Carbon credits allow companies to meet more ambitious climate targets than they can achieve by internal reductions alone. A robust, effective voluntary market would make it easier for buyers to locate and complete transactions with trustworthy carbon project sources and would encourage sellers to scale up their supplies of credits. To this end, a wide variety of private- and public-sector initiatives has emerged, ranging from trading infrastructure to new forms of project certification.
A key challenge to the growth of voluntary markets is how to ensure credit integrity and provide credible price transparency. The heterogeneous nature of carbon projects and credits, combined with the lack of a common framework for verifying their impact, creates potential reputational risks for buyers and stifles demand. Several initiatives are working to address these concerns, including the creation of an independent, transparent verification process. But these efforts can be hampered by the absence of liquid reference contracts, which could help establish market stability and enable risk management.
One way to improve the quality of carbon markets is to establish a core set of carbon.credit exchange principles and a carbon attribute taxonomy that all parties can use to assess carbon project quality. Ideally, these would be hosted and curated by an independent third party. The use of these standards will help to improve transparency and reduce the risk of fraud. In addition, the establishment of a digital process for the registration and verification of carbon projects could lower issuance costs and speed up payments to projects, while also enabling buyers to trace credits and validate their impact at regular intervals, thus improving credibility of corporate claims about using carbon offsets.
Another important challenge is to scale up the supply of credits by introducing an efficient business model that can attract capital to low-carbon projects. Typically, these businesses are structured as'retailers' that assess and source the best carbon projects and then manage portfolios of credits for end buyers. These buyers may be companies that need to comply with environmental regulations ('regulatory carbon markets') or may simply want to achieve more ambitious climate goals than they can achieve through their own internal reductions ('voluntary carbon markets').
In regulatory carbon markets, companies are required by law to hold a certain number of 'carbon credits' each year in order not to exceed an emissions limit 'cap' that the regulator has established. They can then buy and sell carbon credits to other regulated companies who need to offset their own emissions.
Many companies are increasingly interested in carbon credits as a tool to support their commitments to low-carbon strategies. For instance, under Japan's GX League, companies commit to publishing their ambitions for emissions reductions, report on progress, and, if necessary, purchase carbon credits to offset their unavoidable emissions. They can also choose to use them to meet their Net Zero goals. As carbon markets scale up, decision makers across industries should consider their own plans to participate in them. Christopher Blaufelder is a partner in McKinsey's Zurich office; Cindy Levy is a senior partner in the London office; Peter Mannion is an associate partner in the Dublin office; Dickon Pinner is a senior partner in the San Francisco office; and Jop Weterings is director of environmental sustainability, based in Amsterdam.