This page was written by Dolphin Consulting, Finance & Banking. Innovation
Carbon finance
Origins of carbon economy and carbon finance
Some atmospheric gases, mainly carbon dioxide (CO2), but also methane (CH4), halocarbons (HFCs and PFCs), nitrous oxide (N2O) and sulphur hexafluoride (SF6), are called greenhouse gases (GHG): they act as a natural blanket retaining the earth’s heat.
Human activity increases the blanket’s thickness causing significant potential global warming with multiple consequences. Some countries have developed greenhouse gas emissions (GHGs) control systems with the aim of limiting climate change through reduction of greenhouse gases. These policies are based on the principle “polluter pays”
| The politics are based on some key mechanisms | Monetary financial similar concepts |
| Accounting systems: Regional registry systems (country level, Europe, worldwide) allow participants (industries) to track their greenhouse gases emissions units (GHGs) through carbon accounts. The measurement unit is the "ton carbon equivalent" volume of gas emitted (t CO2 eq). | Monetary unit |
| Regulation: greenhouse gases emissions quotas are defined for a given period by geographic area and by industry. Timeframe cap and reduction targets are set. Such constraints policies and market mechanisms are called the "cap and trade" system. | Monetary policy |
Enforcement/Compliance/Control & Incentive System:
|
Money supply |
Free market system to allocate carbon resources:
|
Regulated market OTC Market Derivatives Liquidity Speculative bubble … |
“Carbon finance” is the name given to the mechanisms and markets used to exchange and trade GHG (greenhouse gas) emission quotas.
Mandatory trade and management of CO2 emissions systems go back to the 70’s. The first implementation of a similar system was developed in the United States from the 90’s. Its aim was to regulate emissions of a gas which causes acid rain, sulphur dioxide (SO2).
Nowadays, the carbon economy and finance are in constant evolution, with differences depending on geographical zones . The carbon economy is considered as being one of the major challenges for XXIth century’s economy.
Regulatory frameworks and markets
There exist several carbon regulatory frameworks in the financial markets, based either on international treaties or on private law contracts. Each of them defines an emission allowance trade and exchange system: the organised carbon markets.
There are also alternative mutual agreement transactions systems –organised outside carbon markets: OTC - Over The Counter.
| Regulatory frameworks | ||||
| Participants Industries & Countries | Regulatory texts | Main markets | Carbon Products | |
Kyoto Protocol
|
5 industrial sectors are submitted: |
Kyoto Protocol + European Union Emissions Trading Scheme - EU ETS |
Organised Markets :
|
|
5 industrial sectors are submitted and situated in countries outside EU : Japan, Australia, NZ, Russia, Ukraine, Canada, etc. (listed in the appendix 1 of the Kyoto protocol) |
Kyoto Protocol | |||
| India, Brazil, China, etc. (listed in the appendix 1 of the Kyoto protocol) | Kyoto Protocol regulatory regime applied to countries listed in Annex 2 : not submitted to reduction constraints | |||
Regional regulatory frameworks (outside Kyoto)
|
Energy sector of 10 states of the USA | RGGI - Regional Greenhouse Gas Initiative | Organised Market RGGI | RGGI Quotas |
| 10 USA’s states and Canada | WCI - Western Climate Initiative | Organised Market WCI | WCI Quotas | |
| Electricity sector of New South Wales (AUS) | GGAS - Greenhouse Gas Reduction Scheme | Organised Market GGAS | GGAS Quotas | |
| 7 USA’s states and Canada | Midwestern Greenhouse Gas Reduction Accord | Organised Market in project | In project | |
| Regulations in project phase/ Ratification phase | Canada | Canadian federal law under consideration | MCeX – Montreal’s Climatic stock exchange (along with CCX) | Canada CO2e Units Futures |
| USA | USA federal law under consideration | |||
Voluntary markets
|
Participation on voluntary basis | Chicago Climate Exchange standard | Voluntary markets CCX CCFE - Chicago Climate Exchange Futures |
Quota CFI (Carbon Financial Instruments) Spot, future, option |
| Participation on voluntary basis | NYMEX- Green Exchange standard |
Voluntary market NYMEX- Green Exchange |
Quota EUA Credit CER, VER, VCU Spot-future-swap |
|
| Participation on voluntary basis | Voluntary Carbon Standard | Voluntary markets launchings :
|
Carbon credits VCU, CER | |
| Trading outside regulated frameworks | Participation on voluntary basis | Every industrial sector | OTC Markets | Customised products |
The emergence and development of the new carbon markets is heavily dependent on the evolution of regulatory frameworks (some are still in their design/experimental phase).
