Carbonomics 101: What are voluntary carbon markets and where do they fit within ESG strategies?

Published  8 MIN READ

With the momentum behind net-zero growing and institutional zero-emissions pledges making headlines, we take a closer look at voluntary carbon offsetting, carbon markets, and how financial institutions are using them as part of their sustainability strategies.

While carbon pricing has long been an area of debate, the race to net zero by 2050, if not earlier, has revived the idea of putting a price against one tonne of CO2 emitted or saved. The idea is to help shift the burden of damage from greenhouse gas (GHG) emissions back to those who are emitting them, and to ‘incentivise’ emitters to reduce their GHG output.

Nevertheless, a significant challenge of carbon pricing has been the ‘low-price tag’ for carbon emissions. In consequence, this has, so far, failed to send a strong enough signal to decision-makers to embark on a lower-carbon future. However, this is changing: in the compliance carbon market, the EU carbon price reached an all-time high at the start of September 2021 at €62 per tonne in intraday trading. Some of the appreciation may have been technical given the quieter summer period and expectations that there may be greater demand on gas in the winter, but the trajectory is clear. Interestingly, that was the 40th time in 2021 that the price of carbon hit a new record high (see chart below).

Price of carbon since 2014 (EUR per one tonne CO2)

Source: Sandbag2. EU ETS EUA Prices

So, with the momentum for net-zero growing, and institutional zero-carbon pledges making headlines*, how are financial institutions approaching these challenges and what role carbon credits play as a supplement to their sustainability strategies?

How to categorise GHG emissions

A good starting point in answering these questions is to understand the parameters of GHG emissions, which are classified in three scopes:

• Scope 1 covers direct emissions from owned or controlled sources
• Scope 2 covers all emissions released in the atmosphere from the consumption of purchased energy sources
• Scope 3 includes all other indirect emissions that occur in a company’s value chain

A few examples:

Scope 1Scope 2Scope 3
Fuel combustionPurchased electricityPurchased goods and services (e.g. supply chains)
Company vehiclesPurchased heat and coolingBusiness travel
Fugitive emissionsPurchased steamEmployee commuting
Waste disposal
Transportation and distribution (up and downstream)
Leased assets and franchises

Net-zero, carbon offsets and carbon markets

Cutting emissions is important but isn’t enough on its own to meet the Paris Agreement’s goal of limiting global warming to well below 2˚ C, ideally to 1.5˚ C, compared with pre-industrial levels. Carbon offsets, such as for example sequestration, will continue to play an important role in helping to remove pollution from the atmosphere.

With emissions of all three scopes required to be fully offset by 2050 (or another given date depending on country laws/policies), the voluntary carbon market can go some way towards helping organisations meet this objective. The principle behind this is straightforward: reducing emissions as much as possible is the top priority, while a small and often unavoidable remainder of emissions can be ‘neutralised’ with carbon offsets that equate to the remaining exposure. These offsets, or generated carbon credits from a third party, represent projects such as sequestering carbon, restoring peatlands or preventing deforestation, to name a few.

Carbon markets and the FI world

How, then, do financial institutions (FIs) use carbon markets as part of their sustainability strategies?

Having surveyed various FIs earlier in 2022, it’s fair to say that the organisations were at very different stages of their journey. While some said they are still learning about how to effectively measure and monitor all three scopes of GHG emissions, others told us they are considering a public net-zero target pledge with definite deadlines. Another group of FIs mentioned that they are looking at how carbon offsets could be used to supplement their portfolios and support their organisation’s wider objectives to reduce residual risks, or how the purchase of carbon credits could help protect natural habitats and biodiversity.

Key takeaways from the survey included:

  • It starts with the right metrics: there’s a lot of work underway at the moment to get the data/metrics in place that help measure GHG emissions in the first place; not a simple or straightforward task, as pointed out by many.
  • Carbon credits in demand: FIs have been using a wide range of carbon credits over the years, particularly for their own operational emissions (Scopes 1 & 2), but increasingly also for Scope 3 emissions; alongside switching to renewable sources. With an increasing number of FIs considering offsets, it is possible that the costs for offsets will increase.
  • Who’s to pay: there’s an ongoing discussion about who should pay for the offsets e.g. the asset manager or the asset owner?
  • Inclusion of carbon credit in emission targets: there are divergent views when it comes to the question of allowing carbon credits to be used to achieve emission targets. Organisations that have signed up to the Science Based Target initiative (SBTi) are not allowed, by definition, to use offsets, although offsets are still considered valuable for the residual carbon footprint. By contrast, the Net Zero Asset Managers’ (NZAM) initiative allows for offsets if there is no financially or technologically viable alternative.
  • Divestments not a quick solution: selling off high-emitting assets may not be the answer to support the transition to net zero or to achieve systemic change.

