Stéphane Hedont-Hartmann, Head of ESG at MoZaïC Asset Management, Valentin Lautier, expert in the mandatory market at Homaio, and Erwan Le Méné, involved in the voluntary market with Eco Tree, explore how carbon credits and permits will shape a decrease in carbon emissions in a bid to reach Net Zero.

Scientific studies at the IPCC show that avoiding climate disruption requires limiting the increase in the planet’s average temperature to 1.5¬∞C. Indeed, preventing the exceedance of this critical temperature means limiting net greenhouse gas (GHG) emissions to return to the pre-industrial baseline level.

In this light, stopping the accumulation of greenhouse gases in the atmosphere that has primarily contributed to climate disruption means that the world must set emission targets at absolute values close to zero while deploying solutions to eliminate the surplus. As the following table emphasises, solutions are indeed required, as even keeping to an ideally lowest +1.5°C increase in temperature, the forecast consequences for society and the planet are dramatic.   

Investing to mitigate the future risks

With a clear picture of the likely scenarios, we see two types of investment being logically necessary to mitigate these risks. The first of these is transforming infrastructure, with the double goal of preserving economic efficiency – that is, value creation – while seeking to reduce the carbon impact of this infrastructure.

A second investment is sequestering and eliminating carbon in the atmosphere. Here, observers note that if the “Net Zero” level is to be reasonably achieved by the middle of the century, the current emissions level must average (+) 38 billion tons of CO2 per year (2022, IEA). However, progress could be faster. Given the inaction of economic actors and the paradoxical behaviour of citizens, governments have accelerated a range of legislative constraints, including SFDR, CSRD, green taxonomy, carbon taxes at European borders, and establishing a “carbon” market. Carbon credit trading is a system where companies and countries can buy and sell allowances that permit them to emit a certain amount of carbon dioxide (CO2).

The European legislator has taken responsibility within the framework of the “Green Deal”

The European Commission has motivated the economy to decarbonise to enforce the economic model’s transformation and ensure citizens’ protection. Following COP 21 in 2015 in Paris, the volume of carbon emissions produced by the economy resulted in a “carbon budget” – a closed envelope set as a baseline. This budget is allocated to support decarbonisation according to both the regulatory and voluntary markets.

The regulatory market:

In the former, the rules of the regulatory market are strict. Since January 2024, regulations aim for mandatorily integrating sectors of activity – cement, fossil fuels, steel and maritime transport, to name several – into the system by imposing the monitoring of their decarbonisation trajectory. Furthermore, the initiative has allocated an annual volume of carbon permits per country. Here, the European Commission sets a price for carbon per ton and grants the right to freely distribute licenses to countries that wish to preserve their economy’s competitiveness while consequently losing a source of financing for their transformation – for example, aid to individuals.

Finally, every company within a regulated sector is allocated a certain number of carbon permits each year. Some companies emit more than their limit and are therefore compelled to buy carbon credits on the market, depending on their availability.

The voluntary market:

As mentioned, the European “carbon budget” also aims to impact the currently contested rules of the “voluntary” market, which is marginal in size. By registering carbon credits – “Carbon Offset” – linked to projects with a decarbonisation objective through the following steps:

• Design by project developers (documentation);
• Verification and validation by a third-party auditor (due diligence and audits);
• Project development: from construction to operation (financing by companies or institutions seeking to offset their emissions and support climate R&D);
• Certification: project control and verification by an accredited body;
• Registration and sale of carbon credits directly to end buyers or following indirect procurement through brokers.

After that, the carbon credits and the associated projects are withdrawn from the market. As such, we distinguish between two complementary markets.

A regulated market with supervision of compliance with mandatory international, national, or regional carbon management regimes (such as the European Union Emissions Trading System | EU ETS) and a “cap-and-trade” system where regulated entities receive allowances for a particular share of overall emissions, which they can then trade with others.

A voluntary market in which companies can work with project developers and committed individuals who propose technologies and projects that can result in the issuance of credits equivalent to the impact of decarbonisation they create. Moreover, the existence of this market stems from the desire to support transformation in developing countries, serving as a source of capital to aid decarbonisation and provide social assistance.

The difference between carbon credits and carbon permits

Early days – though large companies have started leading the way

Just as jurisdictions have a choice of carbon pricing measures they can implement to drive reductions in GHG emissions, commercial entities in those jurisdictions have a choice in how to respond. In the case of mandatory regimes such as cap-and-trade, corporations face financial penalties for noncompliance, such as the EU ETS’ EUR 100/tone fine and a requirement to surrender any missing allowances. The alternative is to invest in emission abatement measures (less carbon-intensive Scope 1 processes).

Cap-and-trade markets can be seen as effective as carbon taxes in compliance, as companies seek to avoid legal entanglements, adverse publicity, and financial penalties.

However, the success of carbon pricing in driving corporate policy in industrial sectors is mixed. Since most cap-and-trade systems currently distribute a large share of free permits to industrial firms exposed to international trade, it is challenging to calculate the extent to which the cost of carbon emissions is driving investment decisions or whether other factors are at play. And because carbon offsetting is voluntary, assessing companies’ responses is more challenging than determining compliance markets.

Despite lacking a formal structure, many larger companies have implemented internal carbon pricing to prepare for possible future mandatory pricing or control measures. Measuring an internal carbon footprint involves many of the same monitoring, reporting, and verification procedures, which can lead to a greater understanding of a company’s operations’ climate impact and identifying ways to reduce emissions voluntarily.

A more extreme response to carbon pricing is to relocate a business to another jurisdiction without a carbon price regime. This practice is known as “carbon leakage.”

For these reasons, many large corporate business lobbies have called for a more international carbon price regime, which would aim to establish a single global price for GHG emissions.

Useful links:

• Link up with Stephane Hedont-Hartmann, Valentin Lautier, and Erwan Le Méné on LinkedIn
• Read a related article: A lower-carbon global economy: Coordinating the different pathways
• Discover ESSEC Business School and the ESSEC Alumni Impact Learning Hub – free lifelong learning resources for all those interested in sustainability, CSR, and social impact.

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