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Can a New Sheriff Tame Carbon Markets’ Wild West?

Companies’ use of voluntary carbon markets to meet short-term decarbonisation targets are reigniting investors’ greenwashing concerns.

By now, we all understand most companies can’t transition to net zero greenhouse gas (GHG) emissions overnight – or even by 2030. This is why they are being asked by investors and governments to outline Paris-aligned decarbonisation strategies that leverage energy-efficient business operations, renewables and sustainable technologies.

To ease or accelerate their net zero journey, some companies turn to voluntary carbon markets (VCMs). Here they can buy carbon credits which claim to reduce, avoid or remove CO2 emissions, compensating for those they can’t cut themselves. Companies can either participate in VCMs individually or join industry-wide initiatives like the Carbon Offsetting and Reduction Scheme for International Aviation, where members have pledged to offset all CO2 emissions above a baseline 2020 level.

Companies aren’t the only ones to benefit from VCMs. Governments, NGOs, universities, municipalities and individuals are also able to offset their emissions (outside of regulatory regimes) by purchasing voluntary carbon credits. Without geographical boundaries, VCMs are global, offering market participants exposure to offset projects as far afield as Colombia and Russia. But, without boundaries, or indeed much in the way of regulation, VCMs form a web of carbon credits that is difficult to untangle. Market participants typically depend on standards-setters, such as Verra, to verify whether or not a VCM offset project is credible.

VCMs are not the same as official carbon markets, such as the EU’s Emissions Trading System (ETS), which are set up by governments to incentivise firms in carbon-intensive sectors to reduce their emissions, by controlling the availability and price of permits. Currently, there is very little overlap between official markets and voluntary ones, but it’s hoped that, under the recently finalised Article 6 of the Paris Agreement, trading across markets will become more commonplace.

Friend or foe?

Partly due to their unregulated nature, investors are concerned VCMs facilitate greenwashing, with companies purchasing voluntary carbon credits to offset emissions they could have cut themselves. Rather than contributing to the transition from fossil fuels, VCMs could be slowing it.

There are also concerns about the quality of the projects offering carbon credits on VCMs, with experts noting it is widely variable. Without standardised guidance or regulations, VCMs will continue to be seen as the ‘Wild West’.

“Investors fear that VCMs are ultimately just allowing companies to move emissions from one balance sheet to another,” says Rachel Kyte, Co-Chair of the Voluntary Carbon Market Integrity (VCMI) Initiative’s steering committee.

Launched in July 2021, VCMI is working to ensure VCMs are transparent and robust, contributing to the world’s goal of limiting global warming to 1.5°C. The global multistakeholder platform is co-founded by the UK’s Department for Business, Energy and Industrial Strategy and independent philanthropic organisation Children’s Investment Fund Foundation. It is supported by the COP26 Presidency, the US Special Presidential Envoy for Climate John Kerry and the United Nations Development Programme (UNDP).

Voluntary markets are continuing to grow, reaching US$1 billion in 2021, according to NGO Ecosystem Marketplace. A 2021 report by management consultancy firm McKinsey estimated that demand for voluntary carbon credits could increase fifteenfold by 2030, with the overall market reaching a worth of US$50 billion. This prediction estimates the voluntary markets’ value at over US$3 billion in 2020, reflecting how dispersed and opaque VCMs can be.

Ordering chaos

Since its launch, VCMI has been developing guidance for voluntary markets’ governance infrastructure, equity and access. It will also be considering what VCMs could look like when influenced by eventual regulation at a regional or national level.

One of the biggest areas of focus for the initiative is making sure there is increased transparency around the environmental and social impacts of VCM projects. In support of the United Nations Sustainable Development Goals (SDGs), VCMs should share the benefits of these projects more equitably with local communities, the VCMI’s roadmap notes.

“We want to see companies and investors question the arrangements VCM projects have with indigenous communities,” says Kyte. “Respecting rights holders is a critical part of making sure VCMs have high integrity.”

The initiative will be working with policymakers to develop ‘country access strategies’. These should help to attract investments through VCMs that contribute to countries’ nationally determined contributions (NDCs), broader climate policy objectives and the SDGs.

A previous consultation with stakeholders identified other areas of focus, including the need for guidance to ensure carbon credit claims align with limiting global warming to 1.5°C and the minutiae of the Article 6 agreement.

In April, VCMI will launch its claims guidance document, which will serve as a “practical operational manual for companies”, which lays out the prerequisites for the “credible” use of carbon credits, says Mark Kenber, Co-Executive Director of the VCMI.

Once the initial guidance is published, VCMI will observe how effective it is for companies and identify aspects that need further clarity, before publishing a finalised version later this year, Kenber tells ESG Investor.

“We want to provide certainty, consistency and coherence and, in as much as it is useful to do so, look at how these claims should be regulated – whether it’s by advertising standards authorities, consumer protection agencies or governments,” he says.

Offsetting their way to net zero

VCMI’s Kyte and Kenber both note that assuaging greenwashing concerns is of paramount importance to the initiative; its 2022 claims guidance will emphasise the importance of companies disclosing their decarbonisation progress prior to utilising VCMs.

