· 10 min read
The voluntary carbon markets (VCMs) and implementation of Article 6 of the Paris Agreement represent an unprecedented opportunity to finance the mitigation of climate change via the private sector. However, we understand that without progressive governance in VCMs, Article VI, corporate engagement, and accelerated coordination with governments, this opportunity may be mishandled, or worse, totally missed. As Verra, Gold Standard and other VCM entities have begun to incorporate corresponding adjustments according to Article VI into their credit certification and labeling process, it is a critical time to assess the implications of implementing corresponding adjustments on the global flows of capital for climate mitigation. If implemented wisely, they have the potential to ensure billions flow from the Global North to the Global South to support climate mitigation.
Our recommendation is that a corresponding adjustment should not be applied when there is a trade between a Global South-producing entity and a Global North purchasing entity on the VCM. If there is a trade of credits via VCMs, and potentially Article VI, from a Global South entity to a Global North private entity, we should allow the Nationally Determined Contribution (NDC) claim to stay with the producing country in the Global South and not require a corresponding adjustment where that claim goes to the purchasing country in the Global North. Through this policy, we can enable Global North companies to meet their climate action targets while ensuring Global South countries can meet their NDC obligations, unlocking a potentially massive source of finance to flow from the Global North to the Global South for climate mitigation activities and outcomes.
The challenge and the opportunity
Historically, conservation and restoration efforts have primarily been funded through philanthropy or grant-making. Carbon markets are changing that. For the first time, there is a way to not only value conservation outcomes but to create economic profitability from healthful ecosystems. Simply put, it enables traditional forms of private and public investment into conservation.
With quality assurances and cooperation, the projects that create carbon credits will also create enormous climate and ecological impacts. But beyond those outcomes, which are significant, these projects have the potential to catalyze truly green and regional economies. Green regional economies that support the development of non-extractive activities and livelihoods that are freed from reliance on philanthropic donations.
At this pivotal moment for action on climate change, this may be one of the last best chances to mobilize the volume of capital needed to fundamentally change the calculus for business as usual.
However, we will need hundreds of thousands of projects to affect the impact the IPCC prescribes in their most recent Assessment Report. This requires many nations, particularly developing countries and those with vulnerable and high-value conservation areas, to coordinate a strategy to use and leverage VCMs and Article VI integrated with their own NDCs and jurisdictional compliance markets.
And, as the Loss and Damages fund struggles to gather widespread support, let alone action, carbon markets may be the best tool for channeling climate finance to the Global South to support activities that will benefit both the host country and global climate mitigation.
Context of carbon markets
As a refresher, carbon markets are a set of systems that dictate how carbon credits are defined and created, how they are bought and sold, and for what purpose. Markets can be compliance-driven, usually aimed at curbing energy or industry emissions such as with the EU ETS or California cap-and-trade, or voluntary markets which are largely used by corporations to achieve sustainability goals.
There are many versions of both types of markets, though there is some convergence happening between the two types. Article 6 of the Paris Agreement is perhaps the most obvious sign of this. Only recently ratified at COP26 in November 2021, there are still many aspects to be clarified and actually operationalized, but in general, it provides a framework for signatories of the Paris Agreement (i.e. most countries) to generate mitigation outcomes and sell them to other countries who in turn can use them to achieve their nationally determined contributions (NDCs) for reaching their climate change targets. The credits that countries buy or sell under Article 6 are broadly called ITMOs (Internationally Transferred Mitigation Outcome), though there is some additional nuance in different types of ITMOs and which entities can create and use them.
VCMs, Article 6 and corresponding adjustments
There are a few key features of Article 6 important to understand, though it is important to keep in mind these features are largely still theoretical as very few transactions have yet occurred. The most important and/or relevant feature is ‘corresponding adjustments’, which is the requirement that if one country sells an ITMO to another, then they must account for the transaction on both sides of their emissions reporting (e.g. country X sells 100 ITMOs to country Y, country X then reduces its overall emissions reported to the UNFCCC by 100 and Y losses its option to claim the mitigation outcome that generated the 100 ITMOs). This way, we avoid double counting of mitigation at the country level.
Most countries do not have the capacity to do such accounting yet due to data and technical capacity constraints. A country can also ‘authorize’ mitigation outcomes to do certain things. In theory, for instance, it could authorize a voluntary carbon market credit to be used for other initiatives, such as use in a domestic emissions scheme or as a contribution to its NDC. It could also be authorized as an ITMO and sold with corresponding adjustments. Lastly, there is a provision for countries to be able to provide payments for results-based outcomes such that a country can support another’s activities that contribute to its NDC. In that case, country X may finance a project in country Y that produces a mitigation outcome. However, country X does not claim the mitigation in its emissions reporting, so neither country needs to make a corresponding adjustment.
