Industry

VCM Middlemen Urged to Come Clean

Buyers and sellers in VCMs can reduce intermediaries’ margins and ensure credits finance climate action by establishing registries and disclosing financial information.

Increased disclosure of transaction information is needed to improve transparency in the voluntary carbon market (VCM), reduce intermediaries’ margins and ensure finance drives climate action, according to a recent report by Carbon Market Watch, a non-profit working to ensure carbon pricing drives a just transition.

“It would go a long way to understanding the role that the VCM is playing in financing climate action,” Gilles Dufrasne, Lead on Global Carbon Markets at Carbon Market Watch, told ESG Investor.

“By better measuring the real contribution in financial terms towards real projects, [increased disclosure] can strengthen the credibility of the system as a whole and make it clearer to stakeholders the exact size of the VCM and its contribution to climate action.”

The report recommends that intermediaries be more transparent about their profit margins and fees, but the majority are reluctant to disclose, said Dufrasne, noting a lack of transparency allows them to profit from high margins.

“Many intermediaries will say that this is commercially sensitive information,” he said. “They are making their money precisely because of this asymmetry of information.”

Blackbox market

There is no publicly available data on the prices at which individual projects are traded or retired in VCMs, Aurelia Britsch, Global Head of Climate Research at Sustainable Fitch, told ESG Investor, noting that a large share of credit transactions is done over-the-counter, via private deals.

This means end-buyers, the companies which retire the credits to compensate part of their emissions, can only provide limited information on their offsetting strategy or on the specific characteristics of the projects they source their credits from, said Britsch, adding that there is also a power imbalance between VCM stakeholders.

“Many project developers are NGOs, verifiers are also often not-for-profit organisations, while there has been a flurry of private investment from large financial institutions and stock exchanges in the ‘downstream’ part of the market in recent years, with the multiplication of brokering services, carbon credit exchanges, transaction networks. These financial intermediaries are likely to look for high returns,” she said. “The end-buyers themselves can compensate a large share of their reported emissions and make associated marketing claims for a fraction of their revenues.”

Based on publicly available information in their sustainability reports, Sustainable Fitch estimates that Nespresso, the coffee capsules unit of Nestle, spent around 0.1% of its revenue on buying offsets in 2020 to compensate as much as 24% of its reported emissions, while Google spent about 0.02% of its revenue in 2021 to offset 18% of its emissions.

Britsch noted that due to neither company providing pricing information, Sustainable Fitch’s calculations are based on a “best-guess” basis.

According to a new guide to VCMs, the absence of “reliable, transparent, available price discovery” has proved a hindrance to buyers and sellers, also pointing to difficulties in identifying fellow market participants.

The guide, published by law firm Simmons & Simmons and Climate Solutions, a specialist climate-focused advisory group, also cites further challenges to growth, including variable quality and impact of offsets, double counting, fragmentation and a lack of interoperability.

Shedding light on VCMs

Even though it is in the interest of both project owners and the final users of carbon credits to ensure that as much finance as possible reaches mitigation projects, most stakeholders simply assume that VCMs are an effective climate finance tool, despite the lack of transparency restricting stakeholders’ ability to measure how cost-efficient any platform or market is, the report noted.

To assess any individual VCM’s performance in this regard Carbon Market Watch suggests that buyers refuse to purchase credits from intermediaries that do not disclose their fees and mark-ups publicly. Further all VCM registry account managers should provide information on account holders and their holdings to identify intermediaries and to improve the transparency of VCM transactions.

Any entity wishing to register projects or issue, retire, or transfer credits must have an active registry account.

The results of a study, conducted on behalf of Carbon Market Watch by AlliedOffsets, found that nine out of 10 intermediaries do not disclose their fees or profit margins.

To improve transparency and restore trust in VCMs, several initiatives have been established that are developing best practices and quality criteria.

The two main emerging governance initiatives are the Voluntary Carbon Markets Integrity Initiative (VCMI), created to guide the credible use of offsets on the demand-buyer side; and the Integrity Council for the Voluntary Carbon Market (ICVCM) on the supply side, to ensure the integrity of the projects.

“Pricing transparency does not seem to be addressed by these networks at this point,” noted Sustainable Fitch’s Britsch.

However, there is a lot of willingness to address the issue, said Dufrasne. “It’s in everyone’s interest – except the intermediaries.”

“The project owners stand to gain from it by limiting the margin of intermediaries and increase the amount of money that they receive for carbon credits they sell,” he said. “The buyers also have an interest, because by limiting intermediaries’ margins, they will have to pay less for each credit.

“Stakeholders can work together to circumvent the goal of intermediaries and improve transparency.”

VCMs: Help or hinder?

The lack of transparency in VCMs has driven debate, particularly among academics, on the viability of carbon offsets to effectively drive climate action. But VCMs still remain an vital part of climate finance to compensate for residual emissions from hard-to-abate sectors, said Britsch.

“Transparency on transactions (number of times a credit is traded before it is retired, information on prices), stricter carbon credit supply principles (with strong baselines for deforestation projects and much tighter conditions for renewables projects which suffer from concerns over their actual additionality) and more credible offsetting strategies by end-buyers will help restore the credibility of VCMs – this will take years to be implemented.”

In the meantime, reputational risks for buyers will remain acute, she added.

“As a result, corporations could keep a cautious approach regarding offsetting, which suffers from a growing lack of credibility,” she concluded. “Companies that wish to make credible efforts towards their net zero commitments are likely to reconsider or reduce their reliance on offsets in the near term and will need to focus to a greater extent on actual emission reduction within their operations and supply chains.

“This is likely to require larger investment than buying offsets. Those that continue to rely on low priced offsets risk a reputational backlash, and potential litigation as regulators increase their efforts to stymie greenwashing in 2023.”

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