carbon credit

Report of the Study Group on Financial Infrastructure for Carbon Credit Trading

Norbert Gehrke

28 Jun 2025 — 9 min read

Carbon credits are expected to play an important role in achieving carbon neutrality by 2050, including providing incentives for decarbonization efforts. With the full-scale operation of the emissions trading system starting from fiscal year 2026, further expansion and diversification of trading is anticipated. Under these circumstances, similar to other financial assets, ensuring investor protection through improved transparency and financial integrity is crucial for the sound development of carbon credit trading.

From this perspective, the Study Group on Financial Infrastructure for Carbon Credit Trading (chaired by Professor Naoko Nemoto of Waseda University Graduate School of Business Administration) began in June 2024 and conducted a total of seven meetings. Through hearings with stakeholders primarily from the financial sector, the group worked to understand the actual situation of carbon credit trading while discussing initial issues and other topics.

Based on these discussions, the Study Group has compiled and now has published the "Report of the Study Group on Financial Infrastructure for Carbon Credit Trading".

The report begins by establishing the critical role of carbon credits in achieving Japan's 2050 carbon neutrality goals. Credits are seen as an essential tool for providing economic incentives for decarbonization efforts and for offsetting residual emissions. With the anticipated full-scale launch of Japan's emissions trading scheme in fiscal year 2026, demand for credits for compliance purposes is expected to grow, leading to a significant expansion and diversification of the market. In this context, the report argues that, like any other financial asset, the sound development of the carbon credit market hinges on enhancing transparency and integrity to ensure proper investor protection.

The study group's work is framed within an international context, referencing the November 2023 report by the International Organization of Securities Commissions (IOSCO) on promoting the financial integrity of voluntary carbon markets, as well as high-level principles issued by the United States and the United Kingdom. The primary objective of this report is to analyze the current dynamics of carbon credit trading in Japan, focusing on J-Credits and overseas voluntary credits, and to identify and discuss the key issues from a practical and expert perspective. By presenting a comprehensive overview and organizing the key challenges related to financial integrity, the report aims to deepen the understanding of market participants and contribute to the healthy evolution of the trading ecosystem. It explicitly states that it does not prescribe the specifics of environmental integrity for individual credits nor does it delve into the policy design of the upcoming national emissions trading scheme, which are under the purview of other government bodies.

Part 1: The Current State of Carbon Credit Trading

This section provides a detailed fact-finding analysis of the carbon credit market, covering its conceptual framework, product characteristics, trading trends, supply and demand drivers, and the various functions within its ecosystem.

Conceptual Framework

The report draws a fundamental distinction between two primary mechanisms. The first is "Baseline & Credit," where credits are generated by certifying the reduction or removal of greenhouse gas emissions below a projected baseline. This category includes Japan's domestic J-Credit system and various international voluntary credits (e.g., from Verra's VCS, Gold Standard). This is the primary focus of the report. The second mechanism is "Cap & Trade," where a legal cap is set on total emissions for certain entities, and allowances are traded to meet compliance obligations. Examples include the EU Emissions Trading System (EU-ETS). While conceptually distinct, the report notes that these two systems become interconnected when credits from "Baseline & Credit" schemes are permitted for use within "Cap & Trade" compliance frameworks.

Product Characteristics

Carbon credits, while sharing the common feature of representing a quantifiable reduction in greenhouse gases, are highly diverse and complex. Their characteristics, which directly influence demand and price, include:

Creation Methodology: Credits are distinguished by their origin, such as "emission reduction/avoidance" (e.g., renewable energy projects, improved energy efficiency) versus "carbon removal" (e.g., direct air capture, afforestation). They are also categorized as technology-based or nature-based, with each type having different attributes and perceived values.
Credibility (Environmental Integrity): This is a cornerstone of a credit's value. Key aspects include additionality (the project would not have happened without the revenue from credits), permanence (the carbon reduction is not reversible, a key risk for forestry projects), and robust measures to prevent double counting. The report stresses that doubts about a credit's integrity can severely undermine its price and damage confidence in the entire market. It notes that credibility is typically assured through rigorous verification processes managed by standard-setting bodies and registries, such as the government-backed process for J-Credits or the systems of international bodies like Verra and Gold Standard.
Co-benefits: Beyond carbon reduction, many projects offer additional positive impacts, such as biodiversity conservation, improvements in air and water quality, or benefits to local communities. These "co-benefits" can significantly increase the demand and price for certain credits.
Associated Risks: Trading in carbon credits involves various risks, including price volatility, reputational risk (from using low-quality credits), counterparty risk in transactions, operational risks, and project-level risks (e.g., project failure or delays in credit issuance).

Trading Trends in Japan

The market is currently dominated by J-Credits and overseas voluntary credits. While historically trading was opaque and primarily conducted through bilateral over-the-counter (OTC) transactions, a major development was the establishment of the Carbon Credit Market on the Tokyo Stock Exchange (TSE) in 2023. This has introduced a new level of transparency and liquidity for J-Credits, with daily publication of prices and volumes. The report notes that as of April 2025, cumulative trading volume on the TSE market reached nearly 800,000 t-CO2. However, the majority of global carbon credit trading still occurs in OTC markets, reflecting the diverse nature of projects and buyer needs.

Demand and Supply Factors

Demand Drivers: The primary motivations for purchasing credits are threefold: (1) Reporting and Disclosure, for offsetting emissions under frameworks like Japan's Act on Promotion of Global Warming Countermeasures or for ESG reporting; (2) Compliance, to meet mandatory obligations under schemes like the upcoming national emissions trading system; and (3) Speculative/Investment, for profiting from anticipated price increases. The report highlights that the potential for J-Credits to be used in the 2026 compliance market is a significant future demand driver.
Supply Factors: Supply is driven by the economics of credit-generating projects. The primary constraints are the significant time, cost, and complexity involved in project development, monitoring, reporting, and verification (MRV). The report notes a consensus among study group members that current domestic supply is insufficient to meet potentially large future demand, especially from hard-to-abate industries. Initiatives like the TSE market's market-maker system are intended to improve liquidity and thereby incentivize new project development and increase overall supply.

The Trading Ecosystem

The report maps out the various players and their functions:

Trading Platforms: These are divided into exchange-style platforms like the TSE market, which offer centralized, anonymous, and price-driven trading of standardized credit categories, and marketplace-style platforms, which facilitate bilateral OTC trades by allowing buyers to browse and select specific credits from individual sellers.
Intermediaries: Financial institutions, securities firms, and trading houses play a crucial role in facilitating transactions, providing liquidity, and connecting buyers and sellers. Some are also acting as market makers on the TSE. A notable trend is "local production for local consumption," where regional banks help local businesses sell locally generated credits to other companies within the same region, thereby keeping the economic benefits localized.
Project Development Support: Various entities are providing capital and expertise to help stand up new carbon credit projects, including through direct investment, lending, or the creation of dedicated carbon funds.
Related Financial Products and Services: The ecosystem is evolving to include more sophisticated financial offerings, such as insurance products to cover reputational and other risks, credit-linked bonds, investment funds with carbon credit exposure, and the use of technology. Fintech solutions like blockchain are being explored for tokenizing credits to enhance traceability and enable fractional ownership, while AI is being used to efficiently analyze complex project documentation to assess credit quality.

Part 2: Key Issues for Improving Transparency and Integrity

Building on the fact-finding analysis, this section organizes the key challenges and potential solutions for fostering a sound market, structured around the different participants in the ecosystem.

