November 2022

CARBON CREDIT RIGHTS

UNDER THE PARIS
AGREEMENT

HOW ARTICLE 6 AND THE IMPLEMENTATION OF

NDCS MAY SHAPE GOVERNMENT APPROACHES TO
THE CARBON MARKET, AND WHAT THIS MEAN FOR
RIGHTS RELATED TO CARBON CREDITS
ACKNOWLEDGEMENTS

This paper has been prepared jointly by the Gold Standard Foundation (Hugh Salway)
and by EY Law (Kasia Klaczynska-Lewis, Malwina Burzec, Ewa Waslicka, Elwira
Szczesna, Lilianna Krawczyk and Michal Wyrembkowski). Support was provided by the
Swedish Energy Agency.

In addition to the Swedish Energy Agency, the authors would like to thank Lev Gantly
(Partner, Philip Lee LLP) and Alexandra Soezer (UN Development Programme) for
their review and comments on the paper.

The views expressed in this paper are those of the authors and do not imply
endorsement by or represent any official position of the Swedish Energy Agency or
other organisations that provided comments.

Climate Security and Sustainable Development 2

Table of Contents

ACKNOWLEDGEMENTS ......................................................................... 2

1.0 EXECUTIVE SUMMARY .................................................................... 4

2.0 INTRODUCTION ............................................................................. 6

2.2 CATEGORIES OF RIGHTS ................................................................. 8

3.0 HOST PARTIES CONTROL MECHANISMS ....................................... 10

3.1 RIGHT TO GENERATE .................................................................... 11
3.2 RIGHT TO OWN ............................................................................ 12
3.3 RIGHT TO USE ............................................................................. 14

4.0 ARTICLE 6 FRAMEWORK FOR HOST PARTIES CONTROL ............... 18

4.1 AN OVERVIEW OF ARTICLE 6 ......................................................... 18
4.2 AUTHORISATION OF MITIGATION OUTCOMES .................................. 19
4.3 DISTINGUISHING BETWEEN ‘AUTHORISATION’ AND ‘APPROVAL’ ........ 20
4.4 ARTICLE 6 AND USE-PURPOSES ..................................................... 22

5.0 IMPLICATIONS OF ARTICLE 6 FOR MARKET ACTORS .................... 25

6.0. INITIAL AND POTENTIAL STEPS IN THE NEW CONTEXT .............. 28

6.1 CATEGORIES OF ACTION ............................................................... 28

7.0 CONCLUSION AND KEY MESSSAGES ............................................. 33

Climate Security and Sustainable Development 3

1.0 EXECUTIVE SUMMARY

The adoption of guidance for Article 6 of the Paris Agreement (“Article 6”), combined
with the beginning of implementation of the first Nationally Determined Contributions
(“NDCs”), provides a new international context in which the voluntary carbon market
is operating. This new context may have implications for entities intending to
generate, own and use carbon credits in certain countries, as is already being seen in
some jurisdictions. This paper examines this new context, the steps that governments
are taking or may take in response, and what this means for market actors.

While largely unregulated, the voluntary carbon market has always existed in the
context of different national legal and regulatory frameworks. The rights of ownership
over carbon assets, and their treatment when traded as carbon credits, are derived
from laws, regulations and customs in the applicable jurisdiction and as such are
subject to the evolution of these laws, regulations and customs over time.

Over the past two years, there have been two major changes at the international level
that are likely to shift the way that governments engage with and manage carbon
market activities within their jurisdiction. The first of these changes is the beginning of
the implementation period for countries’ first Nationally Determined Contributions
(NDCs) under the Paris Agreement. Governments now have a greater interest in
tracking – and in some cases incentivising and managing – carbon market activities
that are generating emission reductions or removals that can be counted towards the
targets set in that country’s NDC. The second change is the adoption of new guidance
underpinning Article 6 of the Paris Agreement. This provides a framework for
governments to ‘authorise’ the use of emission reductions and/or removals achieved
within their jurisdiction by other entities, giving government an inherent right to
control the use of carbon credits.

Governments of countries that host carbon market activities may choose to take a
number of different steps in this new context, as some are already doing. Some may
step up their tracking of carbon market activities, for instance requiring registration
and monitoring on a national registry. Some may introduce approvals procedures,
requiring government approval or a ‘statement of no-objection’ before activities can
proceed. Some may establish procedures and a legal basis to implement the Article 6

Climate Security and Sustainable Development 4

mechanisms, and authorise the use of emission reductions and/or removals by other
entities. Meanwhile others may take new and novel steps to incentivise the
development of carbon market activities within their jurisdiction, for instance through
the tax system, by sponsoring the establishment of local market architecture or by
clarifying the legal classification of carbon credits.

These steps may interact in different ways and to varying extents on three distinct
sets of ‘rights’ identified in this paper. The first of these is the right to generate carbon
credits, the second is the right of ownership and legal title to carbon credits, and the
third is rights related to the use of carbon credits. Based on experience to date as well
as market expectations, it seems possible that rights related to the use of carbon
credits are likely to be affected over time by the new context under the Paris
Agreement; rights related to the generation of carbon credits may be somewhat
affected in certain jurisdictions; and rights related to the ownership of carbon credits
may not be significantly affected as a direct result of the two changes described
above.

In addition to uncertainty about what the future may hold, market actors have also
responded with concern regarding a number of steps that governments have taken in
the first year after the adoption of Article 6 guidance at COP26. However, it is
important to remember that there are substantial shared interests between
governments and market actors, when the carbon market is working effectively.
The emission reductions and removals, sustainable development benefits and inward
investment delivered by carbon market activities provide benefits for local
communities, economies and environments, and can therefore support national
objectives. Notwithstanding the current uncertainty in the market in the wake of the
adoption of the Article 6 guidance, it is hoped that increased engagement by
governments can be applied to support, enable, and incentivise the role of socially
and environmentally impactful carbon market activities in achieving the goals of the
Paris Agreement, rather than hindering them.

Climate Security and Sustainable Development 5

2.0 INTRODUCTION

For an asset like a carbon credit, legal rights matter. Carbon credits exist not as
tangible, visible assets but instead as digital assets created by a crediting programme
to represent a verified emission reduction or removal, in line with their specific rules
and methodologies. At the same time, the rights that underpin these assets are
derived from the laws or regulations of relevant national or local authorities (and in
some cases, the customs of indigenous communities), which vary between
jurisdictions1. It is not a surprise, given the importance of this issue, that one of the
three areas focused on by the Taskforce on Scaling the Voluntary Carbon Markets
in 2021 was legal principles to clarify the treatment of carbon credits across
jurisdictions. The International Swaps and Derivatives Association has also deemed
this issue to be sufficiently material to merit a detailed legal analysis2.

