CREDIBLE EMISSIONS REPORTING: OPPORTUNITIES FOR IMPROVED
ALLOCATION IN EMISSIONS TRADING SYSTEMS
ByInterWork Alliance (IWA) Carbon Emissions Token (CET) Taskforce1,2
In this paper, the Carbon Emission Token (CET) Taskforce discusses the evolution of today’sCarbon Compliance Markets (CCMs) and explores the transformative role CET could play inenhancing these markets, specifically around carbon accounting and reporting in Emissions Trading
Systems (ETSs) and cross-jurisdictional carbon leakage. Key takeaways include:••

Advances in digital Monitoring, Reporting and Verification (dMRV) and related tools can play arole in addressing systematic inaccuracies in carbon emissions reporting
A CET can facilitate reporting transparency within a CCM, as well as identifying the embodied
emissions in international trade referenced across markets to address carbon leakage.

Emissions Trading: A Climate Mitigation Success Story
Since the Paris Agreement in 2015, carbon-pricing initiatives, such as national carbon taxes
and regional emissions trading systems (ETSs), have stood as a success story in the fight against
climate change. The EU ETS, for example, the largest and longest-running cap-and-trade system in
the world, has achieved an estimated 1 billion tonnes of greenhouse gas (GHG) emissions avoided
between 2008 and 2016.3 There are 29 other ETSs in force as of this writing, with over a dozen
more under development or under consideration. In 2022, they collectively traded over $900B in
permits and brought sectoral emitters responsible for ~17% of global emissions under regulatory
scrutiny.
Market-based decarbonization approaches such as these are not a panacea. They are one
tool in a multi-pronged strategy to reduce carbon on a global scale, but demonstrably an importantone. If widely reported gaps between actual emissions and Paris Agreement reduction targets set
for 2030 can’t be narrowed in time – and less than seven years remain to do so – we are unlikely to
succeed without pricing carbon to leverage the power of markets to drive behavioral change.
Last year, 46 countries and 33 supra and sub-national jurisdictions operated carbon pricing
mechanisms, collectively reaching ~30% of global emissions. Under a carbon tax, regulators
establish a fixed rate that businesses subject to the tax must pay for each tonne of CO2e they emit.
Conversely, a cap-and-trade system distributes a limited number of carbon emissions “allowances”
1
This paper was authored by members of the Global Blockchain Business Council and InterWork Alliance’s
Carbon Emissions Token Taskforce. If you would like to get involved with the Taskforce or want more information, pleasecontact iwa@gbbcouncil.org.
2
The views expressed in this paper do not necessarily reflect the views of the individual taskforce members or theorganizations they represent.
3
https://www.nature.com/articles/s41598-023-28154-6#:~:text=Statistical%20evidence%20shows%20
that%2C%20between,such%20as%20California%20and%20Massachusetts.

1

– either by free allocation or primary market auction – to covered businesses. Figure 1 offers a
simplified view of how the ETS markets function. It depicts three countries with emissions allowances
assigned to industries in country A and B (dashed lines) that produce added-value products, such as
steel or cement.
Figure 1. Overview of ETSs and their inefficiencies:

Source: Authors
As illustrated, the overall supply of allowances is designed to fall over time, with eachallowance authorizing one tonne of emissions. Industries emitting less CO2e than their allocations
permit (green boxes) can then sell that surplus to covered businesses with excess emissions (orangeboxes). Unused or unallocated allowances can be traded on secondary markets using both spotor derivatives contracts (futures, options, swaps, etc.). The intent is to leverage supply and demand
to empower ETS participants to find the optimal use of their decarbonization resources with theirsectorial and industry contexts. As the supply of allowances falls (or demand increases) prices tend
to rise, increasing the incentive to decarbonize. In contrast to a tax, which sets a predefined price,an ETS relies on price discovery catalyzed through the trading of allowances at market rates to keep
regulated entities within their pre-allocated carbon budgets.