Looking more closely at different categories of FIs, this is what the survey results revealed about each group:


  • Active support for carbon credits: some banks already apply or strongly support the generation of carbon credits. The credits are bespoke in nature or for their own bank offsetting initiatives. In particular banks with public net-zero commitments are using carbon credits. However, banks have not applied carbon offsets to the carbon emissions (Scope 3) of their loan portfolios.
  • Net-zero not universal: not all banks have net-zero ambitions. Instead, they have set themselves percentage targets for certain dates; often applying different targets and timelines to the different scopes.
  • Disclosures vary substantially: mainly depending on bank size, disclosures range from full emission breakdown per scope to no disclosure whatsoever for some of the smaller/start-up banks.
  • Building societies vary in approach: while some use carbon offsets already, others make no mention of their emissions or targets in their published reports.

Asset managers

  • Net-zero funds: in the past three years, an increasing number of asset managers have launched funds targeting net-zero investment options.
  • Verifying offsets: different asset managers are using different sources for their offsets and different ways of verifying them. Verified Carbon Standard (VCS) and Gold Standard were the most frequently mentioned.
  • Only a minority of asset managers are currently willing to buy carbon credits: while a few asset managers have agreed to buy and absorb the costs of carbon credits for specific portfolios, this clearly was the minority of those we surveyed. However, some are open to discussing carbon credits but are not yet set up to do so at a portfolio level. Also, it seems that asset owners have not (yet) fully embraced carbon credits.
  • Seeking dialogue about net zero: many portfolio managers indicated that they are keen to continue engaging with the underlying companies to promote emission reductions rather than those companies relying on carbon credits.
  • Emissions matter: if all else is equal, portfolio managers are likely to choose the lower-emitting company over a higher-emitting company if all other metrics are similar (and available), emphasising how ESG data is affecting portfolio management and investment decisions.

Pension funds

  • Feeling the pressure: apart from regulatory pressure, pension funds are also increasingly challenged by organisations such as MakeMyMoneyMatter to consider public net-zero targets. As a result, some are discussing carbon credits as an option with their asset managers, despite the fact that it will likely be the asset manager that buys and holds the carbon credit on the pension fund’s behalf.
  • Carbon offsets and fiduciary duty: there are questions around the appropriateness for pension funds to use carbon offsets given their fiduciary duty (and when the offset itself does not explicitly provide an expected return but incurs a cost, thereby reducing the return). Others argued that if carbon credits rose in value then they could be sold in the future as a net gain. Some however, were open to the idea of using carbon offsets (albeit described as ‘early stage’ thinking), if it could help them meet their net-zero target or impact objectives.
  • Data and disclosures: similar to other FIs, many pension funds are still working on getting emission data right as well as their disclosures – for example aligning them with the Task Force on Climate-Related Financial Disclosures per the recent regulations.

What’s next?

Carbon credits are not a new concept, although they are arguably gaining more attention as more entities adopt net-zero targets and are looking at portfolio emissions and ways to reduce them – as well as the growing focus on establishing robust infrastructures to reduce some of the unknowns. Carbon credits are seen by many as a ‘last resort’ but a useful step nonetheless in helping to sequester carbon from the atmosphere. With prices set to increase, if much of the increased demand expected from FIs does start feeding through into carbon-credit pricing, questions around when the right time is, the extent to which FIs engage and the technology which they use to do that, could well dominate agendas.

Follow our Carbonomics 101 series, where we address these questions (and more), to help you stay informed on the development of the carbon markets and learn about the role they play in achieving net zero. For our next instalment we will be taking a look at what the voluntary carbon markets mean for corporates.

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*NatWest achieved Net Zero Carbon across its operations in 2020. We achieved this through a combination of emissions reductions, alongside offsetting residual Scope 1, 2 and 3 emissions (business travel) through the purchase of internationally recognised TIST (The International Small Group and Tree Planting Program) Carbon Credits.

[1] EU Emissions Trading System
[2] Closing ECX EUA Futures prices, Continuous Contract #1. Non-adjusted Euro price based on spot-month continuous contract calculations. Source: