India’s voluntary carbon market and nature-based solutions: Key legal questions and emerging opportunities

In this Leading Questions piece, Niti Paul and Mayank Sharma provide an overview of how nature‑based projects generate and trade carbon credits in India’s voluntary market, the unique legal and operational risks they face, and the implications of the new Carbon Credit Trading Scheme.

Question: What are voluntary carbon markets? What is the interplay between nature based solutions and the voluntary carbon market?

Answer: Voluntary carbon markets (“VCM”) are markets in which carbon credits are bought and sold without any mandatory regulatory obligation. Unlike compliance markets, such as the European Union’s Emissions Trading System, participation is driven primarily by corporate sustainability commitments, net-zero pledges, or reputational objectives rather than legal requirements. However, some compliance markets allow entities to use the credits bought from such markets to meet their compliance obligations.

Carbon credits, typically representing one tonne of reduced, removed and/or avoided carbon dioxide emission, are generated through projects that apply approved quantification methodologies, undergo independent third-party validation and periodic verification from accredited agencies, and are issued as serialized units through recognized registry systems such as Verra or Gold Standard. Currently, these credits are traded across jurisdictions.

Nature-based solutions (“NbS”) occupy a central role in this market. Generally understood as projects that “aim to protect, conserve, restore, sustainably use and manage natural or modified terrestrial, freshwater, coastal and marine ecosystems”, these projects are often the preferred mode of generating carbon credits as they simultaneously offer co-benefits around biodiversity, community development, and ecosystem restoration. These projects typically take the shape of afforestation, agroforestry, soil carbon enhancement, and restoration projects.

Question: How are nature based solution projects generally structured in the voluntary carbon market? How are the carbon credits generated from such projects traded?

Answer: An NbS project is typically initiated by a project developer or proponent who identifies suitable land or ecosystems, secures rights or consent from landowners and communities, and implements the relevant carbon activity — such as afforestation, forest conservation, or ecosystem restoration. The project lifecycle includes preparation of a project design document, registration under an applicable carbon standard, implementation, periodic monitoring, third-party verification, and ultimately the issuance of carbon credits into a registry account.

On the commercial side, carbon credit transactions take several forms. Credits are sold on a spot basis after issuance through purchase agreements. For larger projects, we typically see buyers enter into a project development agreement in which the buyer finances the project in exchange for a fixed share of the carbon credits generated along with exclusivity and pre-emptive rights. However, these project structures are constantly evolving. Lately, there has been an increase in buyers demanding financial securities from the project developers akin to a project financing transaction.

Given the VCM operates on a voluntary basis, there has not been much regulation around it. Therefore, while presently the carbon credits in the VCM are traded freely between registry accounts across borders, countries may potentially regulate transfer of credits generated from projects situated within their borders to ensure the carbon credits generated count towards their own Nationally Determined Climate Goals under the Paris Agreement of 2015.

Question: What are some of the risks unique to such nature based solution projects and the voluntary carbon markets?

Answer: NbS projects carry a risk profile that is meaningfully different from industrial or engineered carbon projects, and given their novelty, unforeseen risks are relatively higher for such projects.

These projects depend on the ability to control or influence how land, forests, and community-managed ecosystems are used over multi-decade timeframes (for example, Verra registered projects are required to have a longevity of at least 40 years). Ambiguity around land ownership, encumbrances, community rights, or competing claims affect both the project implementation and the transfer of the carbon credits generated from them. Given that the VCM has heretofore largely operated in a regulatory void, the risks allocation has been largely managed through balancing obligations of the project developer against the financial risk of the buyers under the contractual arrangements that will potentially put to test through contractual enforcements and a constant and fast evolving legal and regulatory framework.

Additionally, NbS projects sometimes involve entering into commercial arrangements with marginalized or protected communities such as Scheduled Tribes in India. This requires careful balancing of rights of the parties. Project documentation has to provide adequate safeguards for the rights of such communities to prevent any regulatory challenge or reputational risk arising from coercion or lack of free and informed consent, while also ensuring alignment with the broader project objectives.

NbS projects also suffer from permanence risk. Emission reduction can be reversed by natural calamities such as wildfire, drought, illegal harvesting, or withdrawal of project asset stewardship. Most standards address this through buffer pools and insurance-like mechanisms, but residual reversal risk remains a contractual and financial exposure. Further, carbon credits are issued based on baseline assumptions, additionality tests, and monitoring methodologies that may be challenged, revised, or superseded, or concerns could be raised by the verification body, leading to shortfall in carbon credits. This requires meticulous risk allocation to be reflected in the project documentation.

Parties should also consider the regulatory transition risk. In India, the Central government has notified the Carbon Credit Trading Scheme, 2023 (“CCTS”) which provides for a detailed mechanism for project registration and carbon credit issuance in a domestic voluntary carbon market. While there is currently no prohibition on registering projects in India with international carbon standards such as Verra’s Verified Carbon Standard, the project documentation should provide for flexibility in navigating the evolving regulatory framework.

Question: What changes are expected in the present voluntary carbon market on account of India's upcoming carbon market framework?

Answer: The Indian carbon credit framework is established under the Energy Conservation Act, 2001 and operationalized through the CCTS mentioned above.

The framework envisages both a compliance mechanism for regulated entities and an offset mechanism (i.e., the domestic VCM) open to non-obligated participants. Under the domestic voluntary market, entities which are not obligated to reduce emissions under the compliance mechanism can set-up emission reduction, avoidance and/or remove projects for issuance of carbon credit certificates which can be traded in accordance with the CCTS.

Crucially, only Indian firms will be allowed to register projects and issued carbon credit certificates under the CCTS and only projects that have started emission reduction, avoidance or removals from or on January 01, 2025 are eligible for registration; retrospective projects will not be considered for registration. Additionally, projects registered under the offset mechanism are not allowed to be concurrently registered under any other carbon market mechanism. The CCTS also, in some cases, allows trading of carbon credit issued under the offset mechanism of the scheme outside India with corresponding adjustments.

The Indian carbon credit framework is expected to provide a fillip to emission reduction, removal and avoidance projects in India. However, the framework is silent on credits issued under standards such as Verra and Gold Standard. Until the Indian regulators clarify their position, international buyers seeking high-integrity credits will face residual uncertainty regarding the credits generated from Indian projects and project developers structuring international offtake will need to build adequate regulatory risk provisions into their agreements.

Niti Paul is a Senior Partner and Mayank Sharma is an Associate at Luthra and Luthra Law Offices India.