Cop26

COP26 Deal to Pave Way for Carbon Markets Growth

Agreement on Paris rules in Glasgow expected to stimulate investment flows, while wider deal seen as key, if limited, step on path to low-carbon transition.

Investor groups and NGOs welcomed the likely boost to climate-aligned investment flows and carbon markets provided by the completion of the ‘Paris Rulebook’ as part of the Glasgow Climate Pact reached at COP26 on Saturday.

The signing-off of the rulebook settles transparency and reporting requirements needed to track progress made by countries against greenhouse gas (GHG) emission reduction targets, including common timeframes.

It also finalises so-called Article 6 rules, which frame the operation and interaction of national and regional carbon markets, supporting international cooperation on emission reductions. This provides a green light for global trading of carbon offsets and credits, accelerating growth of existing voluntary markets used by corporates.

Greater transparency on emissions reduction plans and carbon pricing were among key expectations from asset owners ahead of the two-week summit, which concluded over the weekend with backing for a new agreement, following a last-minute rewording on coal, prompted by India and China.

More transparent global pricing of corporates’ carbon emissions will not achieved solely by agreement on Article 6, but the consensus reached in Glasgow on common rules for carbon trading is seen as bringing it closer to fruition.

Further, the greater integrity of carbon markets provided by the new rules should also enhance the credibility of voluntary offset markets, thus increasing the flow of funds into legitimate nature-based carbon capture and sequestration solutions, also aiding reforestation.

Kelly Kizzier, Vice President for Global Climate at the Environmental Defense Fund, a US-based NGO, said agreement on Article 6 provides the rules for a “robust, transparent and accountable” carbon market that would promote future climate ambition and facilitate finance flows to developing countries.

“The rules, while not perfect, give countries the tools they need for environmental integrity, to avoid double counting and ultimately to clear a path to get private capital flowing to developing countries,” she said.  “They allow countries to focus their efforts on ambitious implementation of their emission-cutting targets.”

The wider pact and other deals reached during COP26 maintain hope of keeping climate change to 1.5 degrees Celsius, but global action is “still falling short”, according to Rebecca Mikula-Wright, Chief Executive Officer of the Investor Group on Climate Change (IGCC) and the Asia Investor Group on Climate Change (AIGCC).

“The net zero emissions transition is inevitable and already underway, and investors want to seize the enormous investment opportunities, worth trillions of dollars, that will be created. There is a huge opportunity to create new jobs and boost economic growth, but only for those countries that get ahead of the curve,” she added, calling also on governments to back up 2050 commitments with “stronger” 2030 targets.

Six years to agree Article 6

The successful conclusion of negotiations on the Paris Rulebook means the rules for delivering Paris Agreement are complete, six years after it was signed and celebrated by world leaders. This includes agreement on the process for holding countries to account as they deliver on their targets.

Under the new Glasgow Climate Pact, countries’ targets will be updated more frequently, with new nationally determined contributions required before COP27 in 2022 and a global stock-taking summit involving heads of state in 2023. Separately, UN Secretary General Antonio Guterres said he would set up a High-Level Expert Group to establish “clear standards to measure and analyse net zero commitments from non-state actors”.

Consensus on how to implement Article 6 of the Paris Agreement establishes the rules for operation of and interaction between national and regional carbon markets, typically operated by governments to place a levy on carbon emissions. Potentially, this allows for the linkages between carbon trading schemes and the international transfer of carbon credits.

But bilateral arrangements are still considered complex and may be made less likely by an element of the Glasgow deal which means countries will be able to exchange carbon credits through a central mechanism set up by the United Nations Framework Convention on Climate Change (UNFCCC). In effect, countries will be able to buy offset credits representing emission cuts by others as a means of partially meeting their targets.

This also legitimises the voluntary markets being developed to allow companies to meet part of their net zero commitments, by buying offsets, which may represent other firms’ emissions cuts or the outputs of projects that sequestrate carbon through natural or technology-assisted means. These have been criticised for lacking rigour and for slowing the pace of transition from fossil fuel use.

The Article 6 agreement agreed in Paris should mean carbon markets are credible, transparent and science-based, and do not permit greenwashing, i.e. allowing targets to be reached without real-world emissions reductions being made.

“Operationalising Article 6 will allow Parties to scale up their cooperation, mobilise additional finance and private sector engagement and ensure that the rules are the same for everyone,” said Patricia Espinosa, Executive Secretary of the UNFCCC.

“Solid and ambitious outcome”

The deal reached on Article 6 resolved a number of longstanding issues which led to the collapse of previous efforts to ensure consistency and fairness across markets in 2019. Previous disagreements over taxation have been overcome, for example, by an agreement for 5% of proceeds from trades on the centralised UNFCCC system to go toward an adaption fund for developing countries.

Compromises were reached on other areas including limiting carry-over of legacy credits under the Kyoto Protocol and avoiding double counting of credits by sellers and buyers.

The International Emissions Trading Association (IETA) said agreed Article 6 guidance sets up a new structure for carbon markets to work in the service of the Paris Agreement goals.

“This is a solid and ambitious outcome, because it establishes an integrity framework to support the expansion of carbon markets to help governments and businesses deliver higher climate ambitions,” says Dirk Forrister, CEO of IETA.

“It will now be up to the private sector to channel green investment using these new market structures and accelerate the race to net zero.”

Previously, IETA had predicted that a well-structured agreement on Article 6 could halve the cost of implementing countries’ emissions targets, enabling the removal of five gigatonnes of CO2.

James Roth, SVP Global Policy and Government Affairs, Conservation International, said the deal on Article 6 provided the framework for “high-quality, consistent and transparent climate action” via carbon markets.

“This level of certainty will drive new investments to scale the climate actions we desperately need across all sectors, including halting deforestation and promoting other natural climate solutions,” he said.

“Through increased financial investment, nature-based carbon credits will benefit countries and communities, which reap both the financial and the environmental gains that forests and other high-carbon ecosystems provide.”

Further urgent progress required

Agreed in overtime on Saturday, the Glasgow Climate Pact broke new ground compared with previous climate summits with explicit reference to the need to “phase down” coal, while also increasing adaption funding to less developed countries and committing to revisiting nationally determined contributions next year.

The deal was also criticised for a lack of progress on funding to less developed countries based on the concept of loss and damage and watered-down language on the ending of “inefficient” fossil fuel subsidies.

As negotiations took place over the course of the two-week summit, a large number of bilateral and multilateral agreements were announced, including a US and EU-led pledge to reduce methane emissions, a new coalition to end oil and gas use, sectoral deals on deforestation, electric vehicles, steel, hydrogen and agriculture, a new funding mechanism to support power transition in South Africa, and a commitment to collaborate on climate action over the next decade by the US and China.

Professor Lord Nicholas Stern, Chair of the Grantham Research Institute on Climate Change and the Environment at the London School of Economics and Political Science, said COP26 represented a “major step along the way”, but admitted that much more action was needed to limit climate change to 1.5 degrees Celsius.

“The Glasgow Pact itself is a major step forward which charts a future for increasing finance from developed to developing countries, doubling of adaptation finance, and on finance in general for adaptation, mitigation and sustainable development,” he said.

“Over the next 12 months there is critical and urgent work to be done to unleash key sources of finance: bilateral, multilateral, multilateral development banks, private sector, and innovative sources, including philanthropy, Special Drawing Rights from the International Monetary Fund, and voluntary carbon markets.”

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