Carbon market mechanism

Carbon market mechanisms are policy tools that put a price on greenhouse gas (GHG) emissions by creating tradable units representing either an allowance to emit or a verified emission reduction. They fall into two broad families: compliance markets, established by law or treaty, and voluntary markets, where buyers purchase credits to meet self-declared targets.

Compliance markets typically take the form of emissions trading systems (ETS), also called cap-and-trade. A regulator sets an overall cap on emissions, issues allowances equal to that cap, and lets covered entities buy and sell them. The EU Emissions Trading System, launched in 2005, is the largest and longest-running example. Other major systems operate in California, the Regional Greenhouse Gas Initiative (RGGI) in the US Northeast, China's national ETS (launched 2021, covering the power sector), South Korea, New Zealand, and the UK.

International carbon market mechanisms are governed primarily by the Paris Agreement's Article 6, adopted in 2015 and operationalized through the Article 6.4 rulebook agreed at COP26 in Glasgow (2021) and refined at subsequent COPs. Article 6.2 allows bilateral trade of Internationally Transferred Mitigation Outcomes (ITMOs) between countries, while Article 6.4 establishes a centralized UN crediting mechanism, succeeding the Kyoto Protocol's Clean Development Mechanism (CDM) and Joint Implementation (JI).

Key design features include:

• The cap or baseline, which determines environmental ambition
• Monitoring, reporting, and verification (MRV) rules
• Corresponding adjustments to prevent double-counting across borders
• Offset eligibility, defining which project types (e.g., reforestation, methane capture, renewables) can generate credits
• Price floors, ceilings, or market stability reserves

Persistent debates concern environmental integrity (whether credits represent real, additional, permanent reductions), equity in revenue distribution, and the risk that offsets delay decarbonization in regulated sectors. Voluntary market standards such as Verra (VCS) and the Gold Standard have faced scrutiny over the quality of forest-based credits, prompting reforms in 2023–2024.