COP26: the impact on carbon markets and policy

After several years of negotiations, the new rule book for carbon markets, Article 6, was finally agreed at COP26. 

That an agreement was reached in Glasgow, after several stalemates, is no small feat, and is a testament to the will of countries to use markets to cooperate internationally at this critical time in our history. It shows that there is unanimous agreement among the governments of the world to use carbon trading to scale climate ambition.

The new rules bring greater clarity and are a statement of intent, as well as a sign of real confidence in the ability of carbon markets, including Voluntary Carbon Markets (VCMs), to benefit all involved. In terms of environmental integrity, the new rules are also far better than many feared. 

But there are still some unresolved questions about how Article 6 will work in practice, and what it means for wider carbon markets. So here’s a summary of what we know, what we think we know, and what we still don’t know about the new Article 6 rule book.

For a deeper dive into the reaction of carbon markets to the Article 6 outcome at COP26, watch our virtual fireside panel recorded November 30, 2021.

What we now know

An agreement was reached on two major topics in Glasgow: Article 6.2, which allows countries to trade with one another, and Article 6.4, which allows countries to produce carbon credits through a new mechanism.

The two topics will work together, and share some common frameworks, most notably regarding their accounting framework, which I discuss below. Bilateral trading under 6.2 is already underway, with countries such as Switzerland having agreed to a number of specific partnerships ahead of COP26 in anticipation of this agreement. In contrast, the new mechanism under Article 6.4 will take some time to set up.

To prevent double-counting or double-claiming, a carbon accounting framework will be required for countries to make claims towards their emissions reduction pledges to the UN, known as their Nationally Determined Contributions (NDCs). It will not be mandatory for private market trading. 

Double counting and double claiming have long been considered a threat to making credible climate commitments using carbon credits. The new regulations make it mandatory for countries trading credits between themselves that count towards their NDCs, formally known as Internationally Transferred Mitigation Outcomes (ITMOs), to apply a carbon accounting framework known as Corresponding Adjustments (CAs). CAs will not be a requirement for the carbon credits traded in the private sector unless the host country chooses to make it one. 

The two largest certifying bodies of voluntary carbon credits, Verra and Gold Standard, have traditionally held opposing views as to whether CAs will help or hinder climate ambition and environmental integrity in VCMs, but both will now be adding “adjusted unit” labels to credits. It remains to be seen how this accounting framework will be used by participants in the private sector.

Kyoto-era credits will be carried over, but they will be easily distinguishable.

The question of whether Kyoto-era Certified Emission Reduction (CER) units would be carried over into the new system has finally been settled. A limited amount of these credits, estimated at 120–300 million, will be carried over. They will be clearly labelled and their use will be restricted. Some countries had argued that none of these credits should be carried over, due to concerns about their environmental integrity, and many of these countries have ruled out purchasing them.

A new mechanism will replace the Clean Development Mechanism (CDM).

The CDM, created as part of the Kyoto Protocol, has been criticised by some countries for having a patchy record on environmental integrity, and specifically for allowing “hot air”, or poor quality credits, to be issued and traded. These countries have long argued that a new mechanism should be created to replace it and learn from its successes as well as its shortcomings. We now have confirmation that a new mechanism will be designed and that it is likely to be known as the Sustainable Development Mechanism (SDM). 

The new mechanism will be guided by a 12-member Supervisory Body, though we don’t yet know who will be on this body. What we do know is that baselines for this new mechanism will be set below Business as Usual (BAU) and that crediting periods will include 5 years, which will be renewable twice, 10 years, which will be non-renewable, and finally, 15 years, which will be renewable twice only for carbon removals.

All carbon trades under the new crediting mechanism will fund climate adaptation in developing nations and result in net negative emissions. 

All carbon trades under the new crediting mechanism will include two automatic cancellations. The first, 5%, known as a Share of Proceeds (SoP), will go towards the Adaptation Fund (AF), a scheme to finance climate adaptation in developing nations. The second, 2%, will simply be deducted to ensure that all carbon trades result in Overall Mitigation of Global Emissions (OMGE). While these percentages are small, they do set a precedent for scaling further ambition through this and similar frameworks.

What we think we know

To prevent double counting or claiming, stricter carbon accounting will also be required for “other international mitigation purposes”. 

Article 6.4 states that corresponding adjustments will also be required for “other international mitigation purposes”. This open-ended term is interpreted by a consensus of experts to refer to the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) and similar schemes to be agreed to by the International Maritime Organization (IMO) and other international organizations.

The role of Reducing Emissions from Deforestation and forest Degradation (REDD+) remains uncertain. 

REDD+ is not explicitly mentioned in Article 6. However, the stricter standards to be developed by the new Supervisory Body mean that historic REDD+ credits will not automatically be able to count towards a country’s NDC. We expect clarity on REDD+ and the eligibility of the various CDM methodologies in the new Article 6.4 framework at COP27 in November 2022.

Besides REDD+ units, the future of emissions avoidance projects, such as projects involving cookstoves, or renewable energy, will be decided at COP27. They will likely be ruled out of the new system, though there is room for a compromise whereby these project types are phased out over a number of years.

What we do not know yet

The Glasgow outcome on Article 6 calls on two distinct bodies to make recommendations on two sets of questions to COP27, which will then make the final decision. The two bodies are the new Supervisory Body for the Article 6.4 crediting mechanism and the UN Climate Convention’s Subsidiary Body for Scientific and Technological Advice (SBSTA).

The new Article 6.4 Supervisory Body will:

• review CDM accreditation standards and procedures
• establish new procedures and methodologies for the mechanism to replace the CDM

• make recommendations on projects relating to greenhouse gas removals, such as afforestation and reforestation projects.
  

The Subsidiary Body for Scientific and Technological Advice (SBSTA) will report on: 

• whether avoided emissions projects should be allowed to count towards NDCs and any other claims
• how CAs should work
• how the automatic cancellation of credits that lead to SoP, AF and OMGE should work
• what the special circumstances for Least Developed Countries (LDCs) and Small Island Developing States (SIDs) should be.

Importantly, we will also learn who will be on the Article 6.4 Supervisory Body. However we do know that it will include two members from each of the five United Nations regional groups.