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There is no net zero without a high integrity, functioning carbon market
25 June 2024

There is no net zero without a high integrity, functioning carbon market

10 min read
Carbon markets & climate policy
Daniel Klier CEO

It was Peter Drucker who said that “the greatest danger in times of turbulence is not the turbulence – it is to act with yesterday’s logic.”

Science tells us that we cannot decarbonise our economy fast enough to keep our collective climate targets within reach, and need finance to flow rapidly and efficiently into the most impactful activities to lower greenhouse gas levels in our atmosphere.

And with emissions-free operations still a far-off prospect for many businesses, we have also passed the point when companies can focus solely on reducing their own direct and indirect emissions.

Emission reduction and avoidance is a viable element of every transition plan, yet we are failing to invest in mechanisms with the greatest potential to cost-effectively channel finance to clean technologies, protecting nature, fair transitions, and global emission reductions: carbon markets.

The status quo will not keep 1.5°c within reach

We know today that the climate crisis is urgent and progress is slow.

Despite efforts to scale up ambition, climate pledges made by governments, businesses and other organisations remain woefully inadequate for limiting average global temperature rise to 1.5°C – the figure climate scientists deem the threshold of relative safety.

Targets have been set by governments, market authorities, and industry groups – but society's ability to meet them moves further out of reach every day.

The annual United Nations Environment Programme's Emissions Gap report is a constant reminder of the persisting gap between the emission reductions considered in countries' climate pledges and what science says we need.

And emissions stubbornly continue to rise each year.

The Global Carbon Budget tells us that global greenhouse gas emissions reached an all time high in 2023, with 1.5°C being overshot multiple times, and six of the nine planetary boundaries have now been crossed.

We need global greenhouse gas emissions to peak before 2025 at the latest – and we are not on track

Scientists working on the United Nations' International Panel on Climate Change (IPCC) believe the world will surpass 2.5°C degrees of global warming this century, unless radical action is taken to decarbonise our economy and scale action to reduce and remove emissions through nature and technology.

  • It is critical that we decarbonise our economies, especially sectors like industry and power production.
  • In parallel, accelerating action on nature has been identified as one of the last opportunities to narrow our emissions gap. We need annual investments in nature-based solutions to triple by 2030 and increase four-fold by 2050 from current levels of USD 133 billion to make that happen.
  • But we also need to deploy carbon dioxide removal technology at a massive scale. According to the IPCC, all pathways that limit global warming to 1.5°C with limited or no overshoot require removing between 100bn and 1,000bn tonnes of CO2 from the atmosphere this century.

Why market mechanisms must scale

Increasing the speed and scale of climate action and finance is the only way to avoid the irreversible effects of climate change tomorrow.

We need private sector climate capital to be fully unlocked, and it needs to work smart and hard, if we are to limit global temperature rise. Annual average finance flows surpassed $1trn in 2021/22, but must increase five fold annually as quickly as possible to avoid the worst impacts of climate change. Private actors provided approximately 49% (or $625 billion) of this total, but much more capital must be unlocked to help contribute to this goal.

The UN's first Global Stocktake defined a clear need for private capital in funding climate action, and intelligent, quick-moving finance is exactly what we need when we're short of time. Today the private sector manages more than $120trn in assets – compared with the $2-4 trn that developing countries now require annually to avoid climate catastrophe.

Market mechanisms are designed to chase the most efficient ways for financing decarbonisation and adaptation solutions.

Therefore, carbon credits, and the carbon markets on which they trade, are vital to achieving the goals of the Paris Agreement – a climate treaty supported by all UN member states around the world.

While imperfect, carbon markets work.

Carbon markets create a financial incentive for industries to reduce their carbon emissions, support sectoral transformations, and promote innovation by encouraging the adoption of cleaner technologies: In the early 2010s, carbon credits helped fund the high cost of clean energy development, making them more affordable. This is an example of the market functioning as it should, by catalysing action quickly until it is no longer needed. In the same way it did then, this market provides catalytic and transformative funding for critical climate solutions and creates financial value for conserving, restoring, and expanding natural carbon sinks, today.

