Could carbon markets be the financial services response to climate change?


There is still an elephant in the room at COP27. And it just got bigger.

At last year’s UN climate change conference in Glasgow, there was remarkably little discussion of the main challenge facing efforts to curb global warming: the huge sums needed to fund the transition. energy in emerging markets.

There has been a lot of talk about which financial institutions are taking on what net zero commitments while financing fossil fuels. But a serious debate about where the world was going to find the estimated $1 billion a year investments that emerging economies would need by the end of the decade? Not really.

At this year’s conference, a report commissioned by the UK government painted an even grimmer picture. Emerging countries, excluding China, will have to invest $2.4 billion a year in the energy transition by 2030, according to the report. At least $1 billion will need to be external funding, most of which will come from the private sector. To put this into context: the amount invested by investors and companies in developed countries in 2020 was only $14 billion.

Investors say they want to do more. A survey of 300 asset owners and managers by British-South African fund manager Ninety One found that only 16% invested in transition finance assets in emerging markets, but 86% said expanding this funding was a priority. It seems utterly implausible that there will be a 50-fold increase in just eight years, as senior executives of major asset managers privately admit.

Even though the cost of sustainable energy systems falls considerably below fossil fuels, investing in large infrastructure projects in emerging markets is difficult, risky and unrewarding. Optimists speak of how increased investment from international development banks and other Western government agencies will be able to “de-risk” projects, attracting much larger sums from the private sector. But the so-called “mixed financing” mechanisms are extremely complicated to set up. “They just aren’t scalable,” says the head of sustainability at one of Europe’s largest asset managers.

If the challenge seemed daunting a year ago, it seems even more daunting today. Inflation and rising interest rates everywhere put pressure on public budgets; many low-income countries are struggling with soaring dollar debt; there have been outflows of international funds from emerging markets; and waning Democratic scrutiny in Congress appears to preclude significant new commitments from US taxpayers.

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This is why the carbon credits initiative announced at COP27 by John Kerry, the US climate envoy, could be so significant. The idea is to tap into demand from Western companies for investment in climate change projects that they can use to offset some of their own emissions. The analysis carried out for the initiative estimates that it could raise $100 billion by 2030.

Several groups are already working to expand the small but rapidly growing carbon credit market. These include a task force involving Mark Carney, the former governor of the Bank of England, and Bill Winters, chief executive of Standard Chartered. Another group is looking for ways to ensure the City plays a key role.

Many critics of carbon credits question their impact and argue that companies use them to avoid reducing their own emissions. Proponents, however, say that if properly designed and controlled, they could provide a great source of funding for projects that would otherwise struggle to attract investment.

“Carbon credits, if properly verified, have a role to play,” says Nazmeera Moola, sustainability manager at Ninety One.

Kerry is proposing a new body that would work with developing countries to verify emission reductions, which they could then issue as tradable carbon credits. The idea received early support from companies such as Standard Chartered, Bank of America and Microsoft, while countries such as Nigeria and Chile showed interest.

The wider reaction to the announcement was mixed. Rachel Kyte, co-chair of the Voluntary Carbon Markets Integrity Initiative, called it a “massive distraction.” A senior official from the city’s carbon markets group welcomed the move, but added that it was important to ensure the various efforts did not become fragmented.

Now that the Americans are taking the lead, it is important for the City that British initiatives keep pace. They are hoping for strong support from Rishi Sunak who was very supportive when he was chancellor.

Emerging markets are responsible for more than 90% of the increase in global emissions. It is therefore essential to curb this growth in order to combat climate change. Without it, the whole effort will fail. Skeptics say building a large carbon credit market will be difficult and even if successful will not match the scale of the investment needed. Maybe. But right now, we’re desperately out of better ideas.

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To contact the author of this story with comments or news, email David Wighton

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