What will the increased financialization of carbon do for decarbonization?
A sentence summary to capture voluntary carbon markets’ impact on climate could read: Markets solve some things, not all things.
If the North Star of sustainability strategy in finance is (buzzwords aside) catalyzing decarbonization in the real economy, then what do developments like the London Stock Exchange Group’s (LSEG’s) launch of a new offering on the London Stock Exchange for carbon credits portend for the path ahead?
Voluntary carbon markets epitomize a strand of business-think that, as far as the climate is concerned, has not delivered the desired results. And in such a pivotal moment for climate action, the efficacy of offsets has proven consistently questionable.
The voluntary carbon market was worth $2 billion in 2021, and the value is estimated at north of $50 billion by 2030. What does the increased financialization of carbon, as epitomized by LSEG’s new offering, mean for decarbonization — particularly in a world where public policy will be more determined to curb emissions?
Getting past ESG
First, a quick brush up on carbon offsets versus carbon credits.
Per the Corporate Finance Institute, carbon credits are a unit of measurement — one ton of CO2e, or carbon dioxide equivalent — with a tradable component. They’re created by governments and allocated to individual companies.
Carbon offsets, on the other hand, are a measurement unit to compensate an organization for a voluntary investment in a project that removes emissions through nature-based or mechanical means. An offset can be kept by the organization that completed the project or it can instead be traded in the voluntary carbon market.
The aforementioned market for funds on the London Stock Exchange will “enable funds and operating companies to raise capital to be channeled into projects … that are expected to generate carbon credits.” It is meant to provide both access to offsets for corporations and exposure for investors to an asset class with a “long-term supply of carbon credits.”
In a world where ESG strategy — a risk mitigation practice used by investors — continues to get conflated with impact and outcomes, there is reason to be optimistic that new funds geared toward carbon credit generation will appeal to climate-conscious investors seeking impact.
Again, markets solve some things, not all, and they often produce results with great speed and sometimes unintended consequences. The voluntary carbon market designation from LSEG aims to mitigate this by requiring issuers to provide additional disclosures for the projects they are financing, “including but not limited to; the qualifying bodies whose standards will be applied to the projects, project types, expected carbon credit yield and the extent to which they are expecting to meet the United Nations Sustainable Development Goals.”
And, to ensure that funds on the exchange are producing a positive environmental impact, all other investments in funds listed via LSEG’s Voluntary Carbon Market must be mapped to FTSE Russell’s Green Revenues Classification System, a taxonomy for green products and and services.
Investing for the future
If you’re an investor betting on a future state, then investing in carbon as an asset class may be really good business.
And if capitalism is to continue — and continue on a livable planet within the boundaries that encircle ours — addressing the externality of carbon through policy, however sharp or blunt the sticks may be, will be necessary to deliver the necessary speed of emission reductions.
So while the Inflation Reduction Act (IRA) provides a bountiful bundle of tasty clean economy carrots, the European Union’s agreement to implement a Carbon Border Adjustment Mechanism (CBAM) — essentially a pollution price on certain imports — signals a change on the horizon for the intersection of carbon and commerce.
Europe has been discussing something like CBAM for decades. If sustainable finance is to deliver real economic results, “rewiring the way in which the finance industry works,” as responsible investor network Principles for Responsible Investment CEO David Atkin put it to me, is necessary. IRA aside, more policy sticks may well end up in the United State policy pipeline to create the market infrastructure that will allow sustainable investors to invest sustainably.
Anything is possible in a future where that future is existentially threatened by actions taken, or not taken, in the present. And a few things are true now that will inform the future: The state of climate change is bad, it’s getting worse, and the United States tends to lag years behind Europe on clean economy-related policy.
Assuming we don’t find ourselves in a civil war over fossil fuels (or are we already in one?), the expansion of carbon-credit schemes in the United States and across the world could lead to a major flow of capital toward decarbonization through mechanisms such as that of LSEG’s voluntary carbon market.