All eyes on carbon markets amid belated progress and domestic challenges

Trading in greenhouse gas (GHG) emissions and reductions has long been touted as a way of leveraging market forces to tackle climate change in the most cost-effective manner, and 2025 may put that theory to the test amid momentous progress and fresh challenges.

For over a decade now, California has required most emitters in the state to participate in a market for emissions allowances. Washington launched a similar program in 2023, and other states are exploring ways to join that effort.

At the global level, following a breakthrough at the late 2024 climate conference (COP29) in Baku, Azerbaijan, 2025 marks the first year when long-awaited carbon markets under Article 6 of the landmark 2015 Paris Agreement are fully operationalized.

Countries can use the Article 6 mechanism to help achieve their Paris Agreement pledges, and private actors can participate to further enhance climate action outside of those national commitments.

At the same time, the Trump Administration is targeting state climate initiatives, including California’s cap-and-trade market, as part of a broader deregulatory push, and the US has again announced its intent to withdraw from the Paris Agreement, removing the world’s largest per capita emitter from the Article 6 market.

Given these developments, emissions trading regimes are expected to figure heavily in discussions at climate week events kicking off this month in San Francisco and Washington, DC. This alert provides key context on what is at stake in the battle over carbon markets.

A brief history of carbon markets

Carbon markets have been a key feature of international climate policy since the 1997 Kyoto Protocol. That treaty, which was adopted under the United Nations Framework Convention on Climate Change (UNFCCC), established the Clean Development Mechanism (CDM) and Joint Implementation (JI) as flexible mechanisms to allow developed countries to meet their emission reduction targets by investing in projects that reduce or avoid emissions in developing countries or other developed countries.

Despite being the world’s largest emitter at the time, the US famously “unsigned” the Kyoto Protocol and refused to participate in the CDM/JI market, limiting the market mechanism’s scope and impact.

Following what many deemed a failure of the Kyoto Protocol’s top-down approach, Parties to the Convention adopted the Paris Agreement, which uses a bottom-up approach of voluntary nationally determined contributions (NDCs) to limit global warming to well below 2 degrees Celsius, and preferably to 1.5 degrees Celsius, increased temperatures over pre-industrial levels. A key feature of the Paris Agreement is Article 6, which provides for the establishment of voluntary cooperative approaches and mechanisms to facilitate the participation of Parties in the mitigation of GHGs and the mobilization of climate finance.

Article 6 envisages the creation of carbon markets where Parties can use internationally traded mitigation outcomes (ITMOs) under Article 6.2 to help achieve their NDCs, and where non-Party actors can trade additional emission reductions outside of the NDCs under Article 6.4 (A6.4ERs), in addition to various nonmarket approaches. But the operationalization of Article 6 was delayed by unresolved technical and political issues, such as how to account for emission transfers, the avoidance of double counting, the generation and allocation of emission units, the role of the private sector, and the linkage with other market mechanisms.

After nearly a decade of negotiations, Parties to the Paris Agreement had failed to meet multiple deadlines for finalizing the detailed rules and guidance for the Article 6 mechanisms and credits until November 2024, when a series of compromises at COP29 in Baku finally resolved the remaining issues.

Despite significant participation in these international negotiations and the increasing focus on international carbon markets as a way of curbing global emissions, the US federal government has never implemented its own carbon pricing scheme or domestic compliance market (a national cap-and-trade bill was passed by the US House of Representatives in 2009 but was not taken up by the US Senate).

Against this backdrop, some US states took the lead in developing their own emissions trading systems. The most prominent of these is the California cap-and-trade program, which Governor Arnold Schwarzenegger signed into law in 2006. California’s program covers about 85 percent of the state’s emissions and is integrated with the Quebec cap-and-trade system.

The California–Quebec market is expected to expand in the coming years, with Washington State recently passing a cap-and-invest bill that seeks to link its market with California and Quebec (California and Quebec would also have to approve the linkage). New York is also expected to issue its own cap-and-invest regulation later this year. These state-led approaches require regulated entities to purchase emission state-issued emission allowances through auctions or secondary markets, with some proceeds dedicated to climate and environmental projects.

Separately from these compliance markets, a robust network of voluntary carbon markets has evolved to allow private entities to meet their own voluntary climate commitments. These markets operate largely outside of official mechanisms, although carbon credits are often heavily regulated under domestic commodities laws to prevent fraud.

