO) may become a barrier to the best available multilateral solution to global warming. The fear is that because the economic risk associated with ratifying the Kyoto Protocol is so great,3 Canada may be forced to abandon the Kyoto Protocol entirely. If these questions are eventually decided by a NAFTA panel, it will have serious implications for the future of market based incentives as solutions to global environmental problems, particularly through the use of multilateral environmental agreements (MEAs).

Conflicts may arise between MEAs, such as the Kyoto Protocol, and international trade agreements, such as the General Agreement on Trade and Tariffs (GATT)/WTO and the NAFTA.4 Member trade obligations under the GATT/ WTO and NAFTA may restrict freedom to participate in the emissions trading system established under the Kyoto Protocol.5 Members to the GATT/WTO and NAFTA are restricted in their ability to place quantitative barriers to trade (such as quotas, sanctions, and taxes) affecting products or services from other member nations. Conflict may emerge because Kyoto Protocol member nations may only account for emission reduction units (ERUs) created in other Kyoto Protocol member nations. Concern arises about the ability of a country that is member both to the GATT/WTO or the NAFTA as well as to the Kyoto Protocol to place trade restrictions on ERUs created in countries that are member to the GATT/ WTO or the NAFTA but not party to the Kyoto Protocol. Neither the GATT/WTO nor the NAFTA have rules governing the mode of dispute resolution under such circumstances, presumably because they have not been pressured to create them.6

This note will focus on such conflicts with emphasis on the case of Canada and the United States. Canada and the United States are parties to both the GATT/ WTO and NAFTA. However, because the current President of the United States, George W. Bush, has refused to present the Kyoto Protocol for ratification,7 Canada may have reason to be concerned about the trade implications associated with their participation in the Kyoto Protocol's emissions trading system.

Article 30 of the Vienna Convention on the Law of Treaties8 offers some preliminary guidelines for appropriate resolution for such a conflict. Of relevance to this note is the second of two scenarios described in Article 30, in which both the United States and Canada are members to the GATT/WTO and the NAFTA, but only Canada is a member to the Kyoto Protocol. Under such conditions, the agreement to which both nations are member will govern (i.e. the GATT/WTO and the NAFTA).9 This note will discuss in great detail how such a dispute would be analyzed from the position of a GATT/WTO or NAFTA dispute resolution panel.10

Specifically, this note will examine the manner in which member obligations under the GATT/WTO and the NAFTA may affect the success of the emissions trading system under the Kyoto Protocol. The author concludes that success will largely depend on how the ERUs created by the Kyoto Protocol are classified under the GATTAVTO and the NAFTA. Classification will dictate which rules apply to trade in emission reduction units, and more importantly, which exemptions to these rules will apply. This note will briefly review the relevant treaties involved and then proceed to examine Canada's options under three possible classification scenarios.

The first classification scenario will assume that ERUs are classified as "goods" under the WTO and therefore subject to the requirements of the GATT and the NAFTA rules pertaining to trade in goods. This scenario will examine related past conflicts reviewed by GATT/WTO dispute resolution panels. Based on these past interpretations, this note will attempt to reconcile the potential conflict described above (between the NAFTA or the GATTAVTO and the Kyoto Protocol) by exploring the option of a Canadian unilateral sanction on U.S.-created ERUs.11 The second classification scenario will assume that ERUs are classified as "services" and are therefore subject to the requirements of the General Agreement on Trade in Services (GATS) under the WTO and the NAFTA equivalent rules. This scenario will discuss possible sub-sector classification within the financial services sector and compare the GATS and GATT stipulations with respect to exemptions. The third classification scenario will present an argument for why emission reduction units should be classified as neither "goods" nor "services," therefore falling outside the jurisdiction of the GATT/WTO and the NAFTA.

This note will then shift focus to discuss how the NAFTA Environmental Side Agreement may hold the potential to protect Canada's environmental laws (for example, the Kyoto Protocol) from a U.S. challenge under the NAFTA. Lastly, this note will touch on some alternative potential trade conflicts which may arise under the Kyoto Protocol's emissions trading system.

II. SUMMARY OF RELEVANT TREATIES

A. THE KYOTO PROTOCOL

1. Overview

The objective of the Kyoto Protocol is to achieve stabilization of greenhouse gas concentrations12 in the Earth's atmosphere at levels that will reduce the likelihood of adverse effects from climate change.13 Countries that are party to the treaty are divided into Annex B and non-Annex B14 parties. Annex B contains 39 members, including those parties that were members of the Organization for Economic Cooperation and Development (OECD) in 1992, as well as those countries in Eastern Europe whose economies were in transition to a market economy at that time. These countries were deemed to be "developed" in 1992 and subjected to legally binding obligations under the Kyoto Protocol. Non-Annex B parties include the developing economies of the G-77.15 The Kyoto Protocol will come into effect 90 days after 55 parties to the UNFCCC have ratified the Protocol as long as those 55 member signatures account for at least 55% of the total Annex B CO2 emissions for 1990.16 Considering the emissions data for 1990, two of the three largest emitters, the European Union, the Russian Federation, and the United States, will likely have to ratify the Kyoto Protocol for it to take effect.17

2. Emissions Reduction and Domestic Policy Requirements

The first commitment period for the Kyoto Protocol will be 2008-2012. During this time-frame, the overall goal is to reduce greenhouse gas emissions from Annex B countries to 5% below 1990 levels.18

To assist in meeting these commitments, the Kyoto Protocol requires parties to promote "sustainable development" through the incorporation of various domestic policy measures into future planning and development. These measures include commitments enhancing energy efficiency, protecting and creating greenhouse gas sinks,19 promoting sustainable agriculture, researching and promoting renewable energy and CO2 sequestration technologies, reducing and phasing out market imperfections20 that run counter to the objectives of the UNFCCC, encouraging policies aimed at greenhouse gas reductions, limiting or reducing greenhouse gases emitted by the transportation sector, limiting or reducing methane emissions through recovery and use in waste management, and sharing information with other members of the UNFCCC.

3. Flexibility Mechanisms

The Kyoto Protocol allows for three distinct flexibility mechanisms to assist Annex B parties in meeting their quantitative emission reduction commitments. The first of these flexibility mechanisms is joint implementation.21 Under this mechanism, two Annex B parties may jointly fulfill their commitments through a regional economic integration organization,22 such as the European Economic Community (EEC), or by engaging jointly in projects aimed at reducing emissions. These projects involve one Annex B party transferring or acquiring ERUs created through these emission reduction activities in the partner country.23

The second flexibility mechanism, emissions trading between Annex B nations,24 is closely related to the projects allowed for under joint implementation. An emissions trading system may create market incentives for parties to reduce emissions beyond commitments levels, reduce compliance costs, and create incentives for new technology development. The Kyoto Protocol will set a cap, or "assigned amount," to each party that will dictate their emission reduction requirements. Annex B parties that reduce their CO2 or CO2 equivalent emissions beyond their commitments under the Kyoto Protocol can sell that difference to another Annex B party.25 These "projects" must create reductions in greenhouse gasses that are supplemental to domestic action.26

Lastly, the Kyoto Protocol allows for a Clean Development Mechanism (CDM). The CDM allows for non-Annex B parties27 to create certified emission reductions (CERs) from projects that reduce greenhouse gas emissions. These CERs can be used to offset emissions in Annex B nations in order to help Annex B nations to meet commitments under the Kyoto Protocol.28

4. Trade Restrictions Embedded in Trading Rules

The Kyoto Protocol does not lay out detailed rules explaining the implementation of the above mentioned flexibility mechanisms, although the Conference of the Parties (COP) is currently negotiating these details.29 The Kyoto Protocol does specify, however, that Annex B parties may trade ERUs among themselves and may trade in CERs with countries not included in Annex B that are parties to the Kyoto Protocol.30 Implicit in this language is that Annex B parties may not trade with any non-parties to meet commitments under the Kyoto Protocol. It is anticipated that the final emissions trading rules will explicitly mirror this restriction.

B. THE GENERAL AGREEMENT ON TARIFFS AND TRADE (GATT)31/WORLD TRADE ORGANIZATION (WTO)32

1. Overview

The General Agreement on Tariffs and Trade was negotiated by the COP in 1947. The goal of this agreement was to encourage economic development by easing restrictions and liberalizing trade among contracting parties. Central to the agreement are three core principles: most favored nation, national treatment, and prohibition on import/export restrictions. Article I of the GATT outlines the most favored nation (MFN) principle. Under the MFN principle, each party agrees to accord unconditional equal treatment to all member nations.33 Therefore, no party may grant any privilege with respect to any imported product to any other party without giving those same privileges with respect to "like products"34 to all other GATT/WTO parties. Article III of the GATT outlines the national treatment principle, which requires that foreign goods imported to member states be treated in the same manner as "like products" produced domestically. In other words, this provision limits or eliminates economic advantages for domestically produced products over imported products.35 Lastly, Articles XI and XIII of the GATT govern the prohibition on import/export restrictions, which prohibit the use of quantitative "prohibitions or restrictions," such as bans, quotas, and import licenses on imports from member countries.36

2. Exceptions to Trade Restriction Under the GATT

Article XX Sections (b) and (g) of the GATT provide some exceptions to allow trade restrictions under specific conditions relating to environmental conservation and protection.37 Article XX provides a legal pathway for trade measures that would otherwise be in conflict with GATT obligations to deviate from those obligations. GATT Article XX requires that the measure meet the following conditions:

* It is necessary to protect human, animal, or plant life or health38 or

* It relates to the conservation of exhaustible natural resources if such measure is made effective in conjunction with restrictions on domestic production or consumption39

Trade measures meeting the above conditions may be exempt from conflicting GATT obligations as long as they do not constitute:

* a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail; or

* a disguised restriction on international trade40

As will be discussed below, in the event of conflict, GATT/WTO tribunals have tended to favor the interests of free trade over those of environmental protection.

