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Decarbonization’s impact on the global economy: Carbon marketplaces grow to meet global demand

Cat Brennan | Strategy Manager, Impact Labs, FIS

November 29, 2021

Companies today are setting more ambitious targets to lower greenhouse-gas (GHG) emissions. However, the path to net-zero is costly and complex. Companies must address shifting stakeholder sustainability demands while maintaining financial performance. Here we consider how carbon marketplaces are transforming to meet the needs of a global economy increasingly shaped by decarbonization.

Carbon Credits can help companies meet ambitious goals

Sustainability metrics are increasingly becoming an indicator and differentiator for company performance today. Key stakeholders, including investors, executive board members, regulators, and consumers, are looking to sustainability metrics to inform their decisions.

The recent rise of net-zero pledges is increasing in parallel to the demand for sustainability data. Companies are driven to meet emissions-reduction goals and to operate sustainably by several motivating factors, including the desire to:

  • Address investor and consumer pressure
  • Position their brand as climate forward
  • Differentiate themselves from competitors
  • Mitigate reputation, resiliency, and regulation risks

With targets in place, companies must now develop and execute complex decarbonization strategies. For most, targets cannot be met without carbon offsets. While strategies should not consist of carbon offsets alone, carbon credits can help companies meet ambitious goals and report to key stakeholders.

An introduction to global carbon marketplaces

Efficiently navigating carbon marketplaces requires an understanding of terms, policies, and players that are unique to the space. A carbon marketplace is a tool for controlling costs within a broader market mechanism to address GHG emissions. A carbon credit is a tradeable certificate representing the right to emit one ton of carbon dioxide equivalent (C02e). Carbon marketplaces operate within one of two systems, Mandatory (Compliance) and Voluntary. Below is an introduction to the two types of systems that exist today:

Mandatory Marketplaces are those in which participation is required and regulated. The first and largest mandatory offset program was established under the Kyoto Protocol in the 1980s. As of 2020, Mandatory Marketplaces account for $277bn in carbon credit transactions with the European Union Emissions Trading Scheme (EU ETS) accounting for the largest volume of transactions today. Mandatory Marketplaces transact carbon credits, called Certified Emissions Reduction (CER) credits, on liquid public exchanges where demand is created by regulatory mandates. Mandatory Marketplaces are characterized by higher standards, trust, and prices.

Voluntary Marketplaces enable businesses, governments, and individuals to offset their emissions outside of a regulatory or working body. Voluntary Marketplaces emerged in the early 2000s as demand for carbon offsetting beyond regulated companies increased. A variety of voluntary carbon offset programs exist today and are rapidly increasing in value and volume. As of August 2021, global Voluntary Marketplaces accounted for $750m in carbon credit transactions, a 58% increase from Dec 2020. Voluntary Carbon credits, known as Verified Emissions Reduction (VER) credits, are traded over the counter with demand driven by voluntary buyers. Voluntary Marketplaces are characterized by flexibility and fragmentation as well as lower trust and prices.

Transforming carbon marketplaces

To better facilitate an efficient global carbon marketplace, many underlying frictions need to be addressed. Three drivers to address these frictions include: standardization, transparency, and liquidity.

Standardization: Broadly accepted policies and increased standardization must be in place to gain confidence and trust in carbon credits. Voluntary carbon marketplaces specifically are fragmented and inherently riskier. Increasing standardization will enable sellers to develop desirable (& consistent) credits, as well as enable buyers to effectively purchase credits aligned to their decarbonization strategies.

Transparency: Carbon Credits today are not interchangeable. While all credits are equivalent to 1 ton of CO2e, there are multiple credit types and no clear classification to indicate quality. The ability to rate and compare credits would increase transparency and fungibility. The matrix below illustrates the differences in quality per credit risk and additionality (amount of CO2e emissions prevented above ‘business as usual’):

Liquidity: The lack of real-time pricing and settlement in carbon marketplaces hinders liquidity. In the voluntary marketplace, buyers must investigate credits and negotiate prices, a process often facilitated by brokers. Real-time pricing data in a central trusted location would provide clear demand signals to sellers and purchase transparency to buyers.

Accelerating the path forward

As of November 2021, one of the more impactful outcomes of the U.N. Climate Conference in Glasgow is the agreed upon guidelines to create and transact carbon credits. The new rules could enable the linking of carbon marketplaces and increase overall trust in carbon credits. Global standardization without required participation allows for both increased transparency and continued flexibility for companies and governments to execute on their decarbonization strategies.