Most current carbon markets are regulated either by the countries or regions in which they operate, such as the EU, California or New Zealand, or by voluntary private sector coalitions, as in the case of the voluntary carbon markets.
However, the UN’s Paris Agreement, a global treaty signed in 2015, sets out the legal basis for a global carbon market for carbon reductions, that will help more than 190 countries achieve their mid-century climate goals.
The UN has tried once before to set up a global carbon trading system. In 1997, countries created the Kyoto Protocol, a market system that set binding emission-cutting targets for nearly 40 of the largest and most carbon-intensive countries.
Despite initial successes the Kyoto Protocol markets became unpopular, as critics pointed out that some of the biggest greenhouse gas emitters were not covered by the system. China, India and Brazil, for example, were not required to take on climate targets.
While the Kyoto Protocol’s market is still generating carbon reductions in many parts of the world, there is no longer any demand from developed countries for these credits, known as Certified Emission Reductions.
Since 2015, however, experts and diplomats have been working to set up a new system under the Paris treaty. The new markets are referred to as the “Article 6 mechanisms”.
Article 6 of the Paris Agreement establishes the legal basis for international emissions trading, as well as the principles of accounting for the trade in carbon credits among countries.
Each country has created its own, self-binding emission-cutting target, known as a Nationally Determined Contribution (NDC). These are submitted to the UN, which maintains a database of all NDCs for analysis and comparison.
The Paris Agreement gives countries the choice between achieving their reductions on their own, or with the help of “international cooperation”, which may include direct financial aid and technical assistance, or the use of markets.
How do markets allow countries to achieve their reduction goals?
Countries that need to make reductions to reach their Paris targets can either spend money to make those cuts domestically, or they can buy emission reductions that have been achieved elsewhere at lower cost.
For example, a project that makes carbon reductions by replacing open fireplaces with efficient cookstoves in an African nation can generate verified emission reductions that can be sold to a developed country like Switzerland. The African country receives the inward investment and the revenue from the sale, while Switzerland can apply the emission reductions towards its annual carbon account.
In order to establish these markets, Article 6.1 of the Paris accord creates the legal principle that allows trading. It recognises that “some Parties [countries] choose to pursue voluntary cooperation [that is, trading] in the implementation of their nationally determined contributions to allow for higher ambition in their mitigation and adaptation actions”.
The rest of the Article lays out the high-level principles that will govern the market.
Article 6.2 gives a formal name to UN-level carbon credits: “internationally transferred mitigation outcomes” (ITMOs), and requires that countries ensure “integrity and transparency, including in governance, and … robust accounting”.
From Article 6.2 stems all the work that the UN is now doing to set up an accounting system to ensure that when countries transfer ITMOs between themselves, these transfers are properly accounted for.
This is important because when a country achieves a reduction in its emissions, but then sells that same reduction to a second country, it cannot count that reduction towards its own goal. Only the buyer can count it, as we will return to later.
Article 6.3 reaffirms that countries’ participation in Article 6, and particularly the use of carbon offsets to achieve NDCs, is purely voluntary.
Article 6.4 introduces a second “mechanism” in the form of a centralised system for generating and trading carbon credits.
The purpose of the Article 6.4 mechanism is “to deliver an overall mitigation in global emissions” by public and private bodies, and to promote this mitigation while also supporting sustainable development.
Importantly, Article 6.4 confers upon individual Parties the right to decide whether to keep carbon offsets for their own carbon accounting, or to sell them to another Party. This becomes important when investors are seeking approval to build a project in a country: if they are intending the project to generate credits that may be sold abroad, they will need host country approval.
The principle of avoiding double-counting is covered in Article 6.5: “Emission reductions resulting from the [Article 6.4 mechanism] shall not be used to demonstrate achievement of the host Party’s nationally determined contribution if used by another Party to demonstrate achievement of its nationally determined contribution.”
Article 6.6 sets out the costs of the Article 6.4 market, by establishing that each project established under the market will contribute a “share of proceeds” to help fund the administration of the market.
Finally, Articles 6.8 and 6.9 create the legal basis for “non-market mechanisms”, in which assistance may be given to countries to achieve their NDC goals without recourse to a market system or to any trading in emission reductions.
Since 2015 legal and technical experts have been working to build the institutions to administer these markets, including the establishment of an Article 6.4 Supervisory Body that is now tasked with creating detailed rules regarding the registration and approval of carbon reduction projects and the issuance of credits.
The new system is expected to begin operating around 2026, when the first new projects under the 6.4 system are expected to be approved, and credits from the new regime should begin to be issued not long after.
