A growing number of investment firms produce, sell or rate carbon credits as companies that emit carbon dioxide increasingly look to offset some or all of their emissions, and the first pension funds are committing to offset funds. Does this young voluntary market offer an opportunity for pension funds? 

 

The need to reduce carbon emissions has moved various governments and the EU to create carbon allowances, effectively giving companies a licence to emit, but with the overall emissions licensed reducing each year, driving up the price. 

 

However, there is now also a voluntary carbon credits market, currently estimated to be worth just $1bn to $2bn, with each credit equivalent to one tonne of CO2. Carbon projects that generate credits can range from tree planting, to financing the avoidance of deforestation, to technological solutions like carbon capture and storage underground. Credits are bought typically by companies with net zero commitments, such as Microsoft, which works to be carbon negative by 2030 and holds a stake in projects around the world, many in forestry. 

 

Forestry projects in particular have come under scrutiny recently. In January, the Guardian newspaper, together with Germany’s Die Zeit and investigative outfit SourceMaterial, accused Verra, the leading carbon standard, of over-inflating its ratings. Verra is strongly disputing these claims. So is this a Wild West of emissions claims, or a serious climate change solution – and potentially even a new asset class? 

 

Some have decided it is worth the risk. The pension funds of Essex, Leicestershire and the City and County of Swansea have invested in the Stafford Capital Partners’ Carbon Offset Fund, which had $242m at its initial close and a fundraising target of $1bn. It invests in timberland and natural forests and says it generates about 30m verified carbon credits for investors.

Master trust Cushon has also bought voluntary offsets, at its own costs, to remove residual emissions after cutting emissions by 60% compared with the "broader economy", according to Julius Pursaill, its scheme strategist.

“We believe there is both an opportunity and a need to stimulate the production of carbon sequestration via investments in natural capital. As with all natural capital investments, we therefore expect in due course to be holding high-quality sequestration based carbon credits - which can be used in either the voluntary or compliance markets - produced by our own investments as part of our strategy," Pursaill says.

 

However, “emission abatement should be the priority for the global economy and carbon credits should not be used as a substitute for emission reductions that can otherwise be achieved”.

 

For pension funds, the attraction of carbon credits for now is more as an additional benefit of a natural asset, believes Nick Spencer, independent adviser at sustainability specialists Gordian Advice. 

 

“These developments are early, and something pension funds will want to encourage,” he says, but “in the near term they will probably look at investments with carbon credit potential, rather than standalone [carbon credit holdings].” 

  

Through forestry or peatland, they could “get access to both the real estate and the ecoservices that come inclusive of carbon credit, and then think how the value and income from credits may grow through time”, he says.  

 

Carbon credits are a move in the right direction but are “very much at the early adopter stage”, he adds. However, if nature is to remove 5-10 gigatonnes of carbon per year from the 2040s or 2050s, “then carbon credits are going to need considerably more investment and more formalising into investment markets”. 

 

Spencer would also like to see the compliance and voluntary markets link up to allow for transfers of carbon credits to create positive momentum. 

 

But while he sees offsetting emissions through carbon credits as a necessary part of the fight against climate change, Spencer stresses that it does not remove the need to reduce as much emissions as possible from underlying businesses: “By far the best way of dealing with excessive greenhouse gas emissions is not to emit them in the first place.” 

 

 

Natalia Dorfman is the chief executive and co-founder of Kita, an insurance start-up that underwrites the risk of carbon credit projects not delivering, in what is a forward-priced market. Dorfman says the market is mainly driven by companies, but also brokers and increasingly, financial players such as asset managers. 

 

The quality of projects “is very much a space where insurance can play a helpful role”, she says. Insurers will carry out due diligence because “if we get this wrong, we will pay out a claim”. 

  

But while insurers take on a particular risk, there are many levels at which a project’s quality can be assessed, she notes – additionality, permanence and durability, as well as any co-benefits. Tech-based projects score better on permanence, for example; natural solutions tend to do better on co-benefits such as biodiversity and social impact, which might be what an investor is looking for. 

 

“Ratings agencies play a really important role,” says Dorfman, as they look at quality across the spectrum and are thereby giving an indication to the market. 

 

The investigation led by the Guardian has cast doubt over the carbon credit market, but many point out that it is a very young market, believing mistakes and ‘foul apples’ will inevitably be found.  

 

“Some companies might blatantly greenwash, others are accused of greenwashing when they are trying to do the right thing but make a mistake, which is easy to do in a young market,” she says.  

 

Dorfman notes that much of the challenge is in the so-called avoidance projects, as they make assumptions about the amount of CO2 that would have been emitted had the project not happened – something that can by nature not be known. The baseline against which additionality is measured is therefore a sticking point. 

 

“Baseline assessments will be recalibrated over the coming years... like any scientific methodology they should be updated,” she says. 

 

Dorfman doubts there will ever be a single regulator for the carbon market. Instead, she sees a combination of regulations on the corporate side related to initiatives like the Taskforce on Climate-related Financial Disclosures. One of the challenges of regulating the area will be that climate has “many interlinked facets”, she remarks. 

 

 

The Voluntary Carbon Markets Integrity Initiative has been set up by various stakeholders, in recognition of the fact that standards are needed to give the sector credibility. The VCMI is currently beta testing and refining its provisional code for making carbon claims. 

 

“For carbon markets to develop and scale they need a certain amount of public information,” says Finn O’Muircheartaigh, head of policy at carbon credit ratings provider BeZero Carbon. The firm publishes its headline ratings online, as well as its methodologies.  

 

“Many projects over or underestimate the credits they will generate,” he observes, saying his firm uses its methodologies to assess the likelihood that a project has indeed removed a tonne of carbon. 

 

“Hopefully we advance the debate and knowledge. We need a far more detailed and nuanced discussion to understand the voluntary carbon market,” he says. 

 

The market can work more effectively if risks and assets are examined closely, he argues. “Ultimately my belief is that the market is going to pivot around a new understanding of quality.” 

 

For any pension funds looking at this area, a secondary market could be of interest. A secondary market exists, says O’Muircheartaigh, with a number of exchanges and a significant increase in secondary market trading since 2021 which, however, plateaued or even decreased in 2022.  

 

“It brings in a greater range of investors and increases efficiency, but we believe the market requires greater standardisation for those secondary markets to scale, and ratings a part of that,” he says. 

 

But others feel that while carbon credits are a useful tool in theory, in reality, the implementation leads to problems that can eliminate most of the benefits. Jan Ahrens, chief executive of SparkChange, a fund looking to make emissions allowances accessible to investors, says most reduction projects are not contingent on the income of carbon credits and would have been implemented even in the absence of these. He also believes that the availability of carbon credits means companies can simply continue business as usual and pay for their emissions.  

 

In combination, Ahrens says the two factors mean that “the voluntary carbon credit market is actually counterproductive; it reduces the pressure on corporates to decarbonise and does not necessarily add emission reductions”. 

 
Ahrens believes for the voluntary carbon market to improve, the best way forward is an evolution into the UN-backed Article 6.4 mechanism created under the Paris Agreement, which would provide for standardisation, some quality control, significant demand from governments and backing of the UN.  

 

Vested interests could be an obstacle, however, he says: “This runs against the interests of the current registry providers... which might be at risk of losing their business model if the entire process transfers to the UN mechanism and registry.” 

 

Ahrens notes also that the large investor associations, such as the Net Zero Asset Owner Alliance, have recently banned the use of carbon credits from their net zero investment guidelines, focussing instead on organic reductions or financing of carbon removals, with the Institutional Investors Group on Climate Change also voicing scepticism.