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LSE opens regulated market to voluntary carbon credits

© Shutterstock / spatuletailLondon Stock Exchange building

The London Stock Exchange (LSE:LSEG) has opened the regulated markets to funds that are invested in voluntary carbon credits. While the launch will only allow the trade of closed-ended investment funds, the intention is to open it to other asset classes in the future.

  • The LSE has launched what it calls a Voluntary Carbon Market (VCM) to allow the trade of funds investing in nature and/or technology based carbon credits.
  • By setting out guidelines and rules for funds trading in credits, this could be a back door into the regulation of the voluntary carbon markets.
  • Allowing funds (and later companies) access to a regulated market funnelling capital to the voluntary carbon markets could drive rapid expansion at scale.

The London Stock Exchange has published the rules of its VCM, which is open to closed ended investment funds and operating companies listed on its bourses. It is intended to direct funds into climate mitigation projects, such as reforestation or carbon capture.

The voluntary carbon markets have been evolving over the last 20 years or so and on the upside of projections around a 570GtCO2 budget, the Taskforce on Scaling the Voluntary Carbon Markets (TSCVM) has predicted the market could hit hit $50 billion in value by 2030.

Today the voluntary carbon markets have a range of standards and registries, supported by international NGOs. As awareness of climate risk increases, and concerns about the potential cost of carbon become part of mainstream financial conversation, it is becoming an increasingly mature section of the financial services market.

According to the LSE however, it remains small and fragmented, and as such it lacks the market infrastructure and access to institutional investment that will truly enable it to scale. Opening the public markets as a venue for trade should change that.

What are the voluntary carbon markets?

While the LSE has called its market the Voluntary Carbon Market, this is a term traditionally associated with the direct trade of carbon credits outside the mandatory compliance markets.

Mandatory compliance markets are frameworks such as the EU-ETS, which was launched in response to international agreement on the importance of cutting greenhouse gas emissions – a basket of damaging gases often described in terms of their CO2 equivalence (CO2e). Initially the trade was mandated under the terms of the Kyoto Protocol, which was superseded by the Paris Agreement in 2015.

Voluntary credits are those credits generated by projects that are bought by corporates and institutions in part to offset their emissions and contribute to their overall net zero goals.

Providing a regulated framework for trade in credits

Issuing carbon credits as a source of finance is only possible if they are derived from projects that would not be undertaken as ‘business as usual’ or via commercial investment – a concept known as ‘additionality’ i.e. the activity is genuinely additive to the sum total of existing global efforts to reduce CO2.

This creates a ‘chicken and egg problem’ – how do you develop a liquid market through which to finance genuinely additive projects without having an existing deep and liquid market? That means a stable market with the ability to buy and sell credits easily, which usually required a high volume of trade.  That usually results in an efficient market, with tight pricing spreads and low transaction costs.

By facilitating the listing of instruments that deploy capital at scale into climate mitigation projects, the London Stock Exchange hopes to contribute to global efforts to address this challenge.

Julia Hoggett, chief executive at the London Stock Exchange, said: “Today’s publication of our admission and disclosure standards marks the launch of the first public markets solution to help raise capital for the voluntary carbon market. It paves the way for capital at scale to be channelled into a range of climate change mitigation projects, while providing corporates and other investors with net zero commitments with the ability to access a diverse supply of high-quality carbon credits.”

She added: “We are in discussions with a wide range of corporates and other investors, fund managers and project developers and expect the first issuer to use the designation shortly.”

How the market will work

Voluntary Carbon Credits are a widely used mechanism for the reduction of emissions – each credit represents one tonne of CO2e prevented, reduced or removed that has been independently verified against robust accounting methodologies.

In terms of the market itself, developers will identify a set of projects which will result in the generation of carbon credits under existing voluntary carbon market methodologies and standards, through the storage or removal of CO2e and other greenhouse gases from the atmosphere.

The fund vehicle that invested in the projects will then be listed on the London exchange with a designation for the carbon markets, and then investors will invest in the fund.

