Carbon markets play a key role in the global energy transition
Carbon credits/offsets are meant to incentivize organizations that can reduce or remove carbon by allowing those that need to emit carbon to trade on the market (Getty images/ Doina Tocmelea)
Carbon markets play a key role in the global energy transition, but many questions are being raised about the quality and integrity of the carbon credits/offsets in circulation today. In response to these challenges, Canadian CPAs and other accounting and finance professionals around the globe have been at the forefront of research into developing new standards and best practices for carbon credits.
We met with three individuals who are leading research on the voluntary carbon market:
- Rosemary McGuire, CPA, vice-president, research, guidance and support for CPA Canada in Toronto.
- Ryan Riordan, a distinguished professor of finance at the Smith School of Business at Queen’s University in Kingston, and director of research for Queen’s Institute for Sustainable Finance, which is working with CPA Canada on projects related to carbon credits.
- Stathis Gould, director of member engagement with the International Federation of Accountants (IFAC) in New York, and a leader and advocate for professional accountants working in business and the public sector.
WHAT ARE CARBON CREDITS/OFFSETS TRYING TO ACHIEVE?
The idea behind carbon credits/offsets is to incentivize organizations that can reduce or remove carbon by allowing those that need to emit carbon to trade on the market, says Riordan.
“We’re using markets for what they’re supposed to be used for. It’s the highest willingness to pay,” he says.
WHY IS THERE INCREASED BUSINESS AND REGULATORY INTEREST IN CARBON CREDITS/OFFSETS?
This is due to the enhanced expectation for organizations to play their part in the carbon transition. “We’re seeing a lot of uptick in net-zero carbon pledges that are being made. The use of carbon offsets and credits is being incorporated in that,” says McGuire.
She notes that the terms “offset” and “credit” are typically used interchangeably, and broadly refer to a reduction in GHG emissions that is used to compensate for emissions that occur elsewhere.
It is recognized that solving the climate problem will require significant reductions in greenhouse gas emissions. While the use of carbon offsets and credits doesn’t directly contribute to emissions reduction, nor is it seen to contribute to solving the climate problem globally, the reality from a business perspective, explains Gould, is that where companies establish a net-zero carbon emissions target, as many have, they will try and reduce emissions to the extent possible with current technology.
But at a certain point they might not be able to reach their targets within the time established because it is either too costly, or they don’t have a technological solution to replace their current infrastructure. For example, airlines currently have few cost-effective options to reduce their GHG emissions from flying, Gould says.
Such circumstances create a need to compensate, which is why carbon offsetting and the use of carbon credits have achieved significant momentum in the voluntary carbon markets, he says.
WHY IS THERE A LACK OF PUBLIC UNDERSTANDING OF HOW CARBON CREDITS/OFFSETS WORK?
“I think it has a lot to do with how quickly the market has grown over the past few years, and the complexity in the way it has evolved,” says McGuire.
“There is not a great understanding of who’s generating the credits, who’s verifying them, and how to distinguish between the quality of various credits. And so that’s really the impetus for us in doing a bit of a deeper dive to uncover what the market and the infrastructure surrounding it look like, and then how the accounting profession can contribute to enhancing the transparency and credibility of the market,” she explains.
WHAT ARE THE POTENTIAL PROs AND CONs OF CARBON CREDITS/OFFSETS?
A key advantage is that carbon credits/offsets provide a good allocation method between organizations that have capital and are unable to reduce carbon cost effectively, and those that need capital in order to reduce or remove carbon, says Riordan.
A major downside, however, is that carbon credits/offsets are often not regulated, hard to verify, and difficult to audit in terms of their impact.
Another con is the potential for ”greenwashing” or reporting on something artificial to make the organization appear good on paper when its activities don’t match. For example, notes Riordan, there have been instances where a forest that wasn’t in danger of being cut down was deemed as being endangered in order to salvage the credits.
WHAT ARE SOME OF THE KEY CHALLENGES WITH USING CARBON CREDITS/OFFSETS?
Voluntary carbon markets are fundamentally different than regulated carbon markets.
For example, a regulated market will feature a cap on a specific number of tradeable permits for carbon credits, subject to regulatory oversight and political scrutiny. In contrast, a voluntary carbon market is totally decentralized, and generally unregulated, with carbon credits being purchased from non-regulated crediting bodies and schemes, says Gould.
Moreover, voluntary carbon markets can be very complex, involving many actors, and appear opaque. Some of the parties involved in the voluntary carbon market are unregulated private sector organizations for whom there is often a perception of poor governance or conflicts of interest. And, unlike the compliance market, which only involves certain industries and companies, voluntary compliance markets are open to all companies, he adds.
HOW CAN CPAs SEIZE OPPORTUNITIES THAT CARBON CREDITS/OFFSETS PROVIDE?
CPAs play a critical role in identifying and managing climate risk and opportunities and helping organizations develop credible transition plans. CPAs need to be able to evaluate when it is appropriate to employ carbon credits/offsets in their organization’s decarbonization strategy and do their due diligence in assessing the quality of the carbon credits/offsets they purchase, as well as minimizing the associated risks, says McGuire.
For corporate financial statements, CPAs need to consider the appropriate accounting treatment before purchasing or generating carbon offsets in the context of how carbon credits have been used to achieve corporate targets of net zero carbon emissions, says Gould.
WHAT IS THE SIZE OF THE CARBON CREDITS/OFFSETS MARKETS TODAY?
The voluntary carbon markets, which began operations about 20 years ago, have grown in late 2023 to approximately 250 to 300 million credits issued annually, with a credit representing one ton of carbon dioxide (CO2) or other gases of the equivalent greenhouse effect, says Riordan. In dollar terms, the voluntary carbon-offset market is expected to grow from $2 billion in 2020 to around $250 billion by 2050.
WHERE CAN CPAs AND OTHER PROFESSIONALS SOURCE THE LATEST PROTOCOLS?
Two important sets of principles are the Oxford Principles for Net-Zero Aligned Carbon Offsetting from the University of Oxford, and the ten core principles established by the Integrity Council for the Voluntary Carbon Market, an independent conference body for the voluntary carbon market, that serve as a global benchmark for high-integrity carbon credits.
“Those two sets of principles provide important advice and guidance about how to increase the quality of carbon offsetting and what to prioritize,” says Gould.
WHAT CAN WE EXPECT GOING FORWARD?
Notable efforts are underway to address growing demands for transparency and accountability.
For example, the new global standard IFRS S2, Climate-related Disclosures, provides specific provisions for climate-related disclosures, including a requirement specifically for carbon credit offsets, where companies must disclose the extent to which, and how, they are achieving any net GHG emissions target based on carbon credits, says Gould.
This includes the verification standard used, the type of projects represented—nature-based versus tech-based, and whether the underlying offset is achieved through carbon reduction or removal, he explains.
In addition, the International Organization of Securities Commissions (IOSCO) is exploring what sound and efficient voluntary carbon markets should look like and what role financial regulators may play in promoting integrity in those markets.
“We hope our forthcoming research will help trigger meaningful dialogue among key players in this space on how we can reduce complexity and encourage the necessary changes and innovation to support a credible and robust carbon market,” says McGuire.
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