Introduction
Carbon credits have become an important tool in global efforts to combat climate change, offering a market-based solution for reducing greenhouse gas emissions. At their core, carbon credits function as tradable certificates that represent the reduction or removal of one metric ton of carbon dioxide (or its equivalent) from the atmosphere. These credits can be generated through a variety of projects, including reforestation, renewable energy installations, methane capture, and improvements in energy efficiency. By purchasing carbon credits, companies or individuals can offset their carbon emissions, effectively balancing their carbon footprint. However, for carbon credits to be truly effective, they must meet rigorous criteria: additionality, which ensures that the emissions reductions would not have happened without the incentive provided by the credit; permanence, which guarantees that the carbon sequestered or emissions avoided are maintained over the long term; and verifiability, which requires independent third-party verification of the emissions reductions.
Despite their potential, carbon credits are not without significant controversies. Critics argue that they can sometimes serve as a licence for continued pollution, allowing companies to maintain business-as-usual practices while superficially claiming environmental responsibility – a practice often referred to as "greenwashing." Furthermore, there are concerns about the actual environmental impact of certain projects, particularly when it comes to ensuring the permanence of carbon sequestration. Additionally, the complex and often opaque nature of carbon credit markets raises questions about the integrity and accountability of the credits being traded. As the market for carbon credits grows, these issues continue to fuel debate over their role in the broader strategy for addressing climate change.
SBTi issues controversial statement, sparking debate on the use carbon credits
Recently, in April 2024, the board of the Science Based Targets Initiative (‘SBTi’) released a statement announcing its intention to extend the use of carbon credits. For many years the SBTi has been lauded as a global leader in providing frameworks for companies to align their business strategies with climate change goals as per the Paris Agreement. However, following its statement, the organisation has faced widespread criticism and has been placed at the centre of a global debate on whether or not carbon credits are a legitimate tool for corporate climate pledges. The SBTi’s proposal would allow companies to use carbon credits as an alternative means to achieve climate targets instead of outright emission reductions. As a result, “SBTi considers this step a way to accelerate the decarbonisation of value chains with compensation logic while companies make their way to eliminate carbon emissions at the root through innovation and technology”. The initial standard, issued in 2021, did not permit the use of carbon credits for emissions reduction. Following backlash on its revised proposal, the SBTi has since released new research suggesting, “various types of carbon credits are ineffective in delivering their intended mitigation outcomes” and has called for additional research to support the revision of its corporate net-zero standard.
While the SBTi has tried to expand the use of carbon credits, the efficacy and integrity of offsetting mechanisms have recently been under increased scrutiny. In a 2023 speech, UN secretary-general António Guterres called for businesses and governments to develop genuine decarbonisation plans with detailed emissions reduction targets, “avoiding dubious offsets or carbon credits”.
Despite various studies showing that up to 90 percent of carbon credit projects likely have no real value on carbon reductions, the carbon credit industry is projected to grow from USD 2 billion in 2020 to approximately USD 250 billion by 2050. The shifting stance of the SBTi perfectly illustrates the decisive crossroad that the world has reached on the role of carbon credits in corporate strategies.
Non-profits condemn carbon credits as obstacles to genuine emission reductions
In July 2024, more than 80 non-profit organisations issued a joint statement criticising the use of carbon credits Among the groups that co-signed the documents are ClientEarth, ShareAction, Oxfam, Amnesty International and Greenpeace. These organisations called for an exclusion of offsetting in frameworks on climate transition planning.
The letter argued that carbon credits would hinder global emission reduction efforts by shifting reductions instead of curbing emissions at the source. The non-profit organisations also pointed out quality issues – such as inflated claims about the environmental benefits of offset projects. This came after the above mentioned plans by SBTi’s to allow use of "Environmental Attribute Certificates" – including carbon credits – to achieve reduction targets on supply chain emission.
That said, several leading US environmental groups, including American Forest Foundation and the Wildlife Conservation Society, have voiced their support to the rule change. They believe that it would help boost investment in climate and environmental action. Major business groups and governments have signalled support – as the policy could potentially widen the source of funding for green projects and hence achieve long term climate goals.
Do carbon credits keep up their promises?
The lack of a standardised approach across the globe to evaluate the impact of carbon credits has resulted in distrust and confusion amongst investors who have become wary of the promises made through carbon offsetting. According to the Core Carbon Principles (‘CCPs’) of the Integrity Council for the Voluntary Carbon Market (‘ICVCM’), an independent governance body established with the aim to set a global standard in the voluntary carbon market, carbon credits should meet the following criteria:
- Additionality – the emission reductions or removals through carbon offsetting should be additional, i.e., they would not have occurred in the absence of the incentive created by carbon credit revenues.
