PRE-CARBON CREDIT FINANCING
Many feared the potential of substantial greenwashing for a country's carbon emissions prior to COP26 in Glasgow. Particularly the question of double counting a country's generated carbon credits had the potential to set emissions reduction efforts way back. Therefore, the ratification of Art. 6 of the Paris Agreement was a step in the right direction into the still missing actual international carbon credit market. In this context, as part of the SDG-Financing course at the IHEID in collaboration with Enabling Qapital, the research project is embedded. It tackled the question of the potential to develop a pre-carbon credit financing vehicle for SMEs involved in the design, manufacturing, and distribution of products limiting carbon emissions. The student researchers’ group structured their research approach in three steps: the market sizing of the current and future carbon credit market; the analysis of existing and potential competitors; the draft of a company pipeline of SMEs involved in the end-consumer utility sector in Europe and Africa.
Overall, the global carbon credit markets grew more than 10% per year to a total issuance of 373 MtCO2e in 2020. A mismatch between the supply and demand for voluntary carbon credits can be observed, leading to a surplus of credits and relative price stagnation. While the compliance carbon credit market remained comparably tiny, the voluntary markets experienced a roaring growth in demand. The compliance market’s small size can be explained due to the lack of domestic compliance carbon schemes allowing for offsets, the predominantly voluntary nature of the market, and controversies about using offsets to meet NDCs. However, with the advancements of the negotiations of Art. 6 of the Paris Agreement, the allowance of international offsets to reach NDCs, and the rise of bilateral agreements, there are prospects for the growth of the carbon credit market. Concluding, the market is no longer just a niche of impact-driven financial players increasingly vying for a piece of the pie but becoming one of many viable tools to financing a transition to a more sustainable economy.
The 28 impact funds examined focus mainly on forestry, ecosystem conservation, and sustainable agriculture. Utilities and SMEs, in contrast, are less present. While Verra and Gold Standard are the most widely used standards, there is still a lack of disclosure regarding the tCo2e reduced per million USD invested.
The group shortlisted around 100 SMEs from several online databases, personal contacts, and fund pitches for a preliminary pipeline. Categories considered for evaluating the companies included operating markets, business type, SDG focus, Co2 reduction, and the growth stage. The companies were divided into five sectors, namely mobility, appliances, water, energy, and others, and assessed according to the investment opportunity. Besides SDG 13, SDGs 7 & 11, in particular, have stood out as a focus, which ideally complements the funding gap in the previously examined impact investing funds. Furthermore, the additional analysis of the projects registered with the Verra and Gold Standard Registry showed that projects in the appliance sector that were of particular interest to the client are limited. Only three projects are currently registered in the European Union with the Gold Standard, and only 37 projects will be implemented in Africa with Verra. Given that 99.2% of the total annual estimated emissions reductions in the appliance sector with Verra in Africa are expected to be from cooking appliance projects, making up 89.2% of all the registered projects, it shows tremendous potential for further offsetting opportunities.
Concluding, the growth potential for a pre-carbon credit financing fund is considered relatively high. This is particularly the case due to the future market growth fueled by company demand and a lack of funding for SMEs and appliances. Further, the 100 shortlisted companies show that there would be sufficient viable investment opportunities. According to the research done, the client should firstly focus on financing companies supplying the growing voluntary market in the short term before the dust settles around compliance markets. Secondly, a focus should be placed on financing projects that plan to issue credits targeting multiple SDGs, particularly SDGs 6, 7, 11, 12, 13, as these are more demanded. Finally, the client should invest in more mature business models, both from a growth and risk mitigation perspective.