Concept of carbon offsets
Adobe Stock / Wanan

This article appears in the Mid-November 2022 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.

By now, investors should be aware of the dangers of unregulated markets that trade products of uncertain value without independent scrutiny. No, we’re not talking about crypto. If market mechanisms are to be any use in the transition to a low-carbon economy, the carbon-credit market must embrace the sort of rules employed in other functioning markets.

Carbon markets are well-intentioned solutions to an existential threat, but that doesn’t make them immune from exploitation and abuse. As the International Organization of Securities Commissions pointed out in its recently launched consultation on carbon-market regulation, integrity is essential for markets to function as intended.

And there are reasons to be worried about the carbon-trading system’s integrity — from the provenance of credits to how they are traded, used and tracked.

Lack of rules and oversight for a fledgling market needn’t always be a major concern. Market operators either address the issues to instil investor confidence and attract liquidity, or the market withers and dies.

However, given the importance of finding feasible ways to shift to more sustainable economic growth, regulators have a duty to step in and make carbon markets work.

The issues with carbon trading aren’t novel — they’re the same concerns that exist in any marketplace, from soybeans to securities. Ensuring adequate transparency, fostering efficient price discovery, and guarding against abusive, manipulative and deceptive trading are all familiar aims of financial regulators. There are well-established ways to build those features into markets.

What’s more challenging is the environmental component: verifying the credibility of the carbon credits being created in the first place. Ensuring that carbon-offset credits actually deliver what they promise goes beyond the expertise of financial regulators. Widely accepted global standards and independent certification of credit quality is essential for carbon markets to work and to gain the scale needed to meaningfully reduce global warming. While the abatement requirements and oversight will have to come from environmental experts, trading venues can help enforce them through the equivalent of listing rules, which stock exchanges use to set minimum standards.

Carbon markets will never be perfect. Even the most established, well-regulated financial markets in the world face fraud and misconduct. But by deploying expertise to help tackle a critical global challenge, financial regulators can protect more than just investors from the devastating costs of market failure.