Carbon Credit Accounts

Europe: The EU Emissions Trading System (EU ETS)

1. Regulatory Framework:

• The EU ETS operates under the Directive 2003/87/EC, amended several times, most notably by Directive (EU) 2018/410 and Directive (EU) 2023/959, which governs the reduction of greenhouse gas emissions in the EU.
• The system covers around 10,000 power stations and industrial plants, flights within the European Economic Area and, since 2024, maritime transport, accounting for around 40% of the EU’s greenhouse gas emissions.

2. Cap Setting and Allocation:

• The cap represents the maximum allowed emissions, decreasing annually to ensure a gradual reduction in overall emissions. This is defined in phases; for instance, Phase 4 (2021-2030) originally aimed at a 43% reduction compared to 2005 levels; the 2023 revision raised the target for the sectors covered to 62% by 2030.
• Allowances are either allocated for free (to avoid carbon leakage, i.e., the transfer of industries to countries with laxer emissions rules) or auctioned. The majority of the allowances are auctioned, with the remainder allocated based on benchmarks related to the efficiency of installations.

3. Project-Based Mechanisms:

• Until 2020, the EU ETS allowed the limited use of international credits from the Clean Development Mechanism (CDM) and Joint Implementation (JI) under the Kyoto Protocol.
• These mechanisms allow companies to invest in emission reduction projects in developing countries (CDM) or other developed countries (JI) and receive credits (CERs or ERUs) in return. Since the start of Phase 4 in 2021, such credits can no longer be used for compliance in the EU ETS.

4. Market Stability Reserve (MSR):

• To address the surplus of allowances and ensure the stability of the market, the EU introduced the Market Stability Reserve (MSR) in 2019. This mechanism adjusts the supply of allowances in the market, thus preventing extreme price volatility.

United States: Regional and Voluntary Programs

1. California Cap-and-Trade Program:

• Established under the California Global Warming Solutions Act of 2006 (AB 32), California’s Cap-and-Trade Program is the broadest carbon pricing system in the U.S., covering the large majority of California’s emissions. Legislation signed in September 2025 extended it, as “cap-and-invest”, through 2045.
• The program sets an economy-wide cap on GHG emissions and allows covered entities (e.g., large industrial facilities, electricity generators, and fuel distributors) to trade allowances. Each allowance permits the emission of one metric ton of CO2e.

2. Allowance Distribution:

• Allowances are distributed through a combination of free allocation (to protect industries at risk of carbon leakage) and quarterly auctions conducted by the California Air Resources Board (CARB).
• Companies can also generate offsets by funding projects that reduce or remove greenhouse gases outside the capped sectors. Examples include forestry projects, methane capture, and destruction of ozone-depleting substances. These offsets are verified and approved by CARB, with specific protocols in place to ensure they represent real, additional, and permanent emission reductions.

3. Regional Greenhouse Gas Initiative (RGGI):

• RGGI is a cooperative effort among Northeastern and Mid-Atlantic states, operating since 2009; its membership has changed over time. It focuses on CO2 emissions from the power sector.
• Each state in RGGI issues CO2 allowances in quarterly auctions, and the proceeds are often reinvested in energy efficiency, renewable energy, and other consumer-benefit programs.
• The regional cap declines every year (by 3% a year from 2021 to 2030).

4. Voluntary Carbon Markets:

• Beyond compliance markets, voluntary carbon markets (VCMs) operate globally. They allow companies, governments, NGOs, and individuals to purchase carbon credits to offset their emissions voluntarily.
• Credits in VCMs are generated through projects such as reforestation, renewable energy, and community-based initiatives. Standards like the Verified Carbon Standard (VCS), the Gold Standard, and the American Carbon Registry (ACR) govern these projects to ensure integrity.

Trading of Carbon Credits

Marketplaces and Trading Mechanisms:

1. Primary Market:

• EU ETS Auctions: In Europe, allowances are primarily distributed through auctions. The European Energy Exchange (EEX) conducts the EU auctions; ICE Futures Europe hosts the auctions of the separate UK ETS. These exchanges conduct regular auctions where allowances are sold to the highest bidder, providing a transparent mechanism for price discovery.
• California Cap-and-Trade: In California, CARB conducts quarterly auctions, jointly with Québec, where entities bid for allowances. These auctions are closely monitored to prevent market manipulation and ensure compliance with state regulations.

