Can the carbon credit markets institutionalise and tokenise at the same time?

November 3, 2023

Wednesday November 1st at 2pm UK time

The voluntary carbon credit market has emerged rapidly as a market-friendly way of combating climate change. It has attracted blockchain-based entrepreneurs that see carbon credits as ripe for tokenisation, in large part because a novel idea developed by people outside the traditional financial services industry has yet to develop an infrastructure capable of hosting issuers, investors and traders safely. Greenwashing, double-counting, lack of transparent prices, an absence of trustworthy intermediaries and even outright fraud are prevalent. Existing efforts to overcome the lack of information and integrity in carbon offset projects have not met with success but both policymakers and institutional quality infrastructure providers are now getting involved, and hopes are rising that the carbon credit market will grow rapidly. But there are formidable obstacles to overcome.

What is the event about?

In November 2007 Sir Nicholas Stern, head of the 2006 Review on the Economics of Climate Change, described climate change was the greatest “market failure” in history.[1] This is a tendentious view. Climate change is what economists call an “externality,” in which the social costs (greenhouse gases) exceed the private economic costs and the social benefits of reducing greenhouse gases exceed the private gains. As a result, private economic actors have no incentive to reduce the pollution they create. It is harsh to describe this outcome as a “market failure” since market mechanisms cannot be applied to a problem in which market participants are unable to benefit from reducing their own emissions or bearing the costs of the emissions of others.

Which is why carbon reduction schemes tend to be led in the first instance by governments, which tend to tax carbon-emitting fuels such as coal and subsidise “renewable” forms of energy. In practice, these measures are a muddled compromise. Governments impose differential rates of taxation on different fossil fuels and actually subsidise some fossil fuels at the same time as taxing them (to win votes, effectively supporting consumption). They also back renewable energy technologies irrespective of their costs (because the costs can be dressed up as benefits in the form of “jobs” and “innovation”) or environmental benefits. Indeed, the inability of governments to adopt the right solution – namely taxing emitters in proportion to the damage they cause and subsidising no one – could be described as a signal case of “government failure.”

It is against this background that all attempts to put a price on carbon must be understood: as a second-best alternative to government failure to tax emitters on the well-founded an easily comprehensible principle that the polluter must pay proportionately to the damage they cause. The European Union (EU) pioneered so-called “cap-and-trade” schemes back in 2005 with an Emissions Trading System (ETS) that enabled large corporations to trade a fixed number of emissions allowances within a steadily reducing cap – set by the authorities – on overall greenhouse gas emissions.

Though the aim was to put a price on carbon, the ETS has malfunctioned as a market. Emissions – caps on which, initially at least, were set at the national level – are hard to forecast, and in the early years of the scheme the allowances available usually exceeded the actual emissions. While ETSs establish a sort of property right in emissions, which makes them tradeable, the overall caps on emissions make it hard for prices to reflect the real preferences of buyers and sellers.

Indeed, the policymakers that set the caps are bound to be influenced by lobbyists using the current state of climate science about global warming to, say, set a limit that is too high (benefiting large corporations that pollute, as happened in the early phases of the European ETS) or too low (hitting consumers that bear the increased costs). When the science turns out to be too bearish, raising the cap is resisted by holders of existing carbon credits, since their value will fall.  It does not help that governments also continue to subsidise carbon-intensive forms of energy and to subsidise renewable energy sources generously, without much regard to the environmental benefits they deliver.

But cap-and-trade is politically less risky than introducing a carbon tax on polluters, so it is likely to persist. Indeed, other countries are queuing up to follow the European example. The ETS map prepared by ICAP lists 48 emissions trading systems around the world that are now operating, or under development, or under consideration. Nine of them are in China, which has benefited from European advice.[2] Efforts are in hand to link these various national systems to create a global market in emissions allowances. In fact, Article 6 of the Paris Agreement of 2015 empowers the signatories to use international trading of emission allowances to help achieve domestic emissions reduction targets.