C. THE NORTH AMERICAN FREE TRADE AGREEMENT41

1. Overview

The NAFTA, negotiated by the President Bush in the early 1990s and then modified and signed into law by President Bill Clinton on January 1, 1994, was developed to create a free trade area between the United States, Canada, and Mexico. It was designed to integrate the economies of Mexico, Canada, and the United States while keeping the political barriers firmly in place.42 The treaty was closely modeled after the GATT/WTO43 in its central goals of decreasing quantitative restrictions to trade through the decrease and elimination of trade barriers such as tariffs, taxes, and import licenses.44

The NAFTA contains several core objectives as defined in Article 102. They include the following:

* Reduction or elimination of trade barriers (such as sanctions, taxes, tariffs)

* Creation of conditions of regional fair competition

* Increased investment opportunities

* Protection and enforcement of intellectual property rights

* Procedures for the implementation and application of the NAFTA, including methodology for settlement of disputes

* Framework for further regional and multilateral cooperation to enhance the benefits of the NAFTA

Immediately following the implementation of the NAFTA in 1994, trade and foreign investment between the three countries increased dramatically.45 However, despite its economic advantages, like the GATT/WTO, the agreement has been widely criticized for its lack of social and environmental protection measures.46 For example, after the passage of the NAFTA, many U.S.-based companies moved to Mexico to take advantage of the lower labor costs and standards as well as the more lenient environmental protection regulations relative to the U.S. equivalents.

2. Trade - Environment Conflicts Under the NAFTA

With respect to trade-environment conflicts under the NAFTA, four categories have gained significant attention in recent years:47

* Domestic health, safety and environmental protection48

* Extrajurisdictional activity: endangered species,49 foreign pollution, and the "race to the bottom"50

* Transboundary Remediation51

* Trade-Environment Institutions52

3. Exceptions to Trade Restrictions Under the NAFTA

The NAFTA allows for many of the same exceptions as the GATT/WTO, allowing for trade restrictions under specific circumstances. However, the NAFTA has been considered more environmentally-friendly than the GATT/WTO because it adds additional allowances for exemptions related to environmental protection. The sections of the NAFTA that may potentially address environmental issues are covered in NAFTA Chapter 21, NAFTA Chapter 1 (art. 104), and the North American Agreement for Environmental Cooperation. Each of these is briefly described below.

i. NAFTA Chapter 21

The text of Chapter 21 of the NAFTA defers specifically to Article XX of the GATT/WTO. It says that for the purposes of trade in goods, "GATT Article XX and its interpretive notes, or any equivalent provision of a successor agreement to which all Parties are party, are incorporated into and made part of this Agreement." The chapeau to GATT Article XX dictates that these provisions apply as long as they are applied in a manner that does not "constitute a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail or a disguised restriction on international trade between the Parties." Historically, these exceptions have been interpreted very narrowly.53

ii. NAFTA Chapter 1

Article 104 of NAFTA Chapter 1 includes exemptions unique to the NAFTA. It specifies that in the event of any inconsistency between the NAFTA and any other such agreement, the NAFTA will prevail except when one of the listed Multilateral Environmental Agreements (MEAs) exists. Additionally, Article 104.1 sets out that additional MEAs may be added to the list provided that it is agreed upon in writing by the parties involved. The currently listed MEAs include: (a) CITES;54 (b) the Montreal Protocol on Substances that Deplete the Ozone Layer;55 (c) the Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and their Disposal;56 and (d) the agreements set forth in Annex 104.1. Article 104 specifies that these conditions will prevail when inconsistencies arise provided that "where a Party has a choice among equally effective and reasonably available means of complying with such obligations, the Party chooses the alternative that is least inconsistent with the other provisions of this Agreement."

iii. North American Agreement on Environmental Cooperation57

The NAAEC, also known as the environmental side agreement, was negotiated by the Clinton Administration to gain support for the NAFTA from environmental organizations.58 The NAAEC requires member countries to effectively enforce their own environmental laws, prohibits them from lowering their environmental standards, and requires them to try to improve them. The NAAEC will be discussed in greater length in Section VI below.59

III. ERUs CLASSIFIED AS "PRODUCTS"

Predicting the WTO or NAFTA classification of AAUs is a daunting task. There is no precedent for classification of AAUs or any similar instrument under the WTO or the NAFTA.60 The limited published work on the topic61 reveals arguments both in favor of and against the classification of AAUs as "products." Werksman recognizes the potential for their classification as "products" because AAUs will have a market value and may therefore be considered a "commodity." However, he goes on to argue that this classification is unlikely because WTO panels have historically interpreted "products" to be "tangible goods."62 Other authors repeatedly refer to AAUs as tradable "commodities" but do not offer any guidance for use of this term.63 Nevertheless, because the possibility does exist for AAUs to be classified as "products," this paper will discuss the potential implications of such a classification. Specifically, this paper will discuss the potential for Canada to exclude non-Kyoto Protocol nation derived AAUs from Canada's domestic trading market through statutory authority or exclusion. The following section will focus on the possibility for legal statutory exclusion of non-Party derived AAUs by way of GATT and NAFTA exemptions.

A. HISTORICAL DISPUTE RESOLUTION: STATUTORY EXCLUSION

In the event that Canada ratifies the Kyoto Protocol, it is likely that it will incorporate the Protocol into domestic law through statute. If this occurs, the trade restrictions contained in the Kyoto Protocol limiting the use of and trade in AAUs from non-Party nations may be effectively viewed as a unilateral trade sanction.64 At first glance, it appears that such a sanction would be impermissible under the NAFTA or the GATT/WTO rules. However, it is possible for a unilateral sanction to be placed on an exporting party's goods if the conditions fall under one of the NAFTA or GATT/WTO exemptions described in Section II(B) and (C) above.65

In the case of a trade dispute between Canada and the United States, a NAFTA panel, rather than a WTO panel, would likely hear the case.66 However, a NAFTA panel has yet to rule on a trade dispute based on imposition of a unilateral trade sanction. Therefore, because the relevant environmental provisions are identical under the NAFTA and the GATT/WTO, the following discussion will focus on how these types of disputes have been historically decided by WTO panels. Based on these past interpretations, we may gain insight into how a WTO or NAFTA panel will interpret the central conflict discussed in this note.

Dispute resolution panels tend to employ similar methodology in interpreting GATT Article XX(b) and (g). In interpreting Article XX(b), the panel will often ask three questions in order to determine applicability:67 (1) is the substance of the measure in question for the protection of human, animal, or plant life or health?; (2) is the measure necessary to protect human, animal, or plant life or health?; and (3) is the measure applied in such a manner so as to avoid arbitrary or unjustifiable discrimination or a disguised restriction on international trade? The operative language is the word "necessary," which can be interpreted in one of two ways. First, "necessary" can take the "protection of human, animal, or plant life or health" as its object and therefore be interpreted to mean that the measure taken is necessary for the protection of that object.68 Alternatively, it can be interpreted to mean that the measure is a necessary departure from the GATT because it "entails the least degree of inconsistency with other GATT provisions."69 The latter of these two interpretations has been favored by recent WTO panels.70

Mirroring the methodology employed in interpreting Article XX(b), interpretation of GATT Article XX(g) has often been carried out by dispute resolution panels based on the following analysis: (1) is the measure related to the conservation of exhaustible natural resources?; (2) does the specific measure relate to the protection of exhaustible natural resources?; (3) are the invoked measures made in conjunction with identical domestic measures or restrictions?; and (4) are the measures applied in accordance with the chapeau of Article XX?71 In answering these questions, the phrase "relating to" has sometimes been interpreted to mean that the measure is "primarily aimed at"72 conservation. However, as seen below in the U.S. Gasoline Standards panel decision,73 the scope of this interpretation has also been significantly limited through an alternate and more narrow interpretation of the phrase "relating to" to mean "necessary or essential."

In addition to direct interpretations of GATT Article XX(b) and (g), the question of extraterritoriality has also been subject to review and interpretation with respect to unilateral trade sanctions. The historical interpretation of extraterritoriality will be discussed in relation to the conflicting panel interpretations from the Tuna/Dolphin I74 and II75 cases. cases taken to WTO dispute resolution panels76 have challenged unilateral sanctions imposed by member nations which claimed that the imposed measures fell under one or more of the exceptions described above. Four of these cases are described below.77 Panel decisions are not binding on future panels and therefore do not offer concrete guidelines or arguments for future dispute settlement. However, they do offer a glimpse at the trends in interpretation of the law that we can expect under similar circumstances. Specifically, examination of these cases provides the framework from which we may analyze the outcome of a potential U.S. challenge to a Canadian sanction on U.S.-created AAUs.