Voluntary carbon markets (VCMs) have pre-built infrastructure that can provide much of the accounting and quality support needed for such strategies. Developed countries, for instance, could provide results-based finance to a country that uses those funds to support VCM projects that produce mitigation outcomes. Because it is results-based for the developed country, the developing country gets financed to support NDC mitigations while the VCM projects are still free to sell their credits. In this scenario, both the private and public sectors are contributing to mitigation, but only the private sector claims it. This creates a de-risked environment of government support and coordination. In another scenario, VCM credits could be authorized for sale as ITMOs from one country to another or from one country to a corporation satisfying international demand for ITMOs. In this case, private investment would still be needed to develop the VCM project but its credit sales would be coordinated or guaranteed by the government.
How exactly countries approach these possible arrangements between national action and VCMs will differ based on many factors. A key element is country-level capacity and infrastructure to coordinate and use these tools. Some countries are more advanced and are embracing synergies with VCMs such as Colombia’s tax and market system. Others are acutely aware of the utility and benefits of carbon markets but want to create their own systems to coordinate their use, such as with Indonesia. Because of Indonesia's need to coordinate new climate action plans with its land sector’s unique importance to its NDC, they have placed a temporary moratorium on issuing more VCM credits. Not because it is against VCMs, but more so because it wants to coordinate its use of increased understanding around the benefits of AFOLU (agriculture, forests, and other land uses) in climate change.
This quandary is ushered in by the fact that Article 6, as opposed to its predecessor mechanism - the Clean Development Mechanism - allows flexibility for more use of AFOLU-based projects, that is, nature-based projects. Countries are considering how their land use emissions and mitigation potential from land uses can be used through Article 6 and their obligations to the Paris Agreement.
It should be noted that most countries are lagging behind in having a clear stance and framework to use carbon markets. This is why public and private sector partnership is key so that VCMs and national action plans are supported to coordinate and scale effectively
One of the most important issues to dissect in all carbon markets is the difference between accounting and claiming. In accounting, emissions are simply noted whether they are avoided, reduced, or sequestered. Many organizations may be interested in accounting for those same emissions for different reasons such as a nation reporting its NDC progress, a corporation tracking its supply chain sustainability, or a farm operator reporting emissions to its banker. Claiming differs in that there is a change in those accounts because of an external activity. For instance, a company accounts for its emissions footprint, and then claims a reduction in that footprint because it purchased carbon credits from a VCM project outside of its scope of reporting. The activities of the VCM project, tree plantings for instance, can still be accounted for by the country in which it occurred, but the claim (in the form of a credit) can only be applied to one external account. In this way, countries do not have to worry about claims going to any particular private entity because the VCM outcome would still be accounted for in their progress towards NDCs. VCMs can be a powerful support mechanism for wealthier private entities to support local development and national climate ambitions.
Actions today
At this critical juncture where VCMs are set to scale and Article 6 is to be implemented, trust for their unique roles in climate action is crucial. We request global leaders both public and private to clarify how different emissions accounting strategies do not compete with mitigation claims (i.e. there can be multiple accounts including outcomes of mitigation activities, but only one can make a claim outside of those accounts).
At a minimum, those countries in the Global North must commit to permitting any claim related to a carbon credit produced in the Global South and sold on the VCM to a private entity headquartered in the Global North to stay with the Global South country to meet their NDC goals. This will allow capital to flow from the Global North to the Global South to support climate mitigation while still ensuring countries in the Global South can meet their NDC obligations. Furthermore, it puts more of the capital and finance burden on the Global North countries, which is entirely logical and fair given their relative responsibility for causing the problem in the first place.
To maximize the Global North's contribution to climate mitigation in the Global South, any 6.2 or 6.4 transactions between a Global North purchasing entity and a Global South producing entity would ideally also allow the NDC claim to stay with the producing country. But, there is of course the question of whether this setup would take away any incentive for Global North countries to purchase ITMOs from Global South countries if they aren’t able to use those credits for their NDC claims. If we do require corresponding adjustments for 6.2 and 6.4 trades between governments, then at a minimum, we need to either make sure that Global South countries can meet their NDCs with climate mitigation activities in addition to 6.2 and 6.4 trades OR simply not expect Global South countries to meet their NDC commitment and refrain from trade embargoes or any other punishments.
It is critical that we enable finance to flow to countries, especially in the Global South, that (1) have the greatest potential to protect and restore nature to meet our global climate goals, (2) are the most vulnerable to the impacts of climate change and have contributed the least to the problem and (3) need support to meet their NDCs and sustainable development goals.
We hope that this blog catalyzes a critical conversation that includes the voices and perspectives of organizations and communities on the ground that are leading conservation and restoration efforts. We further urge private entities to seek those perspectives and engage with governments to support the coordinated development of carbon market opportunities.
illuminem Voices is a democratic space presenting the thoughts and opinions of leading Energy & Sustainability writers, their opinions do not necessarily represent those of illuminem.
