From Wild West to Law of the Jungle

Voluntary carbon markets can direct climate finance to emerging markets, but risks persist despite reforms.  

By the end of 2021, the value of voluntary carbon markets (VCMs) reached nearly US$2 billion, with around 500 million carbon credits traded throughout the year. This has highlighted both the popularity of offsetting CO2 emissions and the potential scope for trouble if the so-called Wild West of carbon markets continues to grow unchecked. 

VCMs facilitate the trading of carbon credits that don’t count towards mandatory decarbonisation targets or fall under regulated carbon markets, such as the EU’s Emissions Trading System. 

Their patchy track record means many see offsets as wishful thinking at best, and fraudulent at worst. But VCMs are seen by others as a useful tool to offset hard-to-abate emissions and direct capital towards sustainable projects around the world – provided every effort is made to first cut as many emissions as possible 

A growing number of underlying projects are geared towards restoring the world’s natural carbon sinks (otherwise known as REDD+ projects), and are being set up in the world’s largest freestanding forests which, more often than not, are located in emerging markets (EMs).  

With demand estimated to swell VCM-based trading to US$50 billion by 2030, and more than two thirds of countries planning to use carbon markets to meet their nationally determined contributions (NDCs), “voluntary markets will continue to play a very real near-term role in helping accelerate the net zero transition of a number of EMs,” notes Agustin Silvani, Senior Vice President at environmental NGO Conservation International.  

However, a lack of regulation, transparency and governance means that EMs choosing to incorporate VCMs into their climate strategies are exposing themselves to a number of potential risks.  

Attempts to introduce order are under way. New sheriffs have set up shop and are drawing up rules on both the supply and demand side of voluntary markets, which may eventually be reinforced by regulation introduced by policymakers in line with Article 6 of the Paris Agreement. 

“At this stage, harmonisation is more important than perfection,” says Amir Sokolowski, Global Director of Climate Change at environmental disclosure platform CDP.  

Climate capital  

EMs are already beginning to shake the VCM money tree, getting paid for carbon sequestration through the sale of carbon credits to investors, polluters and others.  

“Typically, EMs have been operating under economic models that exploit their [natural] wealth and resources,” says Silvani. “VCMs allow EMs to benefit from the protection of nature as opposed to its destruction; they are now being compensated for something that has previously been given to the world for free.” 

Many EMs were already trading credits with more industrialised nations under the Kyoto Protocol but the VCMs offer a channel to attract private investment, too.  

Rob Macquarie, Policy Analyst and Research Advisor to Lord Nicholas Stern at the London School of Economics Grantham Research Institute on Climate Change (LSE GRI), adds that selling carbon credits provides EMs with “debt-free finance, which is particularly important for countries that are struggling with high public or private debt burdens and don’t have large inflows of capital targeting climate change mitigation and adaptation”. 

Global mangrove forests sequester around 22.8 million metric tonnes of CO2 within their roots, trunks and soil every year, according to the United Nations Environment Programme (UNEP). Kenya’s Gazi Bay is home to the Mikoko Pamoja project, through which thousands of mangroves have been planted, thanks to a decade of selling voluntary carbon credits.  

Local residents are managing the 290 acres of mangrove forest – planting 4,000 new mangroves every year – in exchange for an average annual salary of three million Kenyan shillings (US$25,500).  

As the world’s second largest producer of cocoa beans, Ghana’s Cocoa Forest REDD+ Programme (GCFRP) is promoting a climate-smart production system and landscape standard. It incorporates social and environmental safeguards, such as protecting trees against pests and diseases and instituting mechanisms for receiving, evaluating and addressing project-related grievances from affected local communities.  

It is expected that GCFRP will generate 13.5 million metric tonnes in CO2 reductions over a five-year period, with just over 10 million made available for transaction under the terms of its Emissions Reduction Purchase Agreement. 

Mark Kenber, Executive Director of multi-stakeholder platform the Voluntary Carbon Market Integrity initiative (VCMI), notes that Colombia incorporated VCMs into its tax and credit system following the launch of its VCM platform in 2016. 

“Companies can either pay the carbon tax or invest in domestic projects using methodologies developed by Verra and use that as part of their national compliance,” he says.  

Malaysia will be launching its own VCM by the end of this year, which will include product categories for carbon credits derived from nature-based solutions distinct from those based on technological CO2 reduction or removal.  

The revenue generated from these projects can subsequently be used to “finance other local climate-smart or carbon removing activities”, such as regenerative agriculture, thus allowing EMs to “buck trends for climate-harming development”, says Carolyn Ching, Senior Manager of Food and Forests at US investor network Ceres. 

Ahead of COP27, some EMs are pushing for a fairer price on the forest carbon credits they sell. Felix Tshiekedi, President of the Democratic Republic of the Congo (DRC) – home to the second largest expanse of rainforest in the world – is actively calling for a price of US$100 per metric tonne for Congo basin-generated credits, which would be about 20 times higher than the current average for DRC forest credits of around US$4-6 per metric tonne. 

