To address the urgent need for action on climate change, both private and state actors around the world have been utilising economic incentives to limit the increase in greenhouse gas (GHG) emissions. One such tool is the establishment of a market for carbon credits. The carbon credits market provides an opportunity for emerging markets, especially those African countries which are particularly vulnerable to the physical impact of climate change, to finance and manage the energy transition required to curb GHG emissions whilst also creating jobs, additional revenue, improving access to energy and general health.
At Trinity, we are increasingly advising clients on regulatory and structural issues across the carbon credits value chain, including in relation to offtake, financing and marketing arrangements for renewable energy projects, forest protection initiatives and other emission avoidance projects. In this article, we will take a brief look at the carbon credits markets (both regulatory and voluntary), discuss the roles of major stakeholders within the voluntary carbon market and analyse the implications of the growth in the voluntary carbon market from a business and legal perspective.
What are Carbon Credits?
A carbon credit is a tradeable certificate that represents the right of the holder to emit one tonne of carbon dioxide (tCO2e) or the equivalent in other greenhouse gases.
When referring to the carbon market, it is important to distinguish between the compliance or regulatory market and the voluntary market.
The Compliance or Regulatory Market
Under the Kyoto Protocol, there are caps on the GHGs that can be emitted by developed Annex 1 countries. In turn, these countries set quotas on the emissions of the most polluting organisations and manage this through national registries which are monitored by the United Nations Framework Convention on Climate Change (UNFCCC). At the end of a given period, companies and countries that have emitted more GHGs than their allocated allowances, must either purchase additional allowances (i.e., carbon credits) privately from other companies or countries or on the open carbon market through the Kyoto Protocol’s market-based mechanisms (the International Emissions Trading, the Clean Development Mechanism and the Joint Implementation).
The Voluntary Market
Unlike the compliance market, the stakeholders purchasing carbon credits in the voluntary market do so voluntarily as part of their ecological commitment to reduce or offset their GHG emissions rather than to meet a regulatory requirement.
The stakeholders in the voluntary market include project developers or sponsors that set up different types of offsetting projects. For instance at Trinity we have been advising clients on (a) emission avoidance projects (which either reduce the existing CO2 in the atmosphere or reduce fossil fuel consumption or prevent the emission of CO2) such as renewable energy projects and installation of fuel efficient stoves and (b) emission sequestration projects (which store part of the CO2 already present in the atmosphere) such as reforestation projects (including Reducing Emissions from Deforestation and Forest Degradation (REDD+) projects and direct air capture technology).
Certifying bodies or Standards certify whether a particular project has met its stated objects and its stated volume of avoided or sequestered emissions and therefore the number of carbon credits the project produces over time. They also ensure that the core principles of carbon finance, such as additionality, permanence, no double counting, robust independent third-party validation and verification, are respected. These certifying bodies also establish registries to enable the registration and traceability of carbon credits, to ensure they are only transferred once. There are about ten independent certifying bodies in the world, with the three most popular being Verra (formerly VCS) which controls more than 50% of the voluntary market, the Gold Standard and Plan Vivo.
Once the certifying body issues the carbon credits to the project sponsors or developers, these can then be sold to end buyers, typically companies or even individuals seeking to offset part or all of their GHG emissions.
Due to growth in the voluntary carbon market, there have been additional players such as wholesalers who purchase large amounts of carbon credits directly from a project sponsor, bundle them into portfolios and on-sell to end buyers. There are also brokers who buy carbon credits from the wholesalers and market them to end buyers for a commission. Underpinning the voluntary carbon market are carbon credit funds which may be private or government owned funds that finance the development of carbon offset projects or purchase of carbon credits for sale to end customers.
Implications for Businesses
There has been a significant growth in the voluntary carbon market which was estimated as being worth US$2billion in 2021, about four times its value in 2020. It is also estimated that by 2030, it could be worth between US$10billion and US$40biliion. This presents significant opportunities for stakeholders. For instance, businesses involved in renewable energy projects may wish to consider whether such projects will be eligible for carbon finance. Additionally, such businesses may create an additional income stream by obtaining carbon credit certification for such projects and on-selling to end buyers. Finance companies seeking to invest in green projects may also consider offering carbon finance to project sponsors. Companies may also consider purchasing high quality carbon credits to meet their net-zero commitments.
Businesses seeking to participate in the voluntary carbon market will need to understand the legal framework underpinning the market. Firstly, international law does not define the legal nature of carbon credits. Therefore, it is necessary to apply national laws, which may be the governing law of the contract for the sale of carbon credits or the law of the host country in which the project is implemented. However, many countries have not implemented legislation to address this, particularly developing countries in which majority of these carbon offset projects are based. Moreover, even countries which have enacted legislation have done so restrictively with reference to the regulatory market only. Therefore, in the absence of specific legislation, contracting parties need to carefully identify the legal nature of carbon credits by analogy. For instance, by considering them as intangible movable property as seen in England, France and Latin law countries. The legal nature of the carbon credit will determine how they can be traded, how security can be taken and how they are treated on insolvency. Secondly, in the absence of a regulatory framework, it is important to carefully identify the owner(s) of the carbon credits as multiple parties throughout the project value chain may seek to lay claim to the carbon credits. For example, title to Verified Carbon Units (VCUs) under the Verra programme is not based on registration with the Verra, but rather the Verra registry is a public record of who is authorised to deal with which VCUs. Since title to VCUs is passed by the underlying contractual agreements, parties will need to carefully analyse the contribution of all parties and seek to clarify any rights or responsibilities they may have in the contractual arrangements. Thirdly, where multiple owners are identified, parties will need to develop a marketing mechanism for the marketing and sale of the carbon credits on behalf of all owners.
African Carbon Markets Initiative
The carbon credit market provides a significant opportunity for developers, investors and governments in in Africa to take action in tackling climate change as demonstrated by African Carbon Markets Initiative (ACMI) which was established at the COP27, with the aim of growing the voluntary carbon markets across Africa.
ACMI is sponsored by the Global Energy Alliance for People and Planet (GEAPP), Sustainable Energy for All (SEforALL), and the UN Economic Commission for Africa, with the support of the UN Climate Change High Level Champions. Its 13 member steering committee consists of various state and non-state stakeholder contributors (for instance, the Vice President of Nigeria, the Integrity Council for the Voluntary Carbon Market and Verra). ACMI’s core objectives include (a) growing the African carbon credit retirements (i.e. usage) to ~300MtCO2e by 2030 (a 19 fold increase from 2020), (b) creating or supporting ~ 30 million jobs by 2030, (c) raising the quality and integrity of African credits and (d) ensuring equitable and transparent distribution of carbon credit revenue. To date, ACMI has announced thirteen action programmes to support the development of voluntary carbon markets in Africa. Co-ordinated initiatives such as ACMI will be critical in providing the necessary impetus for the development and growth of the voluntary market sector in Africa.
Rinku Bhadoria, Partner
Demilade Banjoko, Associate
 Shell and BCG: “The Voluntary Carbon Market: 2022 Insights and Trends” (January 2023).