Voluntary carbon markets have weathered heavy criticism in recent years, with some environmentalists arguing that credits issued under current and past methodologies lacked sufficient rigor to ensure actual, permanent, and verifiable reductions. Nevertheless, voluntary carbon markets have garnered increasing attention as a way of catalyzing climate action and achieving emissions reductions at the lowest cost.

Indeed, one of the most prominent advocates for the use of voluntary carbon markets, Mark Carney, recently became Canada’s Prime Minister, and recent polls suggest he will make a strong showing when Canadians go to the polls later this month. Whether he will use his office to continue advocating for voluntary carbon markets remains to be seen.

Article 6 finally crosses the finish line

Article 6 has three key mechanisms:

• Article 6.2 sets out the accounting rules for “cooperative approaches” involving the exchange of ITMOs to help achieve countries’ NDCs
  
  
• Article 6.4 establishes a centralized Paris Agreement Crediting Mechanism (PACM) to issue financial security interests in emissions reductions, or A6.4ERs, that participating countries or other entities can use to achieve additional ambition beyond their NDCs, and
  
  
• Article 6.8 creates a framework for nonmarket approaches (NMAs) to support holistic and collaborative mitigation and adaptation actions.

Since the adoption of the Paris Agreement in 2015, countries have been negotiating the rules and guidelines needed to operationalize the provisions of Article 6. The complexity and significance of these rules have required extensive deliberations and technical work. The finalization of these rules at COP29 in Baku was the culmination of years of effort, and represented a critical milestone in the implementation of the Paris Agreement.

The final rules are expected to enhance the transparency, integrity, and effectiveness of international carbon markets, providing countries with the tools they need to meet their climate goals more efficiently and ambitiously.

Article 6 recognizes that some countries will engage in voluntary cooperation through ITMO trading and participation in a centralized crediting mechanism to be administered under the UNFCCC. It also provides for the use of A6.4ERs, which are essentially voluntary carbon credits bearing the UNFCCC’s seal of approval.

The conclusion of these negotiations under Article 6 completed the final chapter of the so-called “Paris Agreement Rulebook,” known more formally as the “Paris Agreement Work Plan.”

COP29 decisions on Article 6

At COP29, Parties adopted the remaining outstanding technical guidance to fully operationalize Article 6 after resolving the larger issues underpinning the international rules for carbon markets in 2021 at COP26 in Glasgow.

COP29 marked a significant milestone by finalizing operational rules for Articles 6.2, 6.4, and 6.8. The most significant aspects of these decisions with respect to market mechanisms include:

• For Article 6.2, the COP29 decision creates a dual-layer international registry system that includes a basic accounting function, Parties’ reported ITMOs and emissions balances in tabular format, and an ITMO issuance function on request for countries that lack the domestic capacity to issue ITMOs themselves. The decision also sets out the conditions and procedures for authorizing, transferring, and using ITMOs, as well as the reporting and review process to ensure consistency and avoid double counting.
  
  
• For Article 6.4, the COP29 decision sets out the authorization procedures for “mitigation contribution” emissions reductions issued under the PACM and their possible transfer to the international registry as ITMOs. The decision also tasks the Supervisory Body of the Mechanism (SBM) with developing further guidance on specific concepts and methodologies for assessing emissions reductions, including for removals activities, and approving a set of priority methodologies to start issuing carbon credits in 2025. Further, the decision allows credits issued from afforestation and reforestation activities under the Kyoto Protocol’s CDM to transition to the PACM if they align with Article 6.4 rules. Under the PACM, participants must also set aside a share of the proceeds from credit purchases to the Adaptation Fund, which finances climate adaptation projects in developing countries.
  
  
• For Article 6.8, the COP29 decision adopts guidance for carrying out the second phase of the work program under the framework for NMAs, including the nomination of focal points and submissions to the NMA Platform, a database that requires international cooperation. Parties emphasized that more support in developing and implementing NMAs and further engagement with a broad range of non-Party stakeholders is needed.

Article 6 is expected to play a key role in enhancing the cost-effectiveness, flexibility, and scalability of climate action, and to foster innovation, collaboration, and sustainable development.

Its successful implementation will depend on the quality and ambition of the latest round of NDCs that countries were obligated to submit by February 10, 2025, as well as the robustness and transparency of the accounting and reporting systems that will track and verify the emissions reductions achieved through Article 6.

