How to build a multilateral carbon pricing system: Balancing vision and reality

Carbon pricing is a key tool in fighting climate change. By putting a cost on carbon emissions, it encourages businesses and consumers to adopt cleaner practices. Mechanisms like carbon taxes and mandatory cap-and-trade systems, such as the European Union Emissions Trading System (EU ETS), aim to reduce greenhouse gas emissions by enabling the economy to price the direct and indirect costs of emissions.

Depending on the systems’ design, carbon pricing systems can generate revenue for national priorities, including social programmes. In 2023, these systems worldwide raised over $100 billion, driven by high EU prices.

However, they only cover 24% of global emissions, underscoring the need for broader adoption. Variations in design across countries create disparities and challenges for reducing emissions, ensuring trade fairness and meeting the 2050 net-zero goal.

The state of carbon pricing reflects a dynamic interplay between unilateral and multilateral approaches, each with its strengths and challenges.

Unilateral carbon pricing, such as the EU’s Carbon Border Adjustment Mechanism (CBAM), effective in 2026, the UK’s planned CBAM, effective by 2027 and US initiatives such as the proposed Clean Competition Act, reflect the rise of unilateral carbon pricing mechanisms.

Canada and Australia have also explored aligning border measures with carbon pricing. These unilateral carbon pricing policies highlight national sovereignty in addressing climate change and help support tailored approaches, low-carbon innovation and funding for green infrastructure.

Challenges include trade disparities requiring border adjustments and limited global impact without broader international consistency among reduction goals and targets.

Multilateral carbon pricing initiatives foster international cooperation to harmonize mechanisms, reduce carbon leakage and promote fair trade. Challenges include complex negotiations, equity concerns for developing nations and ensuring compliance with diverse economic priorities.

The world is struggling to achieve multilateral climate agreements due to persistent geopolitical, economic and policy challenges. Recent examples highlight the difficulties:

Creating a practical global carbon pricing system requires balancing a unified vision with existing regional and unilateral approaches. This means bridging gaps in ambition, capacity and enforcement while aligning systems, encouraging participation, ensuring equity and gradually reducing fragmentation.

A phased approach will encourage gradual progress toward a global carbon pricing mechanism:

The following represents a potential transition roadmap:

Establishing a unified global carbon pricing system requires minimum standards that consider economic differences. A tiered global carbon floor price, like the International Monetary Fund’s proposal, could ensure alignment and equity by adjusting pricing based on development levels.

Uniform reporting protocols for carbon accounting and transparency could enhance credibility and comparability, laying the groundwork for integrating systems and fostering a unified global approach to pricing carbon.

Connecting regional carbon markets is a practical way to reduce fragmentation. The EU Emissions Trading System, California’s cap-and-trade system, the Northeast Regional Greenhouse Gas Initiative and China’s national carbon market could all link to form interoperable pricing systems.

This approach preserves autonomy while encouraging collaboration, strengthening global emission reductions and building a more robust global market.

CBAMs can be vital to reduce carbon leakage and encourage broader global participation in carbon pricing while ensuring domestic industries are not harmed.

To mitigate against adverse effects on developing countries, CBAMs should include support for national trade-exposed industries to help transition them to low-carbon practices.

Wealthier nations, along with a carbon pricing "club" (one large voluntary club to pilot linkage and international harmonization of existing carbon pricing systems) should fund climate finance initiatives that support developing countries in adopting carbon pricing systems and accelerating decarbonization efforts.

Technology-sharing agreements, supported by carbon revenue, can provide efficient, cost-effective emission-reduction strategies. These efforts ensure a smooth transition for developing nations without straining their economies.

Private sector involvement is key to meeting the $1.3 trillion per year needed by 2035 for climate action in developing countries, particularly through voluntary carbon markets and Article 6 mechanisms from the Paris Agreement (allowing cooperation amongst nations to meet climate goals through carbon markets).

These markets allow businesses to support global decarbonization by purchasing high-quality carbon credits. An integrated approach linking voluntary carbon markets, Article 6 and compliance carbon pricing mechanisms enables companies to drive the transition to a low-carbon economy.

However, challenges such as market complexity, credit credibility and price volatility must be addressed. Collaborating with governments and ensuring regulatory compliance and transparent reporting could aid seamless integration. For example, Singapore, Chile, South Korea, Japan and Brazil are integrating voluntary carbon credits into their compliance systems to promote this transition.

Equity must be central to any global carbon pricing framework, including differentiated responsibilities, supporting developing countries in implementing carbon pricing.

A fair system could mean revenue from CBAMs is redistributed to vulnerable nations or affected sectors from the transition, which would avoid overburdening low-income nations while encouraging broader global participation.

Several challenges must be addressed for the roadmap’s success:

Article 6 of the Paris Agreement holds significant potential to usher in a transformative era of global multilateral carbon pricing by creating a cohesive framework for international cooperation.

It facilitates linking regional and national systems through Internationally Transferred Mitigation Outcomes (Article 6.2), promoting collaboration and reducing market fragmentation.

By fostering market integration, Article 6 could enhance liquidity and efficiency. Clear standards and transparency under its framework may bolster private sector participation, supporting innovation and investment in emissions reductions.

Additionally, by enabling resource transfers to developing nations, Article 6 can promote equitable participation and capacity building. Robust monitoring and verification mechanisms aim to ensure credibility and build trust, encouraging broader adoption of carbon pricing systems

To make meaningful progress, scaling existing mechanisms incrementally is key. Multilateral platforms such as the Paris Agreement and World Trade Organization can help mediate disputes and support alignment. A single carbon pricing "club" and regional systems can serve as pilots for broader global cooperation.

This hybrid approach balances ambitious goals with practical realities, allowing gradual progress.

Ultimately, success hinges on multilateral cooperation, equitable financing and a phased, flexible strategy that considers national circumstances. While challenging, this approach offers a path toward global emissions reductions and a fair transition to a low-carbon economy.