- Permanence – the emission reductions or removals should be permanent.
- Robust quantification – they should be robustly quantified, based on conservative approaches, completeness and scientific methods.
- No double counting – they should only be counted once towards achieving mitigation targets or goals.
A recent study by a climate watchdog, CarbonPlan, which analysed 14 carbon credit projects relating to landfills against the ‘additionality’ criteria, showed that “nearly 50 percent of the credits issued under this protocol are likely non-additional” despite the fact that they had all been approved by ICVCM for their quality. The study identified that the landfill’s gas collection operations continued, and in fact, expanded, during the period when the project was not issuing carbon credits.
Reports from Friends of the Earth and the Environmental Defense Fund highlight how vulnerable these projects are to natural disasters like wildfires and deforestation. For instance, the 2021 California wildfires severely damaged forests that were generating carbon credits, releasing stored carbon back into the atmosphere and negating the claimed benefits. Carbon Market Watch revealed that many projects lack adequate insurance or buffer mechanisms to address such reversals, casting doubt on the long-term reliability and effectiveness of these carbon offsets.
Greenpeace and Oxfam have documented how many carbon credit projects use overly optimistic or flawed methodologies to estimate emissions reductions. For example, a 2020 Greenpeace report on REDD+ projects found that some projects overestimated their carbon savings by up to 30 percent due to inaccurate baselines. The World Resources Institute also criticised the failure of some projects to account for the full lifecycle emissions, leading to inflated claims of carbon reduction and questioning the validity of the credits issued.
Double counting poses a significant risk to the integrity of carbon markets. The Institute for Climate Economics (I4CE) highlighted this issue in a 2021 report, particularly within the framework of the Paris Agreement's Article 6. Without stringent accounting rules, both host and buyer countries might claim the same emission reductions, undermining global climate goals. CarbonPlan's 2022 study further showed that in voluntary carbon markets, some credits are counted multiple times across different initiatives, inflating overall climate progress claims and diminishing the true impact of these carbon offset schemes.
Greenwashing in the spotlight
Recent years have seen an increase in consumer demand environmentally, and socially responsible products and services in North America and Europe. For example, in November 2022, a NielsenIQ study found that 69 percent of consumers in the UK feel that sustainability is more important to them than it was two years prior.[1] Similarly, in February 2023, McKinsey & Company and NielsenIQ published another study in which they found that products sold in the US between 2018 and 2022 that made ESG-related claims saw larger growth than those that made no such claims.[2] These studies show that adopting ESG standards, or at least ESG-related claims, has clear commercial benefits for companies. This has driven greater interest from investors to have ESG considerations within their investment strategies.[3]
Greater demand and interest by consumers and investors for ESG-focused companies has also led to greater scrutiny into companies that make ESG-related claims. The risks include reputational concerns, and also regulatory and legal actions taken against companies suspected of making misleading sustainability claims. In January 2023, Sacha Sadan, director of the ESG division of the UK Financial Conduct Authority (‘FCA’), stated that the FCA intends to begin issuing penalties in breach of ESG disclosure regulations.[4] In February 2024, the European Parliament passed new rules approving fines and imprisonment for companies and their directives found to have committed environmental crimes.[5] Additionally, there has been an increase in legal claims made against companies for alleged “greenwashing” in their ESG claims and initiatives.[6] The increased regulatory and legal actions taken against businesses underscores the importance of adhering to ESG standards when making claims regarding sustainability.
The hidden costs of carbon offsetting projects on indigenous rights
Carbon credits markets and carbon trading systems allow corporations to buy carbon credits issued for projects in protected land areas where development and exploitation is prohibited. However, in recent media reports it has come to light that not only is there a general perception that these projects may not lead to genuine emission reductions, but also that these programmes can harm the rights of indigenous populations residing on the protected lands.
This issue can arise where offset programmes exploit developing countries that may be financially motivated to surrender their nation’s land rights in exchange for short-term financial gains. In turn, surrendering these lands to corporations can endanger indigenous people’s living situations and livelihoods. For example, in November 2023 members of an indigenous community in Kenya were evicted from their homes in the Mau Forest by the Kenyan government, in a move that the community’s lawyer suggested was linked to carbon credits and a deal made between a Dubai-based carbon offset company and the Kenyan government. A similar event occurred in 2024, where a community in rural Cambodia reported that they were forcibly evicted from their homes in conjunction with an extension of a carbon credit project in the country.
In addition to carbon credit programmes restricting and removing indigenous peoples from the land itself, these communities also face a lack of benefit sharing agreements, wherein project managers fail to provide compensation or transparency to the indigenous populations. Moreover, there are concerns that corporations and governments routinely fail to obtain free, prior, and informed consent from the affected populations before signing agreements to land rights where these communities reside.