1. Tuna/Dolphin I and II Cases

i. Historical Overview

Thousands of dolphins are killed incidentally as the result of "purse-seine" tuna fishing each year.78 In response to citizen concern over the fate of dolphins and other marine mammals, the U.S. Congress enacted the Marine Mammal Protection Act of 1972(79) (MMPA). The MMPA placed an embargo on tuna and tuna products from foreign nations if the tuna were harvested in a manner that was harmful to dolphins until such time as the Secretary of Commerce certifies that the incidental kill rate of dolphins for a particular nation is in compliance with U.S. standards.80 The MMPA also placed an embargo on intermediary nations.81 The unilateral sanctions imposed by the MMPA have been challenged a number of times under the GATT/WTO. As seen in the discussion below, the challenges were made citing GATT law that is replicated under the NAFTA. Therefore, the panel interpretations of the law are noteworthy in analyzing the potential for a Canadian sanction against U.S.-created AAUs to fall under one of the corresponding NAFTA exceptions.

ii. Tuna/Dolphin I Dispute

In 1991, Mexico requested that a GATT Dispute Resolution Panel be assembled82 to reconcile the disparity between the sanctions imposed by MMPA and U.S. trade obligations under the GATT. Mexico claimed that MMPA conflicted with GATT Articles III and XI. Additionally, Mexico claimed that the MMPA did not fall under any of the Article XX exceptions. Mexico argued that Article XX(b) did not apply because the embargo was not "necessary" to the protection of dolphin life and health because alternative means, consistent with the GATT (such as international cooperation through MEAs), were available. Additionally, Mexico argued that Article XX(g) was inapplicable because the United States was not primarily concerned with the protection of dolphins and that the measure was designed to create a disguised barrier to international trade.

The panel found Article III inapplicable because it only applies to "products," not "processes."83 They argued that tuna taken by purse-seine methods are the same as tuna taken by any other method and are therefore "like products" which cannot be discriminated. The panel also found that the MMPA did not qualify for exemption under any of the Article XX provisions. Their decision hinged on the interpretation of two key issues. The first was the use of the word "necessary," as discussed above. The panel interpreted the "necessary" requirement of Article XX(b) to "refer to the trade measures requiring justification under Article XX(b), [and] not . . . to the life or health standard chosen by the contracting party."84 Effectively, this meant that a nation can impose unilateral sanctions to protect the life and health of humans, animals, or plants only if it has exhausted all other alternatives. The panel decided that the United States had not met this requirement.85

The second issue of interpretation related to the ability of a nation to apply unilateral sanctions extraterritorially. The panel ruled that, although these were not disguised trade restrictions, natural resources and living things86 could only be protected under those provisions that were within the geographical jurisdiction of the country concerned. Similarly, in its interpretation of Article XX(g), the panel ruled that a party can impose "trade measures primarily aimed at conservation of exhaustible natural resources solely within their own jurisdiction."87 Therefore, the United States was not justified in imposing unilateral sanctions aimed at conserving dolphins in areas under Mexican jurisdiction. Because Article XX did not apply, the panel ruled that the United States was in violation of Article XI of the GATT.88

iii. Tuna/Dolphin II Dispute

In 1992, the European Economic Community (EEC), later joined by the Netherlands, filed a request for a WTO panel to review a similar issue with respect to EEC and Dutch fishing fleets. The EEC and the Netherlands challenged the intermediary nation embargo contained in section 1371(a)(2)(C) of the MMPA. They claimed that it violated Article XI of the GATT and that it was not an internal regulation permitted under GATT Article III. The EEC and the Netherlands also argued that GATT Article XX was inapplicable because the measures were taken outside U.S. jurisdiction. The United States claimed that the embargo was protected under GATT Articles XX(b),(g), and (d).89

The panel found that the intermediary nation embargo was not justifiable under GATT Article III, and therefore also violated Article XI. The panel's analysis of Article XX is of particular interest. In applying Article XX(g), the panel imposed a three-prong analysis similar to that described above in Section IV(A). First, the panel affirmed that dolphins are in fact an exhaustible resource and that the U.S. policy was indeed a measure designed at conserving that resource. Mirroring the argument adopted by Mexico in Tuna/Dolphin I, the EEC and the Netherlands argued that even if dolphins are an exhaustible natural resource, the United States could not impose its regulations extraterritorially to protect them. Unlike the decision in Tuna/Dolphin I, the panel disagreed and ruled that there was nothing in the text of the GATT to limit the scope of a protective measure to a nation's own jurisdiction.90

They did rule, however, that this extraterritoriality could only be applied with respect to the countries' own nationals and vessels. Nonetheless, Tuna/Dolphin is a landmark decision opening the door for the first time to the validation of extraterritorial measures aimed at protecting a natural resource.

Second, the panel examined the issue of whether the embargo was applied "in conjunction" with domestic restrictions and policies, and if those policies were primarily aimed91 at the conservation of dolphins. The panel found that the embargo did not meet this requirement because it restricted the importation of tuna products from affected nations regardless of whether the tuna was harvested in a manner harmful to dolphins. The panel also ruled that, because the primary embargo was not held against nations harvesting tuna in accordance with U.S. standards, even if their method was harmful to dolphins, the measure was not applied equally to all nations92 and therefore violated the GATT. Furthermore, the panel ruled that because the U.S. embargoes could not effectively conserve dolphins unless other nations changed their own domestic conservation policies in accordance with those of the United States, the primary and intermediary nation embargoes were not permissible under the GATT. Based on the above analysis, the panel found that the U.S. embargoes were also in violation of the chapeau to Article XX.

The analysis of Article XX(b) mirrored much of the panel's reasoning in its interpretation of Article XX(g). The EEC and the Netherlands again argued the issue of extraterritoriality. In accordance with its interpretation of Article XX(g), the panel ruled that nothing in the GATT limits the scope of a nation's unilateral policies as such. Second, the panel analyzed whether the embargoes were "necessary" to protect dolphin life and health. Again, in accordance with its analysis of Article XX(g), the panel ruled that it was not "necessary" because the policies could not accomplish their objectives without forcing domestic policy changes in the affected nations.93

2. Shrimp/Turtle Cases

i. Historical Overview

A dispute similar to those of the Tuna/Dolphin cases was brought before the WTO dispute resolution panel in 1997 by India, Malaysia, Pakistan, and Thailand.94 This dispute involved unilateral trade sanctions imposed by the United States upon countries whose shrimp harvesting methods resulted in the incidental killing of high numbers of sea turtles.95 In response, the National Marine Fisheries Service (NMFS) developed the Turtle Excluder Device (TED), which significantly decreased the numbers of sea turtles taken during shrimp harvesting operations.96 In 1989, Congress passed Section 609 of Public Law 101-162,97 which prohibits the importation of shrimp from countries whose shrimp harvesting methods fail to meet U.S. standards through the use of TEDs or other comparable measures.

ii. WTO Panel Decision

In arguing this case, the complainants contended that they already had domestic conservation plans in place aimed at the conservation of sea turtles and that use of a TED was not the only shrimp harvest method effective in avoiding the incidental takings of sea turtles.98 In response, the United States argued that the conservation measures taken by the complainants to protect sea turtles were ineffective and that use of TEDs on trawling vessels was necessary for the conservation of the species." In addition, the plaintiffs argued that the United States had violated GATT Article XI100 and that the embargo was not justified under GATT Article XX exemptions.101

The United States did not dispute that the embargo violated GATT Article XI(1); instead they argued that because the embargo was justified by Article XX(b), (g), and (d), the violation was irrelevant. Accordingly, the panel concurred that the embargo was in violation of GATT Article XI(1).

The complainants argued that Article XX did not justify the embargo because the United States could not invoke a measure to protect turtles outside of its jurisdiction. In evaluating the applicability of Article XX, the panel focused on the chapeau. The panel chose to interpret the term "unjustifiable" in the context of the overall object and purpose of the GATT: to promote economic development through free trade. The panel stated that a member is only justified in using Article XX exemptions to deviate from the requirements of the GATT when done in a way that does not undermine the objective of the agreement. Based on this interpretation, the panel ruled that Section 609 did not fall within the scope of Article XX.102

iii. WTO Appellate Body Decision

The dispute was brought to a WTO Appellate Body in 1998. The United States appealed the panel decision on two grounds: (1) The panel erred in finding that it could not review unsolicited information from NGOs; and (2) The panel erred in finding that Section 609 did not fall within the scope of Article XX.

The Appellate Body found that the panel had indeed erred in its interpretation of Article 13 of the Dispute Settlement Body (DSU). The Appellate Body ruled that the panel had the "discretionary authority either to accept and consider or to reject information and advice submitted to it, whether requested by the panel or not."103

Regarding the second issue, the Appellate Body ruled that the panel had erred in its interpretation of the chapeau. It ruled that the panel "did not inquire specifically into how the application of Section 609 constitutes a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail, or a disguised restriction on international trade."104 Additionally, the Appellate Body rejected the panel's chapeau-down approach. The Appellate Body stated that the appropriate way to interpret Article XX was primarily by justifying or rejecting its applicability under Sections (b), (g), or (d), followed by justification or rejection under the conditions in the chapeau.

In its analysis of Article XX(g), the Appellate Body addressed the issue of whether Section 609 applied to an "exhaustible natural resource." In accordance with past panel decisions, it ruled that sea turtles are indeed an exhaustible natural resource. Next, it examined whether Section 609 is "related to the conservation" of sea turtles. The Appellate Body found that based on the amount of scientific evidence provided to the panel regarding the mortality rate associated with shrimp trawling and the effectiveness of TEDs, the measure was indeed "related to conservation" of sea turtles. Lastly, the Appellate Body examined whether Section 609 was a "measure made effective in conjunction with restrictions on domestic" harvesting of shrimp. The Appellate Body found that indeed it was, as the United States had corresponding regulations affecting domestic fishing vessels.

