Net zero investors had their eyes on the voluntary carbon markets once again this week, as the Voluntary Carbon Markets Integrity Initiative (VCMI) unveiled its latest guidance on using carbon credits.
Offsetting has become one of the most headline-grabbing and divisive areas of sustainable finance in recent years, and this week’s rules offer a slightly firmer guardrail against the associated reputational and legal risks.
But, while it may not be getting as much of the limelight, many investors are still pinning their hopes on carbon trading in the compliance markets, not the voluntary markets, to accelerate decarbonisation.
“One of my most frequent refrains is carbon pricing, carbon pricing, carbon pricing,” said Rick Stathers, climate lead at Aviva Investors. “We can all get distracted by the next shiny object, but we’ve seen how [compliance markets] have been used in the past to deal with externalities.”
Back in 1990, the US Environmental Protection Agency established a cap-and-trade system for sulfur dioxide and nitrous oxide emissions, to tackle acid rain. A 2021 study concluded that the scheme had resulted in material reductions in those emissions, and improvements in air quality.
And there are signs that cap-and-trade carbon markets are growing in influence. A recent survey conducted by PwC showed that investors and other market participants are braced for increases in the price of European carbon allowances in coming years, mainly on the back of recent reforms to the EU Emissions Trading System (EU ETS).
Those reforms include a commitment to create a new carbon market for Europe’s transport and real estate sectors – central to meeting the region’s climate goals, but until now almost entirely overlooked in its compliance market. Most respondents also expect carbon removals to be incorporated into the EU ETS following a proposal by the European Commission last November for a new, compliance-grade certification framework.
“A lot of the current media attention is on voluntary markets, but the real action is in compliance markets,” said Dirk Forrister, chief executive officer of the International Emissions Trading Association (IETA), the membership body that commissioned the PwC report.
The price of a tonne of carbon under the EU ETS surpassed €100 for the first time ever in February, and IETA’s members believe that prices will average €84.40 between 2022 and 2025, rising to €100 between 2026 and 2030.
The World Bank’s High-Level Commission on Carbon Prices, led by Nicholas Stern and Joseph Stiglitz, concluded back in 2017 that prices would need to hit $40-80 per tonne by 2020 and $50-70 per tonne by 2030 to be in line with meeting the goals of the Paris Agreement.
The bullishness is not just in Europe – the survey indicates that the 187 respondents think, for the first time, that pricing will get stronger across all major compliance markets.
Last year, the Net Zero Asset Owner Alliance published its thoughts on compliance markets, saying that “more policymakers should consider implementing carbon prices that are legally binding and set in line with science-based evidence” and that existing markets should be expanded.
This week, former Goldman Sachs veteran and architect of the Black-Litterman Global Asset Allocation Model, Bob Litterman, proposed a new asset class to boost carbon prices. Based on the sustainability-linked bonds, carbon-linked bonds would see sovereigns pay lenders higher interest rates if they didn’t achieve their own target carbon prices.
“Investors aren’t letting up on their ambition for all major economies to be under carbon pricing programmes, whether that’s a tax or a market,” said Forrister. “But they are being realistic and looking at jurisdictions that don’t look set to have national programmes anytime soon, and that’s where they’re pushing for voluntary markets to pick up the slack.”
This includes parts of the US, as well as developing and emerging markets, he noted.
Stathers described the compliance markets as “very effective at raising revenues for the net-zero transition”, but notes that there’s another reason that investors should want these regulatory mechanisms to ramp up.
“From a financial services perspective, we can factor in carbon pricing quite easily: we type in the level of emissions and the carbon price, press return, and – lo and behold – it has an impact on EBIT. That’s a really valuable tool. So it might go out of fashion, but that doesn’t mean it’s not the right solution.”
Read the digital edition of IPE’s latest magazine
No comments yet