Voluntary carbon markets (VCMs) are exchanges which allow actors to trade in credits generated from emissions reductions or removals in order to offset their own carbon emissions. In this blog, Dan Marks explores new developments in the carbon market landscape and how these might alter the opportunities and incentives for corruption in the supply chain.
VCMs are often described as an under- or unregulated space. Gold Standard, one of the most important standard setters and registries, describes VCMs as “largely unregulated” although operating “in the context of different national legal and regulatory frameworks”. From an anti-corruption perspective, the ‘largely unregulated’ nature of VCMs has been a blessing and a curse, particularly in a developing country context. On one hand, lack of regulation places a heavy burden on buyers, registries and associated verification and validation bodies (VVBs) to assure quality and lower the cost of malfeasance. On the other hand, lack of government intervention, in some cases, may reduce the opportunities for corruption and motivate more due diligence from market actors.
This lack of regulation feeds into the peculiar dynamics of VCMs. The value of a credit is intrinsically linked to its probity – much more so than, say, a commodity mineral – and, therefore, to its ethical or reputational value to the buyer. Ownership of a voluntary credit is not mandated by regulation and does not give rights to an income stream or a physical asset. VCMs consequently operate in a situation of intrinsic tension. Market participants depend on a perception of integrity to maintain the value of credits and many take part altruistically as NGOs. Meanwhile, the corporate incentive can be to maximise reputational benefit while purchasing the minimum number and quality of credits with as little expense on due diligence as possible.
It is, therefore, unsurprising that a major dip in the market in 2024 coincided with a spate of negative headlines about the efficacy and probity of some credits, an economic downturn reducing discretionary spending, and new restrictions by agencies such as advertising standards authorities across several important consumer markets on the types of environmental claims that can be made on the basis of voluntary carbon credit (VCC) purchases.
A changing market
To date the market has operated mostly on a voluntary basis, but now several developments are changing its underlying structure, with implications for corruption and its impact. First, the line between ‘voluntary’ and ‘compliance’ markets is beginning to blur. Initiatives such as the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) create demand for credits registered with the same private registries that form the backbone of the voluntary market. By 2027 all international flights in and out of International Civil Aviation Organisation member countries, with some limited exceptions, will be required to purchase credits.
Second, from a supply perspective, new routes to market are opening up, most notably through the sale of credits into compliance markets and the operationalisation of Article 6 of the Paris Agreement. Article 6, which provides for the international transfer of emissions reductions accounted for in Nationally Determined Contributions (NDCs), was fully operationalised at COP29, paving the way for a new international registry and market for carbon credits. Selling carbon credits on regulated emissions trading schemes is also increasingly common, with the California Air Resources Board’s (CARB) Compliance Offset Program, part of its Cap-and-Trade Program, often cited as an example.
These developments bring governments much more directly into VCMs, both as regulators and as stakeholders, given that NDC targets will be directly impacted by a domestically produced carbon credit’s route to market. Gold Standard points out that Article 6 guidance provides a framework for governments to “authorise” the use of emissions reductions and/or removals, suggesting “an inherent right to control the use of carbon credits”. Government authorisation is also required for credits to be sold into CORSIA.
New approval procedures for voluntary projects are also a possibility as the market is formalised to accommodate Article 6 and more national registries are expected. Tax and other incentive schemes could be created for carbon credit projects. Governments struggling to reduce emissions elsewhere may choose to maximise domestic credit production, while governments with a surplus of carbon credit production potential may choose to ‘export’ those credits as Internationally Transferred Mitigation Outcomes (ITMOs).
Novel corruption risks
These new roles for governments with limited experience in the market will have diverse impacts on corruption risks. Where regulation can increase transparency and disincentivise misbehaviour by bringing actors under various financial market authorities, it may reduce the risk of corruption. However, regulation and oversight can also create opportunities for corruption. This is particularly true in countries with high levels of corruption in public institutions and limited experience in regulating financial markets.
