Unlocking finance has been a key theme of the COP28 climate summit. Banks, regulators and top officials at COP28 have thrown their weight behind efforts to revive the global trade in voluntary carbon credits which is plagued by criticisms over lack of transparency and inadequate regulation.
The lack of verification and credibility of carbon credits to date has certainly undermined the system. However, carbon credit purchases linked to cuts in the carbon dioxide emitted by burning fossil fuels and deforestation could create “the largest marketplace the world will have ever known” said US climate envoy John Kerry. To achieve this a greater level of accountability and the right signals of the sorts of projects that create the most value from a greenhouse gas emissions perspective need to be better understood and supported.
For carbon markets under the Paris Agreement, we are already seeing and advising governments implementing voluntary cooperative approaches under Article 6 to meet their Nationally Determined Contributions, providing for international transfers of mitigation outcomes. Article 6 of the Paris Agreement sets out the basic mandate for carbon markets, allowing countries to meet their NDCs by purchasing carbon credits. The Paris Rulebook agreed at COP26 seeks to implement this mandate with two approaches.
First, the cooperative approach (Article 6.2) applies when countries trade carbon credits between them. As an example of the cooperative approach, Switzerland and Peru signed an agreement for Switzerland to finance credit-generating projects in Peru in return for carbon credits that Switzerland will use to meet its 2030 NDC target. Second, the sustainable development mechanism (Article 6.4) establishes an international scheme for the approval of credit-generating projects, usually run by private investors. For each approach, the Paris Rulebook sets out substantive and procedural requirements to ensure the integrity of the credits, including requirements on double-counting, additionality, and transparency. The Paris Rulebook gives the host country a critical role in credit-generating projects, determining which approach applies and whether a carbon credit is used to meet its own NDC or not. Host countries may seize on the opportunity to receive additional financing for projects and to foster sustainable development. While this will be harder due to the lack of agreement at COP28 on key texts related to carbon crediting methodologies and international trade under Article 6, there have been substantial developments on carbon markets at this summit.
The Rockefeller Foundation’s launch of the Coal to Clean Credit Initiative at COP28 demonstrates the role of carbon credits in supporting governments’ agreement at COP28 to "transition away" from fossil fuels. This initiative will use carbon credits to retire a coal power plant in the Philippines by 2030, a decade ahead of its retirement date. CCCI is engaging with sovereign buyers of credits under the Paris Agreement and is consulting on a “transition credits” draft methodology to enable funding from carbon markets to accelerate a just coal-to-clean energy transition in emerging economies.
World Bank President Ajay Banga has said at COP28 that he is keen to restore credibility in much-criticized carbon markets as a way to channel money to developing countries. The World Bank intends to sponsor forestry projects in 15 countries over the next 18 months in a push that could generate 125 million carbon credits. The World Bank also has wider plans to deliver 24 million carbon credits to market in the next two years, including from projects in Vietnam, Guatemala and the Democratic Republic of Congo.
Independent certification bodies that have suffered from a collapse in the market have also joined the revival effort. One of the organisations, Verra, said it would aim to meet standards laid out by the independent governance body, the Integrity Council for Voluntary Carbon Markets.
Carbon markets can be highly successful in enable transitioning or financing of projects that may not otherwise be afforded, especially by local government budgets. The view at the Energy Leaders’ Roundtable Dinner, facilitated by CMS at COP28 for the Global Success Partnership, was that the idea behind project based markets is the right one, especially in countries that are considered high risk for investment. Any project that produces carbon has the potential to use carbon streaming as a financial instrument but to qualify, it is important that they are measured and rated by trusted standards. It was commented that carbon credits must not be used to avoid reducing emissions; they do not give permission to continue to pollute. Instead, carbon credits should be used to offset only the hard to abate emissions which remain after reduction efforts.
This has been echoed by the UN’s climate body, which has said that voluntary markets cannot substitute robust internal emission cuts by the private sector. The International Organization of Securities Commissions has proposed a set of measures to prevent fraud and promote greater liquidity, with the goal of bringing financial integrity. Such measures could be key for investors and climate experts who continue to question the accounting and integrity standards that underpin the carbon market.
The pace of global climate action is critical, and it remains to be seen how quickly such measures will allay fears that carbon credits could be used by businesses and governments as a “false solution” to cut their own emissions more slowly. Once businesses are able to use carbon credits with greater confidence, progress towards climate targets demands that carbon offsets must be reserved for unavoidable emissions or hard to abate activities. Effective reductions will still be the priority for the majority of a corporate’s emissions. It is clear that careful project selection, robust verification processes and accurate accounting are needed to prevent claims that your business’ use of carbon offsets is greenwashing.
Businesses making unsubstantiated claims when using carbon credits face significant risks, ranging from loss of reputation to potential fines by domestic authorities such as advertising regulators, shareholder action and litigation (where such claims are deemed false or deceptive). As regulators take notice of growth in voluntary carbon markets, we expect to see increased regulation, enforcement activity and civil litigation around misstatements and the quality of carbon offsets. Last year saw climate litigation against LM Royal Dutch Airlines for allegedly exaggerating the benefits of the carbon offsets it purchased and advertised to compensate for its flight emissions. In May this year, a class-action lawsuit was filed against Delta Air Lines Inc. in relation to carbon-neutral claims relying on allegedly questionable carbon offsets. And for businesses relying on carbon offsetting in their corporate transition plans, that range of risks increases – with company directors liable to be held accountable over miscommunication on the impact offsetting has on emissions reductions.
Swift and continuous improvements to the voluntary carbon market can mobilise the finance necessary to deliver emissions reductions, as well as wider environmental and social benefits from well-designed projects.
