Credibility is required to scale the carbon markets

With the Intergovernmental Panel on Climate Change (IPCC) concluding that it will be difficult (and in some cases impossible) to reduce emissions to zero in certain sectors, several hundred million tonnes of CO2 will need to be removed from the atmosphere to decarbonize the global economy.¹ The voluntary carbon markets are expected to play a critical role in this regard over the next decade and beyond.

The global value of the voluntary carbon markets quadrupled between 2020 and 2021 to USD2 billion, and is expected to grow further as more businesses pledge to operate on a “Net Zero” basis.^2 3 But how fast, and how far, the markets develop will be determined, in large part, by their integrity. The focus on precisely what is being bought and sold, and how it can be used, will intensify.

Credibility is already a key concern. In the past year we’ve seen public critiques of both the markets as a whole and the veracity of particular credits – and the associated quality of the emissions reductions and removals – traded on them. Where these accusations arise, greenwashing claims and reputational damage can follow.

There are multiple platforms that issue voluntary carbon credits, and an even greater number of underlying methodologies and standards. As a result it can be difficult for investors to assess which are robust and can appropriately be used to offset a company’s greenhouse gas (GHG) emissions.

There are several important initiatives under way that are designed to address this issue, including the roll-out of the Core Carbon Principles (CCPs) published by the Integrity Council for the Voluntary Carbon Market (ICVCM), and the European Commission’s proposal to establish an EU-wide voluntary framework for certifying high-quality carbon removals. Here we assess both schemes and pinpoint the elements we believe can support the transition to Net Zero.

What are the objectives of the CCPs and the proposed European regulation?

The ICVCM – an independent body that sets and enforces global standards for the voluntary carbon markets – adopted the CCPs in March 2023. They have a series of objectives tied to governance, emissions impact and sustainable development, but which are not solely about climate change. These were supplemented by an assessment framework which was released in July 2023.

A key objective of the CCPs and the associated framework is to provide the voluntary carbon markets with additional credibility, in turn allowing for greater confidence in carbon offsetting. It remains to be seen, however, whether they will be widely used by participants within the voluntary carbon markets. Initial indications are promising, however, with Verra’s Verified Carbon Standard, the Gold Standard and the American Carbon Registry (being three of the largest standards) all set to take part.

The European Commission’s proposed regulation to establish an EU-wide voluntary framework for certifying high-quality carbon removals was published in November 2022.^4 5 The Proposal is in response to three problems the Commission believes are inhibiting the development of carbon removals in the EU: (i) the difficulty in assessing and comparing the quality of those removals; (ii) a lack of trust in (existing) carbon removal certificates (i.e. voluntary carbon credits); and (iii) barriers faced by providers of carbon removals to access finance.

The Proposal seeks to address these issues through its ‘QU.A.L.ITY’ criteria, which cover QUantification, Additionality, Long-term storage and sustainabilITY. Owners with projects that pass will be able to apply to a certification scheme which records carbon removal units in certain public registries. The certificates would be subject to verification, and once issued could be sold, for example for offsetting purposes. The methodologies underpinning them will be given the force of law through the adoption of delegated acts.

How do the CCPs work, and what are their main challenges?

The regime behind the CCPs is, at its heart, a labelling framework. Where the requisite conditions are met, a voluntary carbon credit (from any standard) can be CCP-labelled. It is intended that CCP-labelled credits will help buyers more easily identify and price high-integrity carbon credits, no matter who has issued them or where they were generated. In turn, this is intended to help overcome market fragmentation, and give buyers more confidence in what they are buying.

To obtain the CCP label, a carbon credit must meet the CCPs at two levels: the program level (e.g., the Gold Standard, which announced its application on 12 October 2023⁶; or Verra’s Verified Carbon Standard, which applied on 21 November 2023⁷), and the category level (e.g., “direct air capture” or “efficient cookstoves”).⁸ More explicitly, specific methodologies from the programs are tested against the latter (e.g., the Gold Standard’s “Simplified Methodology for Clean and Efficient Cookstoves” is being CCP-assessed via the “efficient cookstoves” category etc.).

By early February 2024, six programs had sought assessment, although none had been fully assessed, while checks on the Verified Carbon Standard (being the standard which produces the largest number of voluntary credits by volume) had yet to start. At the end of January 2024, the ICVCM announced that it was assessing more than 100 methodologies with the aim of announcing the first decisions by the end of March 2024.

Key market players have also questioned whether a one-size-fits-all approach is feasible or even desirable in such a versatile market.⁹ It is noted, for example, that some projects that are otherwise promising from a GHG standpoint may fall short of the CCP certification standard for non GHG-related reasons.

The main questions on the project (and supply) side revolve around whether a specific project would be compatible with the CCP’s requirements, whether any extra work would be needed to obtain the label, and whether this would justify the benefit. This will clearly be highly fact-dependent, but where a project is clearly eligible, the key issue is whether adhering to the CCPs will help it generate credits by improving either the price and/or marketability of those credits, and if so, to what extent.

From the investor (and purchaser) side, the principal consideration is whether the benefits of the CCP label justify paying a premium. This could be, for instance, because less time is needed to diligence the underlying project, or because the label gives additional comfort around perceived quality, reducing reputational risk. Linked to this, it will be interesting to see whether CCP-labelled credits are able to remain “scandal free” in the medium and long term, particularly as scrutiny is expected to be high in the initial years.

Even if the CCPs gain traction, we don’t expect the initiative to declutter the fragmented nature of these markets, at least in the near future.

We anticipate that many of the much smaller standards will continue to operate, although some may become further marginalised, particularly if they do not have the resources to participate (i.e., to complete the initial program-level assessment as required by the ICVCM’s regime).

