Carbon Markets in Transition: Where Will the Overlap of Compliance and Voluntary Carbon Credit Markets Lead?

Regulatory and voluntary carbon markets are converging in a growing number of countries. This trend is true for Europe as well, not only since the EU Regulation on Carbon Removal and Carbon Farming (CRCF) has been issued.

Will the strict separation of the compliance and voluntary Carbon Credit market soon be history? And how can companies use Carbon Credits in the future in order to meet the statutory sustainability obligations?

In this blog post you will learn how the CO₂-offsetting system has worked so far, where carbon markets are headed in the future, and what this development means for your company.

Compliance vs. Voluntary Carbon Credit Markets

There are two main markets for companies to offset their CO₂ emissions: the compliance Carbon Credit market (“regulatory market”) and the voluntary Carbon Credit market (“voluntary market”). The origin and driving force behind these two markets is the 1.5-degree goal established in the Paris Agreement, which is why both systems play a key role in the global strategy for reducing greenhouse gases.

The Compliance Market: Fulfilling Statutory Obligations

Companies that are legally required to reduce their greenhouse gas emissions trade on the compliance market. A central instrument of this market is the European Union Emissions Trading System (EU ETS), the world’s largest emission trading system. Companies belonging to this system are allocated a particular number of emission certificates. These grant them the right to emit a certain amount of CO₂.

The EU ETS works according to the “cap and trade” principle:

●     Defining the emissions cap: There is an upper limit (cap) for total emissions and therefore also for the number of certificates issued. This cap is continuously lowered in order to increase the incentive for companies to reduce their CO₂ emissions and support the 1.5-degree goal. The upper limit is defined by political negotiations and decisions at EU level.

●     Trade with emission certificates: Companies can buy and sell available certificates in order to offset their emissions. This trade takes place at exchanges only, where the certificates’ price is determined by supply and demand. Companies emitting less carbon than their certificates allow may sell excess certificates, while those emitting more carbon than allowed must purchase more certificates.

With the gradual lowering of the cap and complimentary certificates coming to an end, it is becoming increasingly more expensive for companies to offset their emissions. Starting in 2026, there will be a transition to an auction phase, in which the price of the certificates will no longer be fixed, but constituted between a fixed minimum and maximum price by the market itself.

These developments increase the financial pressure on companies to invest in more sustainable technologies. At the same time, the market mechanism is designed in a way that reducing emissions becomes economically attractive.

CO₂ Taxes: Fixed Prices as an Incentive for Reducing Emissions

Besides emission trading, there are CO₂ taxes in several countries, such as Sweden and Canada. They are directly imposed on the generated greenhouse gases and also create an incentive to reduce emissions. In contrast to emission trading, where the price of certificates is determined by the market, CO₂ taxes set a fixed price per tonne of emitted carbon.

Thus, companies have a clear base for calculating their emission costs and are motivated to reduce their tax burden by investing in low-emission technologies or efficiency measures. In Germany, for example, the CO₂ price for fuel, diesel, heating oil, natural gas, and liquid gas is supposed to increase the costs for greenhouse gases generated in the areas of traffic and heating, in order to incentivize switching to more climate-friendly alternatives.

The Voluntary Carbon Credit Market: Sustainability Beyond Statutory Requirements

As opposed to the compliance market, the voluntary Carbon Credit market is based on the own individual initiative of companies. Here, they voluntarily purchase Carbon Credits in order to offset greenhouse gas emissions beyond the legal pressure to do so. The Carbon Credits on the voluntary market often stem from projects that invest in renewable energies, reforestation, or other measures for avoiding or reducing greenhouse gases.

These projects contribute to reaching the 1.5-degree goal. However, there is a substantial difference to the compliance market: The emissions offset on the voluntary market are not directly incorporated into a company’s legally valid balance. Instead, the voluntary carbon credit market offers companies the opportunity to go beyond the statutory requirements and mitigate previously unavoidable emissions outside of their own supply chain. Companies can use Carbon Credits as an important part of their own strategy for reducing emissions.

The Science Based Targets initiative (SBTi) currently reviews scientific research results of Carbon Credits in Scope 3 and could very soon issue a binding guideline for their use. You can find out more about this in our white paper How to Optimize Your Sustainability Strategy With the SBTi Framework.

Trending Overlap of Compliance and Voluntary Carbon Credit Markets

Both markets are independent and separated from each other when it comes to how they function. However, it appears that this will not remain the case for much longer. Several countries are already proceeding and allow overlaps between the carbon markets. At present, this is happening for 40% of national systems worldwide – with upward tendency.

The EU Regulation on Carbon Removal and Carbon Farming (CRCF)^[1] currently being developed by the EU is expected to create incentives and certificates for carbon removals as well as for carbon farming, which can be used both in the compliance and the voluntary Carbon Credit market.

This framework could build a stronger connection between the greenhouse gas-offsetting markets that have been separated thus far, because it potentially allows companies to use the same certificates or projects for reaching voluntary as well as regulatory climate goals