Alongside these government schemes a second market is developing in voluntary carbon credits. In these, emitters can purchase carbon credits – each of which represents a tonne of carbon not emitted or (better) removed from the atmosphere – if they wish to increase their own emissions. The credits are issued by the backers of environmental projects such as tree-planting (“green” credits) or mangrove swamps (“blue” credits) or renewable energy technologies (“white” credits). The projects are certified as delivering the promised impact on emissions by registration and certification agencies such as Verra and Gold Standard. Funds are being established specifically to profit from carbon credits, endowed by investors unwilling or unable to engage to directly in environmental projects.

In January 2021, the Taskforce on Scaling Voluntary Carbon Markets (TSVCM) – chaired by former Bank of England Governor Mark Carney – published its blueprint on creating a large-scale, transparent voluntary carbon credit trading market. [3]“A liquid voluntary carbon market at scale could allow billions of dollars of capital to flow from those making net-zero commitments into the hands of those with the ability to reduce and remove carbon, significantly contributing in the transition to net zero,” argued the report.  On a range of scenarios, it predicted a voluntary carbon market worth anywhere between US$5 billion and US$180 billion as soon as 2030.

However, the report also listed the shortcomings of the existing markets in carbon credits. They suffer from greenwashing projects, double-counting due to lack of safe custody and registration, lack of transparent, independent pricing, an absence of trustworthy intermediaries, and even outright fraud. In fact, the carbon credit markets are anarchic. Despite the involvement of certification and registration agents, projects make unverifiable or even reversible claims. Carbon credits that have already been used (“retired”) are sold again. Prices are detached from real environmental performance. A study by the Guardian newspaper, published in January 2023, claimed than more than 90 per cent of rainforest offset credits – a commonly used carbon credit – were unlikely to represent genuine carbon reductions.[4]

Which helps to explain why the TSVCM has been superseded by the vectorially titled Integrity Council for Voluntary Carbon Markets (ICVCM). Its purpose – derived from the original report – is to help the carbon credit markets achieve scale without compromising quality, through the development of Core Carbon Principles (CCPs). The CCPs are intended to become the global benchmark for a high-quality carbon credits. As the TSVCM argued, the carbon credit markets need a “robust exchange, clearinghouse and meta-registry infrastructure” to provide a “backbone for trading, clearing and settlement, while producing transparent market and reference data.”

So far, that central marketplace and standards-based infrastructure with an active secondary market generating transparent prices based on has yet to materialise, even though Mark Carney described it as “imperative.” Instead, a range of private initiatives have emerged, notably blockchain-based enterprises looking to aid trading by tokenising carbon credits or hosting the issuance and buying and selling of tokenised carbon credits on blockchain networks (the TSVCM acknowledged that “advanced technologies” such as blockchain could help).

They include Flowcarbon (which brings together carbon offset projects and major corporations that invest in carbon credits), Lune (which sources projects and sells them to investors), KlimaDAO (a blockchain-based trading platform for carbon credits), Moss MCO2 (which issues tokenised carbon credits as MCO2 tokens), Regen Marketplace (where corporations can trade carbon credits), Toucan (the infrastructure provider behind the Base Carbon Tonne (BCT) reference token), and Liechtenstein-based Carbon Utility Token (CUT, a new carbon credit registry which sources and tokenises its own carbon credit offsets on a blockchain network).

A number of institutional quality carbon credit trading platforms have also started up. They include Xpansiv (a platform for registering, managing, trading, settling and retiring a range of environmental commodities), Air Carbon Exchange (which aims to bring traditional commodities exchange techniques and technologies to the carbon credit markets) and Carbon TradeXchange (which hosts corporations, carbon offset projects and brokers that buy and sell carbon credits).

The latest institutional quality entrant Capturiant, which launched in July 2023 as a blockchain-based  “environmental asset exchange”  where project developers and buyers of carbon credits can meet in a regulated environment (the company operates under the Bahamas’ Digital Assets and Registered Exchanges (DARE) regulatory framework). The company is also looking to bring trust to project authentication and certification as a carbon credit authenticator and registry by bringing to the market the reassuring techniques used in the traditional securities markets (its model includes assigning CUSIP numbers to carbon credits).