The implementation of Article 6 of the Paris Agreement introduces new considerations

for rights related to carbon credits. Under Article 6.2, a host government has the right
to authorise emission reductions or removals (or ‘mitigation outcomes’3, in the
parlance of Article 6) for use towards an NDC or by public or private entities for other
international mitigation purposes. Implicit in this is an understanding that national
governments have certain rights related to emission reductions or removals which
take place within their jurisdiction. Aside from Article 6, there are already examples
of governments beginning to exert new powers over carbon market activities taking
place within their jurisdiction, including those intended for the voluntary carbon
market.

The purpose of this paper is to examine how the new context under the Paris
Agreement, and the decisions that host governments make in this new context,
may affect market actors in relation to the generation, ownership, and use of carbon
credits. This paper considers jurisdiction-specific examples of government

1 https://www.iif.com/Portals/1/Files/TSVCM_Phase_2_Report.pdf
2 https://www.isda.org/a/38ngE/Legal-Implications-of-Voluntary-Carbon-Credits.pdf
3 In this paper, the authors use the term ‘mitigation outcome’ to refer to an emission
reduction or removal that has been achieved, and will typically use the term in the context of
Article 6; the term ‘carbon credit’ will be used to refer to the asset issued to a project
developer for a verified emission reduction or removal. The two terms are therefore distinct
but closely linked.

Climate Security and Sustainable Development 6

requirements, laws or regulations currently affecting market participants; the Article 6
framework created through the adoption of a rulebook at COP26; and the changes
that we may now see as a result of this framework and the new context under the
Paris Agreement.

2.1 Drivers of a changing context

This paper examines two linked but distinct drivers that may lead certain ‘host
governments’ (governments in whose jurisdiction carbon market activities are taking
place) to exert new powers with respect to carbon market activities and the carbon
credits that they generate:

1. Adoption of the Article 6 rulebook. At COP26, governments adopted a rulebook

to underpin the use of Article 6 of the Paris Agreement, including rules related to
the authorisation, reporting and accounting of internationally transferred mitigation
outcomes (“ITMOs”). With the adoption of this rulebook, governments essentially
hold the right to determine (through a process referred to in the rulebook as
“authorisation”) which mitigation outcomes achieved within their geographical
boundaries (including emission reductions or removals represented by carbon
credits) may be transferred for unique use by other countries or entities, and
which mitigation outcomes will – or at least may - be counted towards the host
country’s NDC.

2. Implementation of first NDCs. From 2021, governments have begun to

implement measures to achieve the targets set out in their first NDCs under the
Paris Agreement. Each Party is required by the Paris Agreement to pursue
domestic mitigation measures with the aim of achieving the targets in its NDC, and
to report every two years from 2024 on progress towards meeting these targets as
part of its Biennial Transparency Report. This represents a shift from the Kyoto
Protocol era, in which developing countries held no international responsibility to
set and maintain a national climate mitigation target. In this new context,
governments have a far greater inherent interest in understanding and tracking -
and potentially managing, administering and incentivising - activities that are
achieving emission reductions and/or removals within their jurisdiction, including

Climate Security and Sustainable Development 7

 those in the carbon market, all with a view to achieving the targets set out in that
country’s NDC.

At the level of an individual country, either or both of these two drivers may apply.
Even in a country that has no stated interests or plans to authorise the transfer of
mitigation outcomes under Article 6, the second of these drivers may lead the
government to establish a greater role with respect to carbon market activities within
its jurisdiction. As will be explored later in this paper, governments may for instance
require the registration of activities on a national registry or may introduce incentives
or frameworks to foster a domestic carbon market, to support achievement of the
targets set out in that country’s NDC and broader climate-related plans and
ambitions.

2.2 Categories of rights

This paper also considers three distinct categories of rights related to carbon credits,
to more accurately identify how the two drivers referred to above may have a bearing
on them in the future. These categories are:

RIGHT TO GENERATE

This is the right of a project developer to implement an activity that will

ultimately generate (or cause the applicable carbon registry to issue) carbon
credits. This could, for instance, be affected by any activity approvals processes
implemented by governments. Governments will already be required to approve
all activities within their jurisdiction that intend to be registered with the new
crediting mechanism established by Article 6.4 of the Paris Agreement.
Governments are not obliged to issue similar approvals for activities registered
with other programmes, such as those traditionally associated with the
voluntary carbon market, though some may choose to do so.

Climate Security and Sustainable Development 8

 RIGHT TO OWN

This is the right of a project developer to hold and assert legal ownership over
carbon assets (in the form of credits) that are referrable to emission reductions
or removals resulting from a particular activity. This right is typically subject to
arrangements between parties involved in the applicable activity and the legal,
regulatory and/or customary framework of the country in which the activity
takes place, including laws and customs related to use of and title to natural
resources as well as land and property rights.

RIGHT TO USE

This is the right of an entity to use carbon credits for a specific purpose,
whether that is a corporate claim, an NDC target or a compliance obligation.
It is this right that is most directly affected by the adoption of the Article 6
rules. Under Article 6, a host government has the right to decide whether
mitigation outcomes achieved within its jurisdiction are authorised for use
towards (i) an NDC of another country, and/or (ii) ‘international mitigation
purposes’, which is generally understood to include use by an airline operator
to comply with CORSIA4, the international aviation sector’s offsetting regime.
Host governments also have the ability to authorise the use of mitigation
outcomes for ‘other purposes’, which may include the voluntary market, and an
implicit ability to impose more tailored terms and conditions as part of their
authorisation, such as restricting use by certain types of entity.

This right should be understood to include two related concepts: the ‘right to
claim’ (whether an entity can claim unique ownership over an emission
reduction and therefore make certain claims against it) and the ‘right to sell’
(for instance, whether an entity can sell credits to buyers based in a jurisdiction
other than that in which the emission reduction or removal occurred). While

4 Carbon Offsetting and Reduction Scheme for International Aviation

Climate Security and Sustainable Development 9

 there may be slight differences between these concepts, the implications are
broadly similar.

It is important to keep these categories in mind, as they are likely to be affected to

varying extents by the adoption of Article 6 guidance and the implementation of
NDCs. Broadly, and as explored further in this paper, the authors assess that rights
and abilities related to the use of carbon credits are likely to be considerably affected
over time; rights related to the generation of carbon credits may be somewhat
affected in certain jurisdictions; and rights related to the ownership of carbon credits
are unlikely to be significantly affected as a direct result of the two drivers described
above, though may of course be affected by other factors.

The following section considers some existing mechanisms that governments have in
place to regulate or otherwise manage carbon credits, before turning to the new
context under the Paris Agreement.

3.0 HOST PARTIES CONTROL MECHANISMS

This section explores some of the mechanisms and powers that certain governments
already hold and which affect the categories of rights described in the previous
section. While the focus of this paper is on the implications of the transition to a new
context under the Paris Agreement, it is important to remember that projects
generating carbon credits have always existed within a legal and regulatory context,
which has a bearing on rights relating to those carbon credits. Just as there are some
similarities as to the treatment and categorisation of carbon-related rights between
different jurisdictions, there are also significant variations. This section does not
intend to provide an exhaustive overview, but instead provides some illustrative
examples of the treatment of carbon rights in a number of jurisdictions.

