Overview of Carbon Credit (Part1) – Types, Certification Requirements, and Trends in Japan –

What Are Carbon Credits?

The definition of carbon credits varies, but according to the Carbon Credit Report published in June 2022 by the Study Group on the Establishment of an Environment for the Proper Utilization of Carbon Credits toward Carbon Neutrality (Carbon Credit Study Group), carbon credits are recognized based on the baseline-and-credit approach. Under this approach, when actual emissions fall below projected emissions (the baseline), the difference is certified as credits through a process of monitoring, reporting, and verification (MRV).

For example, in a project that converts heavy oil boilers to city gas boilers, the projected emissions from continued use of heavy oil boilers serve as the baseline, and the reduction achieved by switching to city gas boilers is certified as carbon credits.

Buyers of carbon credits can utilize the purchased credits for voluntary offsetting or for compliance with regulatory reporting requirements, such as those under the Act on Promotion of Global Warming Countermeasures (温対法).

Emissions Trading Scheme

A related system to carbon credits is the Emissions Trading Scheme (ETS). Under an ETS, a public authority sets an emission allowance for specific organizations or facilities. If actual emissions exceed this allowance, the entity must purchase emission permits from companies that have kept their emissions below their allocated limit. This system is based on the cap-and-trade approach.

Furthermore, in emissions trading schemes across various countries and regions, it is common for companies to be allowed not only to purchase emission permits from participating entities but also to acquire and utilize carbon credits from non-participating companies.

Types of Carbon Credits

Carbon credits can be broadly categorized based on their issuing entities. They include:

• United Nations or government-led credits, such as J-Credits and the Bilateral Credit Mechanism
• Privately-led credits, commonly referred to as voluntary credits

Types of Carbon Credits

Type	Overview
J-Credit	The J-Credit system, launched in 2013, evolved from the integration of the Offset Credit (J-VER: Japan-Verified Emission Reduction) System, established in November 2008, and the Domestic Credit System (Certified Domestic Emission Reduction System). It is a domestic Japanese program managed by the Ministry of Economy, Trade and Industry (METI), the Ministry of the Environment (MOE), and the Ministry of Agriculture, Forestry and Fisheries (MAFF). The system certifies credits for greenhouse gas (GHG) reduction and absorption projects, such as the introduction of energy-efficient equipment, deployment of renewable energy, and proper forest management.
Joint Crediting Mechanism (JCM)	The JCM is a system that quantitatively evaluates contributions to GHG emission reduction or absorption by promoting advanced decarbonization technologies and products in developing countries. The credits generated under this mechanism can be used by both Japan and its partner countries to achieve their Nationally Determined Contributions (NDCs) in alignment with the Paris Agreement’s 1.5°C target.
Voluntary Credits	In Japan, an example of voluntary credits is the J-Blue Credit, which is managed by the Japan Blue Economy Association (JBE) and focuses on certifying carbon absorbed and stored by marine ecosystems (Blue Carbon). Internationally, key private-sector voluntary credit standards include the Verified Carbon Standard (VCS), Gold Standard (GS), American Carbon Registry (ACR), and Climate Action Reserve (CAR).

Classification Based on Credit Certification Approaches

Carbon credits can also be classified based on the nature of the efforts undertaken for certification. These classifications include:

• Nature-based credits, such as those derived from forest management
• Technology-based credits, such as those generated through renewable energy projects or Direct Air Carbon Capture and Storage (DACCS)

Certification Requirements and Considerations for Carbon Credits
Currently, there is no standardized set of certification requirements for carbon credits, and each system establishes its own criteria.

The International Carbon Reduction & Offset Alliance (ICROA), an industry organization, has defined general principles for high-quality credits, including Real, Measurable, Permanent, Additional, Independently Verified, and Unique. Some voluntary credits comply with these requirements.

In addition, in 2023, the Integrity Council for the Voluntary Carbon Market (IC-VCM) introduced the Core Carbon Principles (CCP), which set forth requirements for high-quality carbon credits. The Voluntary Carbon Markets Integrity Initiative (VCMI), an NPO established by the UK government, also released the Claims Code of Practice.

Given this transitional phase, where multiple organizations are working toward standardization, it is not necessarily required to ensure that a carbon credit transaction fully complies with all existing standards. Instead, it is crucial to assess whether the carbon credit serves its intended purpose and to consider any relevant risks.

