Last week’s COP27 announcements around carbon have been largely welcomed by the investment industry but investors are encouraged to focus on disclosure for offsetting projects amid moves to increase transparency around offsetting credits.

Among the Finance Day announcements was the International Organization of Securities Commissions (IOSCO)’s consultation into compliance carbon markets (CCMs) while also looking at enhancing the resilience and integrity of voluntary carbon markets (VCMs). The body wants to investigate “what sound and efficient VCMs should look like and what role financial regulators may play in promoting VCMs’ integrity in those markets”.

Meanwhile, the US’s climate envoy John Kerry unveiled a new voluntary carbon trading market scheme with the aim of boosting private investment in clean energy projects in developing countries. Known as the ‘energy transition accelerator’, the initiative has been created in partnership with the Rockefeller Foundation and the Bezos Earth Fund to help deliver the trillions of dollars of investment needed to help poorer countries transition to renewables and stave off disastrous climate impacts, the Guardian reported.

The voluntary carbon market is relatively small and immature with $1bn worth of carbon offsets traded last year – but is rapidly growing, and with this in mind, the COP27 developments were welcome:

“By allowing the purchase of offsets from renewable energy projects in emerging markets, the Biden administration is creating a mechanism that allows the transfer of financial flows to economies that still struggle to switch from fossil fuels to renewables. Timing is critical and this programme aims to promote and accelerate the transition into a more renewable and cleaner energy matrix. So, it’s very timely and welcome,” said Alfredo Nicastro, senior vice-president and head of carbon markets at StoneX.

Tom Astor, investment manager at Gresham House, said the wider development of carbon markets was a “positive step” while Chris Cote, America’s lead for ESG and climate research at MSCI, pointed out institutional investors “may be interested in carbon credits as an emerging and diversified asset class they can invest in because they have set their own emissions reduction targets and want to reduce their emissions”.

Quality is still emerging

However, investors are urged to look at carbon offsets with caution as details on the disclosures of which projects corporations are purchasing offsets from are limited, while “detailed, independent and reliable information” on the quality of those offset projects – whether from building renewable energy or avoiding deforestation – is still emerging, Cote explained.

Voicing her thoughts while in Sharm el-Sheikh Annika Brouwer, sustainability specialist at Ninety One, said the source of credits is incredibly important “because this determines quality”.

“Not all carbon is created equal, and therefore not all offsets are of the same quality.”

Those working within the carbon market defended the quality of disclosure; Henrik Hasselknippe, head of markets at carbon exchange Xpansiv, said a “culture of transparency” has evolved.

“For example, the registries that issue credits make full project documentation available on their websites. In addition, they often share the name of the owners that ultimately claim the credits, providing an end-to-end view of the provenance, transfer, and retirement of a given carbon credit. That level of transparency is rare in any market. 

“In addition, many companies provide detailed data on their carbon credit use in corporate sustainability reports. And uniform disclosure standards contemplated in current regulatory proposals would bring a level of uniformity to reporting, which—done properly—would be a welcome development, from our perspective.”

Another vital factor, Hasselknippe added, that has improved trust, scale and liquidity in the VCMs was the launch of the Global Emissions Offset suite of standardised contracts.

“The establishment of these kinds of benchmarks is a key step in the evolution of any market,” he said.

Market integrity

So, what does a “sound and efficient VCM” look like? What does IOSCO need to consider in its consultation?

Gresham House’s Astor again points to transparency: “The question ‘how does this characteristic of integrity impact the wider carbon picture’ must always be asked, and unintended consequences must be considered. The well-trodden line to the effect of ‘a credit represents either a tonne of CO2 removed or avoided’ must be corrected, since they are fundamentally different concepts, and this confusingly paints them as fungible.”

IOSCO faces a “complex” challenge, said StoneX’s Nicastro but agrees improved transparency is one factor alongside common standards. “A sound and efficient carbon market is one where rules are clear and uniform across the globe, with less fragmentation and more price transparency. The integration of the several international markets at both national and subnational levels is key to allow cross-border transactions. All these aspects are critical to attract investment and increase liquidity.”

He added regulators can promote integrity by defining what kind/quality of carbon credits can be used towards countries’ NDCs goals – notably absent from headline discussions at COP27 – but “business practices and integrity standard should be defined by market participants such as the standards, carbon markets platform and bodies such as International Carbon Reduction & Offset Alliance and the Integrity Council for the Voluntary Carbon Market”.

‘A useful tool’

Even if the transparency and disclosure is improved, carbon offsetting and credits should not be companies’ first port of call on their journey to net zero, commentators said.

NinetyOne’s Brouwer said: “Fundamentally transitioning a company’s system from high to low carbon is what we need for real world change. Carbon credits are a useful tool to leverage en route but are not the ultimate solution,” while Gresham House’s Astor added: “Companies should reduce ‘all but the unavoidable’ emissions first.”

Furthermore, StoneX’s Nicastro reiterated there are a number of things organisations should address before looking at carbon credits: “Companies should first look for opportunities to reduce their own footprints by implementing mitigation projects, waste minimisation, lean manufacturing, and green procurement practices, improving operational efficiency, and investing in carbon sink projects (reforestation, avoided deforestation, etc.) before pursuing the carbon offsets route.

“However, the most efficient way to fight climate change and accelerate climate action is to invest in projects where the mitigation cost is lower and where the opportunities to generate emission reductions are higher. Typically, these are found in developing countries where the technology and regulatory gaps create the ideal conditions to optimise the results of climate action.

“So, the answer is that companies should look for opportunities to maximise the results of climate action in a broader way but prioritising actions that will promote the reduction of their own footprints.”