Climate Security and Sustainable Development 10

3.1 Right to generate

National governments have, over the past two decades, had the responsibility of
approving activities intending to generate carbon credits under the Clean
Development Mechanism (‘CDM’).5 This approval, given to project participants by the
designated national authority of a government, is a pre-condition for any project
intending to qualify for the issuance of certified emissions reductions under the CDM.

A similar standardised approval mechanism (analogous to the approval process under

the CDM) has not historically formed part of other crediting programmes that oversee
and administer projects in the voluntary carbon market. Under the Gold Standard’s
crediting programme, for instance, projects are required to notify national
government officials or focal points as part of their stakeholder consultation prior to
the project’s registration, but any requirements and steps beyond this are considered
to be the responsibility of the relevant national government.6

There are certain countries that impose requirements on activities within their
jurisdiction, as a condition of them operating. In Colombia for instance, activities are
required to register on RENARE, the National Registry of Reduction of Greenhouse Gas
Emissions.7 The act of registration, in which a project needs to report its existence to
a government, is however quite distinct from an act of approval, in which a
government has the right to make an election as to whether or not the project may
exist. There are currently few, if any, examples of jurisdictions in which the
government consistently asserts a right of approval for projects registered with
crediting programmes serving the voluntary carbon market.

5 https://unfccc.int/resource/docs/cop7/13a02.pdf#page=20
6 https://globalgoals.goldstandard.org/standards/102_V2.1_PAR_Stakeholder-Consultation-
Requirements.pdf
7 Law 1753 2015. Article 175 , Resolution 1447 2018

Climate Security and Sustainable Development 11

3.2 Right to own

Project developers seeking certification under established standards are currently

required to demonstrate their legal entitlement to carbon assets before credits
representing those assets are issued by those standards. Under Gold Standard, for
instance, projects are required to demonstrate “full and uncontested legal ownership
of any Products that are generated under Gold Standard Certification”. Where this
ownership is transferred from project beneficiaries, this must be demonstrated
“transparently and with full, prior and informed consent.”8 Similar arrangements are
in place under the Verified Carbon Standard overseen by Verra9 and other established
standards.

The question of the right to extract or harvest natural resources as well as rights to
use of land can often be fundamental to any analysis of entitlements to rights to
carbon assets (which can be defined as a benefit from reduced GHG emissions and/or
sequestered carbon with this benefit ultimately being represented by a digital credit).
Any such analysis is highly context-specific, with significant variations between
jurisdictions. It is nevertheless helpful to compare examples and consider general
trends.

It is first important to assess and categorize different systems of land tenure, which
directly affect the carbon right arising from the sequestration of CO2 by a forest. This
is of particular importance for REDD+ activities as, dependent on the land ownership
status, not all credits could be assigned to the government.

In some developing countries, the government owns or has authority to deny the
rights of others to forest resources. As such, the government becomes a default
owner of the carbon rights from all the forest resources in the country. The
Democratic Republic of Congo made such a move in 2018 by passing a Homologation
Decree, under which private project developers can only have a secondary right to
carbon, which is transferred to them through a certification of homologation. A similar
standard is applied in Mozambique, where all land and natural resources are a

8 https://globalgoals.goldstandard.org/standards/101_V1.2_PAR_Principles-Requirements.pdf
9 https://verra.org/wp-content/uploads/2022/06/VCS-Standard_v4.3.pdf (Section 3.6)

Climate Security and Sustainable Development 12

property of the state and as such the project developers have only a secondary right
to carbon. Projects can, in this context, receive a license to generate carbon credits.

A legal framework which assigns all the carbon rights to the government runs into
some challenges, given the mixed system of ownership, strong communal or statutory
land titles, and a non-negligible role of the government. Local communities and tribes
which steward the land may need to be compensated. In countries such as Ecuador,
where all ecosystem services belong to the state, private projects are not permitted,
and it remains unclear whether and to what extent indigenous peoples should be
compensated. Another challenge is the extent to which land in the country remains
within informal arrangements. Potential compensation is complicated by unresolved
land tenure issues.

Where there are well-established laws on title to private land (including forested
land), landowners can benefit from carbon rights as a part of ecosystem services
arising from their ownership of the land. As such, owners can generate carbon credits
and trade them on compliance or voluntary markets. In Guatemala and Chile for
instance, carbon rights belong to the entity with the title to land and private entities
are free to participate in carbon markets. Similarly, in Kenya, rights to emissions
reductions or removals stem from legal regimes for the ownership of land, thereby
providing a landowner with the right to assign the benefit of the carbon asset to a
third party or to transfer this right by expressly referring to it as part of a leasing or
licensing agreement for the use of the relevant land by such third party.
There are also examples where carbon rights are not necessarily connected directly to
the land title, but rather to stewardship over the land by a multiplicity, individuals,
legal entities, and communities. Carbon rights of project developers in this case are
often claimed as secondary, resulting from project financing and monetization. This is
the case in Peru, where carbon rights can be claimed by communities, land managers
or local governments which steward over the land and sequester the carbon through
reforestation. However, these entities can choose to transfer their carbon rights to
project developers.

In addition to forest rights, there are cases where legal title associated with CO2
sequestration also needs to take into account the ownership of resources below
ground. In Iceland, the ownership of ground resources is attached to the ownership of
private grounds. As such, the carbon right associated with carbon capture and storage

Climate Security and Sustainable Development 13

lies with the project developer. In jurisdictions where resources below ground are
owned by the government, and with no regulation of carbon capture and storage, it
becomes more ambiguous whether the capture of carbon and its storage in the
ground is associated with a transfer of carbon rights to the government.

Furthermore, some jurisdictions (Uganda being one example) passed national laws to
implement certain aspects of the CDM including with respect to appropriation and
transfer of rights to carbon assets. It is important therefore to check whether the
host country for a proposed project has a history with project development under the
CDM and whether a legal or customary precedent has been set in that jurisdiction for
the ownership, appropriation and transfer of carbon rights.

In order to avoid potential disputes, it is key that parties agree who has the primary
carbon right and which party converts it to a carbon credit. In order to achieve this,
carrying out legal due diligence on carbon-related laws, regulations and customs in
the host country for the proposed project is essential. Without understanding the
source of what gives rise to the right to carbon assets and benefits under local laws,
regulations and customs in a given jurisdiction, a project developer, investor or
financier would be ill-advised to commit to providing equity or debt in a carbon
activity in that jurisdiction. Once these matters are understood by contracting
parties, the risk allocation on issues such as the passage of risk and title to carbon
assets as well as the creation of liens, encumbrances or other forms of security can be
documented in a contract. This contract should also specify the rights, responsibilities
and financial benefits arising from the commercialization of the carbon right.

