Demand for different forms of carbon certification has grown over the past five years, and voluntary carbon contributions are increasingly under consideration. Read more about the factors that are driving market activity, and the pivotal role custodians play in helping firms through a crucial and complex sector.
The European Union (EU) Green Deal was first introduced in 2019 and approved in 2020. It’s a set of policy initiatives by the European Commission (EC) to make the EU climate neutral by 2050.
What are carbon credits?
A primary element of the Green Deal is carbon credits, or European Union Allowances (EUAs). These are financial instruments that represent a ton of carbon dioxide that has been removed or reduced from the atmosphere. The number of EUAs is capped and subject to an annual reduction in line with the EU’s climate target.
EU authorities issue carbon credits to companies, notably industrial or power firms, with a view to control pollution. Businesses can buy more credits and sell any surplus on the secondary market.
What have been the major headwinds?
In the five years since the EC tabled its Green Deal, the carbon credit market has faced several headwinds, including price fluctuations in EUAs caused by variables such as weather patterns and energy prices, and macroeconomic factors including inflation and interest rates.
As a result, market participants have had to address the economics of some of the structures involved in carbon credits. For instance, there have been increased demands for different forms of carbon certification, including Renewable Transport Fuel Certificates (RTFCs) which are issued for each liter of sustainable renewable fuel supplied for transport use, and Renewable Obligation Certificates (ROCs), issued to operators generating eligible renewable electricity.
A third example is the EU Carbon Removals and Carbon Farming Certification (CRCF) regulations, which created the first EU-wide voluntary framework for certifying carbon removals, carbon farming, and carbon storage.
How has the EU Emissions Trading System included additional industry sectors?
Further legislative changes include the addition of maritime emissions in the EU Emissions Trading System, which came into force on 1 January 2024—and that will have a significant impact on the shipping industry as well as the wider markets.
While the maritime sector has a relatively small impact on carbon emissions, it is a vital element of world trade, being responsible for transporting around 90% of goods globally. The maritime sector faces a complex, multi-phased transition to reporting well-to-wake emissions while at sea and in port. The obligations are flag neutral and apply to trading in and out of the EU and European Economic Area, which means shipping companies outside of Europe will also have to take the new regulations into consideration.
What are voluntary carbon credits?
Another significant change is the introduction of voluntary carbon credits, whereby organizations choose to purchase credits to offset their carbon-creating activities or sell credits in exchange for reducing emissions.
According to recent research from U.S. investment bank Morgan Stanley[1], the voluntary carbon credit market is predicted to grow 50-fold to $100 billion by 2030.
Drivers behind the take-up of voluntary carbon credits include the rise of the environmental, social, and governance (ESG) agenda and its importance to corporate stakeholders. While many organizations have rolled out ESG strategies that outline their journeys towards net zero carbon emissions by 2050, the cost of doing so can be beyond their current means.
As Morgan Stanley[2] explains: “By purchasing “credits” from projects that remove or reduce carbon output, the private and public sectors hope to mitigate the impact of their emissions in the short term as they work toward eliminating their carbon emissions.”
Why have enquiries been relatively low?
The volume of enquiries reported in the voluntary market so far have been relatively low, especially when compared to a noticeable uptick we have seen in requests for support with regulatory carbon credit management and reporting.
The current low take-up of voluntary carbon credits can be explained by the relative lack of standardized data and consistent methodologies available in the sector.
This may change in the future as voluntary carbon credit market structures are folded into the regulatory regime, and more standards are ratified.
The need for transparency and the role of custodians
Whatever the future holds for voluntary carbon credits, it’s highly likely that the carbon credit market will continue to grow.
While emissions reduction is a key objective of the carbon credit program, this is complicated by the ongoing development of energy intensive initiatives, including the construction of data centres supporting the adoption of artificial intelligence and cloud-based computing.
It means that organizations will continue to balance such initiatives against the need to reduce carbon emissions, making the careful handling of carbon credits even more important.
It will be vital for organizations—or asset managers building carbon credits into instruments such as green bonds—to be as transparent as possible about their management and reporting of carbon credits.
How can carbon custodians mitigate risks?
CSC has seen the number of enquiries and mandates increase substantially following the requirement to reduce risk in the carbon credit reporting and trading environment. For instance, shipping companies are becoming very aware of the financial risks of non-compliance. Not only do they face traditional fines that increase year-on-year if they fail to comply, but also the additional challenge of ships potentially being barred from entering ports or given licenses to trade.
Helping to mitigate such risks is where an experienced custodian plays a pivotal role. A custodian is a trusted third party that has ultimate control over EUA assets and, as an independent third party, minimizes potential conflicts of interest. EUAs are not controlled by either the asset originators or funders and the detached custodial status gives assurance to all parties.
For sectors like shipping—where permitted compliance tools include pooling, banking, and borrowing of EUAs—using an external custodian helps to ensure arm’s length terms and professional execution of the relevant parties’ compliance strategies and pooling agreements.
How can CSC help?
CSC has provided clients with carbon custodian services for almost 20 years, supporting multiple participants globally—notably as a carbon custodian and trustee. Depending on trade volume, we can, at any given time, have between 60 and 80 million carbon tons that we’re holding in custody.
As a carbon custodian, we open trade accounts for and on behalf of our clients within the different carbon registries, receiving and delivering carbon allowances in accordance with the deal or trade specific legal documentation.
At its core, this replicates the services provided by a traditional bank custodian, with CSC acting as a truly independent third party, enabling clients to structure carbon trades in myriad ways across debt and equity markets.
In addition to carbon custody, CSC acts as a trustee, ensuring that secured parties can perfect their security interest over the carbon held. This includes taking security directly over carbon assets, as well as trading accounts.
Are you up to date on changing regulations and legal frameworks in the carbon credit industry? Get in touch and find out more about carbon custodian services from a long-term trusted partner in the sector.
[1] https://www.morganstanley.com/ideas/carbon-offset-market-growth
[2] Carbon Offset Market Trends and Growth: 2050 | Morgan Stanley
