Carbon Markets, Explained

Broadly speaking, there are two types of carbon markets: compliance and voluntary markets.

Compliance markets, also known as emission trading systems (ETSs), are regulated by governments, who allocate companies an annual carbon allowance. This carbon allowance is issued under mandatory systems, such as the EU Emissions Trading System (EU ETS) and the China Carbon Emission Allowances (CEA) scheme.

If companies emit more than their allowance, they must purchase allowances on the compliance market to cover the excess. Failure to do so could result in fines or penalties from the regulatory body that oversees the market. Conversely, if a company emits less than its cap, it can sell surplus allowances to other companies.

Voluntary carbon markets (VCMs) are aimed at financing projects that avoid or remove greenhouse gas emissions. Unlike compliance markets, the companies and individuals who use VCMs are not bound by any enforcement mechanisms. On a VCM, participants can purchase and trade carbon credits that correspond to verified emission avoidance or removal projects.

To limit global warming to no more than 1.5°C, as outlined in the Paris Agreement, global greenhouse gas emissions must fall by 45% from 2015 levels by 2030 and reach net zero by 2050.

Voluntary carbon markets play a critical role in achieving these targets by enabling cost-effective emissions reductions and mobilising private capital to invest in climate solutions.

The credits traded on carbon markets are generated through projects that either reduce greenhouse gas (GHG) emissions, prevent emissions from being generated in the first place or remove GHG from the atmosphere.

When organisations buy carbon credits, they are channelling capital towards a range of activities, from reforestation and methane capture to sustainable agriculture and carbon storage.

Compliance carbon markets, and the carbon allowances bought and sold on them, also have an important role to play in curbing global warming. For instance, they create economic incentives for companies to lower their emissions, allowing them to sell surplus credits in the market.

Companies may refer to HKEX’s Net-Zero Guide which introduces some of the essential steps they should take to develop a pathway to net zero and contribute to global net-zero targets.

Participating in carbon markets offers a wide range of benefits for the planet, and for businesses and institutions.

From an environmental perspective, carbon markets play a vital role in addressing the climate crisis. Global carbon emissions continue to rise, intensifying the greenhouse effect and accelerating global warming. Carbon markets provide an efficient and scalable mechanism to help achieve the global targets put in place to address these issues.

Carbon markets also offer both financial and strategic advantages for their participants, such as facilitating progress on corporate net-zero goals, enabling organisations to generate revenue by trading credits and channelling investment towards sustainability-focused initiatives.

The trading value of the world’s compliance market for carbon credits reached US$1.5 trillion in 2024, per Refinitiv. Emission trading systems and carbon taxes cover around 28% of GHG emissions produced around the world as of 2025, the World Bank estimates – a more than five-fold increase in coverage since 2005.

Nearly a third of the global population are living in a jurisdiction with a compliance market, according to data from the International Carbon Action Partnership.

VCMs are much smaller, with US$535 million in total reported transaction value in 2024, according to Ecosystem Marketplace. But they are rapidly developing in Asia, with platforms in China, South Korea, Japan, New Zealand, Australia and Singapore emerging in recent years.

A carbon credit represents the removal or avoidance of one tonne of carbon dioxide or its equivalent in other greenhouse gases. These credits can be bought by companies or individuals on VCMs to offset their own emissions.

Carbon credits are issued through carbon removal and avoidance projects. Purchasing carbon credits enable market participants to take responsibility for their unabated emissions in the short term as they transition to net zero.

To offset their emissions, the carbon credit owner can retire the credits. This ensures the reduction is only counted once. By turning verified emission reductions into transactable assets, carbon credits help reduce GHG emissions.

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Carbon credits can be described as either nature-based or technology-based, and as either for removal or avoidance.

Nature-based carbon projects and the credits they generate focus on protecting, sustainably managing and restoring nature, such as reforestation and wetland conservation. Technology-based carbon projects, such as cryogenic carbon capture, accomplish the same goal by using low temperatures to separate carbon dioxide from other gases.

Carbon credits from projects focused on emission avoidance prevent emissions from happening in the first place. Avoidance projects include investment in renewable energy, the protection of mature forests and wetland conservation.

Carbon credits from projects focused on emission removal revolve around removing existing emissions from the atmosphere. Removal projects include reforestation, revegetation and carbon capture.

Carbon credits are created from projects that either avoid or remove GHG emissions, and their lifecycle on carbon markets can be divided into four stages.