2. Secondary Market:

• Spot and Futures Trading: Carbon credits are traded on secondary markets, where they can be bought and sold like any other commodity. The most liquid and transparent markets are on platforms like the EEX and ICE. These exchanges offer spot contracts, futures, and options, allowing companies to hedge against price volatility or speculate on future price movements.
• Over-the-Counter (OTC) Trading: In addition to exchange-based trading, many transactions occur in the OTC market. Here, companies trade directly with each other, often through brokers who match buyers and sellers. OTC trades are less transparent but offer flexibility in terms of contract structure and delivery terms.

3. Pricing Dynamics:

• Prices in carbon markets are influenced by regulatory developments, the overall cap level, economic activity, and the availability of offsets. The price of EUAs, for example, has seen significant volatility, influenced by factors like the economic downturn in 2008, reforms in the EU ETS, and expectations around future climate policies.

Exchanges for Carbon Credits:

1. European Energy Exchange (EEX):

• Based in Leipzig, Germany, the EEX is a major exchange for EUAs and other carbon instruments in Europe, offering spot, futures and options contracts.
• EEX also hosts auctions for EU member states, ensuring the transparent allocation of allowances under the EU ETS.

2. Intercontinental Exchange (ICE):

• ICE Futures Europe, based in London, is the most liquid venue for EUA futures and also lists UK allowances. California Carbon Allowance (CCA) futures trade on ICE Futures U.S.
• ICE Futures U.S. also lists futures on RGGI allowances.

3. Chicago Mercantile Exchange (CME):

• The CME has ventured into the carbon markets by offering futures contracts linked to voluntary carbon credits. These contracts are standardized, making it easier for participants to trade voluntary credits in a regulated environment.

4. Voluntary Carbon Market Platforms:

• Platforms like the Carbon Trade Exchange (CTX) and Xpansiv CBL provide marketplaces specifically for voluntary carbon credits, supporting the growth of VCMs by offering transparent pricing and transaction mechanisms.

Transfer of Carbon Credits Between Banks

1. Registry Systems:

• In both the EU ETS and U.S. programs, carbon credits are tracked through electronic registry systems. In Europe, the single Union Registry, operated by the European Commission since 2012, tracks the ownership and transfer of allowances; national administrators open and manage the accounts.
• In the U.S., California uses the Compliance Instrument Tracking System Service (CITSS), while RGGI utilizes its own CO2 Allowance Tracking System (COATS). These registries ensure that every carbon credit is uniquely identified and cannot be double-counted.

2. Account Management:

• Market participants, including banks, must open registry accounts to hold and transfer carbon credits. These accounts are similar to bank accounts but are specifically for the holding and trading of carbon instruments.
• Banks may act as custodians, holding carbon credits on behalf of clients, or as market participants trading on their own account.

3. Transaction Process:

• When carbon credits are transferred, the process is executed through the registry system, ensuring a secure and transparent transfer. For example, in the EU ETS, if a company sells EUAs to another, both parties’ registry accounts are debited and credited accordingly, reflecting the new ownership.
• The transfer typically occurs in real-time, with the registry updating balances immediately upon confirmation of the transaction.

4. Cross-Border Transactions:

• Cross-border transfers of carbon credits can involve different registry systems, depending on the jurisdictions. In such cases, coordination between registries is required to ensure that the credits are correctly debited from one system and credited to another, maintaining the integrity of the credit.
• For instance, transferring credits between the EU ETS and Switzerland’s linked carbon market involves synchronization between the Union Registry and the Swiss Emissions Trading System registry.

5. Clearing and Settlement:

• For trades executed on exchanges like the EEX or ICE, clearinghouses (e.g., European Commodity Clearing, ICE Clear Europe) manage the clearing and settlement process. This ensures that the buyer and seller meet their obligations, mitigating counterparty risk.
• The clearinghouse acts as the central counterparty, guaranteeing the transaction and ensuring that the carbon credits are transferred only after payment has been confirmed.