3.3 Right to use

The classification of a carbon credit for legal purposes is vital for project developers
and buyers of carbon credits, as it determines its tax treatment and the way it is
recognized in financial reporting. Whether an entity decides to acquire carbon credits
may depend in part on the legal certainty that the entity can have about the type of
instrument that a carbon credit represents. For example, whether the relevant
authority considers and treats a carbon credit as a commodity, financial instrument,

Climate Security and Sustainable Development 14

tangible or intangible asset or simply as a set of contractual rights to benefit from the
verification process performed by the project developer10.

So far, a uniform international definition of carbon credits has not been adopted.
By the nature of a carbon credit, it can be seen to have more characteristics of an
intangible asset than a tangible asset. Certain jurisdictions, including Colombia11,
consider carbon credits as intangible property and therefore regard them as a supply
of services. Furthermore, carbon emission allowances are generally treated as
intangible assets for accounting purposes. Only some countries, including Australia
define carbon credits as financial instruments12.

According to the legal definition of voluntary carbon credits (“VCCs”) in Colombia,

VCCs are verified, quantified, tradable GHG emission reductions or removals that are
registered in a public registry, are certified and have been assigned a unique serial
number. VCCs are required to be registered on a public registry, and certain eligible
carbon credits may also be used for compliance purposes under Colombia’s National
Carbon Tax. At the same time, the regulations impose restrictions on project
developers, who are only permitted to develop projects within a defined scope
approved by the government. Only domestic carbon credits with vintages not older
than five years are eligible. In addition, priority is granted to the forestry sector.
The projects must be validated and their removal results verified by the bodies
independent of the standards and projects, duly accredited under the requirements of
ISO 14065. The eligible emission verification bodies are either the National
Accreditation Body of Colombia (ONAC) or, following the modification made by Decree
446[2] of 2020, organisations that are members of the International Accreditation
Forum (IAF) until a Mutual Recognition Agreement is in place13.

Under Colombia’s tax regime (through tax ruling 13505 from 2017), VCCs are defined
for tax purposes as intangible assets representing a right for 1 tonne of CO2 removal
or reduction which is transferable for exchange of a price. The rationale behind this

10 The potential categorisation of a carbon credit as a set of contractual rights to benefit from
the verification process is considered and suggested by ISDA in its paper on the legal
implications of voluntary carbon credits (https://www.isda.org/a/38ngE/Legal-Implications-of-
Voluntary-Carbon-Credits.pdf)
11 Estatuto.co - Estatuto Tributario Nacional Tax Law (Estatuto Tributario). Article 420
12 Corporations Act 2001
13 Resolution 1447 2018, Resolution 831 of 2020, Decree 926 of 2017, Decree 446 2020

Climate Security and Sustainable Development 15

accounting definition is the association of the carbon credits with projects where
carbon capture or reduction is achieved in the activity, duly certified and represented
by a measure in tons of carbon. Once the project is approved and carbon credits are
issued, they can be traded and purchased by those who wish to offset or reduce their
carbon footprint voluntarily. Hence for tax purposes, these credits are considered an
intangible asset under a form of a right to offset or reduce the purchaser’s carbon
footprint for exchange of a price.

Looking at another example, the United Kingdom is taking proactive efforts to ensure
that the voluntary carbon credit market develops significantly. One of the ongoing
actions is the development of the London Stock Exchange's Voluntary Carbon Market.
A proposal for a definition of carbon credit has been submitted by the London Stock
Exchange, public consultations were conducted, and according to the statement from
the Exchange, the final rules should have been published by the end of September
202214.

In the statement, the Exchange proposed to define a credit as a tradable permit or

certificate which represents an independently certified removal or avoidance of one
ton of carbon dioxide or the global warming equivalent of another greenhouse gas.

As English law is commonly used to govern the contractual arrangements between

transacting parties in the voluntary carbon market, the legal categorisation of carbon
credits under English law is important. In its paper on the legal implications of
voluntary carbon credits, ISDA asserts that European emissions allowances (under the
EU’s Emissions Trading System) have been recognised as a form of intangible
property under English law15 and that therefore the categorisation of voluntary carbon
credits could, if tested in court, follow this precedent. The aforementioned paper also
provides considerable insight on the possible categorisation of carbon credits in the US
and Germany and considers the question of what law would be the most appropriate
to determine the categorisation of rights to voluntary carbon credits on the insolvency

14 London Stock Exchange, Market Notice, N12/22 - Consultation on the creation of London
Stock Exchange’s Voluntary Carbon Market and amendments to the Admission and Disclosure
Standards, 2022, p. 6.
15 Armstrong v Winnington [2012] EWHC 10, [2013] Ch 156

Climate Security and Sustainable Development 16

of the project proponent (on the basis that the governing law of the underlying
contract would, at that point, be less relevant)16.

16 The options put forward by ISDA in this context are (i) the jurisdiction of the register on
which the carbon credit is recorded, (ii) the jurisdiction of incorporation of the registrar, (iii)
the governing law of the carbon standard rules and/or registry rules, and (iv) the law of the
location of the project from which the carbon credits are generated. This is a highly
complicated question that merits further detailed consideration by the international legal
community and is, for current purposes, outside the scope of this paper.

Climate Security and Sustainable Development 17

4.0 ARTICLE 6 FRAMEWORK FOR HOST PARTIES CONTROL

4.1 An overview of Article 6

Under the Paris Agreement, all Parties are required to adopt and implement Nationally
Determined Contributions (NDCs), representing the contributions that they will make
towards achievement of the collective goals set under the Paris Agreement. The NDC
of a country typically sets out the economy-wide and/or sector-specific emission
reduction targets that a country has set for itself as well as, in some cases, the means
by which that country intends to meet those targets.

Article 6 of the Paris Agreement recognises that some Parties may choose to
voluntarily cooperate in the implementation of their NDCs, working together to allow
for higher ambition in both climate mitigation and adaptation. Following the adoption
of the Paris Agreement in 2015, Parties took several years to negotiate more detailed
Decisions to underpin key parts of Article 6. This culminated in the adoption of three
further decisions at COP26 in 2021, covering the following areas:

1. ARTICLE 6.2

Guidance for Parties intending to cooperate through the transfer of mitigation

outcomes, with mitigation outcomes achieved in the host jurisdiction available
for use by another Party towards its NDC, or other entities towards other
targets or obligations, provided that the host jurisdiction has ‘authorised’
the use of that mitigation outcome for the intended use-purpose.

2. ARTICLE 6.4

Rules, modalities and procedures for a new carbon crediting mechanism

that has been established within the UNFCCC system and that will effectively
replace the Kyoto Protocol era’s Clean Development Mechanism.

Climate Security and Sustainable Development 18

 3. ARTICLE 6.8

Establishment of a work programme to support implementation of a framework

for non-market cooperative approaches, through which Parties may cooperate
in the implementation of their NDCs but without transfer of rights to mitigation
outcomes.

