Compliance are instigated by governments to reduce their jurisdictions emissions. The laws are such that firms covered by these regulations are compelled to interact with them or else they face sanctions.

Compliance markets are often characterised by cap and trade market systems, and more often than not, only involve the most polluting industries within their jurisdiction, leaving out small and medium sized businesses and the wider population. Thus, it only impacts their lives tangentially through the price of energy intensive goods, or more controversially in the competitiveness of the jurisdictions industrial sector compared to its dirtier competitors.

A cap and trade system involves the government setting a cap on the amount of CO2 which will be emitted, this cap is then broken down into smaller identical units called allowances (or carbon credits). Each allowance gives a company or organisation the right to emit 1 tonne of CO2. The manner in which these allowances are distributed differs from one jurisdiction to another, some for example operate a bidding system, while others give the allowances directly to firms. That explains the cap part so what about the trade. Well anon theory has it that this cap should decrease every year, thereby decreasing the allowances and thus raising their price. Firms which reduce their emissions faster than the reduction in the emissions, can sell their unused allowances to other more polluting firms.

The key distinguishing factors between the compliance and voluntary carbon market are first of all, compliance markets compel firms to take part, whereas in the voluntary market it is as the name implies, voluntary for companies to participate.

Secondly compliance markets most often do not use issue allowances backed by carbon sequestered (absorbed) by nature, this makes them relatively easy to issue and administer.

Examples of compliance markets

The EU ETS the first large scale Emission Trading Scheme

The California and Qubec Cap and Trade Program