For example, government incentives may diverge from those of developers who may seek to influence government decisions through bribery. Indeed, incentives for governments to exaggerate offsets or authorise offset projects at the expense of local communities may also increase as international banks, particularly development banks, enforce Paris agreement alignment on financing. The more offsets are produced domestically – or purchased internationally – the easier it will be to make the case that a polluting project, such as a new industrial park, will be compatible with NDC targets. These factors may in some circumstances create incentives for governments or developers to override local community and environmental interests.
These developments also move the market towards commodification. Currently, most voluntary transactions are bilateral with a relatively high degree of transparency in terms of access to project documentation. Many ‘exchanges’ more closely resemble investor platforms showcasing different projects to potential investors. However, CORSIA and CARB’s Compliance Offset Program are fundamentally different transactional processes. Airlines purchasing Eligible Emissions Units Futures on CORSIA do not have visibility on the project that will produce the credit.
There are benefits to commodification. For instance, the Intercontinental Exchange (ICE) has sophisticated market infrastructure and suspicious activity monitoring capabilities. The more formal market structure is also more conducive for insurers and financiers, which have obligations to enact anti-corruption procedures. But commodification also makes transparency at the point of transaction much more challenging. ICE, which administers CORSIA, relies on accredited registries for due diligence, including Verra and Gold Standard, the two biggest registries in developing countries. Accountability is also reduced by a lack of clarity over which entities in these markets are responsible for ensuring anti-corruption procedures are followed.
In theory, registries carry out KYC (‘know your client’), anti-money laundering and anti-bribery checks on projects, but in practice guidance is often vague and implementation by validation and verification bodies (VVBs) patchy. VVB fees are often too low to support meaningful anti-corruption due diligence, with limited budgets mostly devoted to examining technical compliance with registry standards. Registries themselves are also reluctant to accept any formal liability. The incentive towards trustworthiness and conformity with anti-corruption norms – driven in part by direct oversight and familiarity between credit buyer and seller – may be reduced as commodification introduces degrees of separation between market actors. In voluntary transactions, the buyer will generally carry out some due diligence checks. These can be cursory, but the buyer does have reputational and ethical incentives to take some measures to protect against the reputational damage of financing projects involved in corruption.
Bilateral trading in VCMs also allows for price discrimination based on the type of project. Direct air capture projects, for example, can command fees of hundreds of dollars per tonne of carbon dioxide equivalent removed from the atmosphere. By contrast, reforestation, forest conservation and cookstove projects, which are the most common, frequently sell credits for less than $10/tonne. This is because not all carbon credits are created equal: a tonne of carbon technologically removed from the air and stored underground is permanently removed, whereas some reforestation projects will only guarantee removals for a few decades.
Projects from reputable developers in lower-risk locations might also attract a premium. The single price structure of commodified markets, while typically higher than the cheapest voluntary credits – suggesting that more stringent criteria are having an impact – cannot differentiate between projects based on quality. As such, there is concern amongst some developers that commodification and unit price convergence risk a ‘race to the bottom’ regarding project quality, potentially encouraging attempts to maximise profit through corrupt behaviour.
Conclusion
The nature of VCMs is changing, introducing novel corruption risks. As markets formalise and commodify, they bring more regulatory and governmental scrutiny to the sector. In turn, this may improve standards in some cases and increase demand for carbon credits, thereby increasing the funding available for anti-corruption processes. They may also bring more financial institutions into the market, whose formal reporting and monitoring requirements should reduce the risk of corruption. However, these developments also bring governments more directly into projects as stakeholders and create potentially divergent incentives between governments and developers. This will mean new opportunities for corruption – particularly in contexts of high government corruption. Furthermore, some stakeholders in VCMs are concerned that commodification will reduce transparency and accountability along the value chain.
As carbon offset markets appear primed for fundamental change, all stakeholders must seek to learn the lessons of VCMs to date and build best practice in anti-corruption into the design of the nascent frameworks and markets. If not, the markets risk failure as corruption threatens to derail the ability of credits to retain value and attract investment, diminishing the potential for the world to achieve net zero.
Dan Marks is co-lead on a GI ACE project analysing the complexities of corruption risks across voluntary carbon markets, with a particular focus on verification and certification processes. Find out more about the project here.