Will new Article 6 rules restore confidence in carbon markets?

Parties to the November 2024 COP 29 climate summit in Azerbaijan adopted new rules to govern country-to-country carbon credit trading under the Paris Agreement’s Article 6.2. More critically, a new carbon crediting mechanism - the Paris Agreement Crediting Mechanism (PACM) - was adopted under Article 6.4.

With these decisions, the UN climate regime has promised to turn the page on the Kyoto Protocol’s much-maligned Clean Development Mechanism and restore integrity in carbon markets.

Evidence that carbon markets have overpromised and undelivered has become commonplace, with dozens of high-profile reports pointing to disturbing flaws and persistent greenwashing. A recent Nature Communications study adds to these findings, concluding that less than 16% of all carbon credits issued have delivered real emission reductions.

Such findings have prompted several large corporate buyers of carbon credits, including Delta Airlines, Alphabet’s Google, HSBC and others, to back out of voluntary markets.

Will Article 6 shift markets?

The UNFCCC Secretariat declared within hours of COP 29 closing that Article 6 is now ‘fully operational’, an overstatement since it will take another year for Article 6.4 to elaborate additional standards, an approval process, the new global credit registry to come online, and other details.

Already, governments and firms are lining up behind Article 6 future deals. As of mid-October 2024, more than 700 carbon credit activities under Article 6.4 have been notified, over and above the roughly 140 government-to-government Article 6.2 deals underway or in advanced planning.

Much more volume should be expected. For example, in November 2024, Norway announced its intention to purchase up to US$740 million under Article 6 carbon credits from Benin, Jordan, Senegal, and Zambia, while Japan and Indonesia announced the world’s first Mutual Recognition Arrangement (MRA) under Article 6.2.

Will Article 6 improve market integrity?

There are several encouraging decisions related to Article 6.4, notably the creation of the PACM that will serve as the central mechanism to process deals and curb past problems of double-counting credits. A single global registry promises a big step forward in transparency, essentially acting in similar ways as international commodity or stock markets in tracking transactions and spot prices.

Article 6 also requires the creation of a buffer pool of carbon credits as a form of risk insurance to compensate for both avoidable and unavoidable reversals of carbon offsets, for example, in circumstances in which the anticipated carbon sequestration of a forest is diminished because of wildfires, infestations, or other adverse impacts. The new rules also include room for a new “liability” clause for avoidable reversals.

While these details are welcome, the central question is whether the new Article 6.4 rules will avoid the structural deficiencies of recent and current carbon markets? Specifically, does the COP 29 package entail a ‘fundamental reform’ of carbon market rules called for by the authors of Nature Communications? If not, we can expect more concerns about market integrity as Article 6 moves ahead.

A new sustainable development approach

Among the instruments adopted by the Supervisory Body (SB), the Sustainable Development (SD) Tool is at the heart of the effort to address environmental, social, and human rights risks and impacts that have damaged the carbon market’s reputation. All too often, carbon offsets have lacked adequate local and indigenous community consultations and benefit-sharing arrangements, adherence to land-titles, or a sufficient understanding of the impact on biodiversity.

Environmental, Social and Human Rights Requirements: The SB has set a high bar- far beyond the environment-related requirements of the Clean Development Mechanism. The SB has mandated that “activity participants” (project developers) present PACM with projects that have met the eleven environmental, social, human rights and anti-corruption requirements of the SD Tool. Projects presented to the PACM for SB approval must be validated by SB-accredited “designated operational entities” (DOEs) who can attest to meeting those requirements.

The SD tool is modeled on the environmental and social standards of major international financial development and climate organizations such as the World Bank and the Green Climate Fund. However, it appears to go beyond some of these international standards, such as the World Bank’s, by also mandating human rights due-diligence, assessment of the triggering of any of the seventeen UN Sustainable Development Goals, and a plan on how to achieve those goals as relevant to the particular project or program activity. While laudable, these requirements mean projects will require more extensive preparation and due diligence than those under the CDM.

New Appeal and Grievance Procedures: Complaints about CDM projects often arose from civil society groups questioning the integrity of project additionality or other design and implementation issues. However, the CDM offered limited recourse for complaints or challenges to its decision-making or project implementation. As a result, the SB was encouraged to enhance the accountability systems surrounding PACM decisions and project implementation. Thus, unlike the CDM, the Article 6.4 rules establish detailed appeal and grievance processes for stakeholders, activity participants, and participating Parties who have enumerated grounds to challenge SB project decisions , or to address potential project-related non-compliance. Depending on the nature of the challenge, projects or programs may be suspended or corrective actions required.

On-the-Ground Capacity: As is the case for activities supported by multilateral organizations like the World Bank, Article 6 projects will likely often be situated in complex environmental and social settings within developing countries. However, among these multilateral organizations, there are hundreds of environmental and social specialists with regional and country-specific expertise who for many years have performed environmental and social due-diligence at the project activity level, and provide technical assistance to project developers who may lack the capacity to establish and implement the requisite risk management plans. These organizations also have detailed accountability and grievance systems with extensive experience addressing complex project and program-related challenges. The ambitious SD safeguards will require comparable internal capacities among the DOEs to function.

New credit integrity rules

Private Sector Accreditation: Among the most enthusiastic groups that welcomed the COP 29 Article 6 rules has been private sector carbon credit bodies. For example, the Integrity Council - launched to correct integrity problems that have nearly derailed voluntary carbon markets – welcomed the COP 29 Article 6 decision, helpfully noting that governments interested in Article 6 deals can turn to private crediting bodies to validate and verify expected carbon credit outcomes. The same message comes from Verra, the world’s largest carbon credit issuer, noting the essential role of “independent crediting programmes” (ICPs) in expediting climate progress. Indeed, project developers in both the voluntary and Paris Article 6 market might rely on a similar roster of accredited DOEs for validation and verification of market activities.