Having justified Article XX(g)'s applicability to Section 209, the Appellate Body turned to the chapeau of Article XX. It examined the issues of "unjustifiable discrimination" and "arbitrary discrimination" as they relate to Section 609. In examining the issue of "unjustifiable discrimination," the Appellate Body ruled that the United States was indeed in violation. It found four reasons: (1) the embargo was aimed at forcing other member nations to adopt policy changes; (2) the embargo did not permit imports of shrimp from vessels using TEDs if those shrimp originated in waters under the jurisdiction of nations not certified under Section 609;105 (3) the United States failed to engage in multilateral negotiations to solve the problem before implementing the embargo; and (4) the United States gave differential treatment to different affected member nations through the application of phase-in periods and transfer of TED technology. Next, the Appellate Body looked at the issue of "arbitrary discrimination." It found that the "rigidity and inflexibility," as well as the lack of "transparency"106 of the certification process under Section 609 not only amounted to "arbitrary discrimination," but also violated GATT Article III(3).

Based on the above analysis, the Appellate Body ruled that despite the applicability of Article XX(g) to Section 609, the act failed to meet the requirements of the chapeau of GATT Article XX. Despite the final Appellate Body decision, this ruling is significant in that it opens the door for member nations to impose unilateral sanctions on other member nations provided that certain requirements are met.

3. Asbestos Case107

i. Historical Overview

In the Asbestos case, the Canadian government challenged a French ban on imports of asbestos or asbestos-containing products.108 The decision in this landmark case represents the first time that a WTO panel found that a trade measure in conflict with the substantive obligations of the GATT was justified under GATT Article XX. The case subsequently went to an Appellate Body, which, while upholding the panel's overall conclusion, chose not to rely on Article XX but instead focused on GATT Articles III:4 and XI. The Appellate Body ruled that the trade measure in question did not represent a violation of Article III and was therefore permissible under the GATT.

ii. Panel Decision

The Canadian government contended that the French ban violated GATT Article III because the asbestos products it exported to France were "like products" to substitute products manufactured in France. France claimed that the ban fell within the exemptions allowed for in GATT Article XX. The Panel employed a three-prong analysis in its interpretation. It analyzed: 1) the end uses of the products; 2) consumers' tastes and habits; and 3) the products' properties, nature, and quality.109 The Panel ruled that the Canadian and French products were "like products" because they had similar end uses. The ban was therefore in violation of the GATT Article III. However, the panel found the ban justified under GATT Article XX(b) as well as the GATT Article XX chapeau.

The panel ruled that the ban fell within the scope of GATT Article XX(b) because asbestos presented a significant risk to human health.110 The panel also ruled that the ban was indeed "necessary," because there did not exist an alternative method to protect human health that was "less inconsistent" with the requirements of the GATT.111 Next, the panel turned to the Article XX chapeau and examined the issue of "arbitrary or unjustifiable discrimination." It ruled that because France imposed the ban against all asbestos products regardless of their country of origin, the ban did not constitute "arbitrary or unjustifiable discrimination."112 Lastly, the panel examined whether or not the ban constituted a "disguised restriction on international trade." The panel concluded that because the sanction was published and the WTO was notified of the measure, it was not "disguised."113

iii. Appellate Body Decision

This decision was subsequently appealed to a WTO/GATT Appellate Body. The Appellate Body also reached a landmark decision. The Appellate Body found the French measure consistent with French obligations under the GATT. It concluded that the ban did not violate GATT Article III and therefore Article XX exceptions did not apply.

In reaching their decision, the Appellate Body focused on the definition of "like products." It stated that the panel had not analyzed the term "like products" thoroughly because the panel had not taken into account the "risk"114 factor in its analysis.115 The Appellate Body used a market-based approach in its interpretation. It examined: 1) physical properties; 2) end uses; and 3) tariff classification.116 The Appellate Body noted that the "physical properties" of the products must be analyzed in light of the effect that differences in such properties may have on the marketability of the products.117 It went on to write that the health risk should be included in the analysis of "physical properties," as well as with respect to "consumer taste." Based on these decisions, the Appellate Body found that the Canadian asbestos and the French substitutes were not "like products" because the Canadian products had an associated health risk while the French substitute did not.118 Based on these findings, the Appellate Body declined to review criteria based on "consumer taste and habits," or "tariff classification."119

B. UNDER WHAT CONDITIONS WOULD A CANADIAN-IMPOSED SANCTION ON U.S.-DERIVED AAUS BE PERMISSIBLE UNDER THE WTO/GATT AND THE NAFTA?

A close analysis of the decisions made in the cases described above, as well as some additional inquiry, must be employed before attempting to answer this question. Furthermore, the lack of formal binding precedent set by WTO panels on future WTO panel decisions and on future NAFTA panel decisions eliminates the guarantee with any degree of certainty that the conclusion reached by one panel would be followed by another. However, an examination of the facts at hand can provide insight into what would likely transpire if past interpretations of the law made by WTO panels are taken into account by future NAFTA panels. As noted above in Section II(C)(3), NAFTA Chapter 21 defers explicitly to GATT Article XX. Therefore, references to, and the language of, GATT Article XX will be used in the following discussion. The reader is advised that GATT Article XX is effectively the same as NAFTA Chapter 21 for the purposed of this analysis. The following section will apply the panel decisions discussed in Section III(A) above to the question of whether a Canadian ban on U.S.-created AAUs would fall within the scope of GATT Article XX.

1. Would a Canadian Unilateral Sanction Fall Under the Scope of Article XX?

The very nature of a unilateral sanction, or ban, conflicts with member obligations under the WTO/GATT and the NAFTA as it places a quantitative restriction on products imported from other member nations and thereby also favors like products created domestically. Therefore, a Canadian unilateral sanction imposed against U.S.-created AAUs would likely violate the NAFTA and the GATT's most favored nation (MFN) or national treatment principles, as well as their prohibitions on quantitative restrictions placed on imports from other member countries.120 However, GATT Article XX121 allows for exceptions to these requirements under specific conditions. Therefore, if the Canadian sanction can be justified under GATT Article XX, it may, nonetheless, be permissible under the GATT/WTO and the NAFTA. It is important to note, however, that to qualify for Article XX exemptions, AAUs must be deemed "products" under the GATT/WTO and the NAFTA. This assumption has been made below.

Based on the cases discussed above, there are a number of requirements that must be met in order for a unilateral Canadian sanction against U.S.-created AAUs to fall under the scope of Article XX. Each of these requirements is examined below.

i. Article XX(b)

Article XX(b) requires us to ask the question: is the measure related to the conservation of human, animal, or plant life or health? This is a difficult question to answer in that the sanction itself only protects Canada from economic loss as a result of not being able to account for U.S.-created AAUs under the rules of the Kyoto Protocol. Certainly, the sanction does indirectly protect human health in that it removes one potential barrier preventing Canada from participating in the Kyoto Protocol. The Kyoto Protocol in itself certainly pertains to, and is arguably necessary, to the conservation of human, animal, and plant life and health for a number of reasons. Among the threats to human health, scientific literature cites a number of problems associated with increased global temperature, including: increased death rate among the "very young, very old, and sick" populations; introduction of and increase of tropical diseases such as malaria, cholera, Lyme disease, and encephalitis; increases in air and water borne parasites; and loss of habitation due to increased sea level as polar ice caps melt.122 Animal life and health are also threatened by the effects of global warming.123 Lastly, scientific literature also suggests that plant life and health will suffer as a result of global warming. According to one peer reviewed journal article: "Indirect effects of elevated CO2 on trees and forests are likely to be as, or more important than their direct effects on photosynthesis. For example, elevated CO2 can decrease N[itrogen] concentrations and increase nonstructural carbohydrates and secondary metabolites, all of which can alter tree resistance to pests and herbivores . . ."124

It is unclear how a NAFTA panel may interpret an indirect link between the sanction and the requirements of Article XX(b). However, based on the historical trend of WTO/GATT dispute resolution panels to favor free trade over environmental and human health issues, it is unlikely that a NAFTA panel will be able to jump the gap and find a connection between the sanction and requirements of Article XX(b). Nevertheless, for the sake of argument, suppose a NAFTA panel does indeed find that the sanction is related to the protection of human health. In this case, the necessity of the sanction must be analyzed in conjunction with the policy the sanction is designed to protect.

Therefore, this question must be asked: is the sanction or the Kyoto Protocol "necessary" for the protection of human health? Depending on how one interprets the meaning of "necessary," as discussed in the above cases, the United States could use two broad arguments to assert that a sanction is not necessary: (1) there is a lack of scientific evidence on global climate change to justify that a reduction in greenhouse gas emissions is necessary to protect human health; and (2) the sanction or the Kyoto Protocol are not necessary due to the availability of other options that are "less inconsistent" with member obligations under the NAFTA.125

First, one must look at the interpretation of "necessity" as it relates to the protection of human health. U.S. participation in the UNFCCC serves as an acknowledgement of the global warming problem. Furthermore, U.S. participation in the Montreal Protocol126 is evidence to the fact that the methods undertaken by the Kyoto Protocol to slow down the effects of global warming and ozone layer depletion have been accepted by the United States in the past. Additionally, participation in negotiations leading up to the drafting of the Kyoto Protocol, as well as President George W. Bush's proposal of an alternative to the Kyoto Protocol relying on similar, but voluntary, measures also serve as a U.S. acknowledgement of the necessity for the emission reductions called for by the Kyoto Protocol. Lastly, the U.S. Environmental Protection Agency recently released a report acknowledging that climate change is a problem of concern.127

Regarding the second potential interpretation of the term "necessary," claiming that there are other options that would not require the use of a sanction forcing Canada to deviate from its obligations under the NAFTA, there are a number of issues to consider. First, and foremost, it is absolutely imperative that before employing a unilateral sanction, Canada engage in extensive discussions with the United States in an attempt to solve the problem multilaterally. As seen in the Tuna/Dolphin cases, as well as in the Shrimp/Turtle case, the panels strongly emphasized the importance of attempting to resolve conflicts between international trade agreements and MEAs through the multilateral negotiation rather than resorting to unilateral action. The NAFTA itself, in Chapter 21 Section 104, permits for amendment to the agreement in order to list additional MEAs, such as the Kyoto Protocol, as exempt from the obligations of the agreement. If this outlet were not properly exhausted before the implementation of a unilateral sanction, the results would likely be catastrophic to Canada's case.