1. Project development – A project to avoid or remove GHG emissions is proposed, implemented and managed by project developers and submitted to a global standards body for approval. These projects can range in scope and type, from grassland restoration to the destruction of ozone-harming substances.
2. Validation and verification – A validation and verification body, recognised by carbon crediting standards organisations, assesses the proposed project against certain requirements, which vary from standard to standard.
3. Issuance – Once a project is certified by a global standards body, carbon credits are then issued by the standard body. Each credit has a unique serial number that is registered before a credit can be sold, traded or retired.
4. Retirement – Carbon credits are retired when their owner claims the associated emission reduction. From that point onwards, the credits are removed from circulation in the market and become carbon offsets.

The carbon market ecosystem includes a wide range of participants involved in the development, verification, buying, selling and retirement of carbon credits. We identify some of the principal groups below.

• Project proponents and developers – Project proponents own one or more carbon projects and are able to appoint others as project developers to plan, build and operate projects that remove or avoid carbon emissions.
• Standards bodies – Standards bodies provide rules, requirements and methodologies for carbon projects to follow to issue credits. They can be administered by national governments, non-governmental organisations and inter-governmental organisations like United Nations (UN) agencies.
• Validation and verification bodies – Validation and verification bodies are accredited, independent, third-party auditors who review the documents submitted by project developers to standards bodies. Validation occurs during the initial submission of a project, while verification is an ongoing process that occurs during the entire lifetime of a project and its associated carbon credits.
• Marketplaces – Marketplaces, like HKEX’s Core Climate, offer a platform for the selling and purchasing of carbon credits. They generally recognise the instant, secure and traceable settlement of carbon credit transactions.
• Intermediaries – Intermediaries facilitate the circulation of carbon credits throughout the market ecosystem by connecting project developers and buyers, from higher-volume trading for wholesale buyers to smaller lot sizes for retail investors.
• End-users – End-users purchase carbon credits with the express intention of retiring them and removing them from the market instead of trading them.

Carbon markets emerged in 1997 following the adoption of the Kyoto Protocol, which committed industrialised countries and economies in transition to limit and reduce greenhouse gas emissions.

The Protocol introduced market-based mechanisms that allowed countries to meet their emission reduction targets through the transfer or trading of emission reduction credits, commonly known as carbon credits. One of the first standards was introduced by the UN at this time, called the Clean Development Mechanism (CDM).

With the introduction of the Paris Agreement at COP21 and its operationalisation after COP29 through the Paris Agreement Crediting Mechanism (PACM), which tracks and issues credits for approved climate projects, the CDM has since been eclipsed.

The Paris Agreement, adopted in 2015 at COP21, is a legally binding international treaty that provides a framework for global cooperation on climate action and establishes the rules for effective carbon market mechanisms.

A key component of the Paris Agreement is Article 6, which outlines how countries can collaborate through international carbon markets to meet their emission reduction targets. It enables the transfer of carbon credits generated from verified reductions in greenhouse gas emissions between countries.

At COP29, key rules were finalized to activate international carbon markets under Article 6 of the Paris Agreement. Countries now have flexible options for transferring mitigation outcomes, enhancing clarity and legal certainty. For instance, a host country may apply corresponding adjustments at issuance or upon use.

Hong Kong has capacity to add value to global carbon markets because of its ability to facilitate the two-way flow of capital between Mainland China and international markets.

Hong Kong’s robust infrastructure, internationally aligned regulatory regimes, globalised ecosystem, transparent markets, deep pools of talent, and unmatched connectivity with Mainland China underpin its unique position as a leading international financial centre.

Globally, carbon markets are entering a transformative phase, driven by landmark developments at COP29 that lay the groundwork for robust, transparent and globally connected carbon trading.

Opportunities are growing. The global carbon market is on track to reach US$35 billion by 2030, according to MSCI, as compliance markets extend into new jurisdictions and existing programmes broaden their sectoral coverage, coupled with stronger linkage with voluntary markets. All this means fresh funds being channelled into green technology, nature restoration and sustainable development.

To be sure, challenges remain. Jurisdictional fragmentation is a barrier to cross-border trading, while inconsistent verification standards may undermine trust.

But the bottom line is that carbon markets are no longer a niche concept – they’re a cornerstone of global climate strategy. You can learn more about the role of carbon markets in unlocking a net-zero future by visiting our Core Climate hub.