Businesses across the world are increasingly committed to achieving net-zero carbon emissions. Sometimes, this is done by way of a regulatory push and sometimes , voluntarily. Carbon credits will become an essential component of the net-zero toolbox which allows companies to offset their emissions that they are not able to cut. The market for carbon credits is expected to expand significantly over the next few years.

There are risks and opportunities that come with carbon credits. When carbon credits projects are correctly managed, they will reduce overall emissions. If carbon credits are created in developing countries, they could be able to contribute to other sustainable development goals.

Carbon credits can bring about these positive results only if the credibility of the credits is guaranteed. Regulation of the carbon market is sluggish and fragmented, therefore there is a legitimate concern that certain credits could be little beyond greenwashing.

In order to address the concerns, the international community took important measures during the Glasgow Climate Change Conference in 2021 to strengthen the credibility of carbon credits. They introduced new regulations on the procedures and benchmarks used for credits (e.g. the government approvals, methods for measuring reductions in emissions; as well as monitoring, report, as well as verification). The guidelines aim in ensuring that carbon credits actually result in measurable reductions in global emissions, and also to improve transparency in the process. Due to the complexity and scope of the issue the rules are intricate and challenging to follow in the real world.

The new rules don’t necessarily apply to the entire spectrum that are a part of the carbon credit exchange market. National regulators and private credit certifying organizations are currently deciding on how to incorporate the new rules into their work offering a chance for those involved to have an influence on the final outcome. Initial signs suggest that the new rules will alter the public and private standards in this year, enhancing integrity and, in the future decreasing fragmentation. If they are implemented successfully the rules will allow carbon credits to realize their potential to cut global emissions, and encourage businesses to invest in carbon credits as part of their net-zero path and offer significant opportunities for investors to fund credit-generating projects.

The Article 6 in the Paris Agreement sets out the fundamental mandate of carbon markets, which allows nations to fulfill their international climate commitments (nationally defined contribution also known as NDC) through the purchase of carbon credits. The most significant development that took place in Glasgow was the long-awaited agreement regarding the known as the “Paris Rulebook,” that aims to implement the Paris Rulebook’s mandate. In the following, we will discuss carbon markets as well as The Paris Rulebook, and their interplay.

The carbon markets in a nutshell. Carbon credits are granted as part of an initiative in the “host” country in order to cut or eliminate emissions. Each credit grants the right to emit a specific amount of carbon, typically 1 ton for each credit. Credits are bought by a business or a country that is in compliance or voluntary markets.

In compliance markets, companies purchase credits that are utilized to fulfill obligations to reduce emissions in (i) international agreements (e.g. by nations to achieve the requirements of their NDC in the Paris Agreement or by airline operators to offset their emissions in accordance with CORSIA, the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA)) or (ii) national schemes (e.g. or by corporations to limit their liability under a national emission trading scheme (ETS) or a carbon tax). Every regulator decides on the extent carbon credits may be used to satisfy regulations, as well as the requirements for eligibility for credits.
The voluntary carbon market (VCM) businesses purchase carbon credits in order to fund the voluntary claim (e.g., voluntary net-zero pledgesthat are referred to as “offset claims,” or to demonstrate support for projects to reduce emissions, that is known as “impact claim”). There is currently no uniform international regulation or guidelines on the carbon credits’ quality which can be utilized for the VCM.

The Paris Rulebook in a nutshell. It is the Paris Rulebook develops two approaches to international transfers of carbon credits. The first is it is the Cooperative Approach (Art 6.2) is applicable when two countries exchange carbon credits or, as per some guidelines, when a host country permits another company or country to utilize credits, even if the host nation does not have an agreement with another country. For instance, as an example of this Cooperative Approach, Switzerland and Peru have signed an agreement that allows Switzerland to provide financing for credit-generating projects in Peru in exchange for carbon credits Switzerland will use to achieve its 2030 NDC goal. The second is the Sustainable Development Mechanism (SDM) (Art 6.4) creates an international framework to approve credit-generating projectsthat are typically run through private investment.

For each method, each approach, the Paris Rulebook sets out substantive and procedural guidelines to ensure the authenticity of credits -credits that are meaningfully contributing to reducing global emissions.

What are the main conditions of the Paris Rulebook?

(1) There is no double counting Carbon credits can be counted only one time. The country that hosts it may informally accept that it will not use credits to satisfy its own NDC and instead permit the credit to be used for different carbon mitigation goals (e.g. or by another country to achieve the requirements of its NDC as well as by a business located in a different country). In this case the credit will not be considered by the host country as well as the other country or company.

(2) Additionality A credit-generating venture must result in emissions reductions or eliminations which would not have been possible without the anticipated income stream from the sale of the credits created by the project. This ensures that the project will have an actual — and in addition to decreasing emissions in the country of its host regardless of the person who utilizes the credit. It is the SDM Approach (Art 6.4) includes additional requirements for how to determine the amount of reductions in emissions.