For example, if a company purchases J-Credits for the purpose of regulatory reporting under the Act on Promotion of Global Warming Countermeasures, there should be no particular issues.

However, if a company enters into a long-term agreement to continuously purchase carbon credits while supporting their generation, it should consider factors such as potential changes in legislation, amendments to certification requirements, and the possibility that certain credits may be phased out due to standardization.

Trends in Japan’s Carbon Credit Market

As the global push toward achieving carbon neutrality by 2050 accelerates, Japan has also taken steps to establish a carbon credit framework.

In February 2021, the Ministry of Economy, Trade and Industry (METI) launched a study group to explore economic mechanisms for achieving global carbon neutrality. This group aimed to clarify the role of carbon credits and formulate policies for establishing a carbon credit market. To facilitate more concrete discussions, the Carbon Credit Study Group was established, and in June 2022, the Carbon Credit Report was published.

The Carbon Credit Report examined key challenges and specific policy measures from the perspectives of demand, supply, and distribution. The developments following its publication are summarized below.

Demand-Side Trends

One of the key challenges in Japan is that, despite the existence of various types of carbon credits, their legal and institutional positioning remains unclear. This lack of clarity has led some companies to hesitate in utilizing them.

To address this issue, the report suggests that it is essential to clarify usage methods and promote the proper disclosure of the value and characteristics of carbon credits.

Following the report’s publication, initiatives such as GX-ETS (a voluntary emissions trading system introduced in April 2023 under the GX League) have emerged. Under this system, companies can use qualified carbon credits—such as J-Credits and JCM Credits—to meet their targets. As suggested in the Carbon Credit Report, additional carbon credits may be recognized as eligible in the future, potentially driving further demand growth.

Supply-Side Trends

From a supply perspective, one key challenge is that carbon removal technologies such as Direct Air Carbon Capture and Storage (DACCS) and Bioenergy with Carbon Capture and Storage (BECCS), as well as nature-based carbon sequestration methods such as soil carbon storage in farmland, are not eligible for certification under the J-Credit system. As a result, there is currently no mechanism to promote these methods through carbon credit issuance.

To address this, the report highlights the need to develop schemes that facilitate the creation of carbon sequestration and removal-based credits outside the J-Credit framework.

Following the publication of the report, initiatives have been launched to develop new certification methodologies and revise the J-Credit system, aiming to expand the issuance of forestry-based and sequestration-focused J-Credits.

Trading and Distribution Trends

On the distribution side, while many countries are establishing carbon credit exchanges and trading platforms, Japan still relies primarily on over-the-counter (OTC) transactions. Additionally, trading volumes and prices lack transparency, making it difficult for project developers to assess investment recovery and for credit buyers to forecast procurement costs.

To address these challenges, the report emphasizes the importance of:

• Establishing a formal carbon credit market
• Clarifying legal, accounting, and tax treatment to ensure trading stability

Since the report's publication, Japan has taken a significant step by launching a carbon credit market on the Tokyo Stock Exchange in October 2023. However, this market currently only handles J-Credits, and trading volumes remain limited. The number of private trading platform operators is also increasing, indicating a growing market. Moving forward, further discussions will be needed to enhance market liquidity, including clarification of legal, accounting, and tax frameworks.

How ZeLo Can Support Your Carbon Credit Business

The legal treatment of carbon credits remains unclear, making it essential to exercise caution when designing services involving carbon credits or engaging in carbon credit transactions. Consulting a lawyer can help ensure compliance with evolving regulatory frameworks and mitigate potential risks.

ZeLo excels not only in traditional corporate legal services, such as litigation and dispute resolution, but also in cutting-edge fields such as Web3 and AI, as well as emerging business models. We provide comprehensive support for carbon credit developers and carbon credit trading platform operators, including regulatory advocacy through our Public Affairs team to engage with regulatory authorities.

We also have strong expertise in fundraising support for new businesses and assisting with investments and acquisitions involving carbon credit developers and trading platform operators.

Our team provides tailored and flexible legal advice based on the specific needs and business models of our clients. Please feel free to contact us for further discussion.

Please let us know if you have further questions or may need assistance on this matter. For further information on the above, about our firm or any other matters, please contact through the form (https://zelojapan.com/en/contact).

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The information provided in this article does not, and is not intended to, constitute legal advice and is for general informational purposes only. Readers of this article should contact an attorney to obtain advice with respect to any particular legal matter.