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carbon markets can play an ever-more vital role in the mobilisation of both private and public finance towards carbon neutralisation and reduction projects.

Facing up to the challenges

It’s fair to say that carbon credits have had a somewhat troubled growth story so far. Heralded by many as a viable market-based tool in the fight against climate change – effectively putting a value on the carbon that is used as part of business operations – there have been numerous challenges to their efficacy.

One of the most pertinent issues has been carbon credits’ perception as an alternative for effective action: the belief that they can be used as a get-outof-jail-free card for corporates or institutions unwilling to implement actual systematic reforms towards net zero.

Until recently, the nascent characteristics of the markets and a lack of rigorous standards have also invited mismanagement and abuse. A lack of robust regulation compared with other established markets has in some cases undermined the integrity of implementation, with poor-quality carbon offsetting projects simply failing to deliver meaningful avoidance or removal of carbon.

And while quantifying emissions is relatively straight forward, the pricing of carbon credits remains somewhat opaque, mostly because of the wide variety of credits in the market and the number of factors influencing the price.

What are carbon credits?

A carbon credit represents the verified removal, or avoidance/reduction of one tonne of carbon dioxide from the atmosphere. Carbon credits broadly fall into one of two categories: removal credits and avoidance/reduction credits.

Removal credits - are those that result from projects that directly remove carbon from the atmosphere. At present, removal credits are usually issued from nature-based projects like afforestation or rewilding, but more credits are expected to be issued from technology-based projects such as human-made carbon capture and sequestration, especially once the technology becomes scalable.

Avoidance/reduction credits - are those that result from projects that avoid carbon from being released into the atmosphere, compared to what would have been the case without the project. These include off-grid renewable energy projects, projects to prevent deforestation, farming emission reduction projects and the development of energy-efficient buildings.

A vital part of the climate solution

However, with the momentum for government netzero targets and institutional net zero carbon pledges growing, carbon markets can play an ever-more vital role in the mobilisation of both private and public finance towards carbon neutralisation and reduction projects.

In this sense, with the growing acknowledgement that simply abating emissions is not enough to reach Paris Agreement targets, the voluntary carbon market will become particularly important.

Projects to capture or sequester carbon from the atmosphere are urgently required. As such, voluntary carbon markets have the potential to be an increasingly effective mechanism in channelling the required investment to make this happen – a sentiment reflected in the rising demand and price of carbon credits in recent years.

In addition, much of the climate action will need to take place in the developing world, where there is also the generation of carbon credits. The monetisation of these carbon credits, as reviewed at COP26 under Article 6 of the Paris Agreement, could reduce the cost of the underlying infrastructure to mitigate climate change.

 

How does the carbon market work? 

Progress still needed

But to realise this potential, there’s still important progress to be made in the way carbon is traded. Limited liquidity, insufficient market size, a nonstandard transaction process, and a lack of rational or explainable price mechanisms are all issues that need to be improved for carbon markets to work more efficiently.

There’s also a growing school of thought that believes we need to incorporate the social cost of carbon into balance sheets. That is, the money generated from the sale of carbon credits must also largely benefit local communities in their place of origination. These projects often span 30 to 40 years and carry nature-based and political risks, but the benefits can clearly outweigh those risks, and the higher the critical mass built in supporting these projects, the less risky they potentially become.

It is particularly important to note that climate change has its greatest impact in developing countries or lower economic communities. Therefore, it’s imperative to take into consideration the social implications and reduce the broader socioeconomic impact of climate change.

Carbonplace: the benefits of a well-functioning market

As with any market, price and data transparency can go a long way towards influencing what companies will pay for credits. In the long run, greater transparency usually translates into lower prices. Trading platforms that increase the frequency of carbon credit transactions, broaden the types of organisations participating in carbon markets, improve investment integrity and enhance market transparency will bring much needed liquidity, trust, and price stability.

For these reasons, NatWest Group became a founding member of Carbonplace, an innovative settlement platform which aims to facilitate increased delivery of high-quality, equitable carbon credit projects. In doing so, Carbonplace aims to foster a strong global ecosystem for the voluntary carbon market and assists in the development of tools – leveraging banking relationships that have undergone onboarding governance and using market accepted carbon credit verifiers to help clients manage climate risk.

 I believe that the importance of this kind of well-functioning carbon market in the overall climate solution cannot be understated. Enabling more high-quality credits to be bought and sold with greater ease and transparency could accelerate the flow of private sector capital to near and medium-term climate mitigation, as well as helping to ensure that the social cost of carbon is properly accounted for vital steps if we are to equitably achieve net-zero green house gas emissions.

Caution about this article. The views and opinions expressed in this article are the ones of Caroline Haas and do not necessarily represent the views of the NatWest Group. This article (i) has been prepared for information and reference purposes only; (ii) is intended to provide non-exhaustive, indicative and general information only; (iii) does not purport to be comprehensive; and (iv) does not provide any form of legal, tax, investment, accounting, financial or other advice. Click here to read the full Climate Matters document that contains cautionary statements relating to this content.

Please see NatWest’s 2021 Climate-related Disclosures Report for those views and other information including about our financed emissions and heightened climate-related risk sectors.

 

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