“Trading and purchasing credits should only come after all reasonable efforts to reduce emissions have been made by companies,” says Rob Macquarie, Policy Analyst and Research Advisor to Lord Nicholas Stern at the London School of Economics Grantham Research Institute on Climate Change (LSE GRI).

“If we don’t have that precondition to the use of these tools, then we’re simply not going to achieve the global emissions reductions needed to stay within our goals.”

However, current corporate disclosures on the use of VCMs to reduce GHG emissions are “very few and far between”, points out Luke Sussams, Head of EMEA ESG and Sustainable Finance at investment bank Jefferies.

This makes it much harder for investors to identify cases where companies are buying voluntary carbon credits without fully committing to reducing emissions caused by their business operations.

Erwan Crehalet, Senior ESG Analyst at Amundi, says that the asset manager accepts short-term reliance on voluntary carbon credits, provided companies have 1.5°C-aligned net zero strategies verified by the Science Based Targets initiative (SBTi).

“We are then more assured that the companies in question are only offsetting what they can’t reduce on their own, as they have that credibility,” he says, adding that investee corporates should clearly demonstrate how they intend to “reduce their reliance on offsetting over time”.

SBTi-verified corporate strategies only rely on carbon offsetting for 5-10% of total corporate emissions, according to the initiative’s recently launched Net Zero Standard. “An overreliance on carbon offsets in net-zero targets creates multiple problems around land use, equity, fairness and climate justice,” SBTi said.

Delivering on a promise

Greenwashing fears don’t just centre around whether companies are overly dependent on VCMs, but also whether projects covered by credits are actually achieving their emission reduction goals.

There are examples of certified projects not living up to their claims. In April 2021, Finland-based NGO and offset brokerage Compensate analysed 100 offsets certified by voluntary carbon offset programme Gold Standard and other groups. The report noted that 90% of projects either failed to offset as much as they claimed or actually caused damage to local communities and ecosystems.

A further investigation by The Guardian and Unearthed, NGO Greenpeace’s investigative arm, found that many offsetting schemes used by some of the world’s largest airlines had made emissions-saving predictions that were inconsistent with previous levels of deforestation or overstated their success.

Some projects also sell the same credits across multiple VCMs, meaning that companies may inadvertently buy the same credits. To counteract this, experts are calling for a global registry that will log and keep track of all VCM projects and credits available.

In October 2021, market data provider IHS Markit launched the Carbon Meta-Registry, an online platform that aims to connect existing registry systems around the world to better enable the exchange of carbon market data and reduce the risk of double counting credits.

Ultimately, companies shouldn’t assume a project is high-quality, says VCMI’s Kyte. “There has to be a level of rigour at the company level,” she adds, noting that smaller companies without the resources to investigate the integrity of VCM projects can seek advice from digital monitoring, reporting and verification (MRV) firms and consultants.

There is room for innovation in this space, too. In May 2021 carbon offset ratings company Sylvera launched a platform that uses geospatial data collected by drones and satellite technology to generate real-time carbon sequestration ratings of projects around the world.

“On the one hand, VCMs could provide a cost-effective method for corporates to reduce their emissions,” says Sussams. “On the other, if they are not effective or robust, VCMs could ultimately facilitate the greatest corporate greenwashing exercise in history. The stakes couldn’t be higher.”

Common ground

At the moment, seamless trading between ETSs and VCMs is something of a pipe dream – partly because of the vast differences in trading price and issues with transparency.

Voluntary carbon credits are averaging “unsustainably low” prices between US$3-US$5 per tonne of CO2 (/tCO2e), according to a 2021 report by Trove Research. It is important to note that higher quality VCM credits do cost marginally more, with certified voluntary credits listed by Gold Standard ranging between €8- €13/tCO2e. However, Trove has estimated that VCM credits need to be priced between US$20-US$50/tCO2e by 2030 to ensure “high environmental integrity”.

In comparison, EU ETS prices surged to €90/tCO2e in December 2021, although this was largely connected to the energy crisis, and the UK’s ETS charged over £50/tCO2e when launched last year.

“It’s not the fault of corporates that the price of voluntary credits is very low,” Sussams counters. “But the average price does need to go up quite considerably to ensure that VCMs don’t just serve as a get out of jail free card for laggards.”

However, experts are hopeful that agreement on Article 6 can pave the way to the common ground needed for all carbon trading markets to intersect.

Following six years of debate, and agreed by nearly 200 countries during the eleventh hour of COP26 in Glasgow last year, the finalised Article 6 deal recognised the purchasing of carbon credits as an acceptable method for countries to partially meet their net zero targets. The international carbon market Article 6 lays out would enable countries to purchase emissions reductions from other jurisdictions that have met their own decarbonisation targets – provided a share of the proceeds from trading is funnelled into climate adaption finance for developing countries.

“It’s most likely that the Article 6 rules will become a de facto standard for VCMs, because it creates an incentive to be able to trade credits interchangeably in both markets,” says LSE GRI’s Macquarie. “However, not all credits created are likely to receive the government authorisation required to be used under Article 6, especially those created for VCMs.”

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