22 Apr The Future of the Voluntary Carbon Market
As countries around the world begin to develop and implement effective measures to deliver the Paris Agreement’s goal of keeping global warming to 1.5°C above pre-industrial levels, the voluntary carbon market (VCM) has come into focus as a key tool that can contribute to that goal. Although the VCM has historically played a relatively small role in the fight against climate change, it has proven to be an incredibly effective means of delivering needed finance to projects around the world that demonstrate innovative ways of reducing GHG emissions or removing CO2 from the atmosphere. According to the latest State of the Voluntary Carbon Markets report from Ecosystem Marketplace, to date, the VCM has channeled more than $5 billion into projects around the world, ranging from renewable energy and clean cookstoves to forest conservation. What’s more, many of these projects deliver substantial improvements in people’s lives, meaning they contribute to progress towards the United Nations’ Sustainable Development Goals (SDGs).
Important Role of Voluntary Carbon Market
The important role the VCM can play in the fight against climate change has driven a significant increase in climate action by companies, with approximately one-fifth of the world’s 2,000 largest publicly listed companies having committed to a “net-zero” emissions target. The VCM has also attracted the attention of luminaries like Mark Carney, the former Governor of the Bank of England who led the Task Force on Climate-related Financial Disclosures (TCFD). Mr. Carney has teamed up with Annette Nazareth, former Commissioner of the U.S. Securities and Exchange Commission, Bill Winters from Standard Chartered and Tim Adams from the International Institute for Finance to lead the Taskforce on Scaling Voluntary Carbon Markets (TSVCM), which is developing concrete recommendations to scale the VCM by orders of magnitude.
The existing and potential growth in the VCM highlights the need to ensure that it continues to drive action to truly additional projects while simultaneously embracing increasing government regulation and policies. Given the lack of sufficient finance to tackle climate change at the scale needed, it is critical we design markets to support government action without cutting off investment from corporates, while ensuring that all actors set ambitious targets and increase them over time.
Today, Verra is announcing new requirements for key elements of the VCS Program that will enable us to continue channeling additional finance and investment into climate action all around the world. These new requirements are meant to support markets with different requirements, such as those operating in the context of the Paris Agreement, where corresponding adjustments are likely to be required pending finalization of the Article 6 rulebook, as well as the VCM, where we do not currently see a need to require corresponding adjustments. The VCS rules relating to double counting such as with emission trading programs and renewable energy credits remain in place, and have been updated for clarity.
Driving Additional Finance
The power of the VCM lies in its ability to link corporate and other organizational GHG footprints to investment in project activities. Over time, and as the need to take action on climate change has become increasingly urgent, responsible companies have taken concrete steps. The first, of course, is to measure their organizational GHG footprint, which given the urgency of the problem, turns it into a de facto liability. Leading companies are now also setting future “net-zero targets” that establish a goal for decarbonizing their companies and balancing residual emissions by a specific date. This has resulted in companies undertaking important measures to reduce their footprint, such as by investing in energy efficiency, committing to purchase renewable energy and investing in electric vehicles. Those activities will grow in importance over time as companies aim for net-zero. The most ambitious companies are investing in projects today that reduce GHGs or sequester carbon from the atmosphere as a means of offsetting their residual footprint in order to achieve carbon neutrality now while working towards long-term net zero targets.
These investments in project activities are the foundation for today’s VCM and drive significant impact because they are:
- New. They are additional to what had previously been corporate donations to good causes. The link to a company’s footprint has, in effect, created a new source of finance for activities that have a positive impact on the world, while also scaling their ambition since reaching neutrality (and ultimately net-zero) requires compensating for the full footprint.
- Resilient. This additional source of finance is quite resilient to economic downturns. The current global economic crisis caused by the Covid pandemic appears not to have slowed down the growth in the VCM.
- Supporting developing countries. A significant portion of this new investment in project activities flows from the developed world to the developing world. During 2019, a majority of the carbon credits purchased in the VCM were from projects in developing countries, which underscores the fact that these investments flow to where they are most needed.
- Efficient. The additional finance brought by the VCM flows much more efficiently than other typical means meant to support developing countries, such as traditional overseas development assistance (ODA). Because carbon credits are a pay-for-performance system, the resources flow to those who can address climate change directly through verified results. And, because many projects seek to improve livelihoods as a means of combating climate change (e.g., supporting farmers to adopt more effective land management practices that reduce pressure on forests and providing important community benefits such as education and health care), they often flow to marginalized communities who are ideal candidates for receiving ODA and other government assistance but which have long been unable to secure such support.
