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What To Know About Carbon Trading & Offsetting

Companies across the globe are increasingly committed to achieving zero carbon emissions, often with a regulatory nudge but sometimes out of a voluntary commitment. Carbon credits are an important component of the net zero toolbox, helping companies offset the emissions they cannot yet cut. The market for carbon credits is expected to increase significantly over the next few years.

There are risks and potential that come with carbon credits. As long as carbon credit programs are correctly managed, credits can lower overall emissions. When carbon credits are produced in developing countries, they could help in other sustainable development goals.

Carbon credits could bring these positive outcomes only when the integrity of the credits is ensured. Regulating carbon markets can be very limited and fragmented, so there are justifiable concerns that some credits might amount to nothing more than greenwashing.

To address these concerns the world community took major measures during the Glasgow Climate Change Conference in 2021 to strengthen the credibility of credits, with new regulations for both the procedures and benchmarks used for credits (e.g. the government approvals; methods for measuring emissions reductions; Monitoring, reports, as well as verification). The new rules seek at ensuring carbon credit projects actually will result in a significant reduction in global emissions and provide transparency to the process. Given the scope and complexity of the issue these rules are complex and difficult to comprehend in practice.

The new rules won’t necessarily apply to the entire spectrum in carbon markets. National regulators as well as private credit certifying bodies are currently deciding how to carry the new rules over into their respective work offering a chance for the stakeholders to make an influence on the final outcome. Early indications suggest that these new rules will transform the public and private standards in this year, increasing their integrity and, eventually, reducing fragmentation. If successful, the rules will enable carbon credits to deliver on their potential to reduce global emissions, and encourage businesses to invest in these instruments as part of their net-zero path and also provide lucrative opportunities for investors to finance credit-generating projects.

In Article 6, the Paris Agreement sets out the fundamental mandate of carbon markets, allowing countries to meet their international climate commitments (nationally determined contribution, or NDC) by purchasing carbon credits. The most significant development that took place in Glasgow was the long-awaited agreement regarding the”Paris Rulebook,” also known as the “Paris Rulebook,” that aims to implement this obligation. Below, we introduce carbon markets, The Paris Rulebook, and their interplay.

Carbon markets in a simple way. Carbon credits are given as a part of an initiative in a “host” country in order to cut or remove emissions. Each credit gives the owner the right to emit a specific amount of carbon. It is usually one ton per credit. The credits are bought by a company or a country in compliance or voluntary markets.

In compliance markets, entities purchase credits that are used to meet obligations to reduce emissions under (i) international schemes (e.g. by nations to satisfy the requirements of their NDC as part of the Paris Agreement or by airline operators to offset emissions under CORSIA, the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA)) or (ii) national schemes (e.g., by companies to reduce their liability under a national emissions trading scheme (ETS) or carbon tax). Every regulator decides on the extent carbon credits can be used to meet regulations, as well as the eligibility criteria for credits.
In the voluntary carbon market (VCM) companies buy carbon credits to help support non-binding claims (e.g., net-zero pledges made by voluntary organizations, which are called “offset claims,” or to show support in emission reduction projects which is known as “impact claims”). At present, there is no unified international regulation or guidance regarding the carbon credits’ quality which can be utilized in the VCM.

The Paris Rulebook in a nutshell. In a nutshell, the Paris Rulebook develops two approaches for the international transfer of carbon credits. The first is the Cooperative Approach (Art 6.2) applies when two countries exchange carbon credits or, according to certain instances, when the host nation permits another country or company to use credits, even if the host country has not signed an agreement with a different country. As an example of an example of the Cooperative Approach, Switzerland and Peru agreed to allow Switzerland to provide financing for credit-generating projects in Peru in return for carbon credits that Switzerland will use to meet its 2030 NDC goal. Second, the Sustainable Development Mechanism (SDM) (Art 6.4) creates an international framework to approve credit-generating projects, usually run through private investment.

Each carbon credit exchange method is covered by the Paris Rulebook sets out substantive and procedural guidelines to ensure the authenticity of credits — credits that contribute meaningfully in reducing global emissions.

What are the essential conditions of the Paris Rulebook?

(1) (1) No double counting A carbon credit is able to be counted only one time. The country that hosts it may informally consent not to utilize this credit in order to reach its NDC and, instead, permit the credit to be used for other reasons to reduce carbon emissions (e.g., by another country to meet the requirements of its NDC or by a business in another country). In that scenario, the credit is not counted by both the host nation and the other country or company.

(2) Additionality A credit-generating venture must result in reductions or eliminations of emissions which would not have been possible in the absence of the anticipated income stream from the sale of credits that the project generates. This ensures that a project will have an actual — and added — impact on decreasing emissions in the host country, irrespective of who actually is using the credit. It is the SDM Approach (Art 6.4) has more requirements on how to determine the amount of emissions reductions.

What are the main distinctions between the two methods in the Paris Rulebook?