Complicated web  

The common issues that have long plagued VCMs are having an impact on EMs operating in voluntary markets. 

One of the most predominant issues is opacity. “From the quality and integrity of a new carbon credit-generating project, to the splitting of the revenue once credits have been sold”, says Kenber, “We need radical end-to-end transparency across all parts of VCMs to establish trust.”  

A recent investigation found that a major European logging firm had illegally converted more than a dozen of its timber concessions in the DRC into conservation concessions, without public oversight or consultation with local communities – despite the fact they overlapped with ancestral lands and climate-critical peatlands.  

Kenber says: “It’s very difficult to secure information outlining how the benefits of these projects are being shared with local communities, despite the fact most buyers probably don’t want to be associated with projects where the developer keeps 100% of the profits and the local communities get nothing. It’s morally and ethically unacceptable and it’s damaging the reputation of VCMs.” 

Further, flawed forest carbon credit projects in Colombia could cost the government US$62 million in tax revenue, according to an investigation by NGO Carbon Market Watch and the Latin American Center for Investigative Journalism. Their research noted that two large projects collectively issued 12.4 million credits more than the true volume of expected emission reductions.  

“It’s important to look closely at the parties involved,” says Silvani from Conservation International. “Has the project been verified against an independent third-party standard? Are they paying local communities their fair share? How have they calculated the number of available carbon credits? Some legwork from investors is needed to ensure proper due diligence.” 

There’s also the question of double counting and the application of corresponding adjustments.  

If one country (or company) purchases carbon credits from a project based in a different country, both entities cannot count that credit as their own reduction or removal of CO2. To avoid this, entities are required to apply corresponding adjustments, meaning that the country that sold the carbon credit must deduct it from its ledger.  

As the selling party, EMs often face the difficult task of balancing the need to attract outside capital to invest in climate change adaptation and mitigation with the safety net of having carbon credits available to offset their own harder to abate emissions.  

It’s also a matter of splitting carbon credits fairly. “We cannot allow large companies and polluting developed countries to merely offshore their climate action to EMs and not focus on reducing their own emissions first,” says William Chignell, Chief Commercial Officer of ESG at global financial services provider Apex Group.  

Such uncertainty – around the quality and transparency of projects and the ownership of carbon credit benefits – has prompted some EM governments to take action.  

Following concerning analysis of a proposed carbon offsetting project in Papua New Guinea, which promised to produce 8.1 million carbon credits a year for a century, in March the country’s environment minister imposed a moratorium on new voluntary carbon credit schemes, until the government had implemented a regulatory framework to manage future and existing deals. 

Indonesia and Honduras have also announced temporary moratoriums on trading in VCMs.  

India has plans to launch its own VCM, but announced the market will be limited to domestic trading, citing concerns that selling its generated carbon credits to other countries and international companies will prevent the government from achieving its NDC.  

New order 

Introducing order to previously ungoverned markets isn’t going to be easy, but progress is being made by the VCMI and the Integrity Council for the Voluntary Carbon Market (ICVCM).  

“[Their cumulative work] will hopefully lead to a significant increase in transparency, which will allow participants and observers to better understand how carbon finance can help them achieve their climate objectives,” says LSE GRI’s Macquarie. “We need carbon credits to be as comparable as possible – likewise with companies’ claims to climate performance.” 

Despite similar acronyms, the ICVCM and VCMI are not two sheriffs fighting for the same job. The ICVCM is focused on the supply side of carbon credit generation and the establishment of offsetting projects, whereas VCMI is focused on introducing demand-side rules for entities using carbon credits as part of their decarbonisation strategies.  

As well as being VCMI’s Executive Director, Kenber sits on the board of ICVCM. He tells ESG Investor that the purpose of both groups is to introduce new rules to maintain the integrity of and trust in VCMs “on the way to regulation”. 

In June, the VCMI published its draft claims code of practice to help investors and other actors scrutinise companies’ carbon credit claims. These will be awarded a gold, silver or bronze marker according to the extent to which entities have aligned with the guidance. Companies including tech behemoth Google have agreed to trial the provisional code. 

Now that the trial and consultation period has closed, VCMI intends to publish its next version of the code early next year.  

The ICVCM was established as an outcome of the Taskforce on Scaling Voluntary Carbon Markets, and has published a consultation for its Core Carbon Principles (CCPs) – open until the end of this month. It aims to set threshold standards for what constitutes a high-quality carbon credit and define which existing voluntary schemes (like Verra and Gold Standard) and methodology types are “CCP-eligible”. 

The final CCPs and assessment framework will be published by the end of this year.  

Silvani, who also sits on the ICVCM board, says: “These measures are all building blocks towards a unified market, so that VCMs are not on completely separate tracks to regulated markets, but are aligned as much as possible and fair to everyone involved.” 

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