General Principles for All Participants

Information Disclosure and Conflict of Interest: Proper disclosure is paramount. This includes transparency from registries on credit characteristics, from platforms on trading rules and prices, and from sellers on the products they offer. Robust mechanisms for managing conflicts of interest are essential, especially when a single entity performs multiple roles (e.g., project developer and verifier).
Legal Compliance and Participant Capability: All participants must adhere to relevant laws, including financial regulations, and avoid unfair practices. Crucially, given the market's complexity and novelty, the report emphasizes the need for "capacity building" across the board. All stakeholders—buyers, sellers, intermediaries, and infrastructure providers—must enhance their knowledge and literacy regarding carbon credit products and market practices.
Collaboration and Legal/Accounting Clarity: The report calls for greater collaboration among domestic and international players to share best practices and promote interoperability. It also identifies the urgent need for clear legal and accounting standards. Defining the legal nature of a carbon credit (e.g., as a form of property right) and establishing consistent accounting treatment are critical for providing legal certainty and enabling advanced financial activities like using credits as collateral.

Issues for Intermediaries and Credit Sellers

Appropriate Product Explanation: Sellers and intermediaries have a fundamental duty to provide clear, accurate, and suitable explanations of the credits being sold, tailored to the buyer's knowledge, experience, and objectives. This is especially critical given the informational asymmetry that often exists. The explanation must cover the credit's core characteristics, including its integrity, methodology, and any associated risks. This principle extends to complex products that embed carbon credits, such as tokens or structured notes.
Customer-Centric Business Operations: Financial institutions involved in the market are expected to uphold the principles of customer-centricity, ensuring their actions are in the best interests of their clients.

Issues for Exchanges and Trading Infrastructure

Registry Accuracy and Fair Access: The integrity of the credit registry system is the bedrock of the market, as it prevents double counting and ensures clear title. Furthermore, trading platforms must provide fair and non-discriminatory access to all qualified participants to promote liquidity and efficient price discovery.
Robust Risk Management: Trading and settlement infrastructure must have robust risk management systems to mitigate operational risks and, critically, counterparty risk in transactions. The report cites the TSE's use of an escrow mechanism for settlement as a good practice.
Standardization and Derivatives: To overcome market fragmentation, the report advocates for greater standardization of data formats, contract terms, and product designs. Looking ahead, it notes that while derivatives can provide valuable hedging and price discovery functions, their introduction requires a mature and stable underlying spot market with a solid legal and regulatory framework.
Transparency of Credit Rating Agencies: As rating agencies for carbon credits emerge, their methodologies must be transparent and they must have strong governance to manage potential conflicts of interest, aligning with best practices for ESG rating providers.

Issues for Credit Buyers

Informed Use of Services: Buyers are encouraged to utilize credit rating and insurance services to conduct due diligence and manage risks effectively. However, they should not rely on these services blindly and must retain ultimate responsibility for understanding the credits they purchase.
Transparency in Offsetting Claims: This is a critical point for preventing greenwashing. When companies use credits to make claims about emissions reductions or carbon neutrality, they must provide detailed and transparent disclosure about the credits used. The report aligns this with the requirements of international standards like those from the International Sustainability Standards Board (ISSB) and their Japanese equivalent (SSBJ), which call for disclosure on the type, origin, and credibility of credits used to meet climate targets.
Strategic Position of Credits: The report reinforces the widely held principle that offsetting with carbon credits should be a complementary measure used after a company has made all feasible efforts to reduce its own direct emissions within its value chain. Credits should not be used to justify inaction on internal decarbonization.

Conclusion

The report concludes by reiterating that the carbon credit market is in a nascent, complex, and rapidly evolving stage. Its healthy development requires a concerted effort from all participants. The key themes identified are the urgent need for enhanced capacity building (literacy), greater collaboration among stakeholders, robust and transparent information disclosure, sophisticated risk management, and clarity on the legal and accounting status of credits.

Looking forward, the report suggests that market participants should build upon the issues raised to develop and share best practices. It also strongly implies that Japan should formulate its own set of high-level principles for ensuring the transparency and integrity of its carbon credit market. Such principles would be informed by the analysis in this report and aligned with the high-level guidance already provided by international bodies like IOSCO and leading jurisdictions, thereby ensuring the Japanese market develops in a manner that is both domestically sound and globally credible.