As the urgency to combat climate change intensifies, market-based solutions like carbon credits and emissions trading systems (ETS) are playing an increasingly critical role in the global effort to reduce greenhouse gas (GHG) emissions. These mechanisms not only provide financial incentives for lowering emissions but also drive corporate accountability and innovation in sustainability. However, their effectiveness depends on clear regulations, strong governance, and enhanced international cooperation.
Carbon credits and ETS are often seen as complementary, but their mechanisms differ. A carbon credit represents the removal or reduction of one metric tonne of CO₂-equivalent emissions, typically generated through projects like reforestation or renewable energy. By contrast, an ETS establishes a cap on total emissions within a jurisdiction, allocating tradeable allowances to regulated entities.
The voluntary carbon credit market is expanding rapidly, valued at approximately $2 billion in 2021 and projected to exceed $50 billion by 2030. Meanwhile, the compliance ETS market, covering nearly 17% of global emissions, reached $850 billion in traded value in 2022. Unlike voluntary credits, ETS operates under legally binding frameworks, ensuring stricter enforcement and accountability.
The ETS functions as a “pay first” system, where companies must stay within their allocated emissions allowances, purchasing additional credits if they exceed those limits. This “cap and trade” approach creates financial incentives for emission reductions by making pollution more costly. On the other hand, carbon credits function as a “pay later” system, often used by companies that face challenges in reducing emissions immediately. By purchasing credits, they can offset their carbon footprint while supporting verified climate projects worldwide.
The European Union (EU) ETS has become a key driver behind mechanisms like the CBAM, which seeks to prevent carbon leakage and ensure fair competition between regions with stringent climate policies and those without. The EU has linked CBAM with its ETS, ensuring that imports reflect the carbon cost imposed on domestic industries.
CBAM, which took effect in October 2023, initially covers sectors like cement, iron and steel, aluminium, fertilisers, electricity, and hydrogen, which together represent approximately 7% of EU imports. During the transitional phase from 2023 to 2025, importers must report quarterly on the quantity of imported goods, along with their direct and indirect emissions (Scope 1 and 2) and any carbon price already paid in the country of origin. This reporting requirement ensures transparency and sets the groundwork for full implementation.
Starting in 2026, CBAM will shift to a mandatory compliance system, requiring importers to purchase CBAM certificates corresponding to the emissions declared in their reports. These certificates will be aligned with the EU ETS price, currently around €85 per tonne of CO₂. By imposing equivalent carbon costs on imports, CBAM incentivises cleaner production globally and strengthens international climate commitments.
The future of carbon credits and ETS is intertwined with global ambition and collaboration. As markets evolve, their success will depend on improving transparency, harmonising regulations, and enhancing market integrity. Key developments, such as the implementation of Article 6 of the Paris Agreement and the expansion of CBAM, will shape how these mechanisms contribute to achieving net-zero goals. With clear governance, international partnerships, and alignment with net-zero targets, these tools can become foundational pillars of the global climate agenda, driving sustainable development while accelerating emission reductions.
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