The role of markets in unlocking and deploying private sector capital is not a niche view.

The message from the UN, World Bank, governments, NGOs, businesses, and the media is clear – done right, carbon credits are critical to helping close the climate finance gap.

This is especially so in the Global South, where the impacts of climate change are being felt the most, such as annual droughts, floods, and storms, but finance is being delivered the least. As of 2021, 75% of climate finance flows to North America, East Asia, and Western Europe, which is not a just transition. Carbon credits can help correct this imbalance by directly transferring finance from Global North to Global South.

We need to increase our capacity to remove and reduce emissions in tandem.

Carbon credits are the most viable, near-term option for companies to rapidly deploy finance to the most critical climate solutions beyond their value chain that can do both. They are also creating pathways to compliance markets, enabling these markets to be more ambitious and have a higher impact.



Why fundamental change is needed in carbon markets

The complexity of carbon markets makes the system difficult to understand – and easy to criticise.

Transparency and standardisation will be key in addressing roadblocks for unlocking scale and impact in carbon markets.

For companies to confidently invest in carbon credits, they need a single criteria of carbon credit quality to inform their buying, and definitive guidelines for accurately claiming their investment has made true climate impact. The current lack of standardisation across these two areas – supply and demand – inhibits this from happening and opens the market up to scrutiny.

This spurs corporate leaders' fears of being accused of greenwashing and incurring reputational damage, which in turn leads to greenhushing, and eventually becomes a self-perpetuating cycle of stalling. Many CSOs are waiting for inbound sector regulation, while feeling daunted by the prospect of new legal requirements. This is slowing action when it needs to be accelerating.

The opportunity cost is huge:

If 1,700 of the world's highest emitting companies compensated for just 10% of their emissions through carbon market investments, more than $1 trillion of climate finance could be mobilised by 2030. This can be a meaningful contribution to the $1trn required annually by 2030 and help catalyse the carbon-saving potential of nature.

Natural climate solutions can also provide up to one-third of the cost-effective climate mitigation needed by 2030 to meet the goals of the Paris climate agreement and have proven to reduce communities' vulnerabilities to climate change. Businesses must invest in nature for us all.

Those who are moving ahead regardless are showing impressive leadership.

Research tells us that the companies retiring carbon credits according to the mitigation hierarchy, are decarbonising nearly x2 faster than those who are not. We urgently need more companies to be moving at this pace.

As companies do this, they must follow guidance issued by the Science-based Targets Initiative (SBTi) and the Voluntary Carbon Markets Integrity Initiative (VCMI) who advise carbon credits must be additional to, and never replace, internal decarbonisation efforts, and be deployed strategically over the short term up to 2030. As well, we welcome new signals from SBTi for more flexible use of carbon credits in addressing scope three emissions, along with the VCMI's Flexibility Claim.

There is clear potential to unlock – especially by governments seeking to increase their resilience to climate shocks, boost energy security, and finance their transition to net zero emissions.

Today approximately a quarter of global carbon emissions are currently covered by some form of carbon pricing scheme, such as emission trading schemes or carbon taxes, raising around USD 100 billion in revenue in 2023. The voluntary carbon market coverage is far smaller, but still raised 2 billion in 2022.

Countries are now expected to show, not just tell, how they are consistently increasing the ambition of their national climate commitments. Carbon markets provide a mechanism to increase international cooperation, promote investment into clean technologies and achieve the most cost-effective emission reductions.

How we can move to the next era of carbon markets

The banking world faced a turning point in 2008 – carbon markets are at a comparable inflection point today. The financial crisis shook the foundations of global economies. The lack of transparency, complex financial instruments, and misaligned incentives created a perfect storm that had devastating global impacts. But it was a wake-up call that led to significant regulatory reforms.