Accounting for Voluntary Action
The signing of the Paris Agreement (PA) ushered in a new era of international cooperation on climate change, much different from its predecessor the Kyoto Protocol. Perhaps the most distinguishing feature of the PA is that all countries are required to establish climate change targets, known as nationally determined contributions (NDCs). Through Article 6 of the PA, countries can participate in cooperative approaches and claim resulting internationally transferred mitigation outcomes (ITMOs) from activities hosted in another country towards their own NDC targets. To ensure that double counting is avoided, Article 6 introduces “corresponding adjustments” (CA), a double-entry bookkeeping tool. Countries that participate in cooperative approaches to meet their NDC targets need to ensure that the use of ITMOs towards NDCs is authorised by all participating countries and that participants make CAs to their national accounts to ensure that double counting is avoided. In a nutshell, a CA ensures that the host country does not use the emission reduction or removal being exported towards its NDC. Verra agrees that these corresponding adjustments are needed between countries, so that no two countries are counting the same unit.
The voluntary action that is currently driving the VCM, however, is different than the work envisioned by the PA in one fundamental way. Any emission reductions or removals claimed as offsets by corporate actors are not counted towards the NDC of their country of domicile; rather, they are reported in those companies’ sustainability or annual reports. In other words, there is nothing to correspondingly adjust because the national accounts of the country of domicile are not affected by voluntary action. As a result, CAs are simply not a tool that should be used to account for emission reductions or removals taking place in the context of the VCM.
Over the last several years, Verra has conducted two public consultations on avoiding double counting, with the second one having taken place last year. Some of the main results from these consultations include the following:
- There is overwhelming support for using CAs for international Paris-related programs such as the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). Respondents clearly articulated that two countries must not count the same emission reduction or removal, and that CAs are required in all cases where this applies.
- 82 percent of respondents agreed that there will be a number of markets in the future, and the labeling of units by carbon crediting programs like the VCS (i.e., labelling units that meet the rules of specific markets like CORSIA) can provide the clarity each market needs.
- 74 percent of respondents believe that CAs should not be required for voluntary action, with the main reason cited echoing the above — that CAs are not fit for purpose for voluntary action and are therefore not relevant to the VCM.
- 54 percent of respondents added that they believed requiring CAs for voluntary transactions would hinder climate action.
An important reason to not require CAs for voluntary action is that doing so could provide a perverse incentive for companies to invest only within the countries of their operations, which could lead to greatly reduced finance for developing countries. It is often argued that CAs aren’t necessarily needed for domestic action (despite the various accounting overlaps that still exist) —as there is no movement of a unit from one country to another. Current demand in the VCM comes from developed countries and requiring CAs for cross-border voluntary action would give a distinct advantage to projects located in the same jurisdiction as the company wanting to offset its residual footprint given CAs would not be needed for intra-country action. In addition, requiring CAs would strike at the heart of equity considerations; we would be asking developing countries with scarce extra resources to find additional emission reductions or removals in their economy, which of course would put a strain on limited public finances. This seems particularly harsh when we consider that developing countries often struggle to meet the basic necessities of their populations (e.g., food, shelter, health, education), and they did not cause the climate problem in the first place.
There are a wide range of claims being made currently across markets — from national targets, to corporate carbon neutrality and net-zero and contribution claims, and commodity offsets. As we consider these different claims, it is critical that we separate them from the realities of different accounting systems. Take as an example an e-commerce company (E-C Company) that sells and distributes goods (e.g., Amazon in the US, Alibaba in China, Otto in Germany, Flipkart in India, Rakuten in Japan, Mercado Libre in Mexico). When these E-C Companies take action on climate change, they would first measure their GHG footprint, which would reflect their direct (operational) emissions (Scope 1), emissions from purchased electricity (Scope 2), and the emissions of their supply chains, which include the goods sold on the platform and their associated emissions (Scope 3). Such emissions, and any emission reductions in these scopes should be reflected in the country inventories where they occur. For example, the scope 2 emissions overlap with the emissions of the energy producer, and scope 3 emissions overlap with scope 1 and 2 emissions of the companies and consumers producing and consuming the inputs of the E-C Companies’ supply chains.
