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Voluntary vs. Compliance Markets

Learn the nuances of the two carbon markets.

Greenwashed

Nov 1, 2022 • 3 min read

The term "carbon markets" usually refers to the combination of voluntary and compliance markets.

Voluntary

Businesses, NGOs, and other organizations use voluntary carbon markets to offset emissions or support projects that reduce emissions. The choice is theirs to participate in the markets.

Compliance

Governments create compliance markets to help industries meet their emissions reduction targets. They require businesses to trade carbon credits to stay within their target.

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Distinction: Compliance markets have legal limits on emission levels, and corporations trade carbon credits to meet the limit. The voluntary carbon market (VCM) is where companies or individuals choose to offset their emissions without being required by law.

(Note: Carbon credits and carbon offsets are separate but related concepts.)

Voluntary Markets

The VCM operates on the independent desire to stop the climate crisis. It allows institutions and individuals to compensate for their emissions and support projects helping the climate.‍

According to McKinsey:

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“More and more companies are pledging to help stop climate change by reducing their greenhouse-gas emissions as much as possible. Yet many businesses find they cannot fully eliminate their emissions or even lessen them as quickly as they might like. The challenge is especially tough for organizations that aim to achieve net-zero emissions, which means removing as much greenhouse gas from the air as they put into it. For many, it will be necessary to use carbon offsets to neutralize emissions they can’t get rid of by other means. The Taskforce on Scaling Voluntary Carbon Markets (TSVCM), sponsored by the Institute of International Finance (IIF) with knowledge support from McKinsey, estimates that demand for carbon offsets could increase by a factor of 15 or more by 2030 and by a factor of up to 100 by 2050. Overall, the market for carbon offsets could be worth upward of $50 billion in 2030.”

As of summer 2022, the VCM has channeled more than $5 billion into projects around the world.

Large buyers of offsets want to create a long-term financial strategy, meet sustainability goals, or improve their reputation. These motivations provide demand for offsets. The money they spend on offsets goes back to the projects that helped the climate, allowing them to fund future projects to help the environment even more.

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Basically, the VCM is one big cycle of climate-positive action.

Compliance Markets

Compliance markets involve governments and the issuance of carbon credits. These markets are large in scale and usually have a specific purpose, such as reducing emissions by a certain year or for a particular industry.

The majority of compliance carbon markets use the “cap-and-trade” system.

In cap-and-trade markets, the government limits the number of emissions a company is allowed in a particular industry. For instance, the oil industry may be entitled to emit more than the cupcake industry since emissions are more integral to one business than the other.

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The European Union Emissions Trading System (EU ETS) issued approximately 24.5 million credits to the aviation industry in 2021.

If a firm goes over the permitted level, it’s required to buy enough carbon credits to make up for the difference. If a firm is under the permitted level, it can sell the remaining unused credits to firms that are over the limit.

This model incentivizes companies to change their operations to be sustainable by making businesses pay the price for polluting. However, compliance markets do not directly remove harmful emissions.

Comparing the Impact

Both markets help the environment in different ways.

The compliance market follows limitations set by the government. Over the long term, this system pushes companies to turn their operations sustainable. However, this model relies on the opinion of governments, who have historically been terrible at creating meaningful ways to help fight the climate crisis.

To hold off the worst effects of the climate crisis, we need solutions that can reduce emissions in the short term while also creating long-term financial incentives. By driving money to projects that produce tangible, specific emissions that have been avoided or captured, the VCM provides the immediate positive climate action that the world needs.

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