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Voluntary and Compliance Carbon Markets: the difference

Voluntary and Compliance Carbon Markets: the difference

Using carbon credits to offset residual emissions is one of the building blocks of a sound sustainability strategy. Carbon markets, both voluntary and compliance, offer mechanisms for companies to offset their carbon footprints. This article seeks to explain the functions, distinctions and opportunities within these markets.

What is the Compliance Carbon Market?

Compliance carbon markets are marketplaces through which a certain number of carbon credits are issued per company and per year. These are non-voluntary, and companies must fulfill them. In cap-and-trade (or Emissions Trading Systems - ETS) programs, regulators set a limit on carbon emissions - the "cap," which slowly decreases over time. Participants - often including both emitters and financial intermediaries - are allowed to "trade" allowances to profit from unused ones or meet regulatory requirements.

In compliance carbon markets, regulators set a cap on the total amount of carbon emissions allowed, which gradually decreases over time. Companies are allocated a certain number of carbon credits annually and must manage their emissions within these limits. If they exceed their allowance, they must purchase additional credits from those with surplus, creating a dynamic market for trading emissions.

The most active compliance carbon offset program is the United Nations Clean Development Mechanism (CDM), established under the Kyoto Protocol. Other well-known ones are the cap-and-trade systems from Europe, California, Canada, the UK, China, New Zealand, Japan, and South Korea, with many more countries and states considering implementation. According to Refinitiv, the total compliance market size is US$261 billion, representing the equivalent of 10.3Gt CO2 traded on the compliance markets in 2020.

Examples of Compliance Carbon Markets

Several notable compliance carbon markets set the stage for mandatory carbon trading:

  • European Union Emissions Trading System (EU ETS): The largest and most established carbon market, EU ETS, covers multiple sectors, including power generation, manufacturing, and aviation, within the European Union.
  • CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation): CORSIA is the first global sector-based offsetting scheme. Airlines and aircraft operators must offset any growth in carbon emissions for international flights above 2020 levels using credits from the Aviation Carbon Exchange (ACE), sourced from the voluntary market. CORSIA's pilot phase ran from 2021-2023, and the first phase began on January 1, 2024.
  • Article 6 of the Paris Agreement: Drafted in 2015 and expanded on in 2021 at COP26, Article 6 of the Paris Agreement allows countries to cooperate to meet emissions targets, such as transferring emission reductions between countries. Article 6 allows countries to buy voluntary carbon credits to meet their nationally determined contributions (NDCs), bringing more demand — and complexity — to the VCM.

What is the Voluntary Carbon Market?

The voluntary carbon market (VCM) allows companies, organizations, and individuals to purchase carbon offsets on a voluntary basis. These markets are not mandated by law but are driven by the desire to mitigate environmental impact. Participants buy carbon credits to compensate for their greenhouse gas emissions, supporting projects that reduce or remove emissions from the atmosphere. This market thrives on the principle of corporate social responsibility, enhancing brand reputation, and meeting stakeholder expectations.

The voluntary carbon market is smaller than the compliance market, with an estimated size of US$2 billion in 2023. However, it is expected to grow significantly in the coming years, reaching up to US$10 - US$25 billion by 2030, depending on how aggressively countries pursue their climate change targets. To learn more about current developments in the Voluntary Carbon Market, you can read this update.

Examples of Voluntary Carbon Market standards

Several standards ensure the credibility and effectiveness of projects within the voluntary carbon market:

  • Verified Carbon Standard (VCS): Administered by Verra, VCS is one of the most widely used standards. It covers a broad range of projects, including reforestation, renewable energy, and community-based initiatives.
  • Gold Standard: Established by WWF and other NGOs, this standard emphasizes sustainable development and environmental integrity, ensuring that projects deliver real, measurable benefits.
  • Plan Vivo: Established in the late 1990s, Plan Vivo focuses on projects that deliver measurable climate, biodiversity, and socio-economic benefits. It is particularly unique in its emphasis on empowering local communities and ensuring that they are active participants and beneficiaries of carbon offset projects.
  • Climate Action Reserve (CAR): A North American standard that focuses on high-quality offset projects with rigorous accounting and verification processes.

Conclusion

In summary, voluntary markets offer flexibility for companies and individuals to take climate action beyond compliance requirements, while compliance markets adhere to regulatory standards. Compliance markets are regulated by national, regional, or international governments and laws, and companies participate to meet specific emissions reduction targets. In voluntary carbon markets, companies and individuals can purchase carbon offsets on a voluntary basis without the intention of meeting regulatory compliance requirements. These markets operate independently of mandatory carbon reduction regimes. Both types of markets play an important role in meeting global climate goals.

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Boris Bekkering

Boris Bekkering Head of Climate Impact