How can companies make carbon credits work?
The voluntary carbon market (‘VCM’) has been the subject of increased scrutiny through the course of 2023. Investigative organisations and research institutes such as The Guardian and the international scientific journal Science, have cast doubt on the impact of nature-based carbon abatement projects, and on the reliability of international certification efforts. Many international companies including the likes of Gucci, Volkswagen, Disney, and Nestlé have been accused of greenwashing as a result of their reliance on carbon credit purchases. However, in the face of investor and consumer pressure to reduce their environmental impact, companies the world over have built net-zero strategies that are reliant on making carbon credits work. The VCM provides an emissions management tool to industries with hard-to-abate emissions, and, if stewarded correctly, can have co-benefits aligned with the UN Sustainable Development Goals, such as enhancing access to affordable and clean energy, promoting biodiversity conservation, and improving water quality.
Having acknowledged the integrity issues related to the VCM, the market is at a crossroad, where heightened criticism may make or break this budding industry. Given the potential positive impacts of integrous carbon abatement projects, what enablers might companies need to de-risk participation in the VCM, and make carbon credits a viable, and beyond-reproach, tool in their sustainability strategies?
- As is the case with many indeterminate concepts under the ESG umbrella, standardisation in certification and industry best practice will help companies to effectively measure the relative impact of the carbon projects in which they invest. Independent organisations such as The Integrity Council for the Voluntary Carbon Market are establishing global standards for high levels of integrity in the VCM. However, again as is the case with most ESG impact assessments, companies are also able to set their own internal standards, which, if well-considered and systematically applied, can assist in making VCM investments defensible in the face of heightened scrutiny.
- Regulatory oversight. Although the VCM is by its very nature a voluntary rather than mandated mechanism, the lack of regulatory guidance on engagement with carbon credit products also minimises trust in the projects they are underpinned by. In the US, the Commodity Futures Trading Commission is one regulatory body attempting to improve integrity in the carbon market, by creating a carbon credits ‘rulebook’, establishing a baseline standard for derivative products based on carbon credits and traded on US commodity exchanges. Regulatory initiatives such as this will provide investors with peace of mind that the products they invest in have met a minimum regulatory standard.
- Continued investment. According to BloombergNEF in its Long-Term Carbon Offsets Outlook for 2024, the key variable that will determine the ultimate success or failure of the VCM is demand. Fear of criticism and of rising prices has reportedly caused an elasticity of demand that cannot support the growth of the market, and will not provide the resources required to build trust in carbon credit products. Proponents of carbon credit trading have stressed the influx of climate financing into conservation efforts as a key positive impact of the VCM, and expressed fears that this funding will disappear if the VCM were to fail. For companies to be able to rely on carbon credits as a viable emissions management tool, and for the market to have its intended positive impact on environmental protection projects, continued investment in the establishment of the carbon market is required.
The revelations of 2023 highlighted the work that must still be done to legitimise the global carbon credit market. Although there are heightened reputational risks associated with engaging in this nascent market, global reliance on carbon credits in net-zero strategies necessitates a proactive approach to engaging with the VCM. As independent governance bodies and regulatory agencies are formalising market standards and regulatory guidance, companies must rely in the meantime on their own proactive standard-setting and due diligence of carbon abatement projects. In this way, investors can ensure that their carbon credit investments, which are necessary for the continued formalisation of the market, are defensible when faced with increased scrutiny.
Prepared by: Boitumelo Mogale, Dominik Wilk, Elif Korca, Emma Shewell, Esther Yu, Haddie Hamal, and Rami Assaf.
[1] Source: ‘The changing climate of sustainability has reached a critical moment’, NielsenIQ, 30 November 2022; ‘New Consumer Research on Sustainability’, Play It Green, 25 January 2023.
[2] Source: ‘Consumers care about sustainability—and back it up with their wallets’, McKinsey & Company, 6 February 2023.
[3] Sources: ‘The history of ESG: A journey towards sustainable investing’, IBM, 8 February 2024; ‘Trends for the Next Decade of Sustainable Investing’, Morgan Stanley, 13 October 2023.
[4] ‘UK regulator’s ESG boss says greenwashing fines ‘will come’’, Financial News, 19 January 2023.
[5] Source: ‘Environmental crimes: MEPs adopt extended list of offences and sanctions’, European Parliament, 27 February 2024.
[6] Sources: ‘Climate-washing litigation: towards greater corporate accountability?’, The London School of Economics and Political Science, 17 April 2024; ‘The rapid rise of greenwashing litigation’, Howard Kennedy, 12 July 2023; ‘The litigation risks that companies face in an age of ESG’, Reuters, 26 September 2023.
