Dr Bo Bai, Executive Chairman of MetaVerse Green Exchange, says regulation should reflect the duality of carbon credits to drive green finance growth.
When global leaders gathered at COP26 last year, governments pledged ambitious 2030 emissions reduction targets to achieve net zero by 2050. Months on, the effects have been debatable at best. UN Secretary-General António Guterres dubbed the latest Intergovernmental Panel on Climate Change (IPCC) Working Group report, released in February 2022, an “atlas for human suffering”, in recognition of the growing impact of climate change, as “a brief and rapidly closing window of opportunity” draws near.
Since the early days of the Kyoto Protocol, carbon was the commodity of choice for measuring and offsetting the negative impact on the climate. Countries that ratified the treaty were able to emit carbon at maximum levels for a specific period and participated in carbon credits trading with others. Since then, the Paris Agreement and COP26 put forth new demands, resulting in more robust national climate action plans and the recognition that public and private sector initiatives across both developed and developing were required to achieve net zero.
As countries, financial institutions and multinational companies work in tandem to meet their sustainability goals, we need to think pragmatically about how carbon is treated, so that we can devise better ways of working with it as approaches to achieving net zero evolve. Take the rapidly growing voluntary carbon markets (VCMs) — with a projected value of US$1.5-1.7 billion in 2022 — and the increasing availability of voluntary carbon credits (VCCs) which have effectively transformed carbon into a new asset class — a security — that buyers and investors can now trade as part of their green finance efforts. Should this not change how carbon is regulated?
As the role of carbon evolves, siloed thinking is holding us back: Duality is the way forward. If we can treat and regulate carbon concurrently as both a commodity and a security, we can create better outcomes for corporations and governments alike.
Contextualising carbon as a commodity
International emissions trading systems like the Clean Development Mechanism (CDM) and the European Union’s Emissions Trading System (EU ETS) are both key to understanding why our perceptions of carbon as a commodity are what they are today. Both launched in 2005 after the Kyoto Protocol, these systems led to the monetisation and commodification of carbon via the ‘cap-and-trade’ mechanism. Countries would earn emission reduction credits and sell them on carbon markets at prices determined by the forces of demand and supply — just like how regular products are influenced by the forces of demand and supply.
As part of the CDM, countries earn certified emission reduction (CER) credits if they invest in emission-reduction projects in developing countries. These earned carbon credits can either be sold to other countries to offset their carbon emissions or kept to offset domestic carbon emissions. In fact, CER credits can be traded on the EU ETS system therefore regulating and treating carbon as a commodity.
The rise of the voluntary carbon market
When countries reconvened in 2015 and signed on to the Paris Agreement the following year, it was clear that solely nationally-driven climate initiatives, especially across developed economies, were no longer enough. An ideological shift demanded that addressing the impact of climate change be a holistic global effort across both the public and private sectors as codified by Article 6 of the agreement.
Article 6 effectively advocates for a global carbon market led by voluntary cooperative efforts between countries to help one another meet their nationally-determined contributions. Simultaneously, Article 6 also crucially extends climate action beyond compliance markets to the voluntary carbon markets, where demand is driven by voluntary commitments to reduce emissions and the demand is certainly there.
The entry of private participants into the market has opened the floodgates to a host of new trading options. Last year, the value of global carbon markets hit US$851 billion as different stakeholders all flocked to the EU-ETS market, VCMs and VCCs. The inflow of interest has led to a new ecosystem of green finance, consisting of financial instruments on VCMs in the form of spot trades, futures, derivatives, and green bonds to not only enable multinational companies to meet their net zero targets, but also for financial institutions to manage the carbon footprint of their holdings by financing green projects.
While VCCs are undoubtedly useful in the race to net zero, integrity is sorely lacking, leading to projects exploiting the lack of clear, uniform standards by double counting to make a profit. For green finance to be truly trustworthy and scalable, we need to start viewing and regulating carbon as a security, in addition to a commodity and actively create the structures that provide uniformity and integrity. These structures will fill the gaps in the existing carbon markets, and provide clarity on what they’re likely to look like, and the rules that will govern them.
Carbon as both a commodity AND a security
As governments, regulators and businesses debate the taxonomy of carbon and under whose purview it falls, the climate crisis worsens. This institutionalised inflexibility is restrictive. However, as a physicist, I am at ease with the concept of duality in science. Just as light is both a wave and a particle, and E=mc2 where energy and mass are effectively interchangeable forms of the same thing, regulators should similarly treat carbon in recognition of the different roles it fulfills for different stakeholders.
For corporations, VCCs can be used to satisfy their net zero targets so as long as their actions comply with and are verified based on internationally-recognised standards such as PAS2060. This is especially critical when taken with the European Union’s recently voted-on Carbon Border Adjustment Mechanism (CBAM). In this situation, carbon is still treated as a commodity. However, to avoid the issue of double-counting and falling foul of a country’s nationally-determined contributions, it is possible to effectively convert carbon into a financial instrument — a security — for trade within the international market. This includes MVGX, which has utilised tokenisation in the form of our blockchain-based Carbon Neutrality Token (CNT).
On the other hand, financial institutions have already begun treating carbon as a security by purchasing derivatives of carbon or taking positions in spot carbon credits — not only trading them for profit when carbon prices increase, but also to manage the carbon footprint of their portfolio of financial security holdings. This rise in trading activity has undoubtedly accelerated the growth rate of the VCMs due to increased liquidity in the market.
To date, VCCs can be used to satisfy the requirements of the ETS system and are regulated similarly to commodities. However, as businesses look towards carbon to satisfy their ESG commitments and drive green finance, it’s time for regulators to reevaluate existing policies and adapt to the new ways VCCs are being used to ensure the legitimacy and integrity of credits being traded.
VCMs of the future
In recognition of this fundamental duality of carbon, regulators are taking note as they look to regulate VCMs. Discussions are seemingly most mature in the United States, where it’s predicted that the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission will get involved through compulsory disclosure mechanisms steps and setting climate benchmarks to strengthen ESG reporting while also subjecting any carbon futures trading to CFTC regulations.
Meanwhile, within the EU, the ETS that accounts for 90% of the global carbon credits turnover in 2021 is under the oversight of the European Commission. While in Asia, the Asian Development Bank and the Government of the United Kingdom announced a new US$134 million trust fund to support ASEAN countries as they scale up their green financing initiatives. Amid a slew of new projects, the underlying assets from the region that back VCCs are only primed to grow Asia’s green finance ecosystem.
With only months away until COP27, it’s clearer than ever that governments and businesses will need to rely on VCMs to urgently drive climate action. Regulators must enact new policies to regulate carbon in recognition of its duality as a commodity and as a security to ensure that all VCCs on VCMs are certified and of high integrity. Until regulators themselves can address growing better standards and frameworks, it’s hard to see how we can meaningfully and verifiably hit net zero by the mid-century.