Calendar of Kyoto
See below for the main stages of the implementation of the Kyoto protocol which governs regulated markets as ECX, EEX, the North Pool, Bluenext
Carbon Registry Systems and operations
Registry systems (allowance accounting) record emission allowances:
- by geographical zone,
- by country,
- by industrial actor (ultimate emitter).
They also record operations concerning allocation and exchange of carbon allowances: initial allocation, purchase, sale, obtaining of new rights, etc.
Kyoto protocol carbon accounting units and operations
Registry systems keep track of the emission allowance allocations defined by the Kyoto protocol regulatory framework.
Registry systems are also necessary for monitoring the activity of Kyoto participants (industrial or country) from one of the 3 Kyoto mechanisms (known as Kyoto flexibility mechanisms):
- Emissions Trading : trading system allowing the sale/purchase of “unused” carbon allowance units.
- The Clean Development Mechanism (CDM) : Acquisition of carbon emission credits, later convertible into quotas, by investing in a Kyoto certified projects (that follow the criteria requirements for CDM project, see below)
- Joint Implementation (JI) : Acquisition of carbon emission credits, which are later convertible into quotas, by investing in a Kyoto certified projects (that follow the criteria requirements for JI project, see below)
The operations issued from these mechanisms are recorded through the following units of account:
Opérations |
Units |
Registry unit |
|
Quotas |
AAU Assigned Amount Units |
| AAU Assigned Amount Units | ||
|
Credit (certified Kyoto) |
EUA - European Units Allowance |
|
CER - Certified Emission Reductions |
Kyoto protocol and “clean” projects (CDM,JI )
|
CDM - Clean Development Mechanism | JI - Joint Implementation |
| Eligibility criterias / Allowance Amount |
Additionality criteria : the industrial project has to generate less CO2 than a classic industrial process, this CO2’s differential determines the quantity of allocated credit carbon units | |
| Investor party | Industrialised country listed in Annex 1 of Kyoto protocol | Industrialised country listed in Annex 1 of Kyoto protocol |
| Project Host country/party | Developed country listed in Annex 1 of Kyoto protocol |
Industrialised country listed in Annex 1 of Kyoto protocol |
| Project type | Renewable energy in China and India (hydraulics, etc.) | Gas plant improvements (Russia, Ukraine) |
| Certification Mecanisms | Cumbersome Process | Simplified Process |
| Allocated Unit account (1 ton eq CO2) | CER - Certified Emission Reductions | ERU – Emission Reduction Units |
| Projects Approval | Kyoto Protocol, CDM Executive Board, UNFCCC secretariat | |
Kyoto protocol and registry systems
Registry systems used for kyoto protocol implementation are listed below:
Carbon Trading Markets
Organised carbon trading markets are enforced by both GHG international and regional regulatory frameworks.
The most important market legally submitted to Kyoto protocol framework is the ECX-European Climate Exchange (London) market, representing by itself, 87 % of the global market. There exist other markets committed to Kyoto protocol framework: North Pool (Norway), Bluenext (France) and European Energy Exchange / Eurex (Germany). These organised markets are regulated - FSA, AMF, etc - and have their clearing houses - LCH.Clearnet, the North Pool, etc…
Voluntary Markets
Carbon voluntary markets present more facilities than organised markets:
- Regulatory framework: is defined by the market operator (ex: Chicago Climate Exchange) or by following a standard (ex: Voluntary Carbon Standard)
- Emission reduction targets : Industrials have access to the market on voluntary basis
- Participants : no constraints on industrial sector nor localisation
- Tradable Products:
- carbon products traded in organised markets are also available in voluntary markets
- Standardised carbon products issued from projects that do not require Kyoto standards certification
Investors participate in voluntary markets for different reasons:
- To benefit from arbitrage opportunities created by finance carbon evolution
- To foresight/survey on regulatory frameworks evolutions (financial impacts)
- Improve society’s marketing image through sustainable development (Corporate Social Responsibility).
The leading Voluntary Carbon market is CCX-Chicago Climate Exchange. The CCX trades different carbon allowances issued from a large range of standardized projects: energy efficiency, the renewable energy, the capture of fleeting gases (methane), reforestation, among others. The Voluntary carbon markets are more developed in countries where there is no regulation or where it is under approval. The evolution is prominent across Atlantic (NYMEX-green Exchanges (NY) and CCFE-Chicago Climate Futures Exchange).
Tradable units are defined by each voluntary market. For example, markets following VCS standards (Voluntary Carbon Standard) adopt the following account units and products:
Operations |
Unit type |
Account unit ( In 1 ton CO2 eq / year) |
|
Carbon Credit (Certified VCS) | VCU - Voluntary Carbon Units |
| VER - Voluntary Emissions Reductions or Verified Emissions Reductions |
The carbon markets typology
This page was written by Dolphin Consulting, Finance & Banking. Innovation
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