INTRODUCTION

Greenhouse Gas (“GHG”) emissions, including carbon dioxide emissions resulting from human activity, have had the most catastrophic impact on climate change and global warming since the mid–20th century. Global carbon dioxide emissions from fossil fuels and industries totalled 37.15 billion metric tons (GtCO₂) in 2022 and rose to a record high of 37.55 GtCO₂ (1.1 percent increase) in 2023. Since 1990, global CO₂ emissions have increased by more than 60 percent. Many international efforts have been made to address this environmental issue, including two important accords i.e., the Kyoto Protocol and the Paris Agreement, which price carbon emissions through a mechanism of carbon credits.

A carbon credit is a tradable permit or certificate generated either by (i) emission reductions or removals through certified climate action projects (also known as offset credits) or (ii) issuance of allowances from a regulatory body that provides the holder of the credit with the right to emit one additional tonne of carbon dioxide or an equivalent of another GHG.

GLOBAL FRAMEWORK

The first global effort to reduce GHG emissions worldwide was the Kyoto Protocol, which was adopted in 1997, came into force in 2005 and set legally binding targets for certain industrialised countries to reduce their emissions. In 2015, parties to the United Nations Framework Convention on Climate Change (UNFCCC) signed the Paris Agreement at the United Nations Climate Change Conference (COP 21). The Paris Agreement called on all participating countries to set voluntary non-binding emissions targets through ‘nationally determined contributions’ (“NDCs”). Article 6 of the Paris Agreement allows countries to voluntarily cooperate to achieve emission reduction targets set out in their NDCs using the following three approaches:

The Paris Agreement also stipulates a mechanism of “corresponding adjustments” to prevent double counting of emission reductions (where two countries separately account for the same GHG reductions resulting from the same emission-reduction project) through a form of double-entry bookkeeping. 

At the 2021 United Nations Climate Change Conference (COP 26), it was decided that the Clean Development Mechanism (“CDM”) under the Kyoto Protocol, which issued certified emission reductions (“CERs”), would cease in relation to emission reductions occurring after 31^st December 2020. Thereafter, the Paris Agreement effectively superseded the Kyoto Protocol. At present, A6.4ERs cannot be traded until the Supervisory Body formulates the rules for trading and a centralised registry like CDM is developed. Until then, a process for the transition of CDM projects to Article 6.4 mechanism, as well as temporary measures to allow the CDM executive board to take certain decisions, has been put in place.

India, through the Ministry of Environment, Forest, and Climate Change (“MoEFCC”), has notified the National Designated Authority for the Implementation of the Paris Agreement (“NDAIAPA”) as the national authority for implementing India’s commitments under the Paris Agreement. In February 2023, the NDAIAPA released the list of activities to be considered for trading carbon credits under bilateral/ cooperative approaches under the Article 6.2 mechanism. The list includes renewable energy with storage, solar thermal power, offshore wind, green hydrogen, compressed biogas, carbon capture utilisation and storage activities, etc.¹

INDIAN FRAMEWORK

As of February 2024, India has formulated various energy certificate schemes as well as carbon credit trading scheme and green credit programme. A brief on these schemes is set out below: 

Perform Achieve Trade Scheme (“PAT Scheme”)

Under the PAT Scheme, designated consumers who overachieve the energy consumption targets and standards allocated to them are issued Energy Savings Certificates (“ESCerts”) by the Bureau of Energy Efficiency (“BEE”), an agency under the Ministry of Power (“MoP”). These designated consumers can then trade the ESCerts on energy exchanges with other designated consumers who underachieve their targets. ESCerts are issued under the Energy Conservation Act, 2001.

Renewable Energy Certificates Scheme (“REC Scheme”)

The REC Scheme aims to promote the usage of renewable energy and facilitate the compliance of Renewable Purchase Obligations (“RPO”) under the Electricity Act, 2003. If obligated entities fail to fulfil their RPOs, they can meet the shortfall by purchasing Renewable Energy Certificates (“RECs“) which are regulated under the Central Electricity Regulatory Commission (Terms and Conditions for Renewable Energy Certificates for Renewable Energy Generation) Regulations, 2022 (“REC Regulations”). A single REC represents the environmental attributes of the generation of 1 MWh of energy produced by renewable sources. The REC Regulations define obligated entities as entities which are mandated to purchase a certain percentage of electricity from renewable energy sources, as a percentage of their total consumption of electricity, and eligible entities as entities eligible for issuance of RECs. RECs can be traded on energy exchanges or through electricity traders and purchased by obligated entities to meet their RPO.