When these E-C Companies reduce their ‘internal’ emissions, such as by investing energy efficiency measures, purchasing renewable energy, and investing in electric vehicles and electric vehicle charging stations, such reductions in emissions would be reported in their annual sustainability reports. However, these emission reductions would also be reflected in the accounts of the country where the reductions took place.
Other examples of these overlapping, but separate accounting systems include domestic voluntary carbon markets. In such cases, projects generate emission reductions or removals, companies purchase units and retire them against their footprint (in the same country), and the overall reduction in emissions will show up in the country’s inventory.
Should we pursue a system that ensures that no single emission nor emission reduction is ever reported or claimed by more than one entity, we will end up with an extraordinarily complicated system. Every company with scope 3 goals would need to either not claim any reductions from supply chain companies or such companies would need to ensure their suppliers adjusted units out of their own scope 1 and 2 accounting. In addition, all of those accounting systems would similarly need to be adjusted from national inventories in the host country. Before you know it, a country would have almost nothing left to report, as the majority of emissions across the country are produced by companies operating within them. Importantly, corporates would have very little incentive to go beyond their scope 1 emissions as the complexity would be too great and there would be too much risk over whether their supply chain actors would make the necessary adjustments. We must also keep in mind that for some of the biggest emitters in the world (e.g., oil companies) scope 3 emissions are significantly larger than their scope 1 footprints, meaning that we must ensure there are incentives for them to address their full supply chains, including the use of their products.
Rather than seeking accounting purity at every level, which would mean avoiding every overlap and insisting on adjustments between every actor, the emphasis should be on two things:
- Ensuring that all actors set the most ambitious targets they can, making sure they are more ambitious over time; and,
- Ensuring all actors invest in and report on their own action.
Where a company invests in a project that is truly additional, it is driving emission reductions that go beyond what could have occurred without that finance. That frees up finance from others (e.g., the government) to invest elsewhere. Together that should actually increase ambition, not undermine it.
Advocates of requiring CAs for voluntary action argue that the solution is to allow companies to make “contribution claims”, meaning that their investment has contributed to a country’s NDC. This could be one option and we have provided for that as part of our new requirements. However, it is important to point out that contribution claims remove the rationale for comprehensive corporate action because they end up de-linking action from the corporate footprint, which as described above has now become a de facto liability that needs to be acted upon. Contribution claims could very well put us back to a world where corporates simply make donations to good causes, and in the process undermine the new finance the VCM has brought to bear on the climate crisis.
Importantly, the lack of a CA for voluntary action does not undermine environmental integrity. The example of the contribution claims illustrates this clearly. Under that approach, the only distinction is the name of the claim (contribution vs offset), and yet the atmosphere sees the same reduction. In both cases, a company makes a claim about the emission reduction and the host country can use that emission reduction to meet its target under the PA.
To address the above, Verra believes that corporates need to clarify the claims they are making. In particular, companies purchasing and retiring carbon credits that do not carry a CA can continue to make offsetting, carbon neutrality and net zero claims provided they state that, for the purposes of accounting under the Paris Agreement, those emission reductions/removals accrue to the host country. This maintains the integrity of the claim made by those entities that invest in projects, while recognizing that under the accounting system of the Paris Agreement such units can only be counted once. In addition, this would provide confidence to host countries concerned that credits transacted in the voluntary market might be used to meet other country’s targets. Finally, such a statement would clarify that credits transacted on a voluntary basis help host countries meet their NDCs, a concept which many companies fully embrace and often is an important driver for their investment in the first place.
Voluntary Action and Government Regulation
Voluntary action has always been driven in large part by the fact that governments have been slow to step up to the greater challenge the climate crisis requires. This has created demand for carbon offsets by leading corporations, non-profit organizations (NGOs) and individuals who believe governments are not doing enough and have therefore taken matters into their own hands. On the other hand, supply has come from numerous voluntary carbon projects that are not required by climate regulations and policies. The implementation of the Paris Agreement will change this, and will result in fewer projects being able to meet the regulatory surplus criterion which all credible standards should be using as a filter to exclude non-additional projects. For example, landfills will increasingly be required to capture and destroy the methane they normally emit to the atmosphere, which will reduce the scope for projects in this sector.
Figure 1 below sets out what we expect to play out over the next decade or so, which is that large point sources of emissions (e.g., power sector, industry) will become increasingly regulated. Consequently, mitigation activities in those sectors will either no longer be additional, or if they are covered by caps (such as the EU Emissions Trading System) there will be an alternative source of financing for them. Either way, additional mitigation activities should become increasingly scarce in these sectors. In the meantime, more diffuse and harder-to-regulate sectors such as the agriculture, forestry and other land use (AFOLU) sector will continue to provide ample opportunities for additional projects.
