What are carbon markets and why are they important?

In April this year, the Intergovernmental Panel on Climate Change (IPCC) released an assessment report on global progress towards slowing climate change. Carbon markets arise with the intention of obtaining the necessary emission reductions (targets) at the lowest cost: whoever can carry out the reduction actions at a not-very-high cost, carries them out.

Whoever costs more buys them, and helps to finance, in this way, the projects of the former: this is how the efficiency of the system is achieved.

So how do we drive and finance the transformation needed to address the climate crisis? Many countries are looking at carbon markets as part of the answer.

What are carbon markets?

Simply, carbon markets are trading systems where carbon credits are bought and sold. A tradable carbon credit is equal to one tonne of carbon dioxide, or the equivalent amount of different greenhouse gas, that has been reduced, sequestered or avoided.

Participants can receive an initial allocation of carbon credits free of charge or participate in an auction to purchase them. Companies that subsequently reduce their emissions can sell their excess carbon credits to other participants whose emissions have increased, thereby commodifying the carbon and creating a market.

Regulated carbon markets generally trade only their own carbon allocations, although the use of carbon offsets instead of a proportion of credits is allowed in some schemes if they comply with strict regulatory rules.

How many types of carbon markets are there?

Broadly speaking, there are two types of carbon markets: regulated compliance and voluntary. Compliance markets are created as a result of any national, regional and/or international policy or regulatory requirement.

Voluntary carbon markets, national and international, refer to the issuance, purchase and sale of carbon credits on a voluntary basis.

The current offer of voluntary carbon credits comes mostly from private entities that develop carbon projects, or from governments that develop programs certified by carbon standards that generate reductions and/or elimination of emissions.

The demand comes from individuals who want to offset their carbon footprint, corporations with corporate sustainability goals, and other players looking to trade credits at a higher price for profit.

Regulation and development of carbon market

Carbon regulation has been in the works since 1990 when the first in a series of international reports began to show the growing urgency to act to reverse climate change. By creating a pricing mechanism, the regulation incentivizes emission reductions, offsets, and investment in technology to reduce emissions.

However, while the scientific evidence for climate change has grown stronger, carbon regulation has not kept pace and has developed more slowly.

Regulatory coverage has increased steadily each year since the 2015 Paris Agreement1. Carbon regulations (implemented and scheduled) intensified in 2021, as many countries sought to show leadership ahead of the United Nations Climate Change Conference 26 (COP26) in November in Glasgow, where measures to address climate change were negotiated. Today, carbon emissions are subject to regulations around the world.

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