For the purpose of discussion, assuming the United States refuses to amend Section 104 to include the Kyoto Protocol, the burden still remains on Canada to demonstrate that it has exhausted all other options to resolve the problem of global climate change without causing them to deviate from their obligations under the NAFTA. If such a demonstration is made, the Kyoto Protocol, and thus the sanction protecting it, may qualify as "necessary" under this second interpretation of the term. Evidence that all options have been exhausted will be found in the extent to which the international community, including the United States, has been involved in negotiations surrounding the problem of climate change since the inception of the UNFCCC. The mere existence of the UNFCCC, and the series of negotiations and discussions that have been undertaken, is further evidence to the fact that other options have been explored and rejected, justifying the necessity of the Kyoto Protocol in combating the problem. Easily, President George W. Bush's widely criticized alternative to the Kyoto Protocol and its rejection by the international community as a viable alternative could be evidence to the fact that all other options have been explored and rejected. Therefore, Canada should be able to argue successfully that a unilateral sanction on United States and all other non-party nation derived AAUs falls within the scope of Article XX(b) or the NAFTA equivalent.

ii. Article XX(g)

Article XX(g) requires asking the question: does the measure relate to the conservation of an exhaustible resource? Upon answering this, we are left with the same predicament. Although the Kyoto Protocol is related to the protection of many exhaustible natural resources (such as island nations, coastal habitats, polar ice caps, and fishing industry resources), the sanction itself is a form of economic protection and not in itself directly related to the protection of these resources.

For the sake of argument, assume that a NAFTA panel accepts the fact that, although not directly linked, because the sanction is a necessary precursor to Canadian participation in the Kyoto Protocol, it is in fact "related to" the conservation of exhaustible resources. This raises the question of whether the measure being invoked is made in conjunction with domestic measures or restrictions. The answer to this question will ultimately lie in the wording of the sanction itself. The sanction must be framed so as to affect participation in the Kyoto Protocol's emissions trading system at an individual, corporate, national, and international level equally. If it fails to do so, the sanction would not have a direct effect on domestic Canadian industry and may therefore be found to violate National Treatment principle. In the absence of an explicit reference, it may be argued that the sanction is not being invoked in conjunction with domestic measures.128 Simple testimony to Canada's participation in the Protocol may not be enough. Canadian policy must explicitly affect any emitter, Canadian or not, who is not in compliance with, or working towards meeting Kyoto Protocol commitments.

iii. Article XX Chapeau

Assuming that the sanction and the associated Kyoto Protocol are justified under either Article XX(b) or (g), the panel would then turn to analysis of the chapeau of Article XX. The chapeau first requires examination of whether the measure represents arbitrary or unjustifiable discrimination against international trade. Assuming the sanction affects all nations equally, the sanction is not arbitrary discrimination but equally imposed, calculated discrimination. Under these circumstances, the Canadian government has carefully chosen who will be affected by the ban and has presumably given good reason for the ban. For example, the ban may exclude those who chose not to participate in the protection of the human, animal, and plant life and health through membership under the Kyoto Protocol.

The question of whether the sanction is "justifiable discrimination" is a bit more complicated. Clearly, Canada is justified in its concern that if forced to accept U.S.-created AAUs, it will not be able to account for them in order to meet Canadian requirements under the Kyoto Protocol. However, the Tuna/Dolphin I and II panels ruled against the United States because they interpreted its unilateral trade sanction as unjustifiable in that it forced domestic policy changes on other member nations as a precondition for those nations to gain access to U.S. markets. This appears to be the critical issue. It is quite likely that a unilateral Canadian sanction on non-Kyoto Protocol member-created AAUs will be viewed as a sanction designed to force policy changes, (such as the adoption of the Kyoto Protocol), by NAFTA or WTO member nations who are not party to the Protocol at the time of implementation of the sanction. The Tuna/Dolphin II panel explicitly stated that unilateral measures129 attempting to influence policy changes in other member nations are not acceptable under the GATT/WTO.130 On the other hand, other GATT/WTO panels, such as the Appellate Body reviewing the Shrimp/Turtle case, recognized that unilateral sanctions are inherently designed to influence policy changes in nonconforming nations, and that in some cases and under certain conditions, this may be justified. The Appellate Body approaches recognition of the fact that a unilateral sanction is initially imposed to account for differences in domestic policy. Therefore, ruling that such sanctions are unconditionally unjustifiable under the GATT or the NAFTA would deem the Article XX exemptions essentially self-defeating. Specifically, the Appellate Body stated:

Conditioning access to a Member's domestic market131 on whether exporting Members comply with, or adopt, a policy or policies unilaterally prescribed by the importing Member may, to some degree, be a common aspect of measures falling within the scope of one or another of the exceptions (a) to (j) of Article XX. Paragraphs (a) to (j) comprise measures that are recognized as exceptions to substantive obligations established in the GATT 1994, because the domestic policies embodied in such measures have been recognized as important and legitimate in character.132

The Appellate Body added: "We have not decided that the sovereign nations that are Members of the WTO cannot adopt effective measures to protect endangered species, such as sea turtles. Clearly, they can and should."133

Unfortunately, the Appellate Body does not specifically clarify how a member nation can do this without violating WTO or NAFTA restrictions. Therefore, it is necessary to look at specifics of their interpretations for direction. Although this is a step in the right direction, because WTO panel decisions are not binding on future WTO or NAFTA panels, one is left with uncertainty as to how any particular panel will interpret the law at hand. However, the above analysis provides some direction as to how policy actions designed to protect a market in AAUs may circumvent the NAFTA or the GATT/WTO restrictions.

IV. EMISSION REDUCTION CREDITS: CLASSIFIED AS "SERVICES"

Another, arguably more likely, possibility is that the GATT/WTO or the NAFTA will classify AAUs as "services." If AAUs are indeed classified as "services," they will be subject to the rules contained in the GATS. The GATS contains many of the same stipulations as the GATT, including clauses mirroring the most favored nation (MFN) principle134 and the national treatment principle.135 Additionally, the GATS contains a clause dictating that domestic market access be accorded equally to all member nations.136 Therefore, member obligations to these principles may conflict with obligations under the Kyoto Protocol emissions trading system in the same way as discussed in Section III above. In the event that AAUs are classified as "services" and a Canadian unilateral sanction is challenged by a WTO or NAFTA member nation not party to the Kyoto Protocol, a WTO or NAFTA tribunal would hear the case. Irrespective of AAU classification (i.e., goods or services), the same rules would apply in terms of MFN and national treatment. Therefore, it is likely that a similar line of reasoning would be employed as discussed in the Section II(A) cases above. The following section will examine the key differences between the GATT and the GATS as they relate to trade in AAUs. Furthermore, this section will discuss how these differences could affect trade in AAUs.

A. GATS EXCEPTIONS

1. General Exceptions

The GATS contains a similar, albeit more narrow, environmental exception to the GATT:

Subject to the requirement that such measures are not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where like conditions prevail, or a disguised restriction on trade in services, nothing in this Agreement shall be construed to prevent the adoption or enforcement of any measures:

(a) necessary to protect public morals or to maintain public order;

(b) necessary to protect human, animal, or plant life or health;

(c) necessary to secure compliance with laws or regulations which are not inconsistent with the provisions of this Agreement. . . .137

Although this clause is almost identical to that found in the GATT Article XX, looking carefully at the language reveals one key difference. The GATT requires that for this exemption to be used, "same conditions," in other words, identical conditions, must exist in the two countries involved. The GATS solely requires that "like conditions," in other words, similar conditions, exist in the two countries involved.138 This shift in language clearly broadens the coverage of the GATS agreement in comparison to the GATT. Such language will make it more difficult to exempt trade in AAUs between the United States and Canada based on differences in the "conditions" in the two countries. Moreover, it is difficult to predict how a WTO dispute resolution panel would interpret this exemption with respect to the emissions trading system established by the Kyoto Protocol, because to date this provision has yet to be interpreted by such a panel.

2. Exempted Services

The GATS differs most significantly from the GATT in that, unlike the GATT, it is not entirely inclusive of all services. Whereas the GATT strictly controls all trade related to goods among members, the GATS does offer some options for exclusion with respect to trade in services. Member nations have two options to restrict application of the GATS to specific service sectors. First, GATS Article XX139 requires each Party to designate which specific service sectors are subject to GATS compliance. All service sectors except those named therein must fully comply with the GATS market access and national treatment requirements. These choices are documented in each member's GATS Schedule of Commitments. Therefore, parties may impose quantitative restrictions and restrict market access to trade in specific services with respect to market access and national treatment obligations.

