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Hardman & Co Insight: Voluntary Carbon Markets - LSE: Thinking outside its box

Executive summary:

- In terms of environmental policy, the quest to cut carbon emissions dramatically and to achieve net zero remains high on the political agenda, although the war in Ukraine – and specifically the issue of gas supplies – may weaken these commitments.

- In any event, the environmental performance of China and the US – responsible, between them, for around one half of global emissions – will be key. In Asia, where ca.85% of energy consumption is currently being met by fossil fuels – there are ca.4.6bn energy users – the carbon emissions impact of these two figures is self-evident.

- In the wake of Singapore’s establishment of Climate Impact X (CIX), the London Stock Exchange (LSE) is planning to launch its own Voluntary Carbon Market (VCM) initiative, which aims to both attract more institutional investment into low-carbon projects and to establish a more credible benchmark for trading in the carbon credit (CC) market. The LSE’s VCM proposals are out for consultation until 11 July 2022.

- The VCM initiative presents a major market opportunity for the LSE, as it seeks to establish a more credible – and less volatile – carbon price. With the LSE poised as the financial ringmaster, viable carbon-saving projects should stand a better chance of securing long-term investment.

- Individual CC regimes will be pivotal in enabling potential projects to create offsets and to move to a financial close. At present, most CCs are generated in the EU, the US, the UK, Canada, China, Japan, New Zealand, South Korea and Switzerland.

- The LSE has identified quoted closed investment trusts as its target market. In paragraph 16 of its recent announcement, the LSE stated that a “fund’s investment strategy should have a focus on investing in carbon reduction and/or removal projects that can be expected to yield CCs”. Furthermore, paragraph 17 specifies a three-year investment window before which at least one qualifying project should have been closed.

- The most obvious qualifying projects probably lie in energy generation. Replacing a 100MW coal-fired plant with a solar plant, the different name-plate capacity of which enables it to generate the same amount of output in a normal year, would be an obvious case in point.

- The transport sector, the largest carbon emitter in the US, and the agriculture sector also offer real opportunities. In the former’s case, progressively switching to clean aviation fuels is an obvious option. In the case of the latter, finding viable projects offering decent financial returns, along with the required environmental benefits, may be challenging.

- In terms of countries involved in VCM projects, there is likely to be a real mix. Many third-world countries may struggle to deliver a qualifying project, although those with urgent energy requirements may be prevailed upon – in a few cases – to expand their use of renewable power, especially wind and solar generation.