The market for carbon credits, which are tradable at a price per ton of greenhouse gas (GHG) reductions, is currently growing rapidly as more and more companies and individuals look to offset their emissions. As such, carbon trading has become a central part of efforts to address climate change.
A carbon credit exchange is a measure of one metric ton of emitted carbon dioxide or equivalent GHG. The underlying project that creates a credit can be nearly any type of activity that reduces, avoids, destroys or captures emissions.
Some projects generate credits that are worth a premium because they also help to meet some of the UN’s Sustainable Development Goals (SDGs). These types of credits can trade at a high price, especially when the underlying project has been carefully designed and managed, or if it contributes to environmental improvement or poverty alleviation in the host country.
These projects are typically smaller-scale, and they tend to be more expensive to certify. For this reason, they are more likely to be developed by local organizations or NGOs.
The carbon market is comprised of two separate markets: the compliance market and the voluntary market. In the compliance market, regulated countries and international agencies set a cap on a business’s emissions and require them to buy and sell carbon credits in order to achieve that goal.
This system is based on the principle of cap-and-trade, which was pioneered by the Kyoto Protocol and later refined through the Paris Agreement. These programs reward those that cut their greenhouse gases, while penalizing those that don’t.
In the voluntary market, a company’s emissions are not limited by any government regulations, and the carbon credits that offset those emissions can be purchased on the open market from organizations that have been approved as being able to sell legitimate carbon credits.
To make carbon trading work, there must be a robust and scalable infrastructure that supports all aspects of the transaction life cycle, from trade to post-trade. It should include resilient and scalable clearinghouses and meta-registries, advanced data infrastructure, and robust counterparty default protection, among others.
Moreover, there should be core carbon principles and an attribute taxonomy to ensure that the credits matched to these standards adhere to high environmental and market integrity. These measures should be accompanied by a rigorous vetting process to ensure that only the most trustworthy and transparent projects are listed.
A well-functioning and standardized carbon market would enable the efficient trading of credits with a reliable daily price signal. It should also facilitate the growth of supply-chain financing.
The demand for carbon credits has been driven by a number of factors, including the rise in environmental consciousness and corporate net-zero goals. However, the market has been plagued by some shortcomings, including a lack of transparency and liquidity.
These issues have led to a number of concerns, including the potential for offsetting projects to disincentivize companies from cutting their emissions and the emergence of market manipulation schemes. In response, many companies and governments have sought to improve the quality of their carbon credits by establishing strict guidelines and a more credible verification process for their offsets.