Second, each party has the opportunity to exempt from GATS restrictions specific measures that would otherwise violate its obligations under the MFN principle. This exemption only applies to the restricted service for a limited period of time, generally not to exceed 10 years.140 These options may provide an avenue to exempt trade in AAUs from the provisions outlined in the GATS agreement. Exploring this possibility requires asking: (1) If AAUs are classified as "services," to which sector of services will they belong?; (2) Whether Canada has fully liberalized that service sector, thereby subjecting trade in AAUs to GATS national treatment and market access obligations; and (3) If so, whether there is a way to list trade in AAUs as an exempted service. Each of these questions is discussed below.

i. Service Sector Classification

Jacob Werksman suggests that AAUs might be covered by the GATS Fifth Protocol on Financial Services.141 Within the Financial Services sector there are three sub-sectors under which AAUs may be classified. Werksman suggests the possibility that AAUs may be considered "negotiable instruments" and therefore subject to GATS142 trade restrictions.143 A "negotiable instrument" is:

A written instrument144 that (1) is signed by the maker or drawer, (2) includes an unconditional promise or order to pay a specified sum of money, (3) is payable on demand or at a definite time, and (4) is payable to order or bearer . . . .145

If the international emissions trading system guidelines are designed in a manner similar to that of established U.S. systems, it is likely that AAUs will be documented in both electronic and paper certificate form. It is unlikely that these certificates will contain all four requirements listed above to be considered "negotiable instruments." Although the certificate itself may indeed have the signature of the maker or drawer (i.e., government agencies responsible for creating them), it is unlikely that it will also state an unconditional promise to pay a specified sum of money on its face. As is the case in U.S. domestic markets, a contract associated with the sale of an AAU will likely contain this information. Therefore, perhaps the contract negotiated to purchase or sell a specified quantity of AAUs may be considered a "negotiable instrument." However, because the contract is once removed from the AAU certificate, (i.e., it merely facilitates the trade, and is not the object of the trade), it is difficult to determine whether the AAU certificate would be considered a "negotiable instrument."

A second possibility is that AAUs will be classified as "financial assests." The GATS Annex on Financial Services also subjects trading in all "other financial assets" to GATS provisions. Some may argue that a certificate documenting ownership is not a financial asset, but instead a permit allowing a particular activity. However, an AAU certificate indeed appears to be a "financial asset" because it can be bought and sold in an open market system. Assuming that international emissions trading markets work in a similar manner to U.S. emissions trading markets, one does not have to be an affected source to participate or profit from trading activities. In other words, there are no existing provisions preventing traders or other unaffected profiteers from participating in the market. Therefore, because one can profit from the market without having any need for an actual "permit" to pollute, an AAU certificate should indeed be considered a "financial asset."

A third alternative would treat AAUs as "securities," and thus trade in this service would be regulated by the GATS. A "security" is defined to include

any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, or, in general, any interest or instrument commonly know as a "security," or any certificate of interest or participation in, temporary or interim certificate for receipt for, guarantee of, or warrant or right to subscribe or to purchase, any of the It is possible that an AAU certificate may be considered a "transferable share" because (1) it is transferable from one person or government to another person or government; and (2) it represents the ownership of a portion of total allowable carbon dioxide, or carbon dioxide equivalent, emissions.147 If an AAU certificate were considered a "security," it would certainly apply to the AAU certificate itself and not the contract negotiated for the sale of such a certificate as may be the case if AAUs are classified as "negotiable instruments."

If an AAU were considered a "negotiable instrument," a "financial asset," or a "security," it still remains unclear whether that "negotiable instrument," "financial asset," or "security" is itself considered a "service," or, alternatively, if this simply applies to the process by which they are traded. A more pertinent issue may thus be the effects of allowing market access into an international emissions trading system to non-Kyoto Protocol member nations. As described above, a financial service includes "trading for own account or for account of customers, . . . negotiable instruments and financial services."148 Therefore, if AAUs are considered "negotiable instruments," "financial assets," or "securities," the process by which they are traded149 will likely be subject to GATS provisions. Brokerage houses that broker client AAU trades may be considered "service suppliers" because they provide the "service" of trading a financial asset, even if that particular financial asset is not covered by the GATS.150

If this is the case, it is likely that Canada will be forced to allow U.S. brokerage houses to participate in a Canadian AAU market. In other words, Canada could not restrict market access to these U.S. financial service providers. The GATS does not restrict financial service providers with respect to client nationality, therefore, U.S. brokerage houses may be able to provide legal market access to U.S. corporations or investors. These U.S. organizations or individuals could potentially profit from an AAU trading system, regardless of the fact that they may not have taken on the economic burden of mandatory, legally binding emission reductions at home.151

ii. Implications of Canada's Schedule of Commitments

Once we have determined which service sector AAUs eventually fall into, we must then determine if that service sector is subject to GATS requirement. In order to ascertain which sectors of its services are fully subject to these agreements, we must look to Canada's Schedule of Commitments152 under the GATS and the NAFTA. Canada has liberalized all sectors of trade in financial services under the GATS, with the exception of some Provincial exceptions, which will not be discussed in this paper. Although they have set a number of reservations and requirements for foreign financial service suppliers, none are likely to affect a U.S.-owned brokerage house engaging in brokerage of AAUs, particularly if the company has an office located within Canada with Canadian employees.

Furthermore, under the NAFTA, Canada has fully liberalized trade, except with respect to cross-border trade in securities. Canada has reserved the right to adopt any measure relating to cross-border trade in securities services that derogates from Article 1404(1)153 or, with respect to the United States, from Article 1406.154 Therefore, only if AAUs are classified as "securities" will it be possible for Canada to restrict U.S. participation in a Canadian AAU market. Otherwise, it is likely that the GATT/WTO or the NAFTA may prohibit Canada from imposing restrictions on either the country of origin of AAUs or on countries allowed market access.

Werksman suggests that although a party may not be able to place quantitative restrictions on the "import" of these services, once the service has been "imported," the GATS cannot prohibit Canada from refusing to recognize the validity of these services.155 In other words, if that WTO/NAFTA member is not also party to the Protocol, the GATS does not prohibit Canada from prohibiting use of those allowances to meet Kyoto Protocol commitments. Furthermore, neither the GATS nor the NAFTA will require Canada to purchase any specific quantity of AAUs from the United States. This means that although brokers and other private entities in Canada may be free to purchase allowances from any WTO or NAFTA member nation, the credits may nonetheless be worthless once they have entered the country. A well organized accounting system and registry for AAUs is imperative under this scenario and will likely ensure protection of Kyoto Protocol member nation-derived AAUs from economically unfair trading practices.156

V. FLESHING OUT THE GATT/GATS AND THE POSSIBILITY OF NON-VIOLATION157

It is possible that Article XX of the GATT, Article XIV of the GATS, or both will fail to justify a Canadian unilateral sanction imposed upon U.S.-created AAUs by the reasoning discussed in the preceding sections. With this in mind, it is prudent to flesh out the text of the GATT and the GATS more completely and examine alternative points of argument that may not as yet have been explored. Additionally, it is possible that, as in the Asbestos Appellate Decision, a WTO or NAFTA tribunal may find that trade in AAUs is in accordance with the GATT, the GATS, and the NAFTA. In order to explore the possibility of this option, the two core principles common to all three agreements must be examined. Lastly, it is possible that trade in AAUs will not fall within the scope of the GATT, GATS, or the NAFTA. The following section will first look to alternative arguments based on subtleties of semantics in the trade agreements, as well as the possibility for the United States to utilize the non-violation provisions of the GATT, GATS, or the NAFTA. It will then turn to a close examination of the MFN and national treatment principles and discuss the conditions necessary to escape violation of these principles within an international emissions trading system. Lastly, this section will touch on the possibility of AAUs falling outside the scope of these agreements.

A. ALTERNATIVE ARGUMENTS

The discussion in the preceding sections analyzed the possibility for a Canadian ban on U.S.-created AAUs to fall within the scope of the GATT, the GATS, or the NAFTA environmental exemptions. Thus far, this paper has only looked at this possibility based on arguments used in previous disputes. It is possible that the text of these environmental exemptions, in particular the chapeau to Article XX, can be broken down further in search of a valid argument. Furthermore, it is possible that the United States or other non-Kyoto WTO member nations will utilize the "non-violation" clause contained in the GATT and the GATS. The following section will discuss these two scenarios.

1. The Chapeau

An alternative argument requires looking back at the GATT Article XX chapeau:158

Subject to the requirement that such measures are not applied in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail, or a disguised restriction on international trade, nothing in this Agreement shall be construed to prevent the adoption or enforcement by any contracting party of measures . . . .159

As discussed in Section III(B)(1)(iii) above, based on past panel decisions, a Canadian sanction will likely be viewed by a NAFTA dispute resolution panel as "unjustifiable discrimination." This is because the sanction may be seen to force policy changes in NAFTA member nations in order for the affected nation to gain market access into the Canadian emissions trading market. However, the conditional part of the chapeau states that the sanction must meet this justifiable requirement "in countries where the same conditions prevail." Therefore, one must now examine whether or not "the same conditions prevail" in the United States and Canada pursuant to NAFTA Chapter XXI.160 It can be argued that because, unlike the United States, Canada is undergoing significant changes in its industrial sector to reduce CO2 and CO2 equivalent emissions to 1990 levels pursuant to its obligations under the Kyoto Protocol, the "same conditions" do not "prevail" in the two nations. Under these conditions, the sanction would meet the exemption requirements of NAFTA Chapter XXI and corresponding GATT Article XX. As discussed in section IV(A)(1) above, it is interesting to note the shift in language between the GATT and the GATS with respect to this particular clause with regard to "same" or "similar" conditions, respectively. Clearly, this shift in language expands the scope of the GATS provisions and narrows the room for exception to these provisions under the agreement. It is difficult to ascertain how this argument would be interpreted as it pertains to the GATS because it has yet to be heard in such a context. It is unclear what conditions are sufficient to categorize conditions in two separate countries as "like" as opposed to "same." Furthermore, it is unclear whether this difference in the use of words will be viewed as mere semantics.

