China’s approach to voluntary carbon markets and Article 6 of the Paris Agreement

How China’s approach may help to create opportunities and address key risks

Voluntary carbon markets have an important role in helping support the transition to net zero by:

• promoting natural resources as a valuable commodity;

• monetising the benefits of projects that reduce emissions through the sale, purchase, and retirement of carbon credits;

• helping to connect capital with climate change mitigation projects and opportunities; and

• helping countries, corporates and individuals to realise their individual decarbonisation goals and commitments (provided, of course, that they do not serve to dilute decarbonisation efforts within compliance carbon markets).

Whilst voluntary carbon markets do not seek to limit the volume of emissions released into the atmosphere, they nonetheless provide a flexible mechanism for reducing and removing carbon at an accelerated rate. However, for voluntary carbon markets to be an effective (and scalable) tool to help facilitate global decarbonisation aligned with United Nations targets, it is imperative that they adhere to three core principles:

• environmental integrity: identifying and agreeing the right benchmarks (set according to science based principles) is critical to promote fungibility and help mitigate market fragmentation risk;

• stability: the success of any financial market is, in part, measured by its depth and liquidity. A financial market that is ‘opaque’ is inherently unstable (and therefore unsustainable) because the potential risks associated with that market are unknown and unquantifiable; and

• accountability: proportionality and responsibility are essential components in the effective regulation of voluntary carbon markets that, at the same time, promote growth and protect market integrity.

Achieving sufficiency of scale within voluntary carbon markets requires standardisation (to reduce fragmentation, increase transparency, and increase interoperability) and certainty (e.g. robust systems, clear lines of responsibility, and comparable regulatory classification and treatment).

Article 6 of the Paris Agreement[5] (Article 6) establishes a market-based framework for bilateral trading of carbon credits between jurisdictions (under Article 6.2) and the development of a global carbon market (under Article 6.4).[6] Achieving consensus on the key principles for achieving nationally determined contributions (NDCs) under Article 6, is however proving challenging, at least in part because disagreements persist on whether applicable systems should be centralised or decentralised.

In contrast to the approach adopted in other voluntary carbon markets, China’s CCER scheme operates according to a centralised model which:

• adopts centralised methodologies for CCER projects;

• requires validation and verification of CCER projects by centrally accredited bodies (each applying the centralised methodologies);

• stipulates that all trading must be carried out on a centralised basis through the national CCER trading organization (currently the Beijing Green Exchange);

• provides for registration of all trades with a centralised registration body (whose records are definitive); and

• imposes potential civil and criminal liability for non-compliance with applicable rules.

The potential benefits of a centralised system include avoiding market fragmentation and reducing the risk of double counting. Care is however required in the implementation of a centralised model to ensure that market growth and ambition are not adversely impacted by the streamlining of market infrastructure, or the methodologies that determine project eligibility.

At COP29, the parties are tasked with resolution of the issues that have, so far, hampered progress with regards to the implementation of Article 6 mechanisms. Whilst many countries have initially (and understandably) focused on domestic emissions reduction to achieve their NDCs and mitigate the adverse impact of carbon cost equalisation measures[7] on domestic exports, many jurisdictions will have the need to source carbon credits from non-domestic projects to a greater or lesser extent.

China is an example of a jurisdiction that has the geographic and technological capacity to develop high-integrity projects that reduce/remove carbon emissions. Accordingly, the relaunch of China’s CCER scheme is potentially significant for facilitating low-carbon transition in jurisdictions other than China pursuant to Article 6. For this to be possible, China must adduce evidence that CCERs qualify as “internationally transferred mitigation outcomes” (ITMOs) either for bilateral trading under Article 6.2 or for trading within a global carbon market to be established under Article 6.4.

Alignment of standards and systems within voluntary carbon markets (or at the least, comparability and compatibility) ultimately underpins the success of Article 6 (e.g., avoiding double-counting by making corresponding adjustments between the carbon credit producing country and the carbon credit receiving country). Unlike CCERs, ITMOs are not currently traded within a single, centralised market, according to standardised systems or methodologies. Instead, intergovernmental cooperation agreements or memorandums of understanding set out the requirements for eligibility, authentication, registration, and monitoring of ITMO projects, and the transfer and surrender of ITMOs. As the ITMO market grows and matures, the case for standardisation (to promote integrity, efficiency, scale, and liquidity) similarly gains momentum.

In the nascent stage of Article 6 implementation, flexibility and innovation are of paramount importance. We must however have regard to the lessons learnt in domestic voluntary carbon markets to realise the decarbonisation potential of Article 6 mechanisms.