Carbon Credit Trading Scheme (“Scheme”)

In pursuance of the Energy Conservation (Amendment) Act, 2022, the MoP notified the Carbon Credit Trading Scheme in June 2023. The Scheme classifies entities into non-obligated and obligated entities. Non-obligated entities are entitled to purchase carbon credit certificates voluntarily, and obligated entities are mandated to achieve GHG emission intensity targets as notified by the MoEFCC. Under the Scheme, entities that overachieve the set targets are issued carbon credit certificates (equivalent to one tonne of carbon dioxide or its equivalent) and entities that fail to achieve the set targets are required to meet the shortfall by purchasing carbon credit certificates from the market. The Scheme directs the Central Electricity Regulatory Commission (“CERC”) to act as a regulator, and the power exchanges to act as the platform for trading activities for the Indian carbon market. 

In December 2023, the Ministry of Power amended the Scheme to include the offset mechanism along with the compliance mechanism.² The amendment directs the BEE to develop standards for and register projects under such offset mechanism, allowing non-obligated entities to register decarbonisation projects and actively contribute to generating carbon credits.

In October 2023, the BEE released a draft of the detailed procedure for the compliance market under the Scheme. Under the detailed procedure, obligated entities will be informed of their annual GHG emissions targets for 3 years, which will be subject to revision after the cycle’s conclusion. Obligated entities must adhere to these targets, and those exceeding them earn carbon credits, while those falling short can purchase carbon credits. To this end, obligated entities are required to implement transparent, independent, and credible monitoring and reporting arrangements for GHG emissions.

The detailed procedure categorises GHG emissions into three components: (i) Direct emissions (originating from sources owned or controlled by the obligated entity); (ii) Direct process emissions (resulting from industrial processes unrelated to combustion); and (iii) Indirect emissions (occurring as a consequence of the obligated entity’s activities but taking place outside its boundary). Once GHG emissions are verified for an obligated entity through a detailed and thorough process, the BEE has been authorised to issue carbon credit certificates to the entity. 

After the issuance of carbon credit certificates, obligated entities are required to register themselves on the Indian carbon market registry within 4 weeks, with the objective of getting the equivalent carbon credit certificates credited into the respective obligated entity registry account. Non-obligated entities interested in purchasing carbon credits may also register on the registry. Once registered, entities can trade carbon credit certificates on power exchanges, according to the procedure defined by the CERC. In addition to dealing with the issuance and trading of carbon credit certificates, the detailed procedure also allows for the banking of certificates wherein obligated entities may bank the additional/balance carbon credit certificates from a compliance cycle for use in subsequent cycles. These banked certificates are also permitted to be sold to other obligated entities or non-obligated entities. 

Green Credit Rules, 2023

In October 2023, the MoEFCC notified the Green Credit Rules, 2023 (“Rules”), which launched a Green Credit (“GC”) programme to incentivise environment-positive actions through a market-based mechanism, which allows for the generation and trading of GCs.³ GCs, unlike carbon credits, can be generated by any action that has a positive impact on the environment, including afforestation, water or waste management, sustainable agriculture or infrastructure, pollution reduction, forest conservation etc. Under the Rules, any person or entity may register any environment-positive activity with the administrator for the issuance of GCs. The Rules have designated the Indian Council of Forestry Research and Education as the administrator. The administrator is required to verify the environment-positive activity through a designated agency, post which it can issue a GC certificate to the applicant. The administrator is also tasked with developing the framework for the trading platform where GCs may be bought and sold. The Rules also mandate the development of a GC Registry for the registration and issuance of each GC. The Rules clarify that an activity generating GCs may also generate carbon credits under the Scheme. While the Rules lay down the overall methodology and procedure for the generation and trading of GCs, detailed guidelines are still in the process of development.

CARBON MARKET

A carbon market is a trading system where one can buy and sell carbon credits and make the reduction, removal, or allowances of emissions, a tradable asset. Carbon markets may be divided into various categories based on the approach namely, removal of emissions or allowance of emissions or based on the obligations imposed namely, compulsory or voluntary. A brief explanation of the types is set out below: 

Based on approach

• Removal or Reduction of Emissions (offset approach/baseline-and-credit system): In this system, emission reductions or removals are measured with reference to a hypothetical baseline emission that would have been generated in the absence of the proposed green project. Generated credits may either be consumed or sold to other entities who are required to balance out their carbon footprint.
• Allowance of Emissions (emissions trading system/cap-and-trade system): Under this system, entities are required to comply with legally binding caps on the total amount of emissions they are allowed to emit per year. Entities that are able to reduce their emissions and save the allocated allowances can sell them to entities that have exceeded the maximum/allocated emissions limit.

Based on obligations imposed

• Compulsory: Compulsory or compliance markets are developed and used by governments and impose mandatory obligations on entities who are required to account for their GHG emissions. Such obligated entities are required by law to meet pre-set carbon reduction targets. These targets may be met under either of the approaches set out above.
• Voluntary: The voluntary market enables the government, organisations, individuals, companies, etc. (largely driven by corporate social responsibility goals) to purchase emission reductions or removals that are verified by independent third-party certifying entities, like Gold Standard, VERRA, etc. Voluntary markets largely involve projects developed under the offset approach and the resulting emission reductions or removals are referred to as voluntary emission reductions.  

Compulsory and voluntary markets can be further classified into the primary market and the secondary market.

The Indian carbon market includes both offsets (under the REC scheme) and emissions trading system (under the PAT scheme). However, historically, the voluntary market and projects under the CDM have been most successful in India. As of February 2024, India has a total of 1527 projects at different stages of registration under VERRA⁴ and Gold Standard.⁵

WAY FORWARD

As per India’s updated NDCs under the Paris Agreement, it now stands committed to reducing the emissions intensity of its GDP by 45% by 2030 and achieving about 50% cumulative electric power installed capacity from non-fossil fuel-based energy resources by 2030.⁶ In addition, India is taking active steps to cooperate with other signatories to the Paris Agreement and tackle climate change by developing a robust domestic compliance market for carbon credits. Given such ambitious climate goals, expansion and standardisation of the Indian carbon market is a pressing need. 

A crucial step towards the development of the market would be the creation of a registry and/or certifying authority for carbon credits similar to VERRA or the Gold Standard. As of date, India only has one carbon registry i.e., the CR-I (Carbon Registry – India), a private registry run by the Network for Certification and Conservation of Forests. The Scheme has proposed for the Grid Controller of India Limited (which currently handles the registry of RECs) to be designated as the Indian carbon market registry. A well-developed carbon market would require multiple competing registries, in line with global standards, as well as government oversight to develop uniform criteria for the issuance and verification of carbon credits. 

Standardisation of the market is an equally important issue, given that the Indian carbon market includes multiple schemes, instruments and metrics. A uniform market that permits the conversion of instruments and allows fungibility between similar instruments would greatly increase the demand for carbon credits in the domestic as well as international markets. A parliamentary intent can be seen for planning a transition of the existing instruments into uniform carbon credit certificates⁷ with a standard metric i.e., one tonne of carbon dioxide equivalent (tCO2e). However, such a proposition raises concerns regarding the mechanism and formula for conversion as approximately, 56 lakhs RECs and 44 lakhs ESCerts are currently unsold in the Indian carbon market.⁸

Historically, Indian stakeholders have demonstrated comfort with the offset approach in comparison to the emissions trading system (ETS). However, globally, compulsory markets are typically regulated under an ETS. Therefore, to develop a robust compulsory market and tap into the global ETS market (which amounts to 63 billion USD, by some estimates), Indian players would require capacity building to understand, adopt, and scale the ETS market in India. 