Earlier in 2024, Verra together with another of the top four private carbon credit bodies - The Gold Standard – and Singapore, released a detailed workplan for Article 6.2, suggesting that governments rely on ICPs to avoid the “administrative burden of having to develop their own approaches (e.g. standards for carbon credits).”

These and other bodies are marketing their services to deliver compliance with the new Article 6.4 standards, or more precisely, the two documents that will determine the future of Article 6.4 deals: the new carbon dioxide removals (CDR) standards, and more detailed “requirements …for the development and assessment of Article 6.4 mechanism methodologies.”

The stated objective of these new standards is hard to argue with: they intend to ensure that all carbon credits are ‘real, transparent, conservative and credible.’

A Less is More Approach: To reach that high standard of quality, Parties at COP 29 have adopted roughly 40 new, mandatory requirements covering carbon reductions and removals, specified through ‘shall’ or obligatory rules. For example, baselines must be increasingly ambitious that start at below business-as-usual assumptions; estimates must be conservative; carbon offsets must be durable; compulsory methods must be used to estimate emission reductions or removals that in turn rely on up-to-date scientific information, and rely on various technical performance standards.

These mandatory standards clearly set out the direction and principles needed to ensure high-integrity carbon markets. At the same time, the SB opted to avoid prescribing exactly how these will work. Thus, while Article 6.4 sets clear performance expectations, it may strike some that it is leaving technical standards either for future elaboration, or more likely, for others to lay out.

For example, there is no precise definition of what is meant by a conservative estimate or a durable offset. This is even more striking, given the hundreds of pages issued by the SB in recent years examining questions of durability and permanence. A similar, high-level approach is used in setting out additionality, baselines and permanence standards.

At least at this stage, this approach is a significant departure from CDM methods and current VCM technical rules. For example, the CDM released hundreds of methods to determine a baseline, supported by even technical guidance documents. For the past nine years, the SB released volumes of detailed technical papers that examined a myriad of technical methods to determine permanence, additionality and leakage.

Some technical standards may be forthcoming. The SB indicated that it will develop methodologies in 2025 via the Methodological Expert Panel, likely to include the updating of some CDM baseline methodologies. But the bulk of Article 6.4 technical standards will very likely rely on external practices, methods and rules, of which there are many. 

For example, forest carbon offset programs will likely include REDD+, while aviation offsets will likely continue to reference the CORSIA carbon crediting system. Firms operating in jurisdictions with mandatory carbon offset rules such as the EU Green Taxonomy, Canadian GHG Offset Credit System or sub-national systems like the California Compliance Offset program may need to comply with domestic rules in addition to Article 6.4 guidance, underscoring how important work around standards equivalence and interoperability will be.

Similarly, financial entities planning to book the value of a carbon offset against their net zero targets will need to reference applicable mandatory climate risk disclosure rules as international accounting standards such as ISSB’s climate disclosure framework. Since the GHG Protocol has become the prevailing international standard for carbon metrics, the metric and measurement approaches will likely need to align with Article 6. 

Although these rules and standards contain some guidance regarding how firms may book carbon offsets, the bodies that will likely provide validation and verification of Article 6.4 deals inevitably will include many of the same private sector entities responsible for providing this service for most voluntary carbon credits. Little wonder then that private actors have pointed to the benefits of ICPs for the accreditation and certification steps needed for markets to function.

A practical risk arising from this approach is the potential fragmentation and lack of interoperability of carbon offset rules, over and above the overriding concern that the Article 6.4 methods might engage some of the same entities linked with carbon market integrity problems.

Can Article 6 help plug the climate finance gap?

More than a decade of false starts and many examples of greenwashing show that it is unrealistic to expect perfect, 100% integrity from the carbon offset system currently envisioned. However, Article 6 certainly must improve upon the anaemic 16% success rate identified by the authors of the Nature review.

Yet uncertainty regarding the performance outcomes of carbon offsets on climate targets isn’t likely to be settled anytime soon. A long-awaited review of the science of carbon offsets by Science Based Targets (SBTi) concluded that there is a ‘negligible amount of scientific evidence” to know if any carbon credits actually deliver climate outcomes.

Elements of carbon market finance are inherently more complex than those in most project financing. While carbon has been identified as a commodity, its nature differs from traditionally regulated commodities. The fact that its value is largely determined by its removal makes monitoring and verification systems complex, while offset projects involving landscapes depend on social consent and contracts often involving tiered benefit-sharing arrangements.

The new SD tool has the potential to improve past mistakes such as those projects where land titles held by indigenous or local landowners were ignored, free prior informed consent was not provided, or there were alleged human rights violations.

However, what is also certain is that the new SD Tool and accountability mechanisms will prompt prospective buyers to look more carefully at costs. None of the steps prescribed for Article 6.4 - project preparation, validation, verification, accreditation, annual monitoring and reporting, mandatory insurance linked with potential corrective actions, accountability filings and others - are cost-free. Potential buyers - especially private sector buyers – may be far more diligent before entering deals.

The real test of Article 6’s impact may be determined by its acceptance by some regulators as a compliance mechanism, with recent reports anticipating that several jurisdictions are looking to allow carbon credits to close climate target gaps. 

There is an alternative to a strict compliance regime, which is to accept that the use of carbon credits to achieve GHG reductions are and will remain an imperfect compliance mechanism, but can be an important means of tapping financing, not least private sector financing, towards debt-burdened developing countries, while also contributing to biodiversity and other environmental and social values. By attracting additional financing, Article 6 could also help close the global climate funding gap by pulling financing from carbon credits deals into the many proven low-carbon pathways needed to reach carbon neutrality.

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