Carbon Markets | Evolution & Implications for Financial Institutions

Carbon Allowance, Credit and Offset programmes have been part of the drive towards reducing global greenhouse gas (GHG) emissions for twenty years or more – the Clean Development Mechanism (CDM) is part of the Kyoto Protocol discussed at the UNFCCC’s CoP 3 meeting in 1997 and the EU’s Emissions Trading System (ETS) was launched in 2005 and is now in its fourth phase.  Although many national schemes and initiatives for international cooperation have had issues relating to credibility – particularly relating to the genuineness of GHG emission-reducing projects and initiatives and the carbon credits associated with them – the recent surge of interest in Voluntary Carbon Markets (VCM) and the Paris Agreement Crediting Mechanism (PACM) agreed at CoP 29 in Baku in 2024, as well as the Carbon Offsetting & Reduction Scheme for International Aviation (CORSIA) initiative in the aviation sector have reinvigorated carbon markets and underline their importance – notwithstanding the challenges in implementation – in the reduction of carbon dioxide and other emissions.

What is emerging is something of a lattice of overlapping mandatory and voluntary carbon Schemes, carbon taxation regimes and international initiatives facilitating cross-border cooperation and crediting systems which encourage reduction of emissions within existing industrial processes and transportation networks on one hand and the avoidance or removal of Carbon Dioxide (CO₂) – and other GHG – on the other.

Carbon pricing continues to be driven by both “fundamental” factors – such as the estimated costs of the economic “externalities” resulting from GHG emissions and their resulting impact on climate change across economies and also “technical” factors relating to the relative demand versus supply for carbon credits themselves.  However, other influences can be critically important such as price ceilings imposed by regulators, e.g. the California Air Resources Board’s Cap & Trade Scheme, as well as political influences relating to, inter alia, the impact on local firms’ competitiveness vis-à-vis companies in other geographic regions with less stringent controls over GHG emissions.

Notwithstanding the renewed interest in carbon markets, issues relating to credibility after the Verra scandal and other concerns relating to the actual (positive) impact of Carbon Credit & Offset schemes and the Carbon Project that – at least in theory – support them.  As a consequence, carbon market participants are, understandably, very focused on the accreditation and assurance processes and standards adopted by mandatory and voluntary carbon schemes that underpin their credibility.  Bodies such as the International Council for Voluntary Carbon Markets (ICVCM) seek to provide such accreditation and assurance but, in truth, substantial challenges remain in terms of re-building confidence in carbon markets.

Banks and other financial institutions remain pivotal in the successful development and functioning of carbon markets, playing key roles from carbon project identification, client advisory in VCM participation, carbon credit cycle processes and by participating in the secondary market trading of carbon credits as well as in developing carbon-related financial products based on the generation of credits and the use of carbon offsets.  Many of the world’s leading banks are also working with other organisations to reduce their overall direct and balance sheet financed emissions by supporting carbon-positive projects internationally.

Author: Duncan Hughes, Guest Contributor

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