We are back with the next installment in our carbon finance series. In our last article, we discussed the key carbon pricing regimes across Canadian provinces. This article will provide an overview of some salient aspects of the voluntary carbon market (VCM) in Canada. The VCM is a voluntary carbon credits trading market where businesses and individuals buy carbon credits (described below) representing the measured carbon emissions reduction efforts of others to offset their own carbon emissions or for other business purposes. We will consider certain key questions relating to the VCM, namely how does offsetting emissions work in a voluntary market and who verifies, audits and authenticates the credits.
632 of the top 2000 public firms in the world by revenue announced ambitions to attain Net Zero greenhouse gas (GHG) emissions at the end of COP26 in Glasgow. This total has since risen to 821.[1] Nevertheless, during COP27, the viability of keeping global warming below 1.5°C was questioned and it was determined that GHG emissions need to fall by 45% by 2030 to reach Net Zero by 2050.[2]
In order to attain the Net Zero target, more and more companies have turned to offsetting strategies by using carbon credits to offset emissions they cannot otherwise reduce by changing internal methods, expenditures, processes or operations. This driving force by business, among other factors, has led to the increase in private funding of many climate change projects using carbon finance solutions. Carbon credits encourage spending on the innovation needed to reduce the price of cutting-edge climate technologies.
How does it work
A carbon credit is a certificate, unit or instrument (howsoever created and defined), typically representing one metric tonne of carbon dioxide equivalent or other GHGs, removed from the atmosphere as a result of a carbon-reduction project or emissions avoidance activities.
Compliance credits, which can be used to comply with national or international emissions reduction regimes, have long controlled the global carbon markets. For instance, the Clean Development Mechanism’s (CDM) Certified Emission Reductions, which were mainly utilised to meet the terms under the Kyoto Protocol, accounted for the majority of the initial trading in carbon offsets.[3] On the other hand, and as the subject matter of this piece, credits for voluntary emissions reduction initiatives are created pursuant to global voluntary market standards, such as the Verified Carbon Standard (VCS), and are given out in relation to projects that have registered with such programs in connection with activities that meet the voluntary market scrutiny, eligibility and principles. There are a range of important criteria that are applied by global voluntary market standard bodies to determine whether to affix an approval or ‘stamp’ to a carbon instrument or credit created for trading under the VCM. VCMs are created by projects and sponsors who are not acting ‘business as usual’ and whose credits (among other criteria), meet the test of ‘additionality’ – that is, the voluntary credit is created by actions taken, or not taken by choice, that are above and beyond what may be mandated by a governmental authority. Simply stated, doing what you are required to do by virtue of a compliance burden in effect may give rise to environmental attributes under the compliance market, but may not be eligible under the VCM. Instead of being used to support mandatory business related GHG reduction promises or claims, these voluntary credits are utilised to support voluntary corporate GHG reduction commitments.
By reducing, capturing, and storing emissions through various different procedures, a wide range of different businesses are able to create and sell carbon credits. Renewable energy projects and carbon and methane capture and sequestration are some of the most obvious types of carbon offsetting projects.
Verification and authentication
Accounting and verification methodologies vary in the VCM and mainly because credit’s benefits are not always defined. One of the keys to the development of a robust VCM that is determined to be liquid and safe is the ability to say with confidence that the voluntary credits that were bought or sold, held or retired, reflected real, genuine, permanent, measurable, verifiable and identifiable emission reductions. Stated another way, good verification and authentication of carbon credits is critical. The verification process normally falls to a third party entity who has a vast influence on the development of the VCM and overall market. However, lack of a standardized taxonomy in the verification process causes buyers and sellers of carbon credits to face variety of issues in the voluntary market including low liquidity, inadequate financing and unavailability of risk-management services.[4] It is possible to improve verification approaches and expedite verification procedures. For example, greater clarity in pricing signals for demand could contribute to suppliers feeling more confident in their project plans and persuade lenders and investors to offer funding.
Potential issues in scaling up the VCM
The rapid expansion of the VCMs can make it easier to mobilise funds for nations such as those in the global south, where there is the greatest potential for financially viable solutions to reduce emissions from nature.[5] However, there are certain challenges that may slow down its growth. First, high quality credits can be scarce and there is no standardized verification procedure. This in turn creates its own set of challenges from procurement and demand to carbon washing claims.