4.2 Authorisation of mitigation outcomes

At the heart of the Article 6.2 Decision is a framework and guidance for Parties to
account for transfers of mitigation outcomes. A ‘mitigation outcome’ may be a verified
tonne of CO2-equivalent reduced or removed, as is represented by carbon credits, but
may also represent a flow of allowances within a linked emissions trading system or –
where this aligns with the NDC of participating Parties - other climate-related impacts
measured in metrics other than CO2-equivalent, such as renewable energy capacity.

When a mitigation outcome is authorised by a host Party (i.e., the country in which
the mitigation outcome has occurred) for use towards an NDC or for other
international mitigation purposes, the host Party is required to make an upward
corresponding adjustment to its national emissions ledger on the first transfer of that
mitigation outcome. Parties must report an emissions balance in their ‘Biennial
Transparency Reports’ submitted every two years to the UNFCCC, which represents
their national inventory plus any adjustments to reflect the net transfer of mitigation
outcomes17. For example, if a host Party authorises the use of 30,000 tonnes of CO2e
(represented by 30,000 ITMOs) removed by a certain activity for use under Article 6
and these ITMOs are subsequently sold to another government, a company or an
airline, the host Party would need to adjust its emissions balance for that year upward

17 If another Party is using transferred mitigation outcomes towards its NDC, it reports its
national inventory minus an adjustment to reflect the net flow of mitigation outcomes – thus
the term ‘corresponding adjustment’.

Climate Security and Sustainable Development 19

by 30,000 tonnes so as not to count the mitigation outcomes towards its NDC18
(thereby ensuring that double counting is avoided). These adjustments are known as
‘corresponding adjustments’.

Article 6.2 guidance states that Parties must apply a corresponding adjustment for all
‘Internationally Transferred Mitigation Outcomes’ that the Party authorises. However
not all emission reductions or removals achieved within a jurisdiction are
automatically treated as ITMOs. A Party that hosts activities that generate emission
reductions or removals has the sole right to decide in which cases, under which
conditions, and towards which use-purposes, it is willing to authorise these emissions
impacts as ITMOs under Article 6.2, and therefore to take on an obligation to apply a
corresponding adjustment. At the time of writing in Autumn 2022, very few Parties
have publicly shown a readiness to provide authorisations under Article 6. In some
cases, Parties may choose not to use Article 6 at all; in others, they may do so but
take more time to introduce the legal basis, policies and institutional arrangements
required to do so.

4.3 Distinguishing between ‘authorisation’ and ‘approval’

It is important to distinguish between, on the one hand, authorisation of ITMOs under

Article 6.2 and, on the other hand, a more general approval or non-objection to the
implementation of an activity. The former is specifically tied to and has a specific
purpose under Article 6, essentially committing the host country to apply a
corresponding adjustment. The latter may be applicable for projects that are either
subject to or not subject to Article 6. Further, for projects not registered under the
UN’s Article 6.4 mechanism, an approval or explicit statement of no objection may not
be required by the host country at all.

18 There are several different possible ‘triggers’ for this adjustment. If authorised mitigation
outcomes are for use by another Party towards its NDC, the trigger is the ‘first international
transfer’ of the mitigation outcomes. If the mitigation outcomes are for use for other purposes,
such as CORSIA or the voluntary carbon market, the trigger can be any of the following: the
initial authorisation of the mitigation outcomes; their issuance; or their use. The host Party
must specify which of these triggers will apply. Depending on the nature of the entity that
purchased these ITMOs, it may be required to make a downward rather than upward
adjustment to its emissions balance.

Climate Security and Sustainable Development 20

In practice, a project developer may be free to carry out an activity within a
jurisdiction and may have legal title to carbon credits issued with respect to that
activity, even without an authorisation of those carbon credits as ITMOs. Indeed, this
could be the most common situation for carbon market activities in the future, with
emission reductions or removals represented by carbon credits potentially being
counted by the host country towards its NDC (without such reductions or removals
being categorised as ITMOs following some form of authorisation)19. This is made
explicit in the rules, modalities and procedures adopted at COP26 for the new
crediting mechanism established by Article 6.4. In the section entitled ‘Approval and
Authorization’, Parties must make two separate statements to the mechanism’s
Supervisory Body: first, whether the Party approves the activity proceeding, and
secondly whether it authorizes A6.4ERs issued for the activity for use towards
achievement of an NDC and/or for other international mitigation purposes. Any such
authorisation of an A6.4ER has the effect of converting it into an ITMO, thereby
obliging the host country Party to apply a corresponding adjustment on the first
transfer of that ITMO.

For crediting programmes other than the mechanism established by Article 6.4, for
instance Gold Standard and Verra, such an explicit approval may not always be
required in the future. Instead, approaches may vary between jurisdictions and
possibly between crediting programmes, as is described in further detail in the
following section. It is nonetheless possible that project developers may actively seek
letters of approval or no-objection (as distinct from letters of authorisation20), even
where this is not actively required by the host Party. This may be the case, for
instance, if such letters provide greater investment certainty and/or are required by
partners or funders. In other cases, governments may continue to take a more
laissez-faire approach to carbon market activities, at least in the short- to medium-
term as capacity is built. This may be more likely in countries where the emissions
impact of the carbon market is small relative to overall emissions.

19 There is, at the time of writing, differing views amongst market actors as to how carbon
credits should be treated in the voluntary carbon market when they are not authorised for use
under Article 6, and in particular whether non-authorised credits can be used towards
offsetting claims. Gold Standard provided guidance on this issue in a June 2022 update to its
Claims Guidelines.
20 Letters of authorisation are increasingly likely to be the instrument that host country
governments will use to signal that a particular project or type of activity is or will in the future
be authorised by it for a particular use or purpose under Article 6. The form

Climate Security and Sustainable Development 21

4.4 Article 6 and use-purposes

A host government that is using Article 6 has the ability and the responsibility not only
to decide when to authorise mitigation outcomes generated by a particular activity;
it must also decide which purposes the mitigation outcomes may be used towards.
Under Article 6.2 guidance, ITMOs may be used towards:

1. An NDC other than that of the host country

For example, if the government of Peru were to permit mitigation outcomes

achieved within its national borders for use by other countries, such as
Switzerland, with which it has a bilateral agreement.

2. International mitigation purposes other than achievement of an NDC

For example, the use of mitigation outcomes by aircraft operators to comply

with obligations under CORSIA, the offsetting scheme adopted by the
International Civil Aviation Organization. International aviation (and shipping)
emissions are typically treated and accounted for separately from Parties’ NDCs,
which is why this is generally understood as a distinct ‘international mitigation
purpose’.

3. Other purposes, as determined by the host government

The ability of a host government to authorise mitigation outcomes for use

towards ‘other purposes’ allows governments to choose to allow mitigation
outcomes to be used by companies for voluntary purposes, with the government
granting the company a unique claim by applying a corresponding adjustment.
While there has been extensive debate amongst carbon market actors about
whether Article 6-authorised mitigation outcomes are required for offsetting
claims in the voluntary carbon market, the wording of Article 6.2 guidance –

Climate Security and Sustainable Development 22

 referring to other purposes ‘as determined by the host government’ – seems to
make clear that governments have the right to choose to authorise mitigation
outcomes for this purpose if they wish.

