Scaling VCM Integrity Pt 3: Quality of market operation 🌍

Integrity has been repeatedly identified that the largest barrier to scaling voluntary carbon markets (VCMs) in line with meeting the aims of the Paris Agreement.

In previous posts, we have explored the importance of scaling high quality supply and demand in ensuring that the VCM effectively supports net zero targets. In this final post of the series, we delve into the importance of the integrity of the market itself in making this a reality.

We discuss the impact of decisions relating to Article 6 of the Paris Agreement, the emergence of conflicting industry standards and the role web3 can play in coordinating the market into the future.

Tackling transparency

At present, a lack of transparency within the VCM perpetuates multiple issues, causing integrity concerns from firms seeking to engage in the market. These issues include standards fragmentation, double counting of credits, low price discovery, high mark-ups, and even the risk of fraud and non-delivery. We explored these issues in detail in previous series, alongside the potential of web3 to help resolve them.

Here we delve into additional challenges now facing the VCM, as growing demand and policy attention make high integrity operation more important than ever.

Article 6 and corresponding adjustments

Prior to COP26, the VCM was viewed as separate from domestic emissions trading systems, which are generally driven by industrial cap-and-trade carbon quotas set by governments.

Recent decisions relating to Article 6 of the Paris Agreement however, have blurred the boundary between voluntary and national markets:

• Article 6.2 states that countries can now trade carbon reduction and removal credits between one another. These can count towards reaching their nationally determined contribution (NDC) to the Paris Agreement, or to broader international carbon reduction activities.
  
• Article 6.4 now enables all countries to use markets to enhance investment in carbon projects to increase the ambition of their NDC. This approach replaces the current Clean Development Mechanism, which only facilitated investment from the global north into renewable energy technologies in the global south.

While these updates seek to unleash the cost and time saving potential of markets on accelerating climate action, they also create the issue of the double counting of carbon credits. Double counting would occur when two countries- or the more complex scenario of one country and one non-state actor like a private firm- both try to count an emission reduction as their own.

Managing this complexity requires the development of ‘corresponding adjustments’, which ensure emissions reductions are deducted from a host country’s inventory and added to that of the purchaser accordingly. Corresponding adjustments will therefore enable the country in which the carbon credit is developed to adjust its emissions back upwards to account for the volume of credits sold to an external buyer. The host country would then need to increase other emission reduction efforts to compensate for this.

As countries begin to develop their own national carbon markets these will likely emerge at different speeds, using different platforms and approaches. Ensuring that double counting does not occur will therefore require a sound, underlying corresponding adjustments accounting system. This system is not yet present, with no agreement on exactly how these adjustments will be made.

Any delays to developing this framework prevent flows of capital and co-benefits associated with carbon credit projects to the global South, meaning that governments and VCM actors need to work together to resolve this new dynamic as quickly as possible.

Recent research by Trove in countries with high levels of tropical rainforest indicates that it is unlikely that demand for carbon credits will outstrip supply to 2050, but could cause bottle necks as currently voluntary carbon reduction and removal credits are used by the host country.

Coordinating standards and actors

Alongside the blurring of boundaries between national and voluntary carbon markets, there are many different goals and standards emerging across firms and investors in relation to net zero goals.

This is producing an increasingly complex ecosystem of understanding around the role the VCM will play in meeting private sector aims, lacking coherence and alignment. For instance, at present the Task Force on Climate-related Financial Disclosures (a key body addressing how companies can effectively disclose climate-related risks and opportunities) does not include any guidance on the use of carbon markets and offsetting.

This misalignment across sectors could prevent the market catalysing around supporting high integrity credits and building high integrity demand, further impacting effective functioning.

Fully engaging with and integrating the standards and approaches being developed by private actors is therefore needed to enhance the integrity of market operation.

Web3 for operational integrity

A key feature of web3 technology is that of transparent, immutable record keeping. This presents many opportunities for its application to developing climate markets that have standardized, interconnected goals and accounting systems.

The World Bank for example, are developing a blockchain-based solution to accountably aggregating global carbon credit registries into a central ‘Carbon Warehouse’.

Built on the low carbon Chia blockchain, the Warehouse enables multiple users to record and update data, which is then broadcast across the whole system of users to ensure all registries remain aligned. All updates are tracible and unchangeable, creating a transparent system of integrity and trust. Multiple governments have now trailed the system, with a public observer node available to anyone interested that would like to view or explore the latest phase of project testing.

Toucan Protocol are another organization driving such efforts, seeking to build a neutral, open meta-registry of of high quality carbon assets on the Polygon blockchain. This will enable all credit holders to move their assets on to the blockchain, assisting with transparency, liquidity and price discovery.

Conclusion

This series of posts has explored the importance of high quality supply, demand and market operation in ensuring the VCM is effective in accelerating climate action. Realising these high integrity approaches will require ongoing innovation at each stage, in order to address emerging opportunities and barriers as the VCM rapidly grows.

Web3 solutions will undoubtedly play a role in this process, with emerging applications touched upon throughout the series. We look forward to sharing delving further into the potential of web in future posts! ✨