Along similar lines, we see a risk that, if the CCP label becomes very successful, it could ultimately create a one-size-fits-all approach that is able to directly set the scope and rules of the market. This, in turn, may stifle innovation and, in some cases, potentially limit the flow of carbon finance to projects that do have merit, but don’t fall squarely within the CCPs’ requirements.

What about Europe’s proposed certification framework?

The European Commission’s proposed criteria are only set to apply to carbon removal activities that take place in the EU, which hasn’t yet established itself as a hotbed for removal-based projects in the mainstream voluntary markets. As a result, even if the Proposal is successful, it’s likely to cover only a small proportion of the credits traded on the carbon markets.

That said, it could be an important step. Firstly, we anticipate that any methodologies developed by the Commission are likely to be considered robust, which in turn will help raise the bar on what constitutes a “good” removal credit in similar ways to the CCPs.

Secondly, the mere fact that the Commission itself has developed the methodologies and the context in which the certificates will be issued should give material comfort to more conservative investors, for example around greenwashing risks. This could, therefore, reasonably be expected to bring new participants into the voluntary markets.

Thirdly, the Proposal contemplates a regular review by the Commission of the regulation as implemented and by reference to wider developments, such as the status of the Paris Agreement. Over time, we anticipate this could lead to the regime being extended in the same way as ESG-related corporate reporting has been gradually developed in recent years.

Fourthly, the certificates could be used for purposes beyond offsetting. As a result we expect links could be established between the scheme and wider results-based financing initiatives created by other EU policy instruments, such as the Common Agricultural Policy, as well as state aid schemes run by individual member states.

Some groups have already called for the Proposal to be adapted to prohibit the certificates being used for ordinary offsetting purposes in the voluntary carbon markets.^[10] They argue, for example, that: (i) demands for removals must not come from actors that still have scope to reduce their own emissions but haven’t yet done so; and (ii) companies shouldn’t be allowed to use removal offsets as a means of avoiding carbon pricing or emissions cuts in their own value chains. It remains to be seen what weight the EU’s legislators will give to these sorts of arguments.

Finally, if the Proposal is successfully developed, we anticipate that it could influence similar “sovereign” constructs elsewhere. There is a wider trend for states to seek to control more closely what happens in the voluntary carbon markets vis-à-vis activities undertaken within their jurisdiction. (At the time of writing the EU’s institutions (the European Commission, the European Council, and the European Parliament) were looking to finalise negotiations.)

What would the ideal carbon markets framework look like?

Instilling credibility into the voluntary carbon markets is vital for their success. Buyers of voluntary carbon credits want to know that doing so won’t expose them to reputational risks or accusations of greenwashing. The widespread implementation of (and adherence to) a robust set of integrity standards should bolster market confidence and allow purchasers to make informed commercial comparisons between credits across what is currently a fragmented and diverse global market. Increased direct involvement of states and supranational bodies such as the EU will help increase confidence, too. Both the CCPs and the European Proposal (if implemented) will assist with credibility, but each also has its limitations.

The CCPs, for instance, while setting high standards, remain an independently managed voluntary initiative. Their success will be determined by uptake and how the markets ultimately view their labels and the quality of the underlying credits. The EU Proposal would be voluntary and limited to removal-type activities from EU-based projects only, materially limiting its scope.

The ideal, of course, would be to combine the best elements of both. This would see legislators create robust, publicly managed frameworks through which high-quality voluntary carbon credits can be issued, sold and used, and which sit alongside the existing frameworks offered by the private sector. This is, of course, the hope for the new Article 6.4 mechanism being developed by the United Nations. Over time, the successful deployment of such structures should build credibility in and of itself.

It remains to be seen, however, how successful (and ambitious) the Article 6.4 framework will be, and there are concerns with regard to the proposed integrity and quality of the A6.4 credits that are expected to arise from it. These concerns were, of course, at the heart of a lack of progress on Article 6.4 at COP28, as UN members disagreed on precisely this point. Prolonged deadlock on this issue at UN level will, though, only increase the importance for initiatives such as the CCPs and the EU Proposal to plug the gap. 

In the meantime, the EU and other key players have shown no real appetite to become further directly involved with the management and operation of the voluntary markets. Their position, for now, is primarily focused on softer approaches linked to both corporate disclosures and the regulation of making offsetting claims. Whether such plans, when coupled with initiatives like the CCPs and the EU Proposal, will bring sufficient credibility to the voluntary markets in and of themselves is uncertain. They are, however, steps in the right direction.

Footnotes

<sup>1. IPCC 6th Assessment Report (https://report.ipcc.ch/ar6/wg3/IPCC_AR6_WGIII_Full_Report.pdf#page=48).
2. Ecosystem Marketplace, “The State of the Voluntary Carbon Markets 2022 Q3 Briefing,” August 3, 2022.
3. McKinsey, “A blueprint for scaling voluntary carbon markets to meet the climate challenge”, January 29, 2021.
4. https://climate.ec.europa.eu/document/fad4a049-ff98-476f-b626-b46c6afdded3_en
5. This is a legally binding commitment set out in the European Climate Law which requires balanced emissions and removals of GHGs by 2050 at the latest and with the aim to deliver negative emissions thereafter.
6. https://www.goldstandard.org/blog-item/gold-standard-submits-programme-level-assessment-icvcm-champions-alignment-paris-agreement
7. https://verra.org/statement-verra-submission-icvcm/
8. https://icvcm.org/category-assessment-status/
9. https://verra.org/icvcm-course-correction-needed/
10. See, for example, the open letter from, amongst others, Carbon Market Watch to the European Commission dated November 4, 2022 here: https://carbonmarketwatch.org/wp-content/uploads/2022/11/Open-letter-NGOs-to-Cabinets-on-CRCF-priorities.pdf</sup>