It is not yet clear how governments will practically apply Article 6.2 guidance, when it
comes to authorising use towards specific purposes. For market actors interested in
the development of a liquid global market, there would be advantages to governments
deciding to authorise mitigation outcomes for all possible purposes, rather than
placing limitations on this by only permitting certain use-purposes. Governments may,
however, have their reasons for placing limitations on use-purposes, for instance if
they wish to exclusively hold bilateral relationships under Article 6 with certain other
Parties.

It is also not yet clear how governments will respond to their ability to authorise
mitigation outcomes under Article 6 for use in the voluntary carbon market. After
COP26, a small number of governments including Costa Rica, Colombia, Peru and
Switzerland signed on to a statement that included a vow to ‘apply corresponding
adjustments to support voluntary corporate climate commitments’, as well as to
support ‘transparent and credible corporate claims’21. The ability to authorise
mitigation outcomes for purposes other than NDCs is also incorporated into the
bilateral agreements that Switzerland has now signed with a number of countries,
including Peru and Senegal.

As important as whether governments will authorise mitigation outcomes under Article

6 for use under Article 6 will be whether governments introduce legal or guidance-
based restrictions on the claims that can be made by companies with respect to
mitigation outcomes generated within their jurisdiction. It is possible, for instance,
that certain governments may choose to clarify that mitigation outcomes, represented
by carbon credits, cannot be claimed to offset the emissions of a company or other

21 https://cambioclimatico.go.cr/following-cop26-climate-talks-the-san-jose-principles-
coalition-recommits-to-principles-for-high-integrity-carbon-markets-pledges-to-act-on-them-
together/

Climate Security and Sustainable Development 23

entity if they are counted towards the NDC of the host government. It is of course
also possible that governments choose not to do this.

Climate Security and Sustainable Development 24

5.0 IMPLICATIONS OF ARTICLE 6 FOR MARKET ACTORS

Section 3 considered some of the existing ways in which government regulation

informs and influences rights related to carbon credits. The adoption of Article 6 and
its rulebook introduce a new layer of considerations, which affects in particular rights
related to the use of credits.

As described in Section 4, the Article 6.2 guidance adopted at COP26 gives national
governments the right to ‘authorise’ the use of ITMOs generated within their
jurisdiction by entities other than themselves. Once authorised, ITMOs can be used by
other Parties to the Paris Agreement, public or private entities for ‘other international
mitigation purposes’, which may include use by aircraft operators towards obligations
under ICAO’s Carbon Offsetting and Reduction Scheme for International Aviation
(CORSIA) or by companies towards voluntary climate targets or claims.22 Implicit in
Article 6.2 guidance is that host governments also have the right to choose not to
authorise the use of mitigation outcomes by other entities, instead retaining the right
to use these mitigation outcomes towards their own NDC23.

The host government, under the Paris Agreement, has an implicit right - and indeed a
responsibility - to count mitigation outcomes achieved within its jurisdiction towards
its NDC (assuming the mitigation outcomes are generated inside the boundary of the
country’s NDC), and in addition the government has the right to decide whether and
under what conditions to surrender this first right and allow another entity to count
the mitigation outcome towards a separate NDC, obligation, target or claim.
Governments also seem to have the right to amend or withdraw authorisations at a
later date, with Article 6.2 guidance requiring governments to report every two years
on “any changes to earlier authorisations”24.

From the perspective of a government, the decision to provide an authorisation under

Article 6 – to permit an entity other than the government itself – to make claim to
mitigation outcomes achieved in its jurisdiction is one that should not be taken lightly.
This is as any mitigation that is authorised for use under Article 6 cannot be used

22 https://unfccc.int/documents/460950
23 Furthermore, governments also seem to have the right to amend or withdraw
24 https://unfccc.int/sites/default/files/resource/cma2021_10a01E.pdf (paragraph 21c)

Climate Security and Sustainable Development 25

towards the country’s NDC. If a country were to ‘over-sell’ mitigation outcomes (i.e.,
agree to transfer and surrender rights to too many) or ‘mis-sell’ mitigation outcomes
(i.e., agree to transfer and surrender rights to mitigation outcomes from relatively
low-cost activities that the government could have achieved itself), then it risks failing
to achieve its NDC. While there are no punitive measures for this under the Paris
Agreement, it would likely draw reputational harm both for the government itself,
but also potentially for the concept of market-based cooperation under Article 6.

At the same time, Article 6 provides a significant opportunity for governments if used
wisely. It offers a route for inward investment that could be directed to mitigation
activities that go beyond the capabilities of the government and are not economically
viable without carbon finance, and that can both help the government to achieve its
long-term climate strategy as well as creating jobs and other benefits for sustainable
development25. It is therefore likely to be in the interest of many governments to use
Article 6, and to authorise projects and mitigation outcomes to be used towards
another country’s NDC, towards CORSIA obligations and/or towards a unique
voluntary offsetting claim by a company. Governments may also seek to generate
direct income through their carbon market policy, for instance through fees related to
registration or authorisation.

There are advantages and disadvantages of this new context following the adoption of
Article 6 guidance, from the perspective of a market participant, and in particular a
project developer.

Taking the advantages first, project developers may ultimately have more certainty
about the legal and accounting treatment of their carbon credits by the host
government, which could provide assurance for end-buyers and enable clearer claims.
It is also broadly expected that any carbon credits authorised for use under Article 6
will attract a higher price than non-authorised credits in the future, reflecting factors
including their broader eligibility, the unique claim that the end-user will have, and
potentially the higher cost of implementing the activity26.

25 Good examples are direct air capture and green hydyrogen-producing technologies and
project
26 securing a letter of authorisation from the host country and any obligations that the project
developer is required to take on as a result of this, such as reporting. Second, mitigation

Climate Security and Sustainable Development 26

Looking at the disadvantages, project developers may experience a period of
uncertainty following the adoption of Article 6 guidance, while national governments
establish policy and processes for managing carbon market activities and the
mitigation outcomes that these activities generate. Project developers may also be
subject to greater administrative requirements, costs (including any new taxes or
fees), and delays in the future, if host governments require projects to register with
or be approved by the national government. For this reason, project developers may
choose to take care in protecting themselves through carefully considered contractual
provisions in the agreements that they enter into with their investors and financiers.

Project developers may also be subject to greater sovereign risk, considering that
governments will have the ability to change or withdraw authorisations or approvals.
For this reason, developers, investors and financiers may choose to undertake ‘forum
shopping’ for the jurisdiction of incorporation of their project or investment vehicles,
with a view to accessing the benefits of investment protection treaties. It is though
still to be seen how frequent or rare such changes will be, and what arrangements
(such as insurance products) are available to manage such sovereign risk.