Countries and other actors can demonstrate their readiness and willingness to use carbon markets as a tool to accelerate the transition to a net-zero-emissions and climate-resilient world.

The Trump Administration and carbon compliance markets

President Donald Trump’s second term is continuing his first Administration’s skepticism of climate policy. On his first day in office, President Trump issued Executive Order (EO) 14162, titled “Putting America First in International Environmental Agreements,” which directed immediate notification of withdrawal from the Paris Agreement and “any agreement, pact, accord, or similar commitment made under the United Nations Framework Convention on Climate Change.”

EO 14162 also directed the immediate cessation or revocation of “any purported financial commitment made by the US under the United Nations Framework Convention on Climate Change.” The EO also previewed potential additional steps to disengage from multilateral climate action by requiring various Administration officials to “certify a report to the Assistant to the President for Economic Policy and Assistant to the President for National Security Affairs that describes in detail any further action required to achieve the policy objectives set forth in section 2 of this order.”

America’s withdrawal from the Paris Agreement, including Article 6, will not take effect until one year passes from the date of the notification of withdrawal. Until then, the US remains a Party to the Paris Agreement and could, at least in theory, participate in the Article 6 mechanisms. But few expect the US to do so, meaning the Article 6 market will be effectively deprived of participation by the country with the largest gross domestic product and the largest per capita emitter of climate-change causing GHGs.

Whether Article 6 can deliver on its potential without US participation remains unclear. But the US refusal to join the Kyoto Protocol is widely considered one of the key reasons for that agreement’s underwhelming performance.

On April 8, 2025, the Administration also took aim at state-operated compliance markets with another EO – EO 14260 – this one titled “Protecting American Energy from State Overreach.” EO 14260 singles out so-called “climate superfund laws” in Vermont and New York, which seek to make fossil fuel companies financially responsible for in-state costs related to the impacts of climate change, and what the EO characterizes as California’s policy of “punish[Ing] carbon use by adopting impossible caps on the amount of carbon businesses may use, all but forcing businesses to pay large sums to ‘trade’ carbon credits to meet California’s radical requirements.”

The EO directs the US Attorney General (AG), in consultation with relevant executive departments and agencies, to:

“identify all State and local laws, regulations, causes of action, policies, and practices … burdening the identification, development, siting, production, or use of domestic energy resources that are or may be unconstitutional, preempted by Federal law, or otherwise unenforceable. The Attorney General shall prioritize the identification of any such State laws purporting to address ‘climate change’ or involving ‘environmental, social, and governance’ initiatives, ‘environmental justice,’ carbon or ‘greenhouse gas’ emissions, and funds to collect carbon penalties or carbon taxes.”

The EO continues that the AG “shall expeditiously take all appropriate action to stop the enforcement of State laws and continuation of civil actions identified” through that process. Thus, although the EO had no immediately enforceable legal effect on state climate laws, the expectation is that the AG will move swiftly to challenge those laws once the Administration settles its approach to them. Depending on that approach, it could present significant obstacles for states looking to lead in areas ceded by the federal government.

Looking ahead

The next UN climate conference, COP30, will be held in November 2025 in Belém, Brazil. COP30 is expected to be pivotal in assessing the early performance of Article 6 and identifying opportunities to enhance its effectiveness.

With the clock ticking on the Paris Agreement’s 2030 goals, carbon markets are expected to play a central role in scaling up global climate action. The US will technically still be Party to the Paris Agreement when COP30 convenes. But given the Trump Administration’s position regarding international environmental agreements, US participation in Brazil is expected to be muted at best.

On the home front, state compliance markets for GHG emissions may also face challenges, at least in the short term. During the first Trump Administration, many Democrat-led states took action to address climate change within their jurisdictional reach. Although the Administration repeatedly denounced state climate policies as contrary to the national interest, few official steps were taken to interfere with those laws. This time, EO 14260 on state climate policies could break that impasse and potentially restrict how states use market programs to address climate change.

All of this action leaves voluntary carbon markets essentially untouched. But signals of weakening demand in compliance markets may suppress confidence – and thus prices – in voluntary markets as well. The Trump Administration’s aversion to corporate climate pledges may subject companies making those pledges to greater scrutiny. That could lead to less participation in voluntary carbon markets.

For more information

To learn more about how developments related to carbon markets might affect your business interests, please contact the authors for additional information.