2. Nullification or Impairment

Another potential argument lies within GATT Article XXIII and GATS Article XXIII. These articles contain language intended to further protect the member benefits under these two agreements and allow a party to file a complaint against another party if the former believes that its benefits under the GATT/GATS have been nullified or impaired. This clause allows for a complaint to be filed regardless of whether the "offending" party has violated any GATT161 or GATS162 provisions. These proceedings can result in one party being authorized to "suspend the application to any other contracting party or parties of such concessions or other obligation under [the GATT],"163 or in the "modification or withdrawal of the measure."164 Three specific elements must be present in order to establish an Article XXIII claim: (1) the existence of an applied measure by a WTO Member; (2) the existence of a benefit accruing under the relevant agreement; and (3) nullification or impairment of the benefit as a result of the measure.165

Under Article XXIII of the GATT or GATS, the United States may have standing to seek compensation for a Canadian measure excluding their participation in an AAU market. Two requirements must be met for a GATT Article XXIII complaint to be filed.166 First, "the measure in question cannot have reasonably been anticipated by the complaining party at the time the concession was negotiated."167 Second, "the measure in question must have damaged the competitive position of the imported product concerned."168

The United States will likely be able to meet the second requirement, because it is likely that the market value of U.S.-created AAUs will be dependent on access to, and verification under, the Kyoto Protocol emissions trading system. Furthermore, past disputes under this issue have demonstrated169 that a party need not prove definitive changes in trade flow before and after a measure was instituted. A party need merely prove that an "abstract adverse change in competition"170 has occurred. One author argues that GATT/GATS Article XXIII provide a "panacea" for invalid complaints.171 Although the laws and drafting of history may dictate a strict correlation between result and causation, the panels have not always interpreted the law in accordance with this standard.172 The method by which a WTO dispute resolution panel analyzed and ruled on such issues is exemplified in the following landmark case involving the film manufacturing industry in Japan.

i. Fuji/Kodak Case

In 1995, the United States filed a complaint against Japan regarding the Japanese film manufacturing market. The United States contended that even if Japan had not violated any of the GATT provisions, some benefits to the United States as a GATT 1994 member were nonetheless nullified or impaired. The United States claimed that Japan had performed actions to: (1) create an exclusive distribution sector; (2) restrict the growth of large stores; and (3) restrict the use of sales promotions.173 The panel eventually found the U.S. claims unfounded because the United States could not prove that the measures caused any nullification or impairment. However, this panel's four-step analysis of GATT Article XXTII is noteworthy because it sets guidelines for future panels on how to interpret this Article. If future panel decisions follow the lead of the Fuji-Kodak panel the United States will potentially feel justified in bringing a nullification or impairment suit before a WTO panel concerning the case of a Canadian unilateral sanction on U.S.-created AAUs.

* Actionable Measure - First, the panel looked at the issue of what constitutes an actionable "measure" under Article XXIII. It clarified that the scope of a "measure" was greater than merely a "subsidy" and could include virtually any type of government measure. In fact, it went so far as to allow for actions originating in the private sector that are actually "quasi-governmental" in nature.174

* Reasonable Anticipation of Benefits - Next, the panel analyzed what it means for a benefit to be "reasonably anticipated." It ruled, in accordance with past GATT panels,175 that for benefits accruing from a measure to be legitimate, the challenged measure must not have been "reasonably anticipated" at the time that the tariff concession was negotiated. Furthermore, the panel noted that in order for a measure to be "reasonably anticipated," the measure must have been introduced prior to the closing of the most recent round of tariff negotiations. However, not all cases are linked to tariff concessions. These types of cases are called "independent mode" cases, for which there is little history on how to base correct interpretation of this standard.176

* Nullification or Impairment As a Result of the Measure - Thirdly, the panel examined the relationship between the alleged "nullification or impairment" and the applied measure in question. The panel stated that it is imperative for the measure to have made more than a "de minimis"177 contribution to the alleged nullification or impairment. In making this decision, the panel set a fairly loose standard of causation.

* Detailed Justification Standard - Lastly, the panel examined the evidentiary standard that a party must meet to show injury. Past panels had used the "detailed justification standard," requiring a party to show "detailed justification" that the measure has caused nullification or impairment of a reasonably anticipated benefit. The panel veered from this interpretation and accepted U.S. claims that "detailed justification" was solely a pleading requirement rather than an evidentiary standard.178

Based on the four-part analysis detailed above, it is likely that a measure restricting market access to a Canadian emissions trading market will constitute an actionable measure under GATT/GATS Article XXIII. It is also likely that there will be an economic impairment to the U.S. emissions trading market if the United States is not allowed access. Thirdly, if "detailed justification" is interpreted as solely a procedural pleading requirement, it should not be a difficult hurdle to overcome. Lastly, because of the lack of case law dictating guidelines for interpretation in "independent mode" cases,179 the question of whether the United States is justified in reasonably anticipating benefits from Canadian emissions trading system is difficult to ascertain. It would seem that based on the market access provisions in the GATS and the Nation of Origin provisions under the GATT, the United States would be justified in anticipating the benefits of market access to this trading system. However, without legal precedent on which to base this analysis, comment here is purely speculative.

B. NON-VIOLATION

In contrast to the alternative arguments that could assist a U.S. challenge, it is possible that a NAFTA panel will decide that a Canadian ban is actually in accordance with Canadian obligations under the NAFTA. There are two pathways by which a Canadian sanction on U.S.-derived AAUs would withstand a GATT/GATS or NAFTA challenge. The first of these pathways is if the sanction is found to be consistent with Canada's obligations under the GATT, GATS, or the NAFTA. Specifically, the sanction would have to be consistent with the MFN and national treatment principles of these agreements. The second way in which the sanction could withstand a GATT, GATS, or NAFTA challenge is if AAUs were determined to be out of the scope of these agreements. This would be the case if AAUs were determined to be neither goods nor services.180 These two alternatives will be discussed in the following two sections.

1. MFN and National Treatment Principles

The WTO Asbestos Appellate Body decision reflects a landmark decision in its ruling for the first time that a unilateral sanction excluding certain products from the French market did not violate the MFN or national treatment principles. As discussed above, the appellate body focused on the term "like product" and reached the conclusion that asbestos products manufactured in Canada were not "like products" to the substitute products manufactured in France. The WTO defines the term "like product" as "a product which is identical, i.e., alike in all respects to the product under consideration or, in the absence of such a product which, although not alike in all respects, has characteristics closely resembling those of the product under consideration."181 The Appellate Body classified "like products" based on the following criteria: (1) physical properties of the products; (2) the end uses of the product; (3) consumers' tastes and habits; (4) tariff classification; and (5) the risk associated with the product.182 It is possible that through similar analysis Canadian and U.S.-created AAUs also be found not "like products." In order to ascertain the likelihood of this possibility, we must look back to the interpretation used by the panel and appellate body in the Asbestos case. This line of reasoning is employed below.

i. Physical Properties of AA Us

If AAUs are classified as products, the physical properties of AAUs created in the United States versus those created in Canada will remain virtually identical. One cannot distinguish between carbon emissions on a physical basis, therefore this point will not likely carry any weight in establishing a significant difference between AAUs created in Canada versus those created in the United States.

ii. End Uses of AA Us

The end uses of AAUs created in the United States, in contrast to those created in Canada, provide a platform to argue that these products/services are not "like." AAUs created in Canada, or any other Kyoto Protocol member nation, will be used to meet emission reduction obligations under the Kyoto Protocol. Even if Canada is forced to accept AAUs created in the United States, or any other non-Kyoto Protocol member nation, into a Canadian market, these AAUs will likely not be permitted for use to meet these obligations. Therefore, the end uses of these two products/services are fundamentally disparate.

iii. Consumer Tastes and Habits

Consumer tastes and habits also provide a platform on which to argue that AAUs created in the United States and Canada are not "like" products/services. Based on the author's experience brokering emission reduction credits domestically in the United States, there are two major issues governing consumer tastes and habits with respect to purchasing emission reduction credits. The first concern consumers have is: will the appropriate regulatory body recognize the credits for the purposes of regulatory compliance? Consumers will likely prefer to purchase AAUs that are certain to be recognized by the Canadian government. Furthermore, when the Canadian government is the consumer, it is even more likely that the consumer will prefer to purchase AAUs that can be used to meet Canadian obligations under the Kyoto Protocol.

The second concern consumers often have is the price of the credits. AAUs created in the United States would likely cost less because of the associated risk that the credits may not be recognized by the Canadian government. However, because of the cost associated with creating emission reduction credits, this price differential will likely not be enough to override the risk factor. Therefore, consumer tastes and habits may indicate that U.S.- and Canadian-created AAUs are not "like" products or services.

iv. tariff classification of AAUS

For all intents and purposes, apart from meeting obligations under the Kyoto Protocol, all AAUs are identical. Therefore, this paper will assume that AAUs created in the United States and those created in Canada will be similarly classified with respect to tariffs. Under this assumption, tariff classification does not support the argument.

v. risk associated with use of AAUS

As discussed above, in conjunction with "consumer tastes and habits," the primary risk associated with the use of U.S.-created AAUs is that the credits will not be recognized by the Canadian government for the purposes of compliance with domestic or international obligations. If consumers purchase credits that cannot be used for compliance, they face the risk of economic loss through penalties or the necessity to purchase valid credits that can be used for compliance. The Asbestos Appellate Body decided that a French ban on Canadian asbestos products was justified because the Canadian product had an associated health risk. In the case of a Canadian ban on U.S.-created AAUs, the risk is economic, not health-related.