These factors and their impact will inevitably vary across jurisdictions, as
governments take different approaches and move at different speeds to implement
national frameworks for use of Article 6. This could shape flows of investment through
the carbon market, with jurisdictions with clearer and more stable policies and better
enabling environments considered more attractive for project development.

This is important to bear in mind when considering the potential disadvantages listed
above. Many national governments are likely to see the carbon market as an
opportunity for inward investment, climate mitigation and to generate broader social,
economic, and environmental benefits. Where this is the case, it is therefore in the
government’s interest to incentivise and enable carbon market activity within its
jurisdiction rather than to deter it.

outcomes authorised for use under Article 6 should in theory represent ‘higher-hanging fruit’,
from activities that the host country is not able to undertake themselves to achieve their NDC,
whether due to cost, availability of technology or ‘know-how’ or other reasons.

Climate Security and Sustainable Development 27

6.0. INITIAL AND POTENTIAL STEPS IN THE NEW CONTEXT

6.1 Categories of action

The previous two sections focused on the adoption of Article 6 guidance, and the
implications for market actors. This section looks more broadly at how governments
may act in the new context under the Paris Agreement, as they begin to implement
the measures needed to meet the targets in their NDCs. There are several distinct
forms of legislative and/or regulatory action that governments may choose to take in
relation to carbon finance within the new international context. Some of these
measures include:

TRACKING-
Governments may establish national registries or other mechanisms to keep track of
carbon market activities and the generation of carbon credits within their jurisdiction.
As mentioned earlier, this has for instance already been done by the government of
Colombia, which hosts a National Registry of Reduction of Greenhouse Gas Emissions.
It is also part of plans by the government of Indonesia which drew significant carbon
market attention in 202227. Implemented in isolation, such tracking measures would
not be expected to affect rights related to carbon credits.

APPROVAL-
Governments may introduce procedures and designated bodies to approve new
carbon market activities within their jurisdiction, or to otherwise manage the
generation of carbon credits. All governments intending to host activities registered
under the new crediting mechanism established by Article 6.4 will be required to take
this step, in order to provide approvals. However, it is possible that governments
extend approvals to projects registered with other crediting programmes, through
individual assessments or more general ‘positive lists’ of approved activity types. This
would have a bearing on the right of project proponents to generate carbon credits, if
their ability to implement a project is subject to a decision by the host government.

27 https://www.spglobal.com/commodityinsights/en/market-insights/latest-news/energy-
transition/040722-carbon-credit-issuances-from-indonesia-on-hold-developers-await-clarity

Climate Security and Sustainable Development 28

It is not clear if this step will be common in the context of the Paris Agreement, or if
governments – for capacity reasons or otherwise – will choose not to assert a right of
approval. There are though already examples of governments prohibiting certain
types of activities from generating carbon credits intended for the voluntary carbon
market, notably for forestry-based projects. The governments of Papua New Guinea
and Honduras for instance, both introduced moratoriums in 2022 on REDD+ projects
serving the voluntary carbon market28.

AUTHORISATIONS AND CORRESPONDING ADJUSTMENTS-

Governments intending to host activities under Article 6 will be required to establish a
legal basis, procedures, and institutional arrangements to authorise mitigation
outcomes for use by other entities, and to apply corresponding adjustments. The
ability for a government to authorise mitigation outcomes for use under Article 6 will
have a bearing on rights related to the use of carbon credits. An authorisation by the
host government will enable carbon credits with a vintage of 2021 or later to be used
for purposes that were otherwise not available, such as use towards an NDC or
CORSIA. Some governments are beginning to build readiness to provide
authorisations under Article 6. The government of Uganda, for instance, established
certain legal powers within its National Climate Change Act 202129, a step that a
number of other governments have also taken or are preparing to take.

INCENTIVES-
Governments may take a number of different steps that would incentivise the
generation or use of carbon credits within their jurisdiction. This could include steps to
improve the enabling environment for carbon market activity, such as tax incentives.
It could include building or enabling market architecture, such as a local carbon credit
exchange as planned in Malaysia30. It could also include establishing policy
frameworks that either directly lead to or enable the generation and use of carbon
credits. For example, both Brazil and India have recently introduced legislation that

28 https://www.spglobal.com/commodityinsights/en/market-insights/blogs/energy-
transition/071922-voluntary-carbon-markets-value-retention-host-countries
29 https://climate-laws.org/geographies/uganda/laws/national-climate-change-act-2021
30 https://carbon-pulse.com/169396/?utm_source=CP+Daily&utm_campaign=63dc8e2604-
CPdaily15082022&utm_medium=email&utm_term=0_a9d8834f72-63dc8e2604-110323781

Climate Security and Sustainable Development 29

will underpin the creation of new domestic compliance markets3132. Meanwhile
Singapore has announced that companies subject to its national carbon tax will be
able to use carbon credits to meet a portion of their compliance requirements33.

LEGAL CLASSIFICATION-
Governments may take new steps to provide certainty on the legal categorisation of
carbon credits within their jurisdiction, where this is currently ambiguous. This could
be considered as a form of incentive, as it could serve to provide greater confidence
for investors and other market participants, and to simplify private contracting
between buyers, sellers and financiers.

As a related point, governments may also take steps to clarify and regulate the nature
of the claim that entities can make when using carbon credits generated within their
jurisdiction. As discussed above, for instance, some governments may consider taking
steps to avoid explicit double-claiming between their NDC and an offsetting claim by a
company.

These categories show the types of measures that governments may choose to take
in relation to carbon market activity within their jurisdiction, whether to ensure
improved tracking of mitigation outcomes that can be counted towards the country’s
own NDC, to incentivise and manage the type of activity that takes place within the
jurisdiction, or to enable the authorisation of mitigation outcomes under Article 6 for
use by other Parties or entities. It should be noted that only the third measure –
authorisations and corresponding adjustments – is directly associated with Article 6.
Governments may choose to implement the other measures even in cases where they
have no intention to transfer mitigation outcomes internationally.

For project developers, changing legislation and any lack of clarity about future policy
direction will inevitably lead to uncertainty. As such, the way in which change is
managed by governments, and the timeliness with which they introduce changes,

31 https://www.gov.br/en/government-of-brazil/latest-news/2022/brazilian-government-
publishes-decree-that-regulates-the-carbon-market
32 https://www.bloomberg.com/news/articles/2022-08-02/india-planning-carbon-credit-
market-for-energy-steel-and-cement
33 https://carbon-pulse.com/159011/?utm_source=CP+Daily&utm_campaign=dafd6fd6ed-
CPdaily11052022&utm_medium=email&utm_term=0_a9d8834f72-dafd6fd6ed-110323781

Climate Security and Sustainable Development 30

may in some cases be just as material as the end-state they intend to move towards.
However, as is the case for any sector, this end-state itself will not be static.
Governments change, and the policies that they apply for the carbon market may
therefore change over time as well. This is a reality that market actors are likely to
need to prepare to manage in the period ahead, if and where governments decide to
take on a greater role with respect to the carbon market.

