One of the most critical discussions for many developed and developing countries alike will hence be on the 'rules, modalities and procedures' needed to implement the new market mechanism and rebuilding the global 'carbon markets'.


At a major UN climate conference starting this week in Katowice, Poland, stakeholders will aim to finalize the rules for implementing the Paris Agreement.  The new rules and guidelines will provide the operational framework for new carbon markets.

The conference comes just days after the UN Environment agency reported that carbon emissions rose by 1.2 percent in 2017 – the first rise in global CO2 emissions in four years. Another report issued in October by the Intergovernmental Panel on Climate Change presented alarming prospects for the future if the world fails to drastically cut emissions sooner in line with the Paris commitments.

Against this background, the World Bank’s Independent Evaluation Group (IEG) last week released its evaluation of the World Bank Group’s support to carbon finance under the Kyoto Protocol, the precursor to the Paris Agreement. The report offers policy-relevant insights on the critical function of carbon markets in climate change mitigation.

The role of carbon markets

What is a carbon market?

A carbon market is a market that is created from the trading of carbon emission allowances to encourage or help countries and companies to limit their emissions by using low-cost mitigation options.

For example, under a cap-and-trade system, a limit (cap) is set on carbon emissions and permits are given to emitters to release a certain amount of carbon. If a company goes above its allowance, it must purchase additional permits to offset the excess emissions. If a company does not exceed its limit, then it can sell its unused allowances.

Under the Paris Agreement, one tool for countries to achieve their target reductions of carbon emissions at low cost is to participate in carbon markets. These markets facilitate voluntary transfer of low-cost emission allowances or carbon credits.

One of the most critical discussions for many developed and developing countries alike will hence be on the “rules, modalities and procedures” needed to implement the new market mechanism and rebuilding the global “carbon markets”. The carbon markets were initially created under the precursor to the Paris Agreement, the Kyoto Protocol, which was signed in 1997 and aimed to set internationally binding emissions reduction targets for developed countries (also called Annex B countries). Under the Protocol projects for emission reduction undertaken in developing countries and transition economies can be used as a tool for more cost-effective mitigation in Annex B countries.

The World Bank Group was one of the first movers and a key player in creating and developing the carbon markets. Through its many initiatives, the World Bank Group played multiple roles, which included catalyzing and developing carbon markets; innovating and developing new tools and methodologies; building capacity; exercising thought leadership and convening global and national partnerships for carbon markets and carbon pricing.

However, already damaged by the global financial crisis and carbon credit import restrictions, carbon prices collapsed in 2012, as supply exceeded demand and the world community was unable to agree on a framework for climate policy after 2012. Since then, the regulatory uncertainties and high transaction costs have undermined private sector interest and confidence in carbon markets. The carbon market crisis was particularly painful for low income countries (LICs) which started to access these markets primarily through the Programs of Activities (PoAs) which helped reduce transaction costs for small-scale mitigation activities.

Lessons from World Bank Group’s support to carbon markets under Kyoto

The Kyoto experience affirms that carbon markets can play a critical role for stimulating low-cost climate mitigation which could also contribute to raising ambition. Indeed, the global effort to combat climate change under the Paris Agreement will not succeed without strong climate markets.  As COP24 negotiators finalize the rules governing the framework for the next generation of carbon markets, it will be relevant to consider these lessons learned from the Kyoto experience:

1. A global approach to building the next generation of carbon markets, under the new framework of the Paris Agreement, requires a coherent long-term strategy. The future carbon markets shall be built on a more solid foundation and policy environment than in the past. Policy clarity, long-term demand, and attractive and stable prices are essential. The complex project cycle, unpredictable regulatory decision making, and high transaction costs (which together increase risks and reduce the economic viability of small projects) need attention. Attracting and leveraging private investments will be key.

2. Rebuilding trust in markets requires clear and transparent methodologies and Measuring, Reporting, and Verification (MRV) systems to overcome perverse incentives that undermine market mechanisms. Streamlining of rules and procedures including standardization of additionality assessment and baseline determination, building on the Kyoto experience will be particularly relevant to improve the overall transparency and legitimacy of the new market mechanism under the Paris framework. Safeguards to prevent undesirable incentives which disrupt the functioning of markets is also important to build trust. For example, a concern about perverse incentives led to a ban on the use of industrial gas credits (e.g. HFC23) by the EU and other governments. When abatement costs are very low and global warming effects are very high, instruments other than carbon markets (such as Montreal protocol) could be more effective for reducing certain types of greenhouse gas emissions.

3. Stimulating demand and preservation of the accumulated technical capacity and a pool of expertise will be crucial for revitalizing the market. While the signing of the Paris Agreement has re-ignited interest and carbon markets are showing signs of revival, there is an urgent need to support the development of the next generation of climate markets by building capacity at all stages of project development. The previous crash of the carbon markets led to a significant exodus of critical skills and experience as key players were forced out.

Raising ambition and facilitating a smooth transition from Kyoto to Paris.

The IEG case studies indicate that mitigation actions that generate development and environmental co-benefits (e.g. reduced pollution) could contribute to boosting the overall mitigation ambition.  Mainstreaming climate finance with development investments and monitoring the resulting co-benefits is relevant to increase ambition.

Carbon finance and concessional climate finance can also contribute to raising ambitions by facilitating investments in under-utilized sectors and under-served countries and regions. It will be vital to Identify new ways to use such finance as catalytic funding to unlock transformational approaches and low-carbon opportunities.

Facilitating the transition to the Paris framework under current market conditions also requires providing support to many projects piloted in low income countries to commercialize their emission reductions and/or to sustain the flow of ecosystem services (e.g. forestry and land use projects). New initiatives like the World Bank’s Pilot Auction Facility (PAF) – which provides price insurance for high impact projects facing imminent risk of discontinuation -- are needed to facilitate the transition. Avoiding local fragmentation and enabling sector-wide and global progress in mitigation while exploiting the “bottom-up” structure of the Paris Agreement to catalyze climate actions would be key in moving forward.

For more insights, read the full report:

Carbon Markets for Greenhouse Gas Emission Reduction in a Warming World

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