Stop debating carbon markets and start building them

The writer is UN special envoy on climate action and finance and a former governor of the Bank of England

The brutal reality of climate physics is that the carbon budget to limit warming to 1.5C will be exhausted within a decade if the world remains on its current trajectory. That makes emissions reductions today especially crucial because they create time for the enormous investments needed in clean technologies, while extending the horizon to commercialise such innovations.

Voluntary carbon markets can play a key role in realising this time value of carbon. At present, VCMs are small — just $2bn annual issuance globally. This is largely because they have lacked integrity. There are valid questions about the credibility of claims made for projects and by buyers, the negative impacts on local and indigenous communities and whether the expansion of credits could disincentivise absolute emissions reductions. 

Policymakers are now stepping up to address these concerns. The US government took a groundbreaking step last month in announcing its principles for responsible participation in VCMs. It is putting to work the power of market-based solutions to build a clean economy that supports jobs, communities and growth. This is a vital first move. To reach the scale needed, major economies should work together to build globally integrated markets, not least to expand dramatically the decarbonisation opportunities for emerging and developing economies that are currently starved of capital.

High-integrity VCMs can promote a smoother, more efficient transition. If well designed, they can accelerate the pace of absolute emissions reductions. They catalyse investment by accelerating the deployment of clean energy, improving the economics of new technologies and funding a socially just transition. They can play decisive roles in catalysing the enormous capital needed to transition from coal to clean generation in Asia and to accelerate nature-based solutions everywhere.

But none of this will be possible unless these markets are built on solid foundations, with the right principles. The authorities must establish standards for end-to-end integrity — of supply, demand and markets. Social integrity must also ensure that benefits flow to local communities.

Supply integrity ensures projects deliver credible emissions reductions that would not have occurred otherwise. To that end, the carbon market is coalescing around the new supply-side standards established by the independent Integrity Council for the Voluntary Carbon Market to ensure credit developers have robust governance and transparent reporting, and provide compensation if projects don’t deliver. These standards need to be supported by third-party monitoring, assurance and risk mitigation.

Demand integrity means companies that invest in carbon credits do not delay the decarbonisation of activities over which they have most control. Only those performing against ambitious targets and transition plans should earn the right to invest in credits.

The Voluntary Carbon Markets Integrity Initiative has taken up the challenge of determining how companies can use credits for their net zero transitions, without compromising their incentives to reduce operational emissions. Policymakers must support and build upon these standards, buttressed by an assurance ecosystem for transition plans and credit use that is akin to auditors verifying the accuracy of financial accounts.

Market integrity is fundamental to ensuring the equitable treatment of participants and to developing the infrastructure for VCMs to scale up. This can be reinforced by innovations such as the Global Carbon Market Utility, which was launched at COP27 and will help ensure the markets have strong data transparency as well as management, supporting standardised contracts, robust audits and verification processes and effective dispute resolution mechanisms.

The prize is huge if we get this right. Carbon markets can provide hundreds of billions of dollars in annual cross-border capital flows to emerging markets, promote the end of high-emitting assets and help prevent new coal generation in Asia. They can also create significant financing for biodiversity and indigenous peoples, including the essential reforestation of the Amazon. Far from a distraction, there is growing evidence they will help more companies commit to ambitious net zero goals and decarbonise faster.

Now is the time for the G20 to build on the US initiative, and grasp the nettle to create a globally integrated, high-integrity carbon market. No more debating while the world literally burns.

Climate Capital

Where climate change meets business, markets and politics. Explore the FT’s coverage here.

Are you curious about the FT’s environmental sustainability commitments? Find out more about our science-based targets here

Letter in response to this article:

Voluntary carbon markets will not solve the energy transition / From Paddy McCully, Reclaim Finance, Berkeley, CA, US