Why improving the integrity of voluntary carbon markets matters for companies and net zero

A lack of governance, standardisation and transparency currently threatens the integrity of voluntary carbon markets and poses reputational risks to their users; companies will need to navigate these challenges if voluntary carbon markets are to play a credible role in meeting net zero

Written by Heather Daniel (Associate)

Voluntary carbon markets are growing rapidly

With a growing number of companies committing to net-zero goals, interest in voluntary carbon markets as a means of meeting these ambitions has surged. While the primary focus of net-zero strategies should be direct emissions reductions, many companies in carbon-intensive industries will nevertheless need to rely on the ability to offset unavoidable or ‘hard-to-abate’ emissions. Voluntary carbon markets provide a mechanism for this by allowing companies to purchase ‘carbon credits’ which are then used to invest in projects focused on removing, avoiding or reducing greenhouse gas emissions. Used in this way, carbon markets can be an effective tool for stimulating greater climate ambitions and driving finance towards sustainable activities such as biodiversity protection programmes and local development projects.

Despite widespread recognition of the benefits that voluntary carbon markets can bring, a number of challenges currently undermine their integrity and the degree to which they are perceived to offer viable solutions for reaching net zero. In particular, the fragmentation of the market and lack of common accounting and verification standards have raised concerns around the quality and credibility of some offsets. As scrutiny increases, companies participating in voluntary carbon markets will need to take steps to navigate the challenges and avoid being exposed to reputational risks that may come with their use.

Voluntary carbon markets are expanding rapidly – and will continue to grow

Voluntary markets have gained significant momentum in recent years, with 2021 bringing a 60% increase in value and annual transactions breaching $1 billion.[1] Given that demand for carbon credits is set to rise further as more companies align themselves with the net-zero agenda, the market is expected to grow exponentially over the next few decades. The Taskforce on Scaling Voluntary Carbon Markets (TSVCM), an initiative launched by former governor of the Bank of England Mark Carney, has predicted that demand for credits on the voluntary market will increase 15-fold by 2030 and 100-fold by 2050. This scale of growth could see the voluntary carbon market being worth as much as $50 billion by 2030, with prices reaching $20-50/tCO2e over the same period.[2]

While the growth of voluntary markets is (and will continue to be) primarily driven by the private sector’s net zero agenda, the expansion of mandatory (or compliance) carbon markets may accelerate it further. Government demand for emissions credits has increased substantially in recent years, with voluntary credits already accepted on some mandatory markets, such as Colombia and South Africa’s carbon tax regimes. As government demand continues to rise, overlaps between mandatory and voluntary markets of this nature seem likely to increase further, linking the growth of one to that of the other. In addition, the agreement reached on Article 6 of the Paris Agreement at the COP26 climate conference, which sets out rules on global emissions trading and improving international cooperation, may also play a role in stimulating growth. While Article 6 is expected to primarily trigger the emergence of more national and regional carbon markets, this is likely to raise government interest in purchasing carbon credits and, in turn, generate a further increase in global investment in the voluntary carbon market.

Ensuring the integrity of voluntary markets will be critical to sustainable long-term growth

At present, voluntary carbon markets lack formal governance structures or common accounting and verification standards. Instead, a range of private entities – such as the Gold Standard, Verified Carbon Standard, American Carbon Registry and Climate Action Reserve – have established different eligibility criteria for certifying projects and trading credits. This has created a highly fragmented market plagued by ambiguity, making it difficult for companies to be sure of the impact that specific carbon credits actually have in terms of emissions reductions, and therefore the quality and credibility of these credits. For example, credits generated by forest protection projects (such as under the UN’s REDD+ programme) have become increasingly controversial partly due to the way in which their emissions reductions are calculated; and while some standards verify these projects, others do not.

Projects that prevent deforestation are among those receiving criticism

The lack of governance and regulation of the market also poses the risk that some carbon credit projects may not be sufficiently robust from a broader ESG perspective. Various civil society groups and international agencies have raised concerns that such projects could inadvertently cause human rights abuses, displacement of local communities or violation of indigenous rights – for example by relocating communities for reforestation programmes. Previous offsetting projects established as part of mandatory schemes have faced human rights allegations – for instance, the Alto Maipo hydropower plant in Chile, registered to sell carbon credits under the Kyoto Protocol’s Clean Development Mechanism, was challenged for its alleged impact on water supply and local livelihoods.

