Carbon markets turn emission reductions and removals into tradeable assets. Currently, there are two types of markets: mandatory carbon credits and voluntary carbon credits.
Mandatory carbon markets: Government or regulators limit the emissions that companies in a particular industry or sector can release. The regulator allocates each company a given amount of emissions. Companies that do not need their full emission allotment can obtain a credit and sell these credits in the mandatory market. Companies exceeding their emission limits must purchase credits. Individuals may also acquire credits.
Voluntary carbon markets: Private entities fund projects that reduce greenhouse gas (GHG) emissions or increase carbon capture. The project funding is expressed in terms of a carbon offset credit, which is a transferrable, independently-certified instrument that represents an emission reduction of one metric tonne of CO2 or an equivalent amount of other GHG. Companies and individuals can purchase carbon offsets on a voluntary basis. If you’d like to learn more, check out our previous post
Mandatory carbon markets have government oversight, so these markets benefit from price transparency and greater certainty that the carbon credit has been valued appropriately. In contrast voluntary carbon markets struggle with fragmentation and assurances around measuring and valuing carbon impact and project quality.
Recently, the London Stock Exchange and a consortium in Singapore announced initiatives to provide high quality carbon credits, and promote liquidity to voluntary markets. The Chicago Mercantile Exchange in collaboration with Xpansiv are already facilitating spot and derivatives trading in voluntary carbon offsets.
As the International Swap Dealers Association (ISDA) has pointed out, greater clarity over voluntary carbon credits’ legal treatment would create a more robust market, because the legal treatment governs voluntary carbon credit creation, transfer and retirement. The legal situation also exchangeability, ownership rights, requirements for taking proper security and netting treatment in an insolvency situation.
Clarifying the Legal and Regulatory Framework for voluntary carbon credits
A clearer legal framework is necessary for valuing and transacting in / transferring voluntary carbon credits. Fundamentally, a carbon credit could represent an intangible asset; however, depending on the jurisdiction and project structure, they may be recognized as a bundle of rights.
For voluntary carbon credits to work at scale or on exchanges, there must be consistent or standardized legal guidance globally and regulatory guidance at a jurisdictional level. With a clearer legal framework, the market intermediaries can draft standardized documentation and obtain legal opinions.
According to ISDA, five legal issues need to have agreed minimum standards to promote trading or interchangeability of voluntary carbon credits.
- Using common measurement units. The market appears to have settled on each voluntary carbon credit equaling one metric tonne of CO2e
- Clear roles and responsibilities for carbon standard setting bodies that the global and local markets accept and use.
- Convergence toward a global standard for approving and verifying projects.
- If global or local markets cannot agree to one standard, a series of clear standards differentiated by jurisdiction would provide greater clarity and legal footing.
- Convergence toward global standards for registry rules and transferability of credits between registries. registers for this purpose.
