Carbon Markets: A Growing Pillar of Global Decarbonization and Financial Strategy

Carbon markets are assuming an increasingly central role in directing capital, guiding industrial decisions, and supporting global decarbonization goals. Their evolution is not entirely linear: alongside the now consolidated regulated markets (compliance markets), voluntary markets (voluntary carbon markets), hybrid systems, and new international cooperation mechanisms envisaged by the Paris Agreement are growing.

However, their combination is shaping a multilevel landscape in which finance and climate policies are intertwined to address decarbonization needs with more mature and sophisticated tools. This is the finding of a study by the International Capital Market Association (ICMA), which analyzes this process in depth, showing how carbon markets are reshaping the financial and transition strategies of governments and businesses and are taking on increasingly defined contours, driven by regulatory changes, growing pressure on investors, and the expansion of pricing systems that directly impact industrial decisions.

ICMA’s analysis offers an updated framework in a context where it is crucial to clarify how different types of credits and markets work, in order to understand how instruments, governance, and financial innovation are reshaping the global architecture of carbon pricing.

What are carbon markets?

Carbon markets are based on the use of carbon credits, an umbrella term that includes both carbon allowances and carbon offsets. Each credit typically represents one ton of carbon dioxide equivalent (CO₂e).

Specifically, carbon allowances are permits that authorize the emission of a specific amount of CO₂ and are traded in regulated markets (compliance markets). These markets are governed by regulatory frameworks that establish mandatory emissions limits for certain sectors. Companies that exceed these limits must purchase emission permits.

Carbon offsets, on the other hand, arise from projects that reduce or remove emissions (such as reforestation initiatives, methane capture, or the use or creation of renewable energy farms) and are traded in voluntary markets , fueled by companies and investors who intend to reduce their emissions in a non-mandatory manner, for internal goals or transition strategies.

In recent years, hybrid markets, or “compliance offset markets,” have also emerged, which integrate elements of both systems: while falling within mandatory frameworks, they allow the use of offsets instead of allowances.

Regulated markets: the cap-and-trade model

Compliance markets are systems in which emission-intensive sectors must purchase credits to offset their residual emissions. Most operate with a “cap-and-trade” model, meaning:

an authority sets a cap , that is, a maximum limit on overall emissions;
allowances, or permits to emit, are distributed through auctions or free assignments;
companies that emit less can sell excess credits;
Those exceeding the limits must purchase additional credits.

The quality of the market depends on the calibration of the cap: if too high, the credits lose value and do not incentivize emissions reductions, thus decarbonization. If too low, the risk is slowing production and investment. Currently, there are over 30 regulated carbon markets operating globally, but the most significant are the European Union Emissions Trading System (EU ETS) , the California Cap-and-Trade Program in North America , the Quebec market , and the China National ETS.

Voluntary markets

Voluntary markets, while representing a much smaller trading volume than regulated markets, are characterized by a truly global reach: credits can be freely traded between countries and sectors, without regulatory constraints.

However, poor project integrity has undermined market trust, prompting international organizations such as the Integrity Council for the Voluntary Carbon Market (ICVCM), the Voluntary Carbon Markets Integrity Initiative (VCMI), and the International Organization of Securities Commissions (IOSCO) Good Practices Guidelines to introduce more robust criteria for verifying project emissions and additionality.

The role of carbon markets in the global climate transition

The role of carbon markets in global climate strategy is becoming increasingly defined, driven by regulatory developments, increased pressure on investors, and the expansion of carbon pricing mechanisms.

ICMA’s study highlights how the combination of regulated markets, voluntary markets, and hybrid initiatives has created a multi-layered landscape in which finance and climate policies are intertwined with increasingly mature tools.

The strength of regulated markets

Compliance markets have reached an unprecedented critical mass: in 2024, the value of traded allowances reached nearly $950 billion , covering over a quarter of global emissions. Specifically, the EU ETS is the world’s largest carbon market, representing 85% of global value and enabling a 43% reduction in emissions from the energy and carbon-intensive industrial sectors since 2005. Starting in 2025, the tightening of caps will make the system even more stringent.

In North America, California and Quebec have integrated their systems since 2014, creating a more liquid and standardized market, and in 2024, Washington state also announced a plan to join. These systems represent 11% of the global market. China’s national ETS was launched in 2021 and covers approximately 15% of global emissions. However, trading volumes are still limited (less than 1% of the global market).

Voluntary markets: potential and limitations

With $535 million in trade in 2024, voluntary markets remain marginal compared to regulated systems, yet they retain the potential for global impact thanks to their transnational nature and ability to mobilize carbon reduction or removal projects in widely varying contexts. Platforms operating in this space offer companies useful tools to anticipate future regulatory obligations or support initiatives with significant environmental and social impacts.

