Carbon Markets: EU ETS and Voluntary Markets

Master the Moment and Reach Your Peak with Defoes

“Defoes puts the EU’s hard‑cap carbon market and the softer, self‑policed voluntary market on the same page — showing how a shrinking EU ETS cap, expanding ETS2 and OECD ‘interplay’ rules are slowly forcing both systems into one transition price signal rather than two disconnected worlds.”

For all the noise around carbon pricing, Europe already runs one of the few carbon markets that consistently cuts emissions at scale. The EU Emissions Trading System (EU ETS) is a mandatory cap‑and‑trade regime that now covers power, heavy industry, aviation and, from 2024, maritime transport across the EU, EEA and parts of the UK power system. The cap determines how many EU allowances (EUAs) are issued each year, with each EUA granting the right to emit one tonne of CO₂‑equivalent. After the 2023 reform, that cap is set on a path to reduce emissions from covered sectors by 62% in 2030 versus 2005, with the linear reduction factor increased to 4.3% a year from 2024–2027 and 4.4% thereafter.

EU ETS: the hard anchor

The EU Commission’s 2024 Carbon Market Report shows how that architecture is working in practice. In 2023, emissions from stationary EU ETS installations fell by around 16.5%, driven largely by the power sector as renewables expanded and gas displaced coal. That left covered power and industrial emissions roughly 47.6% below 2005 levels, with the system “well on track” to meet the 2030 target of a 62% cut. The 2025 Carbon Market Report updates that figure to about 50% below 2005 emissions, again emphasising effective decarbonisation of power and industry and the early expansion to maritime transport.

ESMA’s 2024 carbon‑markets report and the Commission’s own assessment both characterise the EU ETS as a “stable and well‑functioning” market, with a robust price signal and trading behaviour aligned with fundamentals. ICAP’s overview notes that by 2024, emissions covered by the EU ETS were about 50% lower than in 2005 and on track for the revised 2030 target. In other words, whatever its design debates, the EU ETS is a functioning hard constraint on emissions for a large slice of the European economy — and the primary carbon‑price anchor for the region.

Voluntary markets: softer, but converging

Voluntary carbon markets (VCMs), by contrast, are not mandated by law. They allow companies and other actors to buy credits from projects that reduce or remove emissions outside their own footprint and retire them against voluntary climate targets. An OECD Environment Working Paper on “The interplay between voluntary and compliance carbon markets” stresses that VCMs can “unlock mitigation ambition and action” by directing finance to lower‑cost opportunities and sectors not yet covered by compliance regimes. At the same time, it warns that environmental‑integrity risks — weak additionality, over‑crediting, double counting, and poor governance — are significant enough to warrant closer government attention.

In the European context, VCM activity is growing around nature‑based solutions, household devices and emerging carbon‑removal technologies, but sits outside the EU ETS cap. Clean Energy Wire’s explainer on the EU ETS highlights that EU law currently does not allow voluntary credits to be used directly for compliance under the main scheme, precisely to protect the integrity of the cap and avoid undermining verified domestic reductions. Instead, the OECD paper envisages “complementary roles” where voluntary credits support additional mitigation, particularly in sectors or geographies beyond the EU ETS scope, provided there are clear rules to prevent double claiming against national inventories.

The interplay: from parallel universes to a single signal

The bullish Defoes view is that EU ETS and voluntary markets are slowly moving from being parallel universes to elements of a single, more coherent transition price signal. On the compliance side, the revised EU ETS and upcoming ETS2 for buildings and road transport will push a rising share of European emissions under a declining cap, with embedded carbon costs increasingly passed through energy, materials and transport value chains. On the voluntary side, international governance efforts (such as Article 6 of the Paris Agreement and emerging integrity frameworks) and OECD guidance are nudging governments to align voluntary activity with national climate strategies and avoid “two sets of books” for emissions accounting.

The OECD’s analysis frames the policy challenge as designing rules that let voluntary markets “go beyond” compliance rather than “around” it — for example, by tightening quality standards, clarifying corporate claims and ensuring that use of credits does not weaken domestic mitigation. For investors and corporates, that means the question is less “EU ETS or voluntary?” and more “how does each instrument fit into a coherent decarbonisation and risk‑management strategy anchored by the ETS price?” The risk is that low‑integrity voluntary use becomes a reputational and regulatory liability; the opportunity is that high‑integrity voluntary activity complements a binding EU ETS by financing additional abatement in sectors and regions the cap does not yet fully reach.

A Defoes stance on using both

From a Defoes standpoint, the EU ETS remains the primary European carbon‑price benchmark — a legally enforced, shrinking cap that is demonstrably driving down emissions in covered sectors. Voluntary markets are more heterogeneous and carry more integrity risk, but OECD and EU‑level discussions show they are being pulled into a tighter governance orbit rather than left entirely to self‑regulation. The bullish but selective stance is to treat EU ETS exposure and pricing as central to understanding transition risk and opportunity in Europe, while viewing voluntary credits as a potential additional lever — useful when they are high‑integrity, transparently governed and clearly supplementary to, not a substitute for, compliance‑driven decarbonisation.

In that framing, EU ETS and voluntary markets are not competitors; they are different layers of the same transition architecture. The strategic work for sophisticated investors is to map which parts of portfolios are directly ETS‑exposed, which rely on voluntary claims, and how both will evolve as Europe tightens its cap, broadens coverage and translates OECD “interplay” principles into concrete rules. That is where pricing carbon stops being a political slogan and becomes an operational input into asset allocation, risk management and opportunity capture.