Similarly, carbon markets have tangibly demonstrated that they can be part of the solution and help put a price on emissions – they now need to evolve to meet the moment.

Here's how:

Restore trust and integrity in the carbon market

  1. We need a globally recognised standard for carbon credit integrity. Critically, national and international regulation should consider and incorporate emerging frameworks developed by non-governmental initiatives to help establish more standardisation in global market structures under the Paris Agreement– and to regain trust in the market. The ICVCM's work on this so far has been foundational to this convergence. A uniformed regulatory approach to carbon credits will further increase interoperability between voluntary and compliance markets, as well as regulatory oversight. Voluntary integrity initiatives have so far helped provide an onramp for voluntary credits to be traded under compliance schemes, carry tighter financial regulations, and eventually lead to market convergence.
  2. Too many people believe carbon credit projects have low climate impact and do not deliver for climate or communities. We need to shift that perception by radically enhancing transparency in the market, showing how projects both reduce GHGs in our atmosphere and support sustainable development. We need to show that carbon credits work and can drive transformational change: for example, a new generation of credits are in development, such as those helping to accelerate the retirement of coal-fired power plants and the decarbonising of industry - all of which show promising impact.

Innovate to solve global challenges

  1. The carbon market has a history to enable new technologies and bring them to a competitive price level. In the same way, the carbon market needs to demonstrate again that it can provide innovative solutions to the most pressing climate challenges. Recent solutions to decommission coal fired power stations, decarbonise industrial processes, and deploy green hydrogen at scale are promising innovations.
  2. We need a market infrastructure that allows for liquid, frictionless trading and makes it far easier for buyers and sellers to access the market. Standardised contracts, registry collaboration, and bank-grade security on each trade can increase confidence in the market, and the overall volume of trading. Already work is being done by the London Stock Exchange Group, NASDAQ, and Singapore Stock Exchange, which should be commended.

Incentivise true climate impact

  1. We need mandatory transition plans for businesses, with a clear role between emission reductions and use of carbon credits, that reduce and avoid and remove emissions wherever tenable. Not all actions are equal, and efforts to compensate and reduce emissions often fall short. While good intentions are growing, the lack of large-scale ambition – using all available, scalable climate solutions – is holding society back from having a true climate impact. Mandatory rules are required to ensure that action.
  2. We need more businesses to adopt best practice claims, and get recognised for channelling finance towards global decarbonisation efforts. Voluntary claims businesses make based on carbon credits have been an issue for a long time, we've seen this suppressing demand. The VCMI Claims Code of Practice is a route forward on this, alongside growing claims-related regulation we expect to see.

South Pole’s role in leading the future carbon markets

As one of this market's longest-standing players, South Pole has had a front row seat since 2006 to all the highs and lows that come with a new market maturing, and we've learnt a lot along the way.

The next generation of carbon markets is well upon us, and few other market actors have the geographical footprint and legacy experience to enact radical market transparency, standardisation, and innovation at the scale and speed South Pole can provide. Our advisory services have helped over 1,000 companies embark on their net zero journey, and our hundreds of climate projects help support everyone from farmers to innovators to indigenous communities to protect the world's wild places and develop new climate technologies.

As a pioneer in carbon markets, South Pole has been carefully preparing for the next phase of the market's growth – from enhancing our due diligence, risk and compliance processes, as well as hiring new leadership with strong experience in regulated markets - also at Board level. As a leader, we seek to be at the forefront of the expanding ecosystem of participants and regulation, while ensuring we can also innovate for impact in the long-term. Going forward, this includes demonstrating market best practice for project transparency and accountability via South Pole's entire portfolio audit, as well as continuing our market-making work investing in innovative climate solutions and trusted climate advisory.

The time for talk is over

We must recalibrate our views on available, workable and promising solutions to avoid locking ourselves into the thinking of the past, and acting "with yesterday's logic".

Today we need to use existing foundations to standardise, regulate, generate, and use the new generation of carbon credits to scale the necessary solutions to meet our collective goals.

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