Getting Carbon Market Governance Right

June 24, 2021

Governing carbon offset credit markets is tricky business. Upstream, credit buyers (usually corporations) try to use the market to avoid carbon reductions at home. Downstream, governments try to extract excessive rents from the sale of credits. Midstream, brokers and financiers intermediate the exchange between buyers and sellers with ever-more complex carbon market securities and derivatives. And to top it all off, these dynamics play out in any number of institutional realms, ranging from sovereign nation states to international treaty administrations (e.g. the famous Article 6).

The pressure is high, because so much is expected of governance. Carbon markets are dynamic, complex systems with unpredictable, emergent outcomes. Those trying to impose order through top-down design very quickly meet the harsh realities of unpredicted consequence. The only way to get carbon markets to work is to let them evolve as a function of constant feedback, complete transactional transparency, and constant consideration of the entire system, upstream to downstream. This, of course, is the essence of modern adaptive governance.

With COP 26 around the corner this Fall, a number of voluntary carbon market design efforts are underway (presumably with the expectation that they blaze the trail for compliance markets down the road), including the Task Force for Scaling Voluntary Carbon Markets (TSVCM) and the Voluntary Carbon Markets Integrity Initiative (VCMI). Both efforts have used extensive outreach and expert consultation, and they focus on the integrity of voluntary carbon credit and the efficiency of the markets in which they are traded.

NatureFinance (formerly known as Finance for Biodiversity (F4B)) and Carbon Advisors are working closely with TSVCM’s principals to ensure that the governance of the envisioned markets is fit for its public purpose, i.e. the reduction of carbon emissions.

The effort is guided by three principles:

Open book accounting (or transaction-level transparency): every transaction, in digitally-enabled real-time, is fully transparent to everybody, including all particulars of the deal, the project baseline and proof of additionality, counterparties, ultimate beneficiaries, benefit-sharing arrangements, etc. In the post 2008 world, transactional transparency has become best practice in many private markets (e.g. mortgage-based securities). In the publicly mandated/purposed carbon markets, they are one of the cornerstones of trust and constant adaptation, especially in places with underdeveloped national regulatory capacity. It rewards those acting in good faith and discourages those who are not, and it provides a robust foundation for real, democratized accountability (see below).

Open governance (or strategic grievance mechanism): any party impacted by any actual transaction can level a grievance that is visible on submission, linked to and flagged against the specific transaction, handled separately from the executive of the initiative/market, and fed directly into the Board for its strategic consideration and oversight.

Now practiced by many multi-lateral organizations, grievance systems creates an open system that ensures that governing bodies are in receipt of and informed by transaction-level grievances. The initiative and its transactions are flagged publicly where grievances have occurred and are outstanding. This helps to prevent unlocking and vested interests undermining the quality of governance.

Systemic oversight: the governors must have ‘shadow’ oversight over the critical “upstream” (buyers) and “downstream” (sellers) aspects on which the market’s success depends. The expertise and interest of carbon credit suppliers, buyers and market makers must be fairly represented and those of potentially affected communities and jurisdiction. The focus must be squarely on the VCM’s good public purpose, even at the expense of discomforting incumbents. Board expertise must go beyond the functional and academic and also include governance expertise and geographic/contextual knowledge; new voices must be included.

Taken together, these three proposals shift the envisaged governance arrangements towards a more dynamic, distributed approach that can be more responsive, more quickly, to both specific and strategic unintended consequences and so also performance enhancement opportunities.

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