In addition to checking the authenticity of carbon offset projects, tokenisation platforms promise the usual benefits: allowing investors to buy and sell carbon credits at transparent prices; enabling carbon credits to be fractionalised so smaller investors can take part; and providing an immutable ledger of transactions to solve the problems of double-counting and re-selling of retired carbon credits. These benefits are evident already in the form of tokenised green and social impact bonds, so environmentally-aware investors are increasingly familiar with tokenised assets.

And, at least in theory, investors ought to be keen to take part in tokenised carbon credit markets. Globally, assets invested in Environmental, Social and Governance (ESG) strategies are expected to hit US$50 trillion by 2025. According to Cerulli Associates, half (49 per cent) of European institutional asset owners plan to make a formal net-zero commitment within the next two years. Though the proportions are lower in Asia (31 per cent) and the United States (29 per cent), the sheer weight of institutional money behind ESG investing ought to make its presence felt in the carbon credit market soon. This Future of Finance webinar will explore what stands in its way.      

[1] “The problem of climate change involves a fundamental failure of markets: those who damage others by emitting greenhouse gases generally do not pay,” Sir Nicholas said in his Royal Economic Society (RES) public lecture in Manchester on 29 November 2007. “Climate change is a result of the greatest market failure the world has seen. The evidence on the seriousness of the risks from inaction or delayed action is now overwhelming. We risk damages on a scale larger than the two world wars of the last century. The problem is global and the response must be a collaboration on a global scale.”




Why attend?

The carbon credit market could grow rapidly in the next few years. Issuers, investors and intermediaries active in other financial markets need to understand how the market is evolving in order to profit from it.

Who should attend?

Developers of carbon offset projects, buyers of carbon credits such as corporations, brokers and dealers that trade commodities, asset managers running ESG funds, and custodian banks that safekeep financial assets.

When is it happening?

At 14.00 London on Wednesday the 1st of November 2023.

What topics will be discussed?

  1. Carbon taxes are a mess (e.g., fossil fuels are subsidised as well as taxed, and at differential rates). Is that good or bad for the carbon credit market?
  2. What is preventing the carbon credit market from growing?
  3. Registries do not seem to have solved the integrity problem in carbon credit markets. What can (e.g., the ICVCM Core Carbon Principles (CCPs))?
  4. Which bodies – securities or futures or commodities regulators – should regulate the carbon credit markets?
  5. The Taskforce on Scaling Voluntary Carbon Markets (TSVCM) advocated “core” carbon spot and futures contracts as “reference contracts” for other carbon credits. Has that idea progressed?
  6. Can and should carbon credit contracts be standardised?
  7. Can existing securities and commodities market infrastructures play a role – or is a completely new infrastructure required?
  8. How might carbon credit markets can be linked to ETS markets, potentially enhancing liquidity?
  9. Is tokenisation an appropriate technology for the carbon credit market?
  10. Does it make more sense to issue carbon credits natively on to a blockchain or to tokenise existing carbon credits?
  11. Is the lack of digital money a problem in the tokenised carbon credit markets as it is in the other token markets (and, if so, are Stablecoins an answer?)
  12. What might the carbon credits market of the near future actually look like?
  13. How durable are carbon credits as an asset class? To what extent are asset managers and asset owners deluding themselves that sustainable investing can also deliver high returns (echoing politicians that dress up costs as benefits)?

Who is on the panel?

James C. Row, Founder and Managing Partner at Entoro Capital, LLC, a middle-market, traditional and alternative investment bank based in Houston, Texas, and CEO of Capturiant.

Deanna Reitman, Partner Head of Carbon and Commodities at DLA Piper

Sean Mullins, Senior Vice President – Digital Assets and Financial Markets at Northern Trust

Gbemi Oluleye, Assistant Professor (Lecturer), at Imperial College London

Moderated by Dominic Hobson, Co-Founder at Future of Finance

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