Voluntary Carbon Markets 101

Following our participation in the industry wide consultation on voluntary carbon markets organised by the Integrity Council for the Voluntary Carbon Markets, hear from one of our in-house experts on the challenges faced and opportunities available within this developing market. 

1. What are voluntary carbon markets and how do they differ from carbon taxes or other regulatory schemes?

Carbon markets refer to trading schemes in which carbon credits are sold and bought, similarly to other forms of financial instrument trading. And here, the traded underlyings are carbon credits, where each credit represents one metric tonne of carbon dioxide equivalent. 

There are two main types of carbon markets: compliance and voluntary.

Compliance carbon markets, also called Emissions Trading Systems (ETS), are created as a result of national, regional or international policy or regulatory requirements. They are essentially marketplaces through which a certain number of carbon credits are assigned per company and per year, allowing them to emit the equivalent amount of carbon or to sell their credits if they emit less than their quota. Market participants – often including both emitters and financial intermediaries – can trade allowances to make a profit from unused credits or to meet regulatory requirements. There are approximately 30 ETS implemented globally, covering 38 national jurisdictions with many more countries and states considering implementation. 

Voluntary carbon markets refer to the issuance, buying and selling of carbon credits on a voluntary basis. Here, voluntary carbon credits are issued in respect of nature or technology-based projects aiming at reducing or removing greenhouse gas (GHG) emissions, once these projects’ benefits have already occurred. For instance, carbon capture is a removal project type and may be achieved through natural (e.g. reforestation) or technological (e.g. direct air capture) strategies These credits can then be sold to corporates, financial institutions, or individuals to support emissions reduction commitments by retiring voluntary carbon credits. This market is neither legally mandated nor enforced but self-governed.

In 2021, COP26’s wakeup call with regards to meeting the Paris Agreement targets by 2050 created a strong momentum for carbon finance and significantly boosted the profile of the voluntary carbon market. 

That year, market transactions in voluntary carbon markets nearly quadrupled the previous year value towards USD 2 billion. While this is still far smaller than the current global compliance market value of USD 850 billion in 2021, our view is that there will be an increasing number of companies working to meet their decarbonisation commitments, thus contributing to the development of the voluntary carbon market. As such, the overall price of voluntary credits is expected to rise, and a more active secondary market is anticipated. We estimate that the voluntary carbon market size will reach approximately 2,5 billion tonnes in 2030 (Source: Taskforce on scaling voluntary carbon markets and Trove Research)for a corresponding market size of about USD 100 billion.  

2. What are the key challenges facing the development of this market and how would you address them?

Voluntary Carbon Markets (VCMs) are relatively new and face several challenges. For one, they lack adequate liquidity, notably due to carbon credits being heterogenous in terms of quality, price transparency, and certification methodologies. This in turn leads to pricing issues as the lack of transparency makes it difficult to set a market price as the true value of the credits. Project developers also lack access to finance because of market opacity and a low investor risk appetite. Additionally, they lack the capacity to efficiently market their credits to multiple buyers. 

These challenges call into question the framing of this market, and the lack of standardisation within. While some may see daunting issues, others see teething problems that can be fixed. While not exhaustive, and at this stage purely prescriptive based on our own views, some useful steps to scale-up this market into a reliable and a safe ecosystem include:

• Definition of common features for carbon credits: buyers and suppliers would interact more efficiently if all credits had common features including quality criteria and attributes standardised in a common taxonomy.
• Uniformity of contracts with standardised terms: making carbon credits tradeable with standard attributes and size would consolidate trading activity and promote liquidity on exchanges. Reference contracts tend to make it easier for companies to purchase large quantities of carbon credits. 
• Enhancing trading and post-trade infrastructure – including Clearing Houses.
• Implementing mechanisms to safeguard the market’s integrity: establishing a digital process, through Blockchain for example, by which projects are registered and credits are verified and issued, resolving the double counting issue which is important to legitimize the market. 
• Attracting institutional investors: as of today, institutional investors are not very present in the VCM due to the limited liquidity and price transparency.

And of course, recognising the importance of the VCM in the net zero transition, as the required last step to offset non-abatable emissions, the wider industry is working together on these governance and market scaling initiatives. I’ll just mention the one that brought us together for this interview: the Integrity Council for the Voluntary Carbon Market. As alluded to above, standardisation is key and that is exactly what the Integrity Council’s Expert Panel, made up of twelve leading carbon market experts, is working on via its Core Carbon Principles. The objective is to set new threshold standards for high-quality carbon credits that will support the increased financing requirements and the price discovery. Societe Generale recently formalized their participation to this initiative which is supported by 250+ member institutions from all horizons including a large part of our peers.

And as an added bonus, the above-mentioned steps and initiatives would also help reduce the greenwashing risk thanks to the definition of a common set of quality standards. 

3. How active is Societe Generale in the voluntary carbon market and what could be the opportunities?

In line with its purpose, to be a responsible bank, leader in sustainable finance, Societe Generale consistently strives for innovative solutions to support the positive transformation of both our clients and the wider society. While very conscious that this nascent market raises a lot of questions, the VCM presents a strong and growing opportunity to have an impact, to accompany our clients in their own transformation. 

As these markets mature, so will our capabilities in the space. At present, our Global Markets division offers two types of solutions. On the structured products front, our offer includes Structured Notes, for both retail and institutional clients, where a fraction of the collected amount contributes to purchase and retire voluntary carbon credits. And on the clearing side, we offer clearing services for futures on voluntary carbon credits traded on CME and ICE.

In addition to VCM opportunities, we continue to advise and support our clients on the use of carbon credits to comply with their strategies, as well as other tactics to reduce overall emissions. Say for example direct actions to avoid emissions through operational improvements, and sustainable and positive impact investment and financing solutions.