Energy Practice Legal Update - Recent Developments In Carbon Offset Markets In Japan - For Achieving A Green Transformation (GX) And Carbon Netzero (Carbon-neutrality)

1. Introduction

The Japanese Government has announced its nationally-determined contribution ("NDC") to achieve 46% reduction of greenhouse gasses ("GHG") by 2030 compared to 2013 and carbon netzero by 2050. In order to achieve its NDC, the Japanese government has been implementing various policies, including establishment of the GX League, Japan's version of an emissions trading system ("Japanese ETS"). Phase 1 of the GX League began in 2023, and discussions are accelerating to launch Phase 2 around 2026. In this newsletter, we will provide an overview of recent developments in the Japanese and overseas carbon credit markets and outline some of the issues that Japanese and international players should be aware of

2. Recent developments in carbon credit markets in Japan

2.1. GX Implementation Council

Implementation of Climate Change policies/regulations in Japan (including rules for a Japanese ETS) have been led by the GX Implementation Council which is chaired by the Prime Minister of Japan.
Since July 2022, the GX Implementation Council has been meeting to discuss measures to achieve a green transformation. At the 10th meeting of the GX Implementation Council in December 2023¹ , the "Sector-specific Investment Strategy Proposal"² was formulated, setting out GX policies in each priority sector for approximately the next 10 years.

Subsequently, at the 11th meeting of the GX Implementation Council held on May 13, 2024³ , in order to improve the predictability of the business environment and promote domestic investment that will maintain and strengthen high-value-added industrial processes essential to Japan's growth, the GX2040 Vision was presented from a longer-term perspective, taking a comprehensive view of industrial structure, industrial sites, and energy, which is a step forward from the previous GX policies. In particular, the topics outlined below were discussed⁴ .

GX can be viewed as a transformation of the industrial structure, and its realization requires upfront investment from both the public and private sectors. The following measures proposed by the GX Implementation Council will strongly encourage public and private investment in GX.

2.1.1. Energy

As industrial competitiveness is expected to be more dependent on energy than ever before, the transition to decarbonized energy, which is currently quite uncertain in terms of demand and technology, needs to be accelerated. To this end, it is necessary to ensure a stable energy supply by taking measures to address issues such as promoting investment in decarbonized power sources where the return on investment is difficult to predict, by developing decarbonized power sources and grids, by ensuring the supply of hydrogen, ammonia, and other new energy sources, and by securing fossil fuels during the transition period.

2.1.2. GX industrial sites

Given the status of development of decarbonized power sources and grids, and other factors such as new energy supply hubs, or bases, it is necessary to consider where to locate energyintensive industries, including data centers, steel, and chemicals, and to discuss where to locate new industrial sites, which could be called "decarbonized industrial hubs." These studies would provide a clear picture of the locations suitable for decarbonized energy bases and GX industrial clusters in each region and improve investment predictability.

2.1.3. GX industrial structure

Japan's industrial structure is expected to change in the process of promoting GX, and what kind of industrial structure should be pursued will become an important issue. It is necessary to discuss how to secure domestic industrial sites for industries in which Japan has advantages, promote innovation through next-generation technologies, and strengthen supply chains in light of the kinds of changes that the economic security environment will undergo.

2.1.4. Creating GX markets (including Japanese ETS)

It is important to promote the creation of GX markets (including Japanese ETS) that appreciates the value of decarbonization, including the design of a detailed carbon pricing system, because instilling in business practices the notion that decarbonization not only increases costs but also creates new value will drive GX investment by the industrial sector.

2.2. Legal Issues Study Group (METI/MoE)

Phase 2 of the GX League, which will begin around 2026, is expected to tighten regulations in a number of ways, and one of the possible measures is the introduction of a mandatory cap-andtrade system that would impose emissions caps on large emitters. However, various legal issues need to be examined before such a system can be implemented.

Under these circumstances, the Ministry of Economy, Trade and Industry (METI) and the Ministry of the Environment (MoE) have been holding meetings of the Legal Issues Study Group (the "Study Group (METI/MoE)") to identify potential legal issues that will arise when applying other countries' emissions trading systems and Japan's carbon credits (e.g., J-Credits⁵ ) to Japan's legal framework, to organize ideas on these legal issues from an academic and practical perspective, and to use such ideas in considering the design of a concrete emissions trading system⁶ .

Footnotes

1 https://www.cas.go.jp/jp/seisaku/gx_jikkou_kaigi/dai10/index.html (Japanese only)

2 Reference Material 2 "Sector-specific Investment Strategy Proposal" of the GX Implementation Council (10th Meeting) (December 15, 2023) https://www.cas.go.jp/jp/seisaku/gx_jikkou_kaigi/dai10/siryou2.pdf (Japanese only)

3 https://www.cas.go.jp/jp/seisaku/gx_jikkou_kaigi/dai11/index.html (Japanese only)

4 Reference Material 1 "To Accelerate a Green Transformation in Japan" of the GX Implementation Council (11th Meeting) (May 13, 2024), prepared by the Minister in Charge of Promoting GX https://www.cas.go.jp/jp/seisaku/gx_jikkou_kaigi/dai11/siryou1.pdf (Japanese only)

5 https://japancredit.go.jp/english/

6 Reference Material 3 "Purpose of the Legal Issues Study Group Conducive to Examining Emissions Trading Systems for Achieving a Green Transformation," prepared by the Secretariat of the Legal Issues Study Group https://www.meti.go.jp/shingikai/energy_environment/gx_implementation/pdf/001_03_00.pdf (Japanese only)

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