Second, as highlighted in COP27, the debate continues as to whether and to what extent companies can rely on carbon credits and use the VCM to achieve their Net Zero target. Intergovernmental Panel on Climate Change (IPCC) science indicates that offsetting should only be employed for industries and processes that will be difficult to reduce their emissions, because the ability to offset and remove carbon will be limited.[6] Some may argue that the focus of the mitigation efforts should be on limiting and preventing the release of GHG emissions as opposed to focusing on balancing out emissions using offsets. Our own view is that companies should engage a diversified toolkit when considering their own role in managing carbon and other GHG emissions, and carbon finance and the trading of carbon offsets has a proper place to play in a prudent, comprehensive corporate plan.
Project carbon
In July 2021, Canadian Imperial Bank of Commerce (CIBC), joined with National Australia Bank and NatWest Group to develop a new technology platform, called Carbonplace, to provide infrastructure to enable the reliable, secure, and scalable trading of voluntary carbon credits.[7] The aim of the project is to reduce the barriers in entering the VCM and provide project proponents in the global south an opportunity to have immediate and direct access to large pool of customers interested in carbon reduction and removal projects. The program has currently gone through its pilot trades and hopes to officially launch in early 2023.
Carbonplace seeks to address issues in scaling up the VCM. To build confidence that the credits that they include are high quality and verified voluntary credits, they are engaging top carbon registries, such as Verra and American Carbon Registry.[8] The platform uses blockchain technology to enhance the process of buying and selling credits across different domains and it is intended to keep the process as transparent as possible by providing full ledger, audit and report functionality to manage the carbon credit lifecycle. We will have to wait and see whether or not the platform will deliver on its objectives and provides for reliable and efficient trading.
Conclusion
To satisfy the increased demand in voluntary carbon credits and the desire for enhanced quality of such carbon credits, promising initiatives are being made to scale up and harmonise the existing disintegrated VCM. In 2021, the Taskforce on Scaling Voluntary Carbon Markets which is a science-based enterprise initiated by Mark Carney, announced the formation of an independent governance body that would administer Core Carbon Principles (CCP) which are a standardized set of environmental integrity standards that would be used to evaluate carbon credits. As Mark Carney put it in the UN Special Envoy on Climate Action and Finance, emissions reduction efforts must be guided by “clear guidance, tools and compliance procedures”.[9]
A word of caution. The VCM is, by definition, voluntary, bespoke and somewhat opaque. Many of the transactions are consummated by sophisticated businesses on a private basis. The commentary herein reflects our own experience. We have developed insights and expertise by advising buyers and sellers of carbon instruments over numerous years and in diverse industries. The next phase of the development of a robust VCM invariably involves a more transparent, price and term discoverable and liquid market of buyers and sellers. We hope to play an active role in the development and trading of high quality, verified and authentic credits for our clients and contacts.
Please mark your calendars for Tuesday March 7, 2023 for our inaugural ESG and Carbon Finance event: ESG and The Mining Industry. This will be an in-person event, held in our Toronto office and will be broadcasted virtually for those who wish to dial in. To learn more, please email [email protected].
We look forward to meeting and exchanging with interested parties on topics of common interest related to ESG and Carbon Finance.
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[1] Net Zero Tracker, Table of 2,000 Largest Publicly-Traded Companies.
[2] United Nations Climate Change. COP27. “COP27 Reaches Breakthrough Agreement on New “Loss and Damage” Fund for Vulnerable Countries”. (November, 2022).
[3] World Bank, State and Trends of Carbon Pricing 2021 (May 2021).
[4] McKinsey & Company. (2022, April 13). How the voluntary carbon market can help address climate change. McKinsey & Company.
[5] Blaufelder, C., Levy, C., Mannion, P., & Pinner, D. (2022, October 24). A blueprint for scaling voluntary carbon markets to meet the Climate Challenge. McKinsey & Company.
[6] Digitalnewshub. (2021, October 22). Heavy reliance on carbon offsets undermines net-zero goals. UN Climate Summit News – COP27.
[7] Three banks join initiative for Voluntary Carbon Market Platform. Reuters.
[8] Carbonplace: Global carbon credit transaction network. Carbonplace. (2022, July 6).
[9] United Nations. (2021). Mark Carney: Investing in net-zero climate solutions creates value and rewards. United Nations.
