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London Stock Exchange's Voluntary Carbon Markets solution – accelerating the availability of financing for projects supporting the low-carbon transition.

Posted: 05 November 2021
  •  The London Stock Exchange is developing a new market solution to accelerate the availability of financing for projects that will support a just transition to a low-carbon economy.
  •  The goal is to address two major challenges: access to capital at scale for the development of new climate projects worldwide; and primary market access to a long-term supply of high-quality carbon credits for corporates and investors.
  •  This will enable companies and investors to confidently augment credible net zero transition strategies, by financing additional projects to offset unavoidable carbon emissions during their path to net zero.
  •  As the Global South is a significant source of high-quality carbon credits, this has the potential to benefit those economies by providing a key financing tool for a ‘just’ transition.

The London Stock Exchange has a centuries-old role as a venue that brings together those who need capital with those who have capital in service of an objective, be that the development of new products, investments in plant and machinery or the creation of jobs.

To this day, fundamental improvements in the way we all live are financed by the capital markets: in the last 18 months alone, the London Stock Exchange has enabled companies to raise capital to weather the storms of Covid-19 and finance the recovery from the pandemic; develop new tools to provide fast, effective and low-cost genome sequencing; scale-up investment in renewable energy and clean hydrogen; and finance the development of a circular and sustainable economy.

Mobilising the transition to low-carbon

The urgent challenges that our capital markets have financed in the last year are dwarfed by the generational challenge of the global transition to net zero and the maintenance of the vital biodiversity that supports our planet.

We are committed to playing our part to adapt the way that markets function to drive climate action through initiatives including our ‘Climate Transition Offering’ which provides data and tools to listed companies to support them to make their transition. This process starts with understanding companies’ preparedness for the transition and progresses to mobilising climate transition plans through access to finance via our markets. Establishing a new market solution to accelerate the availability of finance to projects that will ultimately support a just transition to a low-carbon economy is a natural extension of our climate offering.

Action on climate change by governments worldwide, including policies for carbon pricing, is vital if we are to address the climate crisis. However, we have limited time to reduce and remove carbon emissions: current climate science suggests that we may reach 1.5 degrees of warming as early as 2034[1] – the limit enshrined in the Paris Agreement for the whole of this century. This means that action is needed by the private sector beyond that which is regulated. Fortunately, companies and investors are taking action.

The importance of Voluntary Carbon Markets

A growing consensus has developed regarding the need for a global, scalable Voluntary Carbon Market that can deliver a rigorous, market-based approach for investment in activities that reduce greenhouse gas emissions and remove carbon from our atmosphere. This would enable companies and investors to confidently build upon their net zero transition strategies by financing activities elsewhere that address their remaining emissions whilst on the journey to zero (credibly defined, using Science-based Targets). Doing so will increase the likelihood of avoiding catastrophic climate change, reducing our collective risk and securing a more prosperous future for all. Given the volume of climate mitigation activity that will take place in the Global South, this also provides a key financing tool for those countries in a just transition.

Voluntary Carbon Credits are a proven mechanism for this finance – each credit represents one tonne of CO2 (or equivalent greenhouse gas) reduced or removed that has been independently verified against robust accounting methodologies. However, issuing carbon credits as a source of finance is only possible if they derive from projects that would not be undertaken as ‘business as usual’ or via commercial investment – a concept known as ‘additionality’ i.e. the activity is genuinely additive to the sum total of existing global efforts to reduce CO2.

This creates a ‘chicken and egg problem’ – how do you develop a liquid market through which to finance genuinely additive projects without having an existing deep and liquid market? By facilitating the listing of instruments that deploy capital at scale into climate mitigation projects, the London Stock Exchange will contribute to global efforts to address this problem.

The current Voluntary Carbon Market ecosystem has evolved over 20 years and features credible standards bodies, supported by international NGOs and used by experts in private-sector and non-profit companies to finance climate mitigation projects. It has become increasingly professionalised, but it remains small and fragmented, and as such it lacks the market infrastructure and access to institutional investment that will truly enable it to scale.

The growth in companies that are making commitments to meeting net zero targets by positive action and off-setting strategies for residual risk is being stifled by the combination of a largely OTC procurement model from small entities and rapidly rising secondary market prices for a limited pool of quality carbon credits.

With the creation of a capital markets solution for financing projects that enhance investment in carbon mitigation projects, the London Stock Exchange believes that it can directly address at least two major barriers: capital at scale for the development of new climate projects worldwide and primary market access to a long-term supply of high-quality carbon credits for corporates and other investors. This will also support the market’s broader efforts to deliver investment-grade data and commercial innovation.

How will the new Voluntary Carbon Markets solution work?

In order for funds to be listed, we expect to use the London Stock Exchange’s existing market infrastructure, supplemented by specific requirements relevant to carbon credit projects (starting with the high-level definitions from the Taskforce on Scaling Voluntary Carbon Markets (TSVCM) and ultimately incorporating their approach into the London Stock Exchange admission requirements[2]). We envisage these vehicles being structured in a way that will enable their investors to receive investment returns in specie, in the form of carbon credits, instead of, or in addition to, cash dividends and other distributions. The process of generating carbon credits will use the current ecosystem of standards and verification bodies that is being strengthened by the efforts of the TSVCM, supported by industry experts and civil society groups. In this way, as the TSVCM work on areas the Core Carbon Principles develops, we will build upon what works well today, whilst enabling climate action at scale.

We anticipate that corporates and other investors with long-term needs for carbon credits will be the key investors who will use the output of these vehicles to meet a portion of their needs, possibly investing in multiple funds to spread risk and build a diversified portfolio, which may be supplemented and hedged in the secondary market. Because of the framework we will create, these investors will have the comfort of knowing that their investment will be going directly into climate action on the ground. In turn, this will create the confidence and liquidity needed for institutional investors to participate. Project developers can focus on their core expertise and climate projects around the world, particularly in the Global South, will benefit from access to capital flows that are currently small and inconsistent.

Our intention is to facilitate a deep, liquid venue for the listing of carbon funds, which provides the market with a clear price signal and confidence that they can move in and out of investments as their needs change. If successful, it should enable the development of funds focussed on specific project types that need particular expertise, supported by an entirely new flow of investment capital into the market from corporates. Rather than being categorised as a marketing or facilities cost, which is often the case with offset programmes now, with all of the associated cyclical budgeting risks, these assets can be properly incorporated into companies’ balance sheets, managed by treasury teams and incorporated within climate disclosures in line with the Task Force on Climate-related Financial Disclosure. In turn, asset managers and owners can get a clearer picture of how comprehensive and effective climate action is within their portfolio companies, driving outcomes that benefit everyone on the planet.

As the leading global venue for sustainable finance, we are committed to continuing to play a leading role in the further development of market solutions to the climate crisis. At a foundational level there is a growing need for finance at scale, and channelling this finance, particularly into projects in the Global South, will help reduce or remove emissions from the atmosphere. By combining the governance and rigour of public markets with the best practice in carbon markets today, and as it evolves, this will support and incentivise higher standards and facilitates transparency in pricing. In turn, this strengthening of governance creates greater confidence and will mean more companies and investors want to participate. The greater the depth of engagement, this leads to positive outcomes with more money able to flow into climate reduction. The impact of increased financing will ultimately give rise to an increased supply of carbon credits. To ensure that the market scales globally in a rapid and efficient manner there needs to be collaboration and open frameworks between market participants across the Voluntary Carbon Markets ecosystem which we are committed to do.

How London Stock Exchange can support the scaling of finance to climate mitigation projects

[2] Other credible standards may also be accepted or as they develop to enable specific sectors to be funded.

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