(1) An international approval is required: According to the Cooperative Approach (Art 6.2), the credit-generating project is run under the authority of the host nation but without the approval of an international oversight body. Even though there is no international body, parties must comply with specific reporting and transparency requirements, which are subject to an independent review by experts in technical fields who are able to make (nonbinding) advisory public statements. However, under the SDM Approach (Art 6.4) there are other layers of supervision: A plan needs to be approved by the host country as well as a new international supervisory body which operates on the basis of recommendations issued by an unofficial verification authority.

(2) Levies for mandatory purposes: Under the SDM Approach (Art 6.4), mandatory levies of 7percent are charged to carbon credits. Levies are used to help support adaptation to climate change in developing countries (5% go to United Nations Framework Convention on Climate Change Adaptation Fund) and also to ensure the additionality of (2 percent are eliminated). Levies that are mandatory are not enforced under the Cooperative Approach (Art 6.2), although they are “strongly recommended.”

The new rules allow the host nation a crucial role in projects that generate credit. They have the ability to decide (i) which standards apply (the Cooperative Approach, SDM Approach, or an approach that is not part of the Paris Rulebook) and (ii) whether carbon credits are used to fulfill its own NDC and if it is not. How these decisions are made will determine the value and possible uses of the carbon credit that is resulting.
The impacts that the Paris Rulebook on carbon markets. Although it is true that the Paris Rulebook provides only limited direct regulation of carbon markets, it is anticipated to have a significant effect on market regulation, boosting the quality of credits both in voluntary and compliance markets. Although a variety of the provisions in the Paris Rulebook are still to be developed, efforts are being made to boost the quality of carbon credits in the spirit of it. Notably, some of the top private credit-certifying bodies, like Gold Standard and Verra, are working on strengthening their standards in light in the Paris Rulebook.

The impact that the Paris Rulebook on carbon markets. Although there is no direct regulation of carbon markets, the Paris Rulebook provides only limited direct regulation of carbon markets, it is anticipated to have a significant impact on market regulation, improving the credibility of carbon credits in compliance and voluntary markets. In fact, even though a number of aspects in the Paris Rulebook are still to be formulated, efforts are being made to increase the quality of carbon credits in the spirit of it. In addition, the most prominent private credit-certifying bodies such as Gold Standard and Verra, are working on improving their standards in the light in the Paris Rulebook.

In the VCM there is no unifying international rules for the credit quality. The situation could be changing. Private initiatives are preparing guidelines for enhancing the integrity of credits (e.g., that of the Voluntary Carbon Markets Integrity Initiative) and the first guidelines expected in April. In the meantime, the Paris Rulebook requirements on double-counting, additionality, and transparency will likely guide these guidelines. In the future, certain national regulators could also regulate credits that are used for voluntary reasons such as establishing quality requirements for the credits are used by a business to satisfy net-zero pledges.

In compliance markets, national regulators occasionally allow companies to use credits to meet certain or all obligation under the carbon tax , also known as an ETS. Regulators can now make eligibility criteria more demanding according to the Paris Rulebook. Other countries that have a carbon tax or ETS could be more likely to permit the utilization of credits with high-quality that meet requirements of the Paris Rulebook requirements. While the CORSIA scheme to offset carbon emissions from air transport already has fairly stringent rules regarding high-quality carbon credits, countries might be able to improve the quality of those standards.

The Paris Rulebook is also expected to affect pricing. Credits that are compliant with the Rulebook will have higher integrity and will likely to be able to be used in more markets. They could, therefore, expect to be rewarded with the price of.

Opportunities and risks for stakeholders. It is clear that this time of rapid-changing regulatory and market dynamics offers enormous opportunities and risks for all stakeholder. Particularly important:

Businesses can purchase high-quality carbon credits to fulfill their net zero commitments (either optional or perhaps mandatory). More scrutiny of the validity of carbon credits both by regulators and consumers underscores the necessity to choose the right carbon credit “product.”
Investors and developers of projects are able to make investments in, and even develop top-quality projects, although with some doubts about how market and regulatory aspects will play out (including, e.g., price dynamics and the stability and liquidity of the market as it expands).
Regulators now must further develop and implement the Paris Rulebook and decide whether and how they can modify the eligibility requirements for their respective local ETS and carbon tax systems. Internationally, regulators have to think about how the rules affect schemes like CORSIA and whether or not they want to expose different industries (e.g., ships shipping) under similar rules.
Host countries can take advantage of the chance to obtain additional funds for carbon reduction projects taking care to determine which carbon credit approach to use to reduce emissions and promote sustainable development.

We’re ready to assist stakeholders in navigating this complex landscape. This includes, for example providing clients with advice on the benefits and risks of financing their own emissions reduction projects via the creation and sale of carbon credits; purchasing carbon credits that offset emissions and meet net zero targets future-proofing carbon credit investments considering the rapid-changing regulatory changes and working with government officials to take advantage of the advantages and mitigate the risks associated with engaging in the carbon market.