Figure 1. Sectors Covered by Emissions Trading Across Systems
Technology too will continue to evolve, making some project types no longer eligible and introducing new opportunities for offset projects. A good example of this is Verra’s decision to no longer accept grid-connected renewable energy (e.g., wind, solar) projects in most countries because those technologies are now cost-competitive with fossil-fired power generation facilities and have become common practice. At the same time, there are new technologies (e.g., Direct Air Capture, or DAC) that could benefit from carbon finance, much like it did in the early days of renewable energy projects.
As a result of these dynamics, standards bodies like Verra will need to be vigilant that they are not crediting activities that are no longer additional. For our part, Verra is planning to update our rules on additionality to ensure that we are staying ahead of the regulatory and technology development curves.
In addition, more work is needed to provide guidance and support to countries to establish policies that regulate emissions and help to direct voluntary finance to the areas that most need finance, such as hard (or expensive) to abate sectors. With careful policy design, voluntary markets can attract much needed finance, as well as technological innovation, providing a testing ground for new approaches that can inform future regulations, and can direct investment to local communities and technologies that go beyond what policy can directly stimulate.
It is also possible to ensure that such voluntary action does not undermine government ambition. Where voluntary finance helps achieve a country’s NDC, especially if combined with policies that help ensure voluntary finance is directed at hard to abate sectors, it should free up other sources of finance to support countries going beyond their NDC and to setting stronger future targets. Voluntary finance can help support innovation that can change the development pathway, leap-frog technologies, and drive change beyond the specific project activities. More research and collaboration with governments is needed to provide best practice ways to do so.
With this in mind, Verra, in collaboration with Climate Focus, the Indonesia Research Institute for Decarbonization (IRID), South-South-North and Transforma have begun a new Global Dialogue that seeks to identify how voluntary carbon markets can drive mitigation activities that support national climate plans and local priorities, and provide additional benefits for communities and businesses. This initiative has as its main objective bringing developing country perspectives to bear on the debate about the future of the VCM.
Despite its limitations in a world where governments will (hopefully) increasingly regulate GHG emissions, the VCM can play a critical role in going beyond the NDC targets. Even if we assume that governments do step up and deliver the policies and regulations that get us to that desired 1.5° world, we should aspire to go beyond, especially considering that the current 1°C above pre-industrial levels is already causing devastating changes in the climate. The VCM can be a key driver for that additional finance, which by 2050 will surely need to be targeted towards projects that are removing carbon from the atmosphere.
The debate about the future of the VCM needs to focus on what the VCM can do to scale ambition. Since its beginnings, the VCM has demonstrated it can drive a significant amount of money for climate action where it is needed the most. Now that we are poised to see continued growth in the VCM, we need to ensure that it continues to drive action to truly additional projects while simultaneously embracing increasing government regulation and policies. Certainly we can all agree that there is not enough money to tackle climate change right now, so let’s not make it any harder for investments in good projects to flow.
Verra is proud to be setting out our new rules for a robust and vibrant VCM going forward. Our new rules will ensure that projects using units under Article 6 or other international Paris-related programs (such as CORSIA) have secured CAs, and will allow such units to be used in the VCM where desired. Verra does not currently require CAs for voluntary action given this could be problematic for the reasons set forth above. Verra also will continue to make sure that our VCS Program issues only credits that have environmental integrity and take into account evolving NDC implementation and technological advances. We also plan to provide guidance on claims made on the back of emission reductions and removals we issue to help ensure they are accurate and transparent.
The VCM has tremendous promise, and it will continue to provide a credible tool to fight climate change as governments start to roll out and implement policies and regulations to meet the promise of the Paris Agreement. Until then, the focus needs to be around driving as much finance to climate action as possible.
 Donofrio, S., Maguire, P., Zwick, S., and Merry, W. Ecosystem Marketplace Insights Brief: Voluntary Carbon and the Post-Pandemic Recovery, Forest Trends’ Ecosystem Marketplace: September 2020. Available at: https://www.ecosystemmarketplace.com/carbon-markets/
 ICAP. (2020). Emissions Trading Worldwide – Infographics: Status Report. Berlin: International Carbon Action Partnership.