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Addressing Methodological Challenges To Optimize Performance
These CCMs face two core challenges: (1) how to ensure accurate, consistent, andtransparent emissions reporting within the ETS; and (2) how to manage the potential for carbon
leakage, the phenomenon where industries move their operations – and in turn emissions – toforeign jurisdictions that lack, or less effectively enforce, carbon pricing mechanisms. Since climatechange is a global problem, such regulatory arbitrage directly undermines the objective of an ETS.
A robust ETS must find ways to price emissions outside of its jurisdictional boundaries and ensure
emissions are accurately and transparently reported internally and externally. This is the purposeof the EU’s proposed carbon border adjustment mechanism (CBAM). Represented by the tradebalancing arrows at the bottom of Figure 1, this is a solution approved by the European Commission
to address carbon leakage in the EU ETS. It taxes embodied emissions of imported goods at a rateequivalent to the price of allowances auctioned in the ETS.
As an unintended consequence, countries without an ETS could become a magnet
for high-polluting industries operating in jurisdictions with an ETS. Although environmentallycounterproductive, it becomes economically rational for businesses in Countries A and B to offshore
their facilities to Country C and re-import the final goods. Inefficiencies such as this make it harder tomore closely match allocations with emissions, which is the animating purpose of an ETS in the firstplace, as the Figure illustrates with red shading.
As the carbon markets evolve, like all markets, they undergo transformations which improverates of success in overcoming major obstacles. Current emission accounting methodologies
and verification practices provide solutions to the twin problems of reporting and leakage, which
cap-and-trade markets around the world converge on. These solutions are deemed sufficient toaddress. Yet, a policy effective at managing yesterday’s problem can quickly look wanting in lightof tomorrow’s circumstances, and, in the fight against climate change, the stakes are rising fast.
Both the accuracy and consistency with which regulated emissions are measured, and the degreeof openness and transparency with which those results are disclosed to the public, can now beimproved.
It is important to improve measurement inaccuracies and disclosure to ensure that
CCMs continue to thrive, especially as public scrutiny of all climate change regulatory policies
increases. ETS administrators are dependent on covered businesses demonstrating complianceby surrendering allowances – or, where permitted, offset credits – equal to self-reported annualemissions. Self-reported historical emissions are also commonly used to calculate baseline
allowances. While most ETSs require verification performed by an accredited independent thirdparty, which provides a credible guard rail for the market, that typically only reveals departures froman established monitoring plan. Where that plan is less robust in applied MRV and methodology,
the ETS may inadvertently over-allocate allowances, and, in so doing, fail to set a carbon budget
sufficiently constrained to incentivize reductions. An ETS that fails to provide open, transparent
reporting of on-going emissions may be unable to detect and deter behaviors at high risk for carbon
leakage. In both scenarios, efficient and effective carbon price discovery in the CCMs would be atrisk. Using best available methodologies and maximizing transparent public reporting of the results
achieved is also critical to the success of complementary policies such as the EU’s CBAM.

3Implementing New Solutions Enabled By Emerging Tech: CET
How, then, with no bank, asset manager, or corporation unaffected by carbon regulations
proliferating across the world, can we help to deliver carbon reporting that is transparent, auditable,and delivered in a more timely manner? Part of the solution: tokenized carbon emissions with linked
digital measurement, reporting, and verification (dMRV). New tools are needed to rise above thehistorical snapshots vulnerable to systematic under-estimation of carbon production, as well as toreduce the moral hazard created when businesses are free to use opaque reporting standards.
Improving Emissions Accounting and Reporting Accuracy and Transparency. While someETSs may ask for direct measurement using continuous emissions monitoring systems, this is notalways possible in practice. Regulated entities are usually instructed to estimate their annual carbon
footprint based on emissions factors and manually collected activity data. This is generally sufficient.
In concept, the scope 1 emissions targeted by ETSs are not challenging to estimate with precision,
assuming in practice the methodologies used to do so are sound and implementation occurs
without incident. By contrast, emerging plans to start adding harder-to-measure direct emissions
such as methane leakage, or the indirect emissions of imported goods as is required under the EU’sCBAM, warrant improvements in both accounting and reporting systems.
These can include incorporation of automation, remote sensing instruments, machinelearning, IoT, nested accounting, public ledgers, or other modern digital MRV tools. Not all estimatesbased methodologies for calculating emissions are created equal. One may involve rigorous analysis
of a company’s granular spending data, while the next may depend on a highly generalized averageof emission intensity that ignores local variations in geography, technology stack, or operational
practices. Still another may be over-reliant on incomplete or expired data, or it may derive its
emissions factors from obsolete technology. Estimates may also be inherently easier to manipulate
versus direct measurement, whether intentionally or inadvertently. And, of course, climate science iscontinuously improving; it is not uncommon for significant gaps to be identified between emissions
as estimated versus measured directly, as has occurred in other contexts.
Certainty in how a company regulated under an ETS is reporting its emissions is crucial tomaintaining the confidence in that ETS as a tool for combating climate change. If historical emissions
are inflated, too many allowances will be issued; if annual emissions are undercounted, excess
emissions will be hidden; if MRV requirements merely seek to verify compliance with specified
methodologies, weaknesses inherent in those methods will be exploited by regulated entities todelay emissions reductions. While the VCM’s flaws have drawn more attention, the VCM was lessthan $2B in 2021, with just 116M tonnes of CO2e in trade and only 0.3152% of global emissions
covered. By contrast, the world’s ETSs, of which there are currently 29 in force, had $909B in deal
flow, encompassing 17% of global emissions.
Scaling an effective and politically acceptable ETS across multiple jurisdictions requires both
effective internal measurement and reporting, and coordination with external markets to address
carbon leakage. What role can CET play in achieving this? First, CET is presented as a tool to advancereporting transparency internal to a CCM referencing across different markets. It is not being
proposed as a mechanism for the trading of allowances under an ETS. The focus is on using CET asa public registry of the scope 1 emissions of a business to compare against available ETS allowances,and help regulators coordinate trade.