In the absence of standardised rules and robust governance, the rapid growth of voluntary carbon markets is likely to exacerbate these challenges. With new offsetting projects needing to be developed quickly in order to meet increased demand for credits, and before standardised verification and accounting methodologies are developed, there is a risk that some projects may be developed without sufficient assurance around their emissions impacts and ESG performance. As a result, companies investing in carbon credits could find themselves inadvertently purchasing low-quality carbon offsets, being unable to re-sell credits, or experiencing long lead times before offsetting projects come online.

A number of initiatives have recently been launched in an effort to address these concerns and lay the groundwork for greater consistency and regulation. The Voluntary Carbon Markets Integrity Initiative (VCMI), for instance, is a multi-stakeholder platform that aims to improve governance of voluntary markets, and plans to produce guidance for ensuring integrity in both the demand for and supply of carbon credits, including through transparency and assurance criteria. With guidance expected to be published by VCMI in the first half of 2022, and followed by guidance from other initiatives, there are hopes that many of the challenges associated with the voluntary markets will be smoothed over before long. This may be further aided by the development of standardised accounting methodologies for mandatory markets under the previously-mentioned Article 6, which would likely be applicable to and/or adopted by voluntary markets as well.

While such developments offer a glimmer of hope, companies need to take steps in the meantime to ensure the integrity of credits that they purchase. Undertaking due diligence of specific projects, using existing reputable standards to provide third-party validation and assurance, and being transparent about participation in voluntary markets, will all be critical in helping stave off the reputational risk of being associated with poor-quality or controversial carbon credits. This should also help companies provide assurance to investors and other stakeholders that credits purchased represent genuine emissions reductions.

‘Greenwashing’ will continue to be a concern

Despite efforts to improve the governance and integrity of the voluntary market, its growth has exacerbated fears among critics that it could enable widespread greenwashing by high-emitting companies attempting to avoid making meaningful changes to reduce emissions. Such accusations of greenwashing are not new. Offsetting has long been criticised by green activists and NGOs of enabling big polluters to avoid taking direct action to reduce their own emissions. The worry now is that the growth of the market and emphasis on net zero could encourage more companies to choose offsetting over emissions reduction. As such, the TSVCM has been accused of being a ‘greenwashing scam’ by civil society groups, with protestors even gathering outside TSVCM’s COP26 event designed to promote the use of carbon offsets.

Civil society will continue to question the credibility of voluntary markets

Criticisms of this nature are unlikely to dissipate entirely and may even intensify over the longer term as the need to take direct action to meet the Paris Goals becomes increasingly urgent. However, improvements in the regulation and governance of the voluntary market – particularly by credible multi-stakeholder groups – may help to reassure some stakeholders. For example, credible and standardised verification of credits could reduce the ability of companies to make exaggerated claims around their emissions reductions – and in turn reduce the degree to which critics can accuse companies of making false claims.

Beyond supporting multi-stakeholder initiatives and improvements to the market itself, companies can help mitigate against accusations of greenwashing by developing credible emissions reduction strategies that are clearly communicated to stakeholders. The dominant view remains that offsetting should only be used as a last resort after other realistic means of reducing emissions have already been implemented, or where the technology to do so does not currently exist. It will be critical for those companies that rely on carbon credits to tackle at least some of their emissions directly and demonstrate that participation in voluntary carbon markets is not being used to delay meaningful changes. Without improved transparency from companies and improved governance of the system itself, the integrity of voluntary markets will continue to be questioned – creating potential reputational risks for companies using them and undermining the value that these markets could bring to the broader net zero agenda.

[1] State of the Voluntary Carbon Markets, 2021 report, EcoSystem Marketplace; Insights, EcoSystem Marketplace, November 2021

[2] Taskforce on Scaling Voluntary Carbon Markets, Phase 1 – Final Report, January 2021;  Future Demand, Supply and Prices for Voluntary Carbon Markets – Keeping the Balance, University College London and Trove Research, June 2021