Global carbon pricing mechanisms and their interaction with carbon markets

The urgency of climate change and the need to mitigate it has been rising up the public and political agenda in recent years. Limiting global warming to a 1.5 degrees Celsius pathway should significantly reduce climate risk.

Financial markets play a fundamental role in helping to allocate capital efficiently; following on from this, carbon markets can provide price signals to efficiently allocate capital across the carbon cycle, and to manage the uncertainties in meeting the goal of net zero. Simply put, this goal is to conserve the world’s finite carbon budget under a 1.5 degrees Celsius scenario. However, markets need reliable environmental and energy benchmarks to support an efficient transition from high- to low-carbon energy generation, and to create asset classes for natural and technological carbon sinks.

This report begins by describing the main carbon-pricing instruments. These instruments are foundational, because they enable atmospheric pollution to be quantified, rather than treating it as an (uncosted) negative externality as was historically the case. It then explains the various ways the financial services industry contributes to progress towards net-zero targets, beyond straightforward project financing; its contribution includes ensuring market liquidity, delivering tools which aid in the creation and discovery of high-quality carbon credits, and reducing financing costs for new, clean-energy technologies. Finally, to the extent possible given limited data availability, the report quantifies the growth and scale of various carbon-pricing instruments and carbon markets: carbon-tax schemes, emissions trading systems (ETSs) and carbon-crediting programmes.

It is clear from the research that these markets have the potential to contribute in a significant way to net-zero targets, which have ever-greater reach: Carbon Trust estimates that by 2021, 90% of global GDP was covered by net-zero targets. But carbon markets still need greater scale to fulfil their potential in this regard.

As the use of environmental markets becomes more widespread, the UK has an opportunity to play a leading role in these markets’ ongoing development given its robust financial-market infrastructure combined with its strengths in energy and environmental markets.

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