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

(1) Approval from the international community: As per the Cooperative Approach (Art 6.2) The credit-generating project is managed with the approval of the country that hosts it, but without the endorsement of an international supervision body. While there isn’t an international body, the parties must adhere to specific reporting and transparency requirements, which are subject to the approval of independent technical experts who are able to make (nonbinding) publicly-recommended recommendations. Contrary to the SDM Approach (Art 6.4) There are additional layers of supervision: A plan must be approved by the country of origin and an international supervisory bodythat is based on the recommendations of the independent body of verification.

(2) Levies that are mandatory: In the SDM Approach (Art 6.4), mandatory levies of 7percent are imposed on carbon credits. These levies are intended to help support adaptation to climate change for developing nations (5 percent are credited to the United Nations Framework Convention on Climate Change Adaptation Fund) and also to ensure the additionality of (2 percent are cancelled). Levies that are mandatory are not enforced in the Cooperative Approach (Art 6.2) however they are “strongly recommended.”

The new rules grant the host country an important part in projects that generate credit. They are able to decide (i) what standards are applicable (the Cooperative Approach, SDM Approach or an approach that is not part of the Paris Rulebook) and (ii) whether carbon credits are used to satisfy the country’s individual NDC and if it is not. The way the choices are made will determine the potential value and use of the carbon credit that is resulting.
The effect on carbon markets is the result of 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 major impact on market regulation, increasing the quality of carbon credits in voluntary and compliance markets. In fact, even though a number of aspects that are part of the Paris Rulebook are still to be formulated, efforts are being taken to improve credibility of carbon credit in accordance with. In addition, the most prominent private credit-certifying bodies, like Gold Standard and Verra, are currently improving their standards in the light that of Paris Rulebook.

The effect on carbon markets is the result of 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 major impact on market regulation, increasing the quality of carbon credits in voluntary and compliance markets. In fact, even though a number of aspects that are part of the Paris Rulebook are still to be formulated, efforts are being taken to improve credibility of carbon credit in accordance with. In addition, the most prominent private credit-certifying organizations like Gold Standard and Verra, are currently improving their standards in the light that of Paris Rulebook.

In the VCM there aren’t uniform international standards for the quality of credit. This could be changing. Private initiatives are currently developing guidelines to improve the integrity of credit (e.g., for instance, the Voluntary Carbon Markets Integrity Initiative) The first guidelines due in April. It is expected that the Paris Rulebook requirements on double-counting transparency, additionality, and double-counting will likely influence these guidelines. In the future, certain national regulators could also regulate credit used for voluntary purposes by, for instance, establishing the quality standards for credit that companies use to fulfill net-zero commitments.

Compliance markets regulators in national jurisdictions often allow companies to make use of credits to fulfill certain or all requirements under the ETS or carbon tax. Regulators are now able to make eligibility requirements more stringent in accordance with the Paris Rulebook. Other countries that have ETS or a carbon tax might be more likely to allow the utilization of credits with high-quality that satisfy requirements of the Paris Rulebook requirements. While the CORSIA scheme to offset emission from aviation international already has fairly stringent rules regarding how carbon credit quality is assessed, other countries could further improve those standards.

The Paris Rulebook is also expected to impact pricing. Credits that are compliant with the Rulebook are more reliable and will likely to be able to be used in greater markets. They could, therefore, be expected to receive an additional price.

Risks and opportunities for all the stakeholders. It is evident that the current state of rapidly changing regulatory and market dynamics offers huge opportunities and threats for all participants. Particularly important:

Businesses can purchase carbon credits of high quality to fulfill their net zero commitments (either optional or perhaps obligatory). The increased scrutiny of the authenticity of carbon credits from both regulators and consumers underscores the necessity to choose the correct carbon credits “product.”
Investors and developers of projects can invest in and develop projects of high-quality, but with some doubts about how market and regulatory dynamics will unfold (including, e.g., pricing dynamics , and the stability/liquidity of the market as it expands).
Regulators must now further refine their own rules and regulations to implement Paris Rulebook and decide whether they should modify the eligibility requirements under their local ETS and carbon tax systems. In the international context, regulators should consider how the rules impact schemes such as CORSIA and whether they should subject different industries (e.g., marine shipping) similarly to schemes.
Countries hosting the project may take advantage of the chance to obtain additional funding for carbon-reducing projects by carefully assessing the best carbon credit strategy to use to reduce emissions and encourage sustainable development.

We are ready to help those who need assistance in navigating this complicated environment. This could include, for instance providing clients with advice on the risks and opportunities with financing their own emission-reducing projects via the creation and selling of carbon credits; buying carbon credits in order to reduce their carbon emissions and reach net-zero goals; the ability to secure carbon credits in the future considering the rapid-changing regulatory changes and working with the government to maximize the benefits and minimize the risk of taking part in the market for carbon.

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