However, the sector’s overall credibility has been repeatedly called into question due to instances of overestimation of benefits, deficiencies in oversight, and methodological inconsistencies that have emerged in certain project categories. New initiatives from ICVCM, VCMI, and IOSCO aim to create clearer and more comparable standards to restore trust.

Hybrid Markets and CORSIA: The Role of Aviation

Compliance and voluntary markets, though separate, may overlap to a limited extent: some compliance markets accept conditional and limited quantities of offset carbon credits. This has given rise to hybrid systems. The most notable example is the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA ), the global mechanism for offsetting emissions from international aviation.

Starting in 2021, airlines can use selected offsets (according to International Civil Aviation Organization criteria) to offset a portion of their emissions. Until 2026, only flights between countries that volunteer to participate in CORSIA are required to surrender offset credits. These countries include Europe, North America, parts of the Middle East, Southeast Asia, Australasia, and Africa. From 2027, the system will become mandatory for most international flights, opening up a new demand for high-integrity credits.

International pressures: Article 6 and CBAM

According to ICMA, two elements could determine a significant acceleration in the growth of carbon markets.

One is Article 6 of the Paris Agreement , which allows for cooperation between ETS systems in different jurisdictions and could facilitate the recognition of offsets in mandatory systems in the future. However, its implementation remains complex and subject to multilateral negotiations.

The other is the European Carbon Border Adjustment Mechanism (CBAM) , which applies a carbon price to imports into the EU, encouraging third countries to develop their own ETS-compliant systems. This could foster the emergence of new compliance markets in Europe’s main trading partners.

Sustainable finance and innovation

For sustainable finance, the role of carbon offsets remains limited, both in terms of recognition and diffusion. Nevertheless, innovative instruments are emerging that seek to integrate environmental performance and financial returns , opening up new perspectives for investors and markets. Among these, the World Bank ‘s “outcome bonds” represent an interesting model where part of the bond’s return is linked to the value of the credits generated by the financed projects, creating a direct link between investment and environmental impact.

The World Bank, in particular, has issued three sustainability bonds structured as “outcome bonds”: the Amazon Reforestation-Linked Bond , the Plastic Waste Reduction-Linked Bond , and the Emission Reduction-Linked Notes . While they differ in environmental objectives, counterparties, and structural details, all three incorporate carbon offsets in the same way, demonstrating how this approach can be replicated in different contexts.

These instruments’ mechanism provides investors with a guaranteed return that is slightly lower than standard World Bank bonds with similar maturities. The difference between the standard and guaranteed returns is used to finance sustainable projects, thus generating a tangible environmental impact. In return, investors can benefit from additional payments tied to the value of the carbon offsets generated by the projects, provided they achieve their objectives. Thus, outcome bonds not only offer an opportunity to contribute to concrete environmental initiatives, but also the possibility of improving returns compared to traditional World Bank bonds.

While promising integration between finance and sustainability, the scalability of these solutions remains uncertain, especially in a market that demands high standards and predictable results.

Overall, future prospects point to an expansion of compliance markets , especially in emerging countries and economies interconnected with Europe . The introduction of ETSs in India, Japan, Brazil, and Turkey, combined with increased pressure on industrial sectors, could double the size of regulated markets by 2030. At the same time, voluntary markets could regain ground only if integrity standards are rigorously enforced and if recognition by CORSIA and other hybrid systems increases operator confidence.

__

(Featured image by Chris LeBoutillier via Unsplash)

DISCLAIMER: This article was written by a third party contributor and does not reflect the opinion of Born2Invest, its management, staff or its associates. Please review our disclaimer for more information.

This article may include forward-looking statements. These forward-looking statements generally are identified by the words “believe,” “project,” “estimate,” “become,” “plan,” “will,” and similar expressions. These forward-looking statements involve known and unknown risks as well as uncertainties, including those discussed in the following cautionary statements and elsewhere in this article and on this site. Although the Company may believe that its expectations are based on reasonable assumptions, the actual results that the Company may achieve may differ materially from any forward-looking statements, which reflect the opinions of the management of the Company only as of the date hereof. Additionally, please make sure to read these important disclosures.

First published in ESG NEWS. A third-party contributor translated and adapted the article from the original. In case of discrepancy, the original will prevail.

Although we made reasonable efforts to provide accurate translations, some parts may be incorrect. Born2Invest assumes no responsibility for errors, omissions or ambiguities in the translations provided on this website. Any person or entity relying on translated content does so at their own risk. Born2Invest is not responsible for losses caused by such reliance on the accuracy or reliability of translated information. If you wish to report an error or inaccuracy in the translation, we encourage you to contact us.