Climate change is often described as a market failure. In truth, it is an accounting failure. We still do not measure — let alone charge for — the real economic damage caused by every tonne of greenhouse gases released into the atmosphere. Until we correct this omission, the world will continue deploying capital in ways that undermine long-term growth, weaken financial stability and accelerate planetary risk.
Two reforms can change this trajectory. The first is the systematic use of shadow carbon pricing — a monetary estimate of the true social cost of emissions — in all major public and private investment decisions. The second is a step financial regulators have so far avoided: recognising high-integrity carbon credits as high-quality liquid assets (HQLA), akin to US Treasuries or top-tier sovereign bonds, once strict market, integrity and liquidity criteria are met.
Together, these reforms could anchor a credible global carbon price, reroute financial flows at scale and finally make pollution economically expensive.
The world already knows what carbon really costs — it simply isn’t using it
Institutions from the World Bank to the IMF already publish recommended social costs of carbon for use in project appraisal. Studies show that when governments apply shadow prices in the range of $50–$150 per tonne — a level consistent with IPCC pathways — investment decisions shift markedly toward low-carbon transport, resilient infrastructure and renewable energy. Yet few countries embed these prices consistently in national planning or regulatory oversight.
The result is policy incoherence: we subsidise resilience on one hand while underwriting fossil-fuel risk on the other. Shadow carbon pricing corrects that inconsistency by translating climate risk into a financial cost that investors cannot ignore.
Why carbon credits must evolve from a niche commodity into a liquid asset class
Carbon markets today are fragmented, credibility constrained and volatile. But this is an argument for system reform, not abandonment. If a narrowly defined class of verified, standardised, centrally cleared carbon credits were established — meeting stringent permanence, additionality and social-safeguard tests — these units would begin to demonstrate the characteristics required of HQLA under Basel III: predictable valuation, deep markets and resilience under stress.
Central banks have already moved in this direction. The European Central Bank expanded collateral eligibility for certain green assets, acknowledging the financial-stability relevance of climate-aligned instruments. Similar mechanisms could be used to pilot the cautious acceptance of “Tier-1” carbon credits as collateral, applying conservative cuts and concentration limits.
Such acceptance would not be just symbolic. If banks can repo high-integrity carbon assets, liquidity will deepen, price discovery will stabilise, and developers of real emissions-reduction and removal projects will access cheaper capital. This virtuous cycle is how green bonds moved from marginal to mainstream over a decade.
Integrity concerns are valid — but solvable
Investigations by academic institutions and major media outlets have revealed significant weaknesses in parts of the voluntary carbon market. Critics warn that treating carbon credits like sovereign bonds risks financial greenwashing. They are right to demand caution.
But the solution is not to reject carbon markets; it is to enforce integrity. Global standard-setting initiatives — including the Integrity Council for the Voluntary Carbon Market (ICVCM) — VERRA , Gold Standards now provide transparent criteria for quality, governance and monitoring. Once a top-tier category of credits meets these thresholds and trades in regulated, centrally cleared exchanges, the asset can be assessed on its merits like any other financial instrument.
The economic logic is unavoidable
Pricing pollution through shadow carbon values — and making high-quality credits liquid — is not ideological. It is economically rational.
• A recognised carbon cost corrects a trillion-dollar market failure, as shown repeatedly in IMF fiscal papers.
• Liquid, standardised credits channel capital to high-impact mitigation and removal projects, lowering the cost of decarbonisation.
• Banks gain a viable low-carbon liquidity instrument, enabling climate-aligned lending at scale.
• Governments gain a transparent tool to align investment, taxation and industrial policy with net-zero pathways.
In a world where climate risk is a financial risk, failing to integrate carbon into the operations of global finance is itself a systemic risk.
A call to action for the world’s financial regulators
The climate transition will not be delivered by moral appeals. It will be delivered by balance sheets. Regulators should:
- Adopt shadow carbon pricing in all infrastructure and energy-planning decisions.
- Mandate integrity, transparency and central clearing for carbon markets.
- Pilot the collateral eligibility of top-tier carbon credits at central banks with strict haircuts.
- Create regulatory pathways for banks to treat the highest-integrity credits as HQLA — cautiously at first, then progressively as evidence builds.
If we want capital to flow into the real economy’s decarbonisation, we must make pollution expensive and climate integrity financially rewarding. The tools exist. What is needed now is regulatory courage.