Currently, carbon credits can be traded through both spot and derivatives contracts (futures, options, or forward). Derivatives can be traded on exchanges like NSE, BSE, or MCX (known as exchange-traded derivatives) or between the two parties without the involvement of an exchange (known as over-the-counter derivatives). Derivatives are mainly used for speculation or hedging of risk. One of the main reasons for the failure of future contracts of CERs launched in the year 2008 on MCX and NCDEX can be attributed to the isolation of foreign participants from the Indian commodity derivatives market, making it difficult for them to hedge the risk involved in carbon price fluctuations in the physical carbon market. However, in 2022, SEBI permitted foreign portfolio investors to participate in exchange-traded commodity derivatives in India subject to certain conditions.⁹

Exchange-traded commodity derivatives are regulated by the Securities Exchange Board of India (“SEBI”) in accordance with the Securities Contracts (Regulation) Act, 1956 (“SCRA”). In 2016, carbon credits were notified as “commodity derivatives” under the SCRA by the Central Government in consultation with SEBI. However, the Scheme has designated CERC as the regulator of trading activities in the Indian carbon market and the power exchanges are obligated to seek approval of CERC before commencing trading in carbon credit certificates. In 2021, the jurisdictional issue between SEBI and CERC with regards to various forms of contracts in electricity was resolved by the Supreme Court of India, wherein it was decided that CERC will regulate all physical delivery based forward contracts whereas financial derivatives will be regulated by SEBI.¹⁰ At present, there is no derivative trading of carbon credits in India. However, once the Indian carbon market becomes operational, there could be similar conflicts between regulatory bodies like CERC and SEBI, as seen with electricity derivatives. Accordingly, clear guidance from regulators and the government is necessary to address jurisdictional issues and establish clear procedures for the Scheme’s implementation. 

In relation to the export of carbon credits, there appeared to be a regulatory intent initially to impose a ban on the exports of carbon credits to the extent required to meet India’s NDCs. However, in August 2023, the Minister of Power stated that India is open to allowing the export of carbon credits to countries that buy green hydrogen from it.¹¹

Once the detailed procedure introduced by BEE is implemented, it will mark a significant step in establishing a robust carbon credit trading programme in India and will bring additional clarity to the operation of the carbon market in India. With a focus on annual targets for obligated entities, categorised emissions, and a meticulous calculation process, the framework provides a comprehensive approach. The transparent monitoring, verification, and reporting mechanisms, overseen by accredited agencies, ensure adherence to GHG emission intensity targets. The registration and trading of carbon credits on the Indian carbon market add a practical dimension to the program. Overall, the initiative holds the potential to drive sustainable practices, reduce emissions, and contribute to India’s commitment to environmental responsibility. 

While India has taken steps towards building its carbon market, the Government may look to draw from its own experience of administering the PAT Scheme and REC Scheme as well as experiences abroad such as the EU-ETS, Korean-ETS, to further develop and refine the existing framework. 

[1] Available at https://pib.gov.in/PressReleseDetail.aspx?PRID=1900216

[2] Available at https://beeindia.gov.in/sites/default/files/CCTS%20Notification.pdf

[3] Available at https://egazette.gov.in/WriteReadData/2023/249377.pdf

[4] Available at https://registry.verra.org/app/search/VCS/All%20Projects

[5] Available at https://registry.goldstandard.org/projects?q=&page=1

[6] Available at https://pib.gov.in/PressReleaseIframePage.aspx?PRID=1847812

[7] Available at https://powermin.gov.in/sites/default/files/uploads/LS09022023_Eng.pdf

[8] Available at https://energy.economictimes.indiatimes.com/news/renewable/credibility-of-india-carbon-credit-market/101666885

[9] Available at https://www.sebi.gov.in/legal/circulars/sep-2022/participation-of-sebi-registered-foreign-portfolio-investors-fpis-in-exchange-traded-commodity-derivatives-in-india_63474.html

[10] Available at https://pib.gov.in/PressReleseDetailm.aspx?PRID=1761701

[11] Available at https://www.cnbctv18.com/environment/carbon-credts-transfer-buy-green-hydrogen-india-countries-power-minister-rk-singh-renewable-energy-transition-17434041.html