TAXATION
The relationship between carbon credits and taxation will also be important in the
new context under the Paris Agreement. While this does not directly affect rights
related to carbon credits, it is closely linked. Governments of course have and
generally choose to assert rights to tax economic activities within their jurisdiction.
If the scale and value of the carbon market grows, as is expected, in the years
ahead, we may see new approaches to taxation of carbon credit or carbon market
activities in the future.

There are broadly two categories of issue to consider:

1. Taxation policy related to carbon credits or mitigation outcomes, and activities
generating these
2. The eligibility of carbon credits for use within carbon taxation frameworks

TAXATION POLICY
Governments may in certain cases use tax policy, and tax incentives, to stimulate
the growth of domestic carbon market activity. This could result in lower purchase
costs for carbon credits, which may make carbon credits from that jurisdiction more
internationally competitive, therefore increasing demand and activity.

The main tax incentives that could be introduced by host governments are indirect
tax incentives, especially VAT treatment for purchasing and trading carbon credits
and direct tax incentives to boost supply. This is also connected with the specific tax
treatment of carbon credits for accounting purposes, as discussed in Chapter 2.
Through the indicated mechanisms, Host Parties can also influence the transactional
costs associated with the purchase of carbon credits. Appropriate use of tax
incentives can enable investment funds to be channelled towards project types that

Climate Security and Sustainable Development 31

 are prioritised by the government or could attract investment from specific entities,
such as locally based project developers.

With respect to indirect tax incentives, governments may also consider VAT
exemptions. At present, countries take various approaches on VAT treatment of
carbon credit trading.

In developing countries there is a trend to zero-rate international transactions so as

to attract new investments from entities in developed countries. In this model,
transactions between entities within a country may be taxed, but transactions with
foreign entities (non-resident transactions) will be zero-rated. Countries that have
implemented this type of incentive can attract new investors, while not entirely
excluding budget revenues linked to the voluntary carbon market.

At the same time, governments may choose to introduce new taxes, fees or levies
related to carbon market activities. Indonesia, for example, is reported to be
adopting new regulations that would require a portion of carbon credits from local
projects to be withheld, so these can if required be used towards the country’s
NDC34. It should be expected that other governments will be exploring similar plans.
The challenge for all governments intending to introduce new taxes or levies related
to the use of Article 6 and to carbon credits will be balancing the potential revenue
that could be generated with the potential impact on the attractiveness and
competitiveness of the jurisdiction for carbon market investment.

ELIGIBILITY UNDER CARBON TAXES

There are already several examples of governments enabling companies to meet a
portion of their obligations under a national carbon tax policy through the use of
carbon credits. This is for instance possible under the carbon taxes of both
Colombia, South Africa and South Korea, with varying criteria for the eligibility of
carbon credits.

34
https://carbon-pulse.com/177053/

Climate Security and Sustainable Development 32

 It is likely that we will see further examples of such policy approaches in the future.
The government of Singapore has already announced that it will permit the use of
carbon credits to meet a portion of a company’s obligations under its national
carbon tax in the future. Such policies may lead to greater demand for carbon
credits in the future, as well as clearer regulatory treatment. It is also an example
of the ability of governments to determine and shape the use of carbon credits, and
therefore their market value, as discussed elsewhere in this paper.

7.0 CONCLUSION AND FINAL MESSAGES

The carbon market now exists in a new context following both the adoption of an
Article 6 rulebook at COP26, and the beginning of the implementation period for
Parties’ first NDCs. The extent and nature of change stemming from these two drivers
is likely to vary between jurisdictions, depending on their legal and regulatory
regimes, the choices made and approaches adopted by governments. In some cases,
change – and any period of uncertainty in the build-up to change - may prove
disruptive to private sector investment. In other cases, change is likely to prove
supportive of private sector investment, for instance if governments introduce
frameworks, policies and/or tax incentives to enable and incentivise carbon market
activity. Like any market, private actors are likely to be drawn to jurisdictions that
create positive and more certain enabling environments.

It is also clear, when considering the distinction between rights related to generation,
ownership, and use of carbon credits, that the direct effect of the transition to the new
context under the Paris Agreement is likely to be quite targeted. It is not obvious, for
instance, that a project developer’s rights related to ownership of carbon credits
would need to be affected as a result of this new context. However, rights related to
the use of carbon credits will inevitably be affected, with governments holding the
authority to decide whether to authorise credits for additional uses, such as towards
NDCs or CORSIA, and whether to introduce requirements or guidance on the use of
carbon credits towards voluntary claims.

Finally, and as is often the case, the period of transition – and the uncertainty
inherent to this period - from the past context to the new context may prove more

Climate Security and Sustainable Development 33

disruptive for the private sector than the new status quo itself. One only has to look at
recent examples, such as reaction to comments (since clarified) by the Indian Power
and Renewable Energy Minister in August 2022, to see the effect of policy uncertainty
on market actors35.

This paper concludes with four key messages and recommendations, to inform the
transition to a new phase for the carbon market in the context of the Paris
Agreement:

• Uncertainty itself can cause disruption. Examples in 2022 show that market
actors do not respond well to instances where the intentions of governments with
respect to the carbon market are either ill-defined or not clearly communicated.
Governments can therefore support market confidence and investment through
clear communication and well-considered long-term plans. Project developers,
investors and financiers, in turn, can choose to mitigate the risks of this currently
uncertain environment through structuring and contractual protections.

• Markets involve shared interests. When functioning effectively, carbon markets

can bring considerable shared interest for project developers (who earn an income
from the sale of carbon credits), local communities (who benefit from investment
and co-benefits such as job creation) and national governments (whose climate
targets and plans are supported by the mitigation outcomes achieved through
market activities). Governments can take steps to maximise these benefits, for
instance through incentivising private investment into certain sectors and creating
a positive enabling environment.

• Local contexts matter. Each government will take a slightly different approach to
carbon markets in the future: the regulatory treatment of carbon rights, the
requirements on activities, and the willingness of the government to authorise
mitigation outcomes under Article 6 may all vary. Project developers and other
market actors should therefore understand the local context and requirements in
the jurisdiction in which they are operating, through legal and market diligence.

35 https://carbon-pulse.com/169050/

Climate Security and Sustainable Development 34

• Market action continues to matter. One of the drivers of change that is not
directly discussed in this paper is the growth of the voluntary carbon market in
recent years, and the broader recognition of the role that markets – both voluntary
and compliance - can play in achieving the goals of the Paris Agreement. While
some steps by governments in 2022 may have caused disruption in the carbon
market, lying behind these steps is an understanding that the carbon market – and
the emission reductions and removals achieved as a result of it – matter for
national targets and for global climate efforts. What will be important over the next
few years is that governments and the private sector find ways to work effectively
together in partnership, to realise the full potential of market activities to drive
climate security and sustainable development.

Climate Security and Sustainable Development 35