Integrity Crisis of the Voluntary Carbon Market (VCM)

30 August 2024

Analysts:

Tan Kian Hwee, Toh Wei Hao, Yeow Zong Wei, Stuart Aaron Sy

Introduction to the Voluntary Carbon Market (VCM)

What are Voluntary Carbon Markets and their importance

Carbon credits are measurable, verifiable emission reductions from certified climate action projects. (South Pole, n.d.). Usually, one carbon credit represents one tonne of greenhouse gas emissions reduction, avoidance or removal and thus can act as a form of carbon pricing. There are two main types of carbon markets: the compliance emissions trading market designed at different jurisdictional scales to legally cap emissions across industries, and the voluntary carbon market (VCM) which is a voluntary scheme usually used by companies to meet their reputational voluntary emissions targets. In this article, we will focus on the VCM, and distinguish the terminology “carbon credits” (or offsets) used in VCMs from “carbon allowances” that are used in compliance cap-and-trade programs (Ahmed & Gonzalez, 2023).

The Flow of Carbon Credits in the Voluntary Carbon Market

1. To participate in the VCM, project developers have to verify their projects through third-party carbon-crediting programs which issue credits, including Verra, Gold Standard, and Climate Action Reserve.

2. These standard issuers use their assessment frameworks to establish standards for project methodologies. 

3. The standard issuers vouch for projects aligned to their standards, and thus act as certifiers of project integrity and credibility in the decentralised VCM. 

4. Once verified, the carbon credits are issued and can be entered into a registry. Subsequently, buyers can purchase these credits on various exchanges or brokers. 

Usually, these marketplaces also conduct their independent checks and balances before listing these projects, in order to ensure overall integrity and compliance (refer to Figure 1).

Figure 1: The start-end process of a carbon credit transaction

Source: Burzec and Lewis (2021)

ICVCM: Another Key Market Player

Alongside carbon-crediting programs and carbon-credit marketplaces, another key player in the VCM space is the Integrity Council for Voluntary Carbon Markets (ICVCM). The ICVCM functions as an independent governance body for the VCM and aims to establish global carbon accreditation standards and to ultimately integrate finance into climate action.

Types of carbon-offsetting projects

Carbon offsetting projects are mainly categorised into two types – (1) avoidance-based projects which avoid emitting GHGs entirely, and (2) removal-based projects which remove GHGs directly from the atmosphere (refer to Figure 2) (Favasuli & Sebastian, 2021). Among the various carbon projects, REDD+ projects are the most common and contribute about 25% of all credits (Haya et al., 2023). REDD stands for 'Reducing Emissions from Deforestation and Forest Degradation in Developing Countries,' with the '+' representing additional forest-related activities (UNFCCC, n.d.).

Figure 2: Types of Offsetting projects 

Source: (senken, 2023)

VCM in Crisis

The Gulf between Promises and Reality

However, there has been a recent confidence crisis in the VCM that has divided investors. The central promise of the VCM has been to achieve net-zero emissions by balancing emissions with offsets (or avoided emissions) globally. Critics however claim that the VCM is at best ineffective, and at worst could derail the path towards net zero since the promised benefits have not materialised.

Phantom Credits

In January 2023, a Guardian investigation cited results from scientific papers that used satellite imagery analyses and found that “more than 90% of [Verra-certified REDD+] rainforest carbon offsets are worthless” (Greenfield, 2023). The high-profile article generated shockwaves and casted doubts on Verra’s REDD+ methodologies which appeared to have significant loopholes that were abused by project developers.

Later in August 2023, another study further examined Verra’s flawed methodologies and highlighted factors for the rampant over-crediting, namely flawed baseline estimates, potential emission leakages, durability, high estimates of carbon stocks, as well as the lack of community safeguards (Haya et al., 2023). They found that project developers overstated their projects’ impacts by exaggerating deforestation estimates in the project area that would have occurred without their projects’ intervention. Synthesised results from previous studies suggest that flawed baselines alone contributed to 92% of over-crediting, which means that projects had claimed to be 13 times more impactful than they actually were.

Moreover, many REDD+ deforestation projects ignored leakage risks. Despite best practices to include leakage rates of 10 to 70% as indicated in Verra’s methodologies and academic literature, 59% of Verra-registered REDD+ projects failed to apply any leakage deductions, while most of the remainder only applied lax total leakage rates less than 25%.

This industrial malpractice calls the system’s integrity into question. When the number of issued phantom credits grossly outnumbers the actual amount of emissions that are claimed to be “offset”, the balance topples in the direction of net emissions rather than the promised net-zero future. This is especially alarming given that REDD+ type projects are the most prevalent in the VCM.

