Biden Policy Aims to Crowd in Private Capital for Carbon Markets

In this article for Bloomberg Law, partners Paul Barker and Jim Dolphin analyze how recent Biden administration policies signal U.S. support for voluntary carbon markets (VCMs).

The Biden administration’s recently announced approach to advancing high-integrity voluntary carbon markets seeks to encourage private investment and corporate demand that could help accelerate decarbonization and the achievement of global net-zero emissions by 2050.

Proponents contend that, absent a mandatory price on carbon (such as a tax or national cap-and-trade system), VCMs are an important tool to help incentivize businesses’ decarbonization, especially as use of decarbonization technologies in hard-to-abate industries continues to scale.

The Biden administration similarly believes high-integrity VCMs can help to further crowd in private capital and provide financing and stable, long-term revenue streams for both nature-based (including agriculture) and technology-based projects that reduce carbon emissions or remove carbon from the atmosphere.

However, in light of concerns over greenwashing and market integrity, the administration considers that “further steps are needed to strengthen this market and enable VCMs to deliver on their potential.”

VCMs

VCMs involve voluntary transactions of carbon credits (also known as “offsets”) administered by private crediting programs and registries. Each credit claims to represent one ton of carbon dioxide equivalent that’s reduced or removed from the atmosphere.

In contrast to compliance carbon markets like California’s cap and trade program, businesses aren’t legally mandated to purchase carbon credits on VCMs. Rather, demand is driven by voluntary commitments to reduce emissions and by net-zero goals, including by many of the world’s largest companies and financial institutions.

VCM proponents argue that, by purchasing carbon credits to “offset” their residual emissions, businesses can provide vital private financing to projects that generate emissions reductions or removals that wouldn’t have occurred otherwise. Assuming a rise in credit prices over time, businesses are in principle incentivized to invest in decarbonization to reduce their emissions; carbon credits aren’t a substitute for emissions reductions.

However, the role of carbon credits in achieving net-zero is contested; the Intergovernmental Panel on Climate Change envisions carbon removals must be used to balance residual emissions that can’t be eliminated by 2050. Yet most carbon credits generated today represent emissions reductions (such as avoided deforestation) rather than removals (such as reforestation or direct air capture).

Advancing High-Integrity VCMs

In response to reputational and legal issues concerning integrity and greenwashing in VCMs, market-led initiatives—such as the Integrity Council for the Voluntary Carbon Market, Voluntary Carbon Markets Integrity Initiative, and Science Based Targets initiative—are introducing voluntary guidance for the supply and demand sides of VCMs. Regulators in the EU, Singapore, and elsewhere are seeking to establish objective standards. Last September, California enacted a mandatory climate disclosure law covering carbon credit use, and proposed further regulation of the VCMs.

The Biden administration’s joint policy and principles reflects these global trends, stating that “widespread confidence in the integrity of credited emissions reductions and removals is critical for VCMs to reach their potential.”

The White House embraces a whole-government approach, acknowledging the Commodity Futures Trading Commission’s regulatory role, State Department work on Article 6.4 of the Paris Agreement, the Treasury’s expanded 45Q tax credit incentives under the Inflation Reduction Act, and the Department of Energy’s carbon dioxide removal award, among others.

The Principles

The administration’s approach is broadly consistent with evolving market-led guidance and notably supports the use of carbon credits to address some Scope 3 emissions in science-aligned emissions pathways. The principles articulated by the administration cover both the supply and demand side of the market as well as overall market efficiency:

Supply Integrity. Carbon credits and generating activities should meet credible atmospheric integrity standards and represent real decarbonization. And credit-generating activities should avoid environmental and social harm and support co-benefits and benefits-sharing.

Demand Integrity. Corporate buyers that use credits should measure emissions reductions in their value chains, publicly disclose the nature of purchased and retired credits, and accurately reflect the climate impact of retired credits in the public claims they make. They should only use credits that meet high integrity standards.

Lowering Transaction Costs. Market participants should contribute to efforts that improve market integrity. They and policymakers should facilitate efficient market participation and seek to lower transaction costs.

Crowding in Private Capital

Government support of VCMs could increase demand for carbon credits and influence how stakeholders use them, and also raises important considerations for legal and compliance teams when they assess the role of VCMs in overall climate strategies.

A number of corporate and private investment fund sponsors are focusing on investment opportunities in VCMs, including structures that distribute carbon credits to investors and cash returns. New carbon credit products and contracts are also being developed to reduce risk and lower transaction costs for corporate purchasers in the complex VCM ecosystem.

Rather than supplant these market-led efforts to increase participation, the Biden administration aims to support and complement private efforts to increase integrity in VCMs and innovation of decarbonization technologies.

The administration’s approach isn’t overly prescriptive and broadly aligns with market-led initiatives and regulatory interventions to promote market integrity and combat greenwashing, including climate disclosure legislation like California’s AB 1305.

By providing guidance to US, market participants amid increasing scrutiny of VCMs from regulatory authorities, the policy and principles may help participants navigate the evolving market and mitigate reputational and legal risks along the way.