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Carbon markets: what to watch

As carbon markets take on increased importance, Victoria White, Derivatives and Structured Finance Senior Associate, discusses the outlook for carbon trading, highlighting the key developments shaping these markets.

With carbon trading playing an increasingly significant role in national and corporate decarbonisation efforts, it is crucial market participants understand and closely monitor the factors affecting carbon market development.

There’s no doubt that properly scaled primary and secondary carbon markets will form an important part of the global response to tackling climate change and adhering to climate regulation and interest is growing in both the compliance markets (nationally or regionally mandated carbon schemes in which participants trade regulator issued allowances) and voluntary carbon markets.

However, it is voluntary carbon markets where the biggest growth is expected, with the private sector leading initiatives to develop these market-based solutions. According to a 2021 McKinsey report, demand for voluntary carbon markets is projected to increase by a factor of 15 or more by 2030, and by a factor of 100 by 2050. The Taskforce on Scaling Voluntary Carbon Markets projects that the value of the voluntary carbon markets could reach $5 billion–50 billion by 2030, while the UN’s special envoy on climate action and finance, Mark Carney, has expressed a need for the market to grow to between $50 billion and $100 billion a year.

Unlike compliance markets, where participation is mandated by legal or regulatory obligation, entities participate in voluntary carbon markets for a variety of reasons, including to assist transitions to net zero or other ESG targets. Both markets, however, have the common aim of establishing a platform in which carbon is priced to accurately reflect the risks and costs of carbon emissions worldwide, with the ultimate objective of driving a reduction in greenhouse gas emissions.

By putting a price on carbon, compliance and voluntary carbon markets allow for an assessment of the risks and costs of polluting. Both markets also provide secondary market trading opportunities. The need for a global carbon price has never been stronger; however, much needs to be done before a coherent and consistent voluntary market emerges worldwide.

Read the full article which was first published in the Allen & Overy co-sponsored ESG climate special risk report in the PDF below, and the full report by clicking here