Regulated Carbon Credit Markets

Carbon credit markets came about in 1997 when the IPCC developed a carbon credit proposal to reduce carbon emissions (widely known as the Kyoto Protocol). There are 192 parties to the Kyoto Protocol, whereby countries are given targeted carbon emissions reductions.

One regulated carbon credit is equivalent to one ton of CO2 in a given year and has an expiry. It acts as a right to pollute for companies. Essentially, governments issue a cap amount of permitted carbon emissions to each company, and if a company manages to emit less carbon than their permitted level, they could sell those unused carbon credits to other companies that have exceeded their permitted levels (indirectly those companies were taxed for over-pollution). This is known as the cap-and-trade market, as illustrated.

The governments lower the emissions cap each year, increasing the value of carbon credits over time and offering companies the incentive to invest in clean technology as it becomes cheaper than buying carbon credits.

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Carbon credit certificates come in various classes - most countries have their own individual standards which means that some certificates are not universally accepted. This adds additional complexity to cross border transactions because standards may not be recognised and could therefore be deemed non-compliant with local jurisdictions. This means the market is neither efficient nor open, resulting in price inefficiencies for carbon credits traded on regulated markets. Additionally, governance and stringent regulations mean that there are significant obstacles to overcome when it comes to carbon certification. Only permitted companies can trade on these carbon credit regulated markets to achieve their carbon caps, and overzealous compliance makes it costly for businesses to create a trading position for their offsets.