Green Finance Engagement Team
The second primer in our Green and Sustainable Finance Spotlight Series gives an overview of carbon markets and explores the mechanisms that put a price on greenhouse gas emissions. Carbon markets are becoming increasingly important in reducing carbon emissions globally, so understanding how they work is crucial to making informed financial decisions.
What are Carbon Markets and Carbon Pricing Mechanisms?
Carbon markets and pricing mechanisms assign financial value to greenhouse gas emissions, giving institutions an incentive to reduce their environmental footprint.
These systems enable the trading of carbon credits, which represent verified emissions reductions. Transactions usually occur between organisations that can reduce emissions at lower costs and those that find it more expensive to do so.
The main carbon pricing approaches include:
- Emissions Trading Systems (ETS): Market-based systems where businesses operate under emissions limits and can buy or sell allowances based on their pollution levels.
- Carbon Taxes: Direct fees charged on emissions, typically set by governments.
- Voluntary Carbon Markets: Platforms where companies choose to buy carbon credits to offset their emissions.
Key Market Developments Around the World
- European Union: The EU ETS, launched in 2005, is the world’s first international emissions trading system. It follows the ‘polluter pays’ principle where those responsible for environmental damage pay to cover the costs.
- Hong Kong: In October 2022, the Hong Kong Exchanges and Clearing Limited (HKEX) launched Core Climate, an international marketplace for trading voluntary carbon credits in HKD and RMB, strengthening Hong Kong’s position as a green finance centre.
- Mainland China: China’s national carbon emissions trading system was launched in 2021 and now covers 2,200 coal-fired power generation companies responsible for about 5 billion tonnes of CO2 annually. The national carbon trading market is expanding to include the steel, cement and aluminium sectors, which will cover more than 60 per cent of China’s carbon emissions.
- Singapore: Climate Impact X (CIX) is a carbon marketplace and exchange based in Singapore focused on transparent pricing and high-quality carbon credit trading.
- Japan: Japan’s Joint Crediting Mechanism (JCM) invests in advanced green technologies for developing nations, allowing both countries to share credits from greenhouse gas reductions. Japan has established JCM partnerships with 29 countries across Asia, Africa, Latin America, the Middle East, and Eastern Europe.
Market Size and Growth
According to MSCI, over 6,200 carbon projects were registered across major international crediting registries by the end of 2024. These projects issued 305 million tonnes of carbon credits in 2024 and have now issued more than 2.1 billion credits since the Paris Agreement was signed in late 2016. Carbon credits worth a total of US$1.4 billion were used by corporations last year, slightly below 2022’s peak of US$1.7 billion.
With more companies setting climate goals and favourable policy developments, including the finalisation of the UN Paris Agreement’s Article 6 rules for international carbon trading at COP29, the market is expected to grow significantly.
MSCI projects the global carbon credit market could rise in value to at least US$7 billion, and as much as US$35 billion, by 2030. By 2050, the market is estimated to be worth between US$45 and US$250 billion.
Source: MSCI
Why Should Companies and Investors Care?
For Companies:
- Provides cost-effective ways to meet climate goals
- Creates potential revenue from emissions reduction projects
- Helps manage carbon costs and comply with regulation
For Investors:
- Carbon markets present new investment opportunities
- Pathway to reduce carbon exposure in investment portfolios
- Improve understanding of carbon-related financial risks
Getting Started
Companies can:
- Assess Their Carbon Exposure:
- Identify where emissions come from
- Find the best opportunities to reduce emissions
- Understand the relevant carbon pricing rules that apply to them
- Develop Carbon Strategies:
- Set an internal price on carbon within the organisation
- Look for ways to generate carbon credits
- Consider the environmental impact when making investment decisions
Investors can:
- Participate in Carbon Markets:
- Learn about different carbon trading systems
- Evaluate the quality of carbon credits
- Consider investments in market infrastructure
- Integrate Carbon in Portfolios
- Include carbon pricing in investment models
- Engage with companies about their carbon strategies
- Develop investment approaches aligned with net-zero goals
Conclusion
Carbon markets and carbon pricing mechanisms serve as essential tools for channelling global investments towards greenhouse gas reduction. As these markets evolve and expand, understanding their dynamics becomes increasingly critical for both effective financial decision-making and meaningful climate action.