Responses to Controversy

In response, Verra disputed the results of the January papers and are undergoing an internal review to address the concerns flagged by Haya et al. about their REDD+ methodologies. Moreover, in December, a group of scientists from the nature data company Space Intelligence attacked a key paper that was included in the aforementioned studies (West et al. in Haya et al.) and claimed that the paper’s methodology was flawed (Space Intelligence, 2023). This formal rebuttal was submitted to the scientific journal Science and is currently undergoing a peer review process to assess its merit.

For the time being, it appears that the jury is still out on whether the VCM has been effective. Nevertheless, carbon market governance must step up to assure investors about quality and regulate project developers.

Recent Initiatives to improve VCM Quality and Credibility

High-integrity Carbon Credits

In March 2023, the ICVCM established the Core Carbon Principles (CCP) (refer to Figure 3) and Assessment Frameworks as a global standardised benchmark to guide high-quality carbon crediting projects. This was to address the previous gap where varying inconsistent and unclear standards left the definition of “high-quality” up to individual interpretation.

Figure 3: ICVCM’s Core Carbon Principles (CCPs)

Source: (ICVCM, n.d.)

These principles are grouped by (1) emissions impact, (2) governance, and (3) sustainable development. 

The carbon-technical emissions impact category concerns the quantification of project impacts to achieve an overall emission reduction. Notably, the additionality criterion refers to creating a positive impact compared to baseline situations without project intervention, while permanence means that such reductions are not easily reversed, nor leaked or displaced from within project boundaries to elsewhere.

To ensure that projects fulfil their promises, the VCM and projects must be properly governed and verified. The governance category demands that projects are officially registered, trackable, and thus rigorously disclose their impact quantification methodologies and realised impacts on the ground.

The final category guides projects towards the goal of achieving net-zero emissions 2050 in a manner that promotes sustainable development outcomes. It advises projects to conform with social and environmental safeguards to do no harm, while avoiding the application of carbon-intensive practices that would compromise the net-zero objective.

Additionally, the CCP-label will only apply to carbon credits that fulfil a “two-tick” process; the credit should be accredited by a “CCP-Eligible” crediting program, and the project that generates the credit needs to follow a “CCP-Approved” methodology.

To provide further guidance on the use of the CCP assessment framework and procedures, the ICVCM published its CCP handbook version 1.1 on 15 May 2024. They have also published a “Summary for Decision Makers” section which aims to educate decision makers and stakeholders on the ICVCM’s approach.

Push for Greater Transparency signals Commitment to Market Integrity

Players in the VCM have quickly responded to the controversy in support of the ICVCM’s CCPs. In December 2023, leading standards like Gold Standard and Verra and others announced their support for ICVCM’s governance, and pledged to create a collaborative framework to improve consistency and transparency across the industry (Cognito Media, 2023). This verbal commitment materialised within half a year, with 5 carbon-crediting programs comprising 98% of market share being approved for CCP-eligibility after changing their procedures to comply with the CCP criteria (ICVCM, 2024).

Meanwhile, the CCP label has become applicable to credits from seven carbon crediting methodologies approved by ICVCM since June 2024. 27 million eligible carbon credits are estimated to be generated from the two project categories of ozone-depleting substances and landfill gas (CarbonCredits.com, 2024). A further six methodologies are set to be reviewed by multi-stakeholder working groups, ranging from improved forest management to renewable energy. 

Additionally, the ICVCM had joined forces with the Voluntary Carbon Markets Initiative (VCMI), another key player that governs the demand side of the VCM, Science Based Targets Initiative (SBTI), GHG Protocol, and We Mean Business Coalition (WMBC). They had announced a collaboration to create an “end-to-end” integrity framework that signals a commitment to give businesses guidance on how to decarbonise and use carbon credits to offset residual emissions (ambipar, 2023).

With commitments to higher integrity and transparency across the market players, from exchanges to standard issuers, there is optimism for a more trustworthy VCM. We believe that it is crucial to distinguish between CCP-aligned and non-aligned credits, yet the CCPs’ efficacy will likely depend on the stringency of their application. Hence, it remains to be seen if these pledges will result in tangible checks and balances that can curb greenwashing and address the controversy uncovered in 2023.

Leveraging Novel Technologies to Prevent Double-counting: Climate Data Action Trust

Other institutions are also chipping in by leveraging novel technologies to increase transparency. The current iteration of the global carbon market is fragmented, and consists of disconnected registries and national-level carbon markets. This prevents the notarisation of transactions outside of the respective registries and creates a loophole that enables multiple registries to claim the same carbon credit generated by a particular project. To address the concern of ‘double counting’, the Climate Data Action (CAD) Trust was conceived as an initiative between the World Bank, the International Emissions Trading Association (IETA) and the Government of Singapore. Indeed, in just over a year since its initial launch in late 2022, the platform has since onboarded six registries that cover 85% of all carbon credits issued to date, with coverage set to further expand in 2024 and beyond.

