Roadmap to net zero aligned carbon market regulation
Carbon markets facilitate and scale efforts to reduce or remove carbon dioxide and equivalent greenhouse gases in a cost-efficient way. Allowance-based carbon markets, such as emissions trading schemes (ETS), typically compel actors to reduce their emissions in line with a declining cap with a provision to trade emissions allowances among entities within a given sector. Carbon credit-based markets, such as the voluntary carbon market and the emerging Paris Agreement Crediting Mechanism (PACM), by contrast, typically enable project-level financing of activities that avoid, reduce or remove greenhouse gases. In general, the former set mandatory targets and the latter are voluntary in their participation. Both types of markets can operate at a range of substate, national, regional, or international scales. The two domains do not exist in isolation but are increasingly converging. As Figure One illustrates, carbon credits can be surrendered instead of allowances under an ETS regime4 or in lieu of paying a carbon tax obligation in some instances.
Such fungibility between different forms of carbon units has become increasingly pronounced
with the rise in international carbon trading under Article 6 of the Paris Agreement. Article 6
facilitates cross-border carbon trading, enabling governments to enhance the ambition of their
Nationally Determined Contributions (NDCs) and other national targets, as well as corporates
to meet their own climate goals. As a result of the emergence of these increasingly dynamic
carbon market types, we are seeing an increasingly interlocking web of carbon trading, creating
complexity from a regulatory perspective.
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