If by the reasoning above AAUs created in non-Kyoto Protocol member nations are not considered "like" products or services to those created in Kyoto Protocol member nations, trade in AAUs will likely fall outside the scope of the GATT, the GATS, and the NAFTA national treatment and MFN principles. Therefore, if a U.S.-created quantified emission reduction is not a "like" product or service to a Kyoto Protocol-approved AAU, it would likely not be subject to equal treatment under the NAFTA, which prohibits quantitative restrictions on "like, directly competitive, or substitutable products" from member nations.183

2. AAUs: Not Within the Scope of the WTO or NAFTA

Alternatively, Canada may withstand a U.S. challenge if a panel deems that AAUs are not an entity that is governed by the WTO or the NAFTA. Although the literature on this topic is sparse, those who have written on the topic of AAU classification184 find it very possible that AAUs will be considered neither "goods" nor "services" under the WTO or the NAFTA. The UNCTAD suggests that the WTO may view AAUs as neither goods nor services because AAUs "exist by virtue of an international agreement and their sole use is for meeting sovereign obligations under that agreement."185 Under this scenario, restricting trade in AAUs to Kyoto Protocol member nations would not be subject to WTO or NAFTA rules. However, these authors also recognize that "in the absence of a WTO ruling, the risk remains that WTO rules apply [to trade in AAUs]."186 AAUs represent a completely new "commodity," which could warrant a completely new category of classification under the WTO or the NAFTA. Furthermore, because AAUs are proving so difficult to classify, this uncertainty could leave room for a politically motivated decision, one therefore even more difficult to predict.

VI. CAN THE NAAEC PROTECT CANADIAN CLIMATE CHANGE POLICY?

Lastly, it is possible that the North American Agreement on Environmental Cooperation (NAAEC) may be able to protect a Canadian sanction on U.S.-created AAUs. The NAAEC requires that NAFTA member nations enforce and improve their environmental standards and policies. Under these requirements, Canada may be able to institute domestic policy restrictions on trade in AAUs so long as the policy is clearly designed to protect the environment. The NAAEC protects domestic environmental legislation. Therefore, it probably does not matter if AAUs are classified as "products" or "services."

The NAAEC may offer protection for Canada if the trade restrictions embedded in the Kyoto Protocol187 come under attack by non-Kyoto Protocol parties that are party to the NAFTA.188 The following section will provide a detailed description of the environmental protection measures provided for in the NAAEC, briefly discuss the process by which those environmental protection measures can be enforced, and finally discuss how Canada may be able to use this agreement to justify domestic implementation of the trade restrictions mandated by the Kyoto Protocol.

A. NAAEC: ENVIRONMENTAL PROTECTION PROVISIONS

The NAAEC contains measures allowing for the: (1) enhancement of domestic environmental policies; (2) investigation of charges involving inadequate enforcement of domestic environmental policies; (3) arbitration of environmental disputes; and (4) sanctioning of members found to be in violation of NAAEC requirements.189 Additionally, the NAAEC established a new body known as the North American Commission for Environmental Cooperation (CEC) to ensure that the NAAEC requirements are met and to handle dispute resolution under these requirements. The specific stipulations are cited below.

1. NAAEC Preamble

The preamble emphasizes the importance of sustainable development and intergenerational equity to the protection of the environment. It links the importance of environmental protection to sustained economic growth. The preamble stresses the "importance of the conservation, protection, and enhancement of the environment," as well as the "essential role of cooperation [among parties] in achieving sustainable development for the well-being of present and future generations."190 These statements do not equivocate in their purpose of environmental protection.

2. Enforcement of Domestic Environmental Policy

The NAAEC goes on to state specifically that all member nations must "enhance compliance with, and enforcement of environmental laws and regulations."191 Additionally, "interested persons" have the right to request action in response to a violation of this stipulation by instigating administrative, quasi-judicial, or judicial proceedings.192 As in the preamble, the text is bent towards protection of national sovereignty in the case of domestic environmental policy.

3. Enhancement of Domestic Environmental Policy

The NAAEC not only requires that member nations effectively enforce their environmental policies already in place, but also uses the harmonization principle to require member nations to improve on these policies. Harmonization ensures that the country with the least stringent environmental protection regulations does not become the common denominator. The NAAEC states that members must "foster the protection and improvement of the environment," "better conserve, protect, and enhance the environment," "ensure that its laws and regulations provide for a high level of environmental protection, and strive to continue to improve those laws and regulations."

4. Creation of the CEC

Central to the NAAEC is the creation of the CEC. Among other duties, the CEC provides a forum through which parties, individuals, or NGOs can resolve disputes surrounding a party's failure to enforce its environmental regulations.

5. Arbitration on Environmental Disputes

When disputes arise surrounding the requirements of the NAAEC, any party may commence formal consultation with any other party accused of being in violation. If the parties are unable to reach resolution through this consultation process, the Council can choose to defer the issue to a five-member arbitral panel.193 This process will be discussed in more detail in Section V(C) below.

B. OPTIONS FOR ENFORCEMENT: POTENTIAE FOR PROTECTION

Based on the requirements described above, the NAAEC may permit Canada to ratify the Kyoto Protocol and incorporate its policies into Canadian law without breaching its NAFTA obligations. This could happen in one of two ways. First, NAAEC rules allowing for the improvement of environmental regulations among member nations may be employed to justify the rules contained in the Kyoto Protocol. Second, the NAAEC rules requiring member nations to enforce their environmental regulations may be employed to uphold the rules contained in the Kyoto Protocol. Each of these arguments will be explored below.

The NAAEC permits member nations to improve their domestic environmental policy. The Kyoto Protocol is indeed a policy designed to protect and improve the quality of the environment.194 Therefore, if Canada chooses to adopt and incorporate the Protocol into its own legislation, the trade measures included therein may be protected by NAAEC Articles 1(a), 1(c), 3, and 5.195

The CEC can only hear cases related to the failure of a member government to enforce its environmental regulations. Therefore, if the Canadian government chooses to accept U.S.-derived AAUs in hopes of avoiding such a U.S. challenge, any resident or resident organization of Canada, the United States, or Mexico may be in a position to challenge this decision. Any such party could claim that Canada would not be enforcing its environmental policies as dictated by the Kyoto Protocol in allowing U.S.-derived AAUs into the Canadian market. Article 5 of the Kyoto Protocol specifies that AAUs can be transferred among Kyoto Protocol Party nations:

Any emission reduction units, or any part of an assigned amount, which a Party acquires from another Party in accordance with the provisions of Article 6 or of Article 17 shall be added to the assigned amount for the acquiring Party ....

Any emission reduction units, or part of an assigned amount, which a Party acquires transfers to another Party in accordance with the provisions of Article 6 or of Article 17 shall be subtracted from the assigned amount for the transferring Party.196

Furthermore, Article 17 of the Kyoto Protocol stipulates: "Parties included in Annex B may participate in emissions trading for the purposes of fulfilling their commitments under Article 3. Any such trading shall be supplemental to domestic actions for the purposes of meeting quantified emission limitation and reduction commitments under that Article."197

These statements can be interpreted in one of two ways. On the one hand, if the United States is not a Kyoto Protocol member nation, engaging in international emissions trading as defined by the Kyoto Protocol will clearly not be "supplemental to domestic actions for the purposes of meeting . . . commitments under" Article 3. Therefore, it can be inferred that by engaging in emissions trading with the United States, Canada would be engaging in an illegal trade as defined by the Kyoto Protocol. On the other hand, although the Kyoto Protocol explicitly states who a party nation can trade with, it does not necessarily state who a Party cannot trade with. This is demonstrated in Article 5, as quoted above, and Article 6 of the Kyoto Protocol. Article 6 states as follows:

1. For the purpose of meeting its commitments under Article 3, any Party included in Annex I198 may transfer to, or acquire from, any other such Party emission reduction units resulting from projects aimed at reducing anthropogenic emissions by sources or enhancing anthropogenic removals by sinks of greenhouse gases in any sector of the economy, provided that:

(a) Any such project has the approval of the Parties involved;

(b) Any such project provides a reduction in emissions by sources, or an enhancement of removals by sinks, that is additional to any that would otherwise occur;

(c) It does not acquire any emission reduction units if it is not in compliance with its obligations under Articles 5 and 7; and

(d) The acquisition of emission reduction units shall be supplemental to domestic actions for the purposes of meeting commitments under Art. 3.199

Clearly, a party can account for AAUs acquired from, or transferred to, another party. However, Article 5 does not state that a party may not account for AAUs acquired from, or transferred to, a non-party. Similarly, Article 6 stipulates that parties may acquire or transfer ERUs resulting from "projects" from any other party. Again, it does not stipulate that party nations may not engage in such actions with non-parties. Articles 6 (c) and (d) state that in order to participate in this process, parties must comply with Articles 5 and 7, and also that any such actions must be supplemental to domestic actions. However, because the United States will presumably not be a party to the Kyoto Protocol, it is not bound by these rules.

Furthermore, the Kyoto Protocol does not hold parties responsible for the compliance obligations of their trading partners. Therefore, because the Kyoto Protocol does not specifically prohibit party nations from trading with non-party nations, Canada's obtainment of AAUs from the United States may not be seen as a failure to enforce Canadian environmental regulations. In