Uniquely, CAD Trust consolidates carbon registry data using open-source blockchain-powered digital infrastructure. This data system combines real-time, comparable, and verifiable emissions reduction data from myriad registry systems around the world, so that these registries can disseminate their data on a central platform (Climate Action Data Trust, 2023). This prevents double counting, and promotes a common digital platform shared among various registry systems. Essentially, when carbon registries utilise blockchain, market participants can see a transparent digital record of every credit, aggregating credits across different standards and countries of origin, into a single integrated platform. The resulting interoperability and improved transparency can raise confidence in overall carbon credit transactions (Tan, 2022).

The Crossroads of Voluntary Carbon Markets 

With the current and upcoming regulations and initiatives in place to quell the controversies, VCMs are now at an inflection point. While liminal improvements in standards have led to a marginal increase in transparency and resultant confidence from corporate investors, fundamental concerns relating to the validity of carbon credits still remain. It is with these considerations that our group proposes the following recommendations:

1. Standardise the Empowerment of Central Regulators across Carbon Marketplaces

The current “wild west” of the VCM is plagued by many borderline fraudulent projects that fly under the radar in the absence of a central regulator. Their excesses would have been left undiscovered if not for the arduous work of watchdogs, investigative journalists and scientists. Our group thus proposes greater check-and-balance mechanisms running through a central financial regulator with better funding, more information, and stronger enforcement powers from governments presiding over the respective carbon marketplaces. 

In June 2023, the US Commodity Futures Trading Commission established the Environmental Fraud Task Force to “combat environmental fraud and misconduct in derivatives and relevant [voluntary carbon credit] spot markets” heeding the call in a recommendation paper by think tank Center for American Progress in the preceding year (CFTC, 2023; Friedman & Phillips, 2022). We believe that equivalent governmental regulators across jurisdictions can similarly step up to audit market players such as project developers, registries, and exchanges, since many players would be monetarily incentivised to churn out credits at the expense of credit quality. 

To prevent loopholes and project leakage, we propose that regulations and checks are multilaterally standardised across economically important jurisdictions which might share ambitions of becoming green finance leaders. If the regulatory playing field can be levelled, all parties will benefit from a more trustworthy VCM. This is imperative to maintain confidence in credit quality, and thus cultivate global demand from investors who desire to fulfil legal or reputational obligations through credit purchases.

While we acknowledge that regulatory rigour can act as a barrier to market expansion, we also believe that ensuring the quality of credits is of the utmost priority. We believe that it is more important to grow a tighter market that can guarantee credible and high-quality credits than to loosen the thresholds just to accelerate the growth and damage of fraudulent projects.

2. Distinguish credits based on project types’ CCP-eligibility for greater transparency

Zooming into the credits themselves, there may be a need to reconsider the types of projects that VCMs should prioritise. As seen from the diagram below, there are different levels of projection for CCP-eligibility across the diverse project types. Trove Research correctly predicted landfill gas as one of the first project types approved, and notably predicts carbon engineering and other non-carbon dioxide gases-based projects as being the most likely to obtain CCP eligibility (Loffler et al., 2024). This could skew the initial batches of CCP-eligible credits towards such project types, and thus associate these projects with high quality.

Figure 4: Estimated proportion of projects achieving CCP eligibility by project type

Source: MSCI Carbon Markets (2023)

However, it is important to remember that CCP eligibility accounts for other factors apart from the quality, transparency and legitimacy of the projects. It also depends on the ease of documentation from both exchanges and independent verification agencies due to the ICVCM requirements of monitoring, reporting and verification.  This means that CCP-ineligible projects could still be high-quality, but simply lack the paperwork necessary to qualify for eligibility. Hence, there will still be a market for ineligible projects for corporations to consider, although investors should remain cautious and perform their own due diligence before purchasing such credits.

Ultimately, our group firmly believes in the need for more stringent documentation pertaining to project developments, especially on the developers’ ends, and clearly distinguish whether CCP-ineligibility was determined on the basis of documentation. 

Conclusion

The recent controversies in the VCM uncovered a system in need of greater checks and balances. With the VCM set to bounce back in the near future, it is important that a methodical approach towards implementation of these checks and balances is maintained to ensure the robustness of the system. With its great potential, we hope that the VCM can become more transparent and reliable to effectively channel green finance to impactful climate action projects.

References

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