Carbon credits, the tradable permits that allow companies to emit a set amount of greenhouse gases sit at the heart of compliance carbon markets. By capping total emissions and letting firms buy and sell allowances, governments create both a financial incentive to cut pollution and a market price for carbon.
Global carbon markets received a decisive boost last week as California lawmakers approved a landmark package extending the state’s cap-and-trade program rebranded as “Cap-and-Invest” through 2045. The move, combined with tighter Low Carbon Fuel Standard (LCFS) rules that came into effect in July 2025, strengthens long-term confidence in compliance carbon pricing and provides clearer visibility for investors in carbon-linked exchange-traded funds (ETFs).
Among the primary beneficiaries are the KraneShares California Carbon Allowance Strategy ETF (KCCA), which offers exposure to California’s allowance market, the KraneShares Global Carbon Strategy ETF (KRBN), which captures a basket of compliance programs worldwide, and the KraneShares European Carbon Allowance Strategy ETF (KEUA), which tracks the EU’s benchmark system.
California: The Largest Carbon Market in the Americas
California’s cap-and-trade system, launched in 2013, remains the largest carbon market in North America, covering roughly 80% of statewide greenhouse gas emissions across sectors such as transportation, industry, and power. The program, linked with Quebec’s system, conducts quarterly auctions where supply declines by ~4% annually, a mechanism designed to steadily increase scarcity of allowances.
By locking in the framework through 2045, lawmakers have given investors confidence that the program will continue tightening supply for the next two decades. Key features were preserved, including the Allowance Price Containment Reserve (APCR) and a price ceiling, while giving the California Air Resources Board (CARB) flexibility to adjust if consumer costs rise too steeply.
The regulatory tailwinds extend beyond cap-and-trade. California’s LCFS amendments, effective July 1, 2025, increased stringency in fuel carbon-intensity targets, adding demand for credits and reinforcing the structural scarcity of carbon allowances.
EU ETS: The World’s Benchmark Carbon Market
In parallel, the European Union Emissions Trading System (EU ETS) remains the largest and most liquid compliance carbon market globally. Established in 2005, the ETS covers more than 10,000 installations across 27 member states plus Norway, Iceland, and Liechtenstein, including power generation, heavy industry, and intra-EU aviation.
Under the EU’s Fit for 55 climate package, the annual emissions cap reduction rate has accelerated to ~4.2% per year, up from 2.2% previously. This structural tightening has kept prices elevated, with EU Allowances (EUAs) trading in a band of €90-100 per metric ton of CO₂e through mid-2025. The ETS remains the bellwether for global compliance markets, influencing both policy design and investor sentiment worldwide.
How Investors Gain Access to Carbon Markets ETFs
- KRBN – KraneShares Global Carbon Strategy ETF
Tracks the S&P Global Carbon Credit Index, providing diversified exposure across major compliance systems including the EU ETS, California CCA, the U.S. Regional Greenhouse Gas Initiative (RGGI), the U.K. ETS, and Washington State. - KCCA – KraneShares California Carbon Allowance Strategy ETF
Offers targeted exposure to California’s carbon market. Notably, California employs a 5% + CPI price floor on allowances, giving the market an embedded inflation-linked scarcity mechanism. The program’s extension to 2045 materially strengthens long-term visibility for KCCA. - KEUA – KraneShares European Carbon Allowance Strategy ETF
Tracks EU Allowances through the IHS Markit Carbon EUA Index, providing investors with exposure to the EU ETS’s tightening cap and structurally high allowance prices.
Why California’s Extension Matters
California’s decision to extend its cap-and-trade program through 2045 carries global significance for compliance with carbon markets by embedding long-term scarcity into the system. With the cap declining at roughly 4% annually, total allowances are set to shrink by more than 60% from today’s levels by the time the program sunsets, ensuring a structural supply squeeze.
The program’s quarterly auctions continue to reinforce this dynamic, with the August 2025 sale clearing at $43.51 per allowance, a 15% increase from the same period in 2024 while the July 2025 amendments to the Low Carbon Fuel Standard tightened carbon intensity reduction targets by 20% through 2030, adding incremental demand from fuel producers. Investor confidence is further supported by the preservation of mechanisms like the Allowance Price Containment Reserve (APCR) and the program’s 5% plus inflation price floor, which together mitigate the risk of policy reversals or disorderly price swings. Globally, the move signals the durability of carbon pricing as a climate policy tool: California Carbon Allowances currently trade in the $42-44 per ton range, while EU Allowances hover between €95 and €100 per ton, reflecting both regional ambition and the increasing financial relevance of compliance carbon assets. With the EU ETS alone generating €751 billion in trading volume in 2023 (Refinitiv data), California’s extension underscores that carbon credits are not just regulatory instruments but a maturing asset class with global investor traction.
The Fragile Side of Carbon Market Investing
Carbon ETFs remain highly policy-driven, meaning their performance is tied directly to the credibility and stability of regulatory frameworks. Political turnover or shifting economic priorities could slow the pace of cap tightening, dilute enforcement, or temporarily depress compliance credit demand as seen in 2020, when EUA prices briefly dropped below €20 during the COVID-19 recession before rebounding.
Liquidity is another key consideration: while the EU ETS is the world’s deepest carbon market, trading over €750 billion in volume in 2023 (Refinitiv), California’s CCA program is far smaller, which can magnify volatility and lead to sharper swings in allowance pricing. Investors must also account for the mechanics of carbon ETFs themselves, since funds such as KCCA, KRBN, and KEUA typically hold futures contracts rather than physical allowances.
This structure introduces roll costs when contracts are renewed, as well as potential tracking error relative to spot markets. In stressed periods such as the 2022 energy crisis in Europe, futures prices have diverged materially from underlying allowance fundamentals, underscoring that carbon ETFs, while liquid, are not perfect mirrors of compliance markets.
Key Takeaways and Conclusion
California’s decision to extend its cap-and-trade system through 2045 underscores the evolution of compliance carbon markets from policy experiments into a durable asset class. By locking in a long-term framework of shrinking allowance supply, the move strengthens the investment case for ETFs like KCCA, KRBN, and KEUA, which channel policy-driven scarcity into accessible portfolio exposure.
With both U.S. and EU systems tightening, compliance markets are entering a phase of maturity, marked by greater liquidity and credibility. Risks remain from political shifts to volatility in thinner markets but the structural case for carbon pricing has rarely been stronger.
ETFs now offer one of the most practical ways for global investors to participate in the financial architecture of decarbonization.
