What will happen if we fail to meet Paris Agreement targets and the Earth’s temperature rises by over 1.5°C? Experts are forecasting a huge increase in natural disasters, famine, species extinction and mass migration, which some parts of the world are already experiencing. Climate change is also a major threat to business and economic stability. In 2021 alone, climate disasters cost the U.S over $1bn.
Without the private sector, net zero isn’t possible. Taken together, countries’ national emissions reductions targets, known as Nationally Determined Contributions (NDCs) under the Paris Agreement, are currently not sufficient to limit global temperature increases to 2°C, let alone 1.5°C. As a global community, we need to increase ambition and accelerate emissions reductions and removals. Here the private sector can lead the charge. The net zero transition is inevitable—it presents massive opportunities for organizations that are well prepared and massive risks for those that drag their feet.
We need to use every available resource that will make a meaningful difference. Many of us realize that Voluntary Carbon Markets (VCMs) are a valuable tool to tackle climate change – in fact annual trading exceeded $1bn for the first time in 2021 – but we also understand that the market is complex.
This guide is intended to help Sustainability Leaders better understand the VCMs, so that you can navigate through some of the questions and complexities surrounding them, and deliver your sustainability goals with confidence.
What are Voluntary Carbon Markets (VCMs)?
Voluntary Carbon Markets are international markets that allow the sale and purchase of carbon credits. Often credits are bought by emitters, including individuals and organizations, to allow them to offset their greenhouse gas (GHG) emissions. Unlike compliance carbon markets, VCMs are not currently regulated by a centralized authority, such as a government.
Compliance and voluntary markets have developed in parallel, with key developments such as the Kyoto Protocol in 1997 and the Paris Agreement in 2015. At COP26, the rules relating to Article 6, concerning carbon markets, were agreed. Both types of carbon markets have the potential to incentivize positive environmental outcomes and finance projects that cap, reduce or remove GHGs. However, VCMs lack the regulation and transparency of compliance markets like the EU ETS.
This can make VCMs difficult to navigate, especially for those who lack the experience or resources to properly evaluate carbon project performance. However, VCMs also present a number of opportunities when approached with the appropriate expertise.
Over the years, companies have been called out for “greenwashing” when they used carbon offsetting instead of prioritizing emissions reductions from their business activities. We have also seen examples of substandard projects receiving investment from organizations, which resulted in high profile scandals. This has given the market a reputation of being risky and highlighted that today not all carbon credits are created equal.
In 2022, Sylvera surveyed 500 ESG decision makers at UK and US corporations with over 10,000 employees, and asked them what they considered to be the biggest risks and benefits associated with carbon offsetting.
How do VCMs work?
Carbon credits are tradeable units sold by project developers that have been created with the purpose of reducing, avoiding or removing GHGs in the Earth’s atmosphere. Each carbon credit is measured as one ton of carbon dioxide (CO2) or an equivalent GHG that is or will be avoided or removed from the atmosphere.
There is an ongoing debate about which is more effective, but in reality both are essential in the fight against climate change. Currently removals credits make up 3% of the market and non-removal nature-based solutions make up 45%.
To learn more on avoidance vs. removals, read our deep-dive article.
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What are the types of carbon projects?
There are a number of project types in the VCMs. They all fundamentally serve to either avoid, reduce or remove emissions, but may also have additional benefits. By purchasing credits, you are normally funding the project’s activities; however, this is usually not the case for larger-scale renewables. Since the quality of carbon projects can vary, it’s important to understand how they are designed, implemented, and monitored – and whether they align with your organization’s sustainability goals.
These projects make up the vast majority of VCM credits
Carbon Project Checklist: What you need to know before investing
Policy & regulation implications to consider
While the VCMs are not currently regulated anywhere in the world, they are largely shaped by the broader policy environment relating to climate change and national decarbonization strategies.
Key policy and regulatory initiatives currently shaping the VCMs are:
The Paris Agreement, which sets the global goal to decarbonise all human activity, and is the ultimate driver for all climate action. The Paris Agreement operates on a cycle whereby every five years each country is expected to submit an updated and more ambitious national climate action plan (a Nationally Determined Contribution, or NDC). The next round of updated NDCs are due by 2025.
The Task Force on Climate-related Financial Disclosures, or TCFD, describes a set of global principles for climate-related disclosures which a growing number of national regulators are enshrining. This includes all members of the G7. Companies’ TCFD reporting is becoming more detailed every year, and increasingly covers companies’ use of carbon credits.
The US Securities and Exchange Commission (SEC) recently released a draft rule on climate disclosures, along the lines of the TCFD. However, the draft SEC rule includes substantial disclosure requirements on the details of carbon credits being retired, which would bring a new level of transparency to the markets.
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You’ve read the highlights, now access the full report for a deeper dive into how carbon credits make it to market, how to evaluate quality and how to prepare your organization for imminent regulatory changes.