Carbon credits are here to stay, that much was made certain at COP26 when the agreement on carbon markets was reached. This change to the agreement, known as Article 6, in practical terms allowed countries to use carbon credits in their nationally determined contributions.
Alongside this progression, it has become clear that the corporate transition to net zero is now inevitable. Sixty per cent of the FTSE 100 – worth a combined total of £1trillion – now have net zero targets, which is quite a remarkable shift. The challenge now is to make those targets a credible, achievable reality. The intent is there and real but we are still in the rhetoric phase. Quality information, informing robust action, will be needed.
As a result, there is now huge market demand for voluntary carbon credits. The market has soared from around £225m in 2019 to over £750m today. While companies need to be reducing emissions wherever possible, for many organisations net zero is impossible without offsets due to the state of current technology, so the industry will continue to grow. By 2030, the median estimate for the size of the industry is £25bn. We are about to experience a stratospheric period of growth.
Asset managers – especially long-term investors like pension funds – need to ensure they are resilient in this changing landscape for three reasons. First, investors may want to buy carbon offsets in order to achieve carbon neutrality year on year. Second, their portfolio companies may be buying offsets and they need to review that risk. Third, they are looking to invest in offsets and nature-based solutions as a niche but growing new asset class.
It is difficult for investors to manage this risk at present because there is currently no way of knowing what quality looks like. In simple terms, “quality” is the likelihood that the carbon credit actually does what it says in the tin: removes or avoids a tonne of carbon dioxide emissions.
Firstly, no functioning market has no correlation between quality and price. Secondly, and more importantly for investors, it’s terrible for risk management practice not to be able to correlate price and quality, or value,
in a portfolio.
The way we approach this market failure through our BeZero Carbon Ratings framework is to assess the quality of any carbon credit using six risk factors: additionality, over-crediting, permanence, leakage, perverse incentives and policy environment. Ratings specialists then use qualitative, quantitative and satellite data to rate the credit between A and AAA+, allowing purchasers of carbon credits to manage the risk of the credit they are buying. This approach also enables them to pick out a certain risk factor, for instance permanence, and assess the ability for that credit to remain sequestered over time.
This is ever more important as regulation begins to roll down the track. As the changes to Article 6 show, and other initiatives such as the Mark Carney Taskforce for Scaling Voluntary Carbon Markets, governments and regulators are increasingly alive to this emerging market and are keen it does not become a guise for greenwashing. Investors need to get ahead of this regulation and ensuring credits are of a good quality will do this.
We can already see that pension funds and large institutions don’t want to be left holding billions of pounds worth of carbon-intensive assets. Most recently one of the largest pension funds in the world, ABP, sold £11.2bn worth of fossil fuel holdings including Royal Dutch Shell.
But nor should they want to be left holding worthless carbon offsets. The lack of current data and knowledge of the voluntary carbon market presents a significant reputational and regulatory risk for these companies. If investors go down a road of worthless offsets with little carbon impact, not only are they threatening the climate but they are leaving themselves open to criticism and a breach of their fiduciary obligations.
Whether you like it or not, carbon offsets are here for the long haul. To mitigate the risks, investors need to ensure they are buying quality carbon offsets, which genuinely make a positive climate impact. There is a huge opportunity to transform the market to be a force for good, but bold action is needed today to ensure this.
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