What makes the process interesting is that instead of issuing dividends to investors, these funds will issue carbon credits. Investors will also be able to trade in the funds themselves, providing a new secondary market driving the trade in voluntary credits.

Is this regulation of the voluntary carbon markets?

The LSE said that its VCM requires issuers to disclose information on the climate mitigation projects that are being funded, for example to what extent they plan to meet the United Nations Sustainable Development Goals.

By creating formal standards and disclosure frameworks, the LSE is providing a standardised approach to investors in the voluntary carbon markets, as well as those companies buying credits to use as offsets.

The new rules also require that activity and investments are mapped to FTSE Russell’s Green Revenues Classification System, to ensure the credit issuers are having a net positive impact on the environment.

This is a potentially huge step for the voluntary carbon markets, which have been unregulated over the last couple of decades. Strong standards, methodologies and certifications have been developed, with Verra (formerly the Voluntary Carbon Standard) and the Gold Standard (focused on achievement of the SDGs) providing clarity and consistency for investors and developers alike.

The market has remained fragmented, however. The last couple of years have seen the launch of the Integrity Council for the Voluntary Carbon Markets (ICVCM), as well as the Taskforce on Scaling Voluntary Carbon Markets (TSCVM).

One the supply side the ICVCM is working on agreeing frameworks for the development of the global voluntary carbon markets, while on the demand side the TSCVM is exploring a global benchmark for carbon credit quality.

The jury is still out on how widely accepted such determinations will be and therefore the impact they will have on the market. In terms of the ICVCM’s development of its Core Carbon Principles, for example, questions remain about the different approaches being undertaken, as well as about the cost of compliance with new methodologies and approaches.

Offsetting cannot be the main component of emissions reduction

Offsetting, or the use of carbon credits to offset emissions, has a controversial history. Naturally, there are concerns that the use of carbon credits would allow companies and sectors to simply continue to emit on a business as usual basis. Then there were well-founded concerns that the credits were sometimes issued for projects which could not prove that emissions had been reduced or removed, especially over time.

Over time however the increase in understanding of carbon removal technologies, and developments in nature based storage projects has grown. The amount of data available to track the performance of particular projects, from satellite data to onsite sensors, has vastly improved the monitoring and verification process. There are today high quality carbon credits available, with co-benefits ranging from nature restoration, local development, cleaner air and water and much more.

The question then arise, how many offsets or carbon credits should be used in a companies net zero strategy. It is widely accepted that companies should not rely solely on offsetting their GHG impact, but instead they should change their business strategy to ensure that they cut or eliminate their emissions.

Kim Schumacher, associate professor in sustainable finance and ESG at Kyushu University, said: “Mainly due to profitability reasons, many VCMs lack proper project-level impact MRV (measurement, reporting, and verificaton) capacities, leading to a significant expertise disconnect between overly optimistic claims and ex-post implementation; so they risk facilitating further corporate greenwashing.”

“If VCMs were serious about the integrity of their projects, they would submit eligible projects to blind-peer review by genuine expertise such as climate scientists and ecologists. However, this would likely disqualify many of their currently selected projects.”

Credible climate action requires high quality credits in small amounts

The Science Based Targets Initiative (SBTI), which defines and promotes best practice in emissions reductions and net-zero targets in line with the latest in climate science, requires companies to commit to actual emissions reduction of 90% in order to receive validation for their net zero strategies. No more than 5-10% of emissions should be offset.

In the UK, the Climate Change Committee (CCC) has issued a report warning that, “Offsets can mask insufficient efforts from firms to cut their own emissions, they often deliver less than claimed, and they may push out other environmental objectives in the rush to capture carbon.”

The challenge is that poor quality offsets may out compete high quality credits on price. Given that credits can range in price from a couple of dollars up to $300 for credits using carbon removal technology, there is an incredible range to choose from. Usually cheaper credits have not addressed the challenges of additionality, performance, leaking and ongoing monitoring and verification.

The CCC stated: “Ultimately, if voluntary carbon markets are genuinely to complement the transition to Net Zero, businesses must be supported to directly decarbonise their operations and supply chains. The role of a carbon credit should be to support, not discourage the reduction of actual emissions.”

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