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Table 1. Positioning of CET within an ETS:
Organizational scope (directemissions)Internal Credible identification of allowanceto ETS
surplus and deficits
Reference ETS allowances andExternaltransactions made by organizations into ETS
external markets/geographiesProduct scope (embodied emissions)Credible identification of internal ETS
allowances an importer must purchase
Reference of the carbon footprint of products
sourced from an external jurisdiction

Table 1 summarizes different options for positioning CET based on both internal and external factors of a CET, as well as organizational and product value chain emissions.
For an example of internal positioning related to the organizational scope, consider theEU Emission Allowances (EUAs) used in its regional ETS. At the close of the reporting cycle, anorganization can trade excess EUAs. CET could be used to facilitate the discovery of an organization’s
EUA surplus or deficit. Verified CET data would support the credible discovery of internal trading
rights or obligations of companies. Using a CET to publicly report inventories referenced by an
ETS could also facilitate the disclosure of methodologies used by different organizations, as wellas assess the quality of data used as a basis to determine a company’s budgeted allowance andorganize trade.
Improving Carbon Leakage Detection and Prevention. CET can play an even more impactfulrole in identifying gaps and potential carbon leakage resulting from activities external to a single
ETS. This deals specifically with the pricing of embodied emissions in the trade of international
goods, such as under the EU CBAM. The CBAM integrates externally sourced goods into the EU
ETS, requiring importers to pay a tariff for the applicable embodied emissions equal to the price ofEUAs. It includes provisions that allow importers to discount the number of allowances they must
purchase. For example, an importer that sources goods, such as cement, produced by a business inChina is subject to its own national ETS.
Such cross jurisdictional accounting is one design feature to avoid CBAM being labeled as abarrier to trade under WTO rules. This includes exceptions under the General Agreement for Tariffs
and Trade (GATT) for the protection of the environment.4 CET records can be used to reference
payments made by organizations in different regional carbon markets. These records can be usedin conjunction with cross-border taxation mechanisms, like CBAM, to assist importers reported
environmental costs paid in the source country in accordance with GATT exceptions.
Managing carbon leakage under CBAM requires tracking embodied emissions beyond
organizational accounting. This is a particular use case for the CET under a product life cycle scope.
This covers the tracking of emission records under the product life cycle approach in line with thePathfinder Framework for the exchange of product carbon footprint data. In the case of EU ETS,
product CETs can offer a reference of the embodied emissions of goods sourced outside of the EU,
and the total amount of EUAs that importers are required to purchase and surrender under CBAM.
By tracking the various organizations involved in a product life cycle, CET can facilitate the tradebalancing rules described above.
4

https://www.wto.org/english/tratop_e/envir_e/envt_rules_exceptions_e.htm

5In the examples outlined above, different instances of CET can be used to support thediscovery of an organization’s direct, or a product’s indirect, reporting obligations linked to an ETS.
While this offers some degree of flexibility, coordination of different CET instances and carbon
markets is crucial. Companies subject to an ETS must consent to the use of the CET instance they
participate in. Similarly, the market operator must confirm the adequacy of the CET instance. This
will likely require guarantees that CETs are minted by approved agents of the market, including
independent auditors and verifiers.
Beyond Emissions Trading
Our goal with this paper was to showcase CETs as one of many emerging technologies whose
application to regulated cap-and-trade environments could help to drive ETS markets to even higher
levels of integrity, accountability, and credibility, increasing their already substantial utility in the fightagainst climate change. Ultimately, however, we anticipate CET’s value proposition will go far beyond
ETSs. Currently, our Taskforce is preparing the release of a comprehensive guidance document
to enable CET’s implementation across a wide array of climate mitigation strategies. With the UN’s
declaration of climate breakdown, the world needs an “all-of-the-above” approach. Applying the CETframework can enhance the outcomes of carbon taxation models, bolster the integrity of carbon
emissions accounting and reporting, support cross-border trade of embodied emissions, thereby
integrating markets in different jurisdictions to address carbon leakage, and more.

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