Carbon Credit Markets Are Evolving, And Now Corporations Have Choices

by | Jul 19, 2023

Green cloud with "net zero" printed over it

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The mainstream press has hammered the voluntary carbon market, saying that carbon credits are equivalent to greenwashing” and exaggerate the rainforests they preserve. But a new carbon asset class is emerging — “sovereign REDD+ credits,” which got fast-tracked at the COP27 climate conference in Egypt.

Carbon credits help countries and companies achieve their net-zero goals. For example, businesses can’t eliminate their CO2 releases through clean energy use and energy efficiency, causing them to buy credits to save tropical rainforests — natural CO2 vacuums. In effect, companies pay the rainforest owners to keep their trees standing and not sell them for wood or to clear the way for farming.

The two are on the same team — Team Rainforests. But some stakeholders in the voluntary carbon market say the sovereign REDD+ market can’t sell to corporate concerns, as it operates under a framework that only contemplates country-to-country transfers. This writer spoke to the international law firm of Clifford Chance in Bonn, Germany, at a major climate conference, the precursor to COP28, in Dubai. It disagrees with that reasoning, which its partners will explain here.

This writer is also the editor-at-large for the Coalition for Rainforest Nations, comprised of 65 countries with the potential to sell sovereign REDD+ reduction units.

“There may be no clear statement that the private sector can participate in the sovereign REDD+ market, but equally, there is nothing to say they can’t,” said Adam Hedley, partner at the Clifford Chance law firm in London. “When you look more forensically at all the relevant rules for sovereign REDD+ and the Article 6 market mechanisms, private entities have a role here.

“Ultimately, if the country parties to the COP give authorization for private entities to trade sovereign REDD+ results under Article 6, it gives you a great deal of confidence there is a legal mandate for those trades under the Paris Agreement and the national laws of those countries. In that sense, it is a self-fulfilling prophecy; if all the countries involved want the private sector to be involved and pass laws to allow that to happen, who will step in and say you can’t do that?”

The Paris climate agreement has adopted the REDD+ results-based payment mechanism and created the framework for a sovereign REDD+ market mechanism, meaning 192 nations have agreed to develop this solution to the global deforestation problem. The aim is to make the trees worth more alive than dead — or used for farming or timbering. The developing countries fought to include the “sovereign” REDD+ mechanism in the final COP27 agreement. Under that plan, governments account for their forest lands and set targets to stop deforestation.

The UN Framework Convention on Climate Change monitors their progress and documents the carbon reductions and removals they have achieved on a public database – the REDD+ Information Hub.

Are Sovereign REDD+ Credits Fungible?

“These results can be used to attract results-based finance under other initiatives and programs and can contribute to the host countries’ nationally determined contributions, but cannot be used as (corporate) offsets,” says IETA, per Carbon Pulse. “It could also potentially mislead many corporates and expose them to reputational risks …”

The international law firm of Clifford Chance says that sovereign REDD+ results are independently assessed by UNFCCC, easily tracked on the REDD+ Information Hub and, once converted into sovereign REDD+ reduction units, are transferrable as Internationally Transferred Mitigation Outcomes (“ITMOs”) under Article 6 of the Paris Agreement. Both countries and corporations can purchase and transfer them as ITMOs once the necessary national authorizations are in place.

An ITMO — internationally transferred mitigation outcomes — is a financial vehicle that counts as an emission reduction, allowed under Article 6 of the Paris Agreement.

It adds that such credits are based on historical progress — not future promises – meaning that sovereign REDD+ credits represent verified carbon reductions on a national scale, rather than smaller-scale avoidance activities. Each country must do 54 things before notarizing the carbon reductions it has achieved under the sovereign REDD+ mechanism.

Those claims are reviewed twice by the UNFCCC, typically taking a country about four years to complete. More than 86% of countries claiming REDD+ carbon reductions had to revise and resubmit their evaluations and results.

Nigel Howorth, a partner at Clifford Chance, explained that a corporation looking to buy these ITMOs want to understand key issues. Importantly, how does sovereign Redd+ work? Companies investing in a market-based mechanism to save the rainforests must know how the emissions reductions are measured and verified. The goal is high-integrity ITMOs.

The next set of concerns center on the legal framework — ensuring that the ITMOs can be legally sold and bought under the Paris Agreement. Finally, they want to understand what they are getting — the legal status of an ITMO. Is it intangible property or something else? There is not a clear answer to that last question, but a lot of work is going on to resolve it.

Keep Your Eye on the Goal — Getting to Net Zero

While corporations are interested in the first two sets of questions, the next set is critical to markets — scaling them up so that the price of ITMOs  goes up and the rainforests are worth more alive than dead. Investors, traders, and banks are thus involved, leading to the trading of those financial products on secondary markets in the form of derivatives and forwards.

“Scaling the market is the ultimate objective,” said Howorth, “because it increases prices and delivers greater revenue to the rainforest nations. It is all about fungibility and scale.

“Paris allows cooperative approaches through sovereign REDD+ and private entities to transact with them,” Howorth added. However, host countries must implement domestic legal frameworks and ensure robust assessment, monitoring, and verification for sovereign REDD+ markets.

The goal is to get to net zero and save the rainforests. While the voluntary carbon market is now navigating some problematic issues, the corporate world has a new option — the emergence of sovereign REDD+ reduction units known as ITMOs. Markets are changing — part of the capitalistic model where the entity with the best widget wins.

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