By Carine Smith Ihenacho, Chief Governance and Compliance Officer and Kristin Verpe, Investment Stewardship Analyst in Corporate Governance.
- Carbon credits can help finance much-needed mitigation and sequestration opportunities globally, and carbon removals will be needed by many companies seeking to achieve net zero emissions by 2050.
- In the near term, companies should prioritise reducing their own greenhouse gas (GHG) emissions, and only use carbon credits as a supplement to signal high climate ambitions.
- Any carbon credits purchased should represent additional and verified emission reductions. Over time, companies should prioritise those linked to durable removal of CO2 from the atmosphere.
- Investors would benefit from greater transparency on companies’ use of carbon credits. We propose a disclosure template for companies that purchase carbon credits.
Relevance to us as a long-term financial investor
Our expectations of companies on climate include expectations for how companies use carbon credits in their transition plans. Given the complexity and importance of the topic, we want to provide a more detailed view from the perspective of a long-term, financial investor - in line with international standards such as the OECD Guidelines for Multinational Enterprises on Responsible Business Conduct. In doing so, we hope to contribute to the ongoing debate related to carbon offsets and carbon credits in voluntary carbon markets and highlight for investee companies the key elements we believe are important for credible use of carbon credits.
The fund has a financial interest in an orderly transition towards net zero global emissions by 2050, aligned with the goals of the Paris Agreement. We therefore expect companies we invest in to commit to align their business activities with this goal. For companies in certain sectors, reducing emissions to zero seems unfeasible given today’s technologies. Many companies will therefore use carbon removals to “net off” residual corporate emissions in their net zero target year. Some companies are also using carbon credits to supplement their internal decarbonisation efforts in the short and medium term.
The activity of compensating for an entity’s emissions through the reduction or removal of emissions outside the purchasing entity’s value chain is often referred to as ‘offsetting’. In practice, companies purchase carbon credits from other entities managing emission reduction or removal projects, where one credit represents an emission reduction or removal equivalent to one metric tonne of CO2. These projects may be nature-related, where emission reductions are achieved through, for example, wetland management or afforestation, or technology-based, where emission reductions are associated with the application of energy-related or industrial technologies.
This view applies to activities in voluntary carbon markets (VCMs). VCMs are markets where companies can purchase carbon credits for voluntary use, and the use of such credits has increased alongside the rise in corporate emission reduction targets. VCMs differ from compliance carbon markets that are created and monitored by governments, such as the EU Emissions Trading System (ETS), where entities are required to participate in fulfilment of regulatory requirements.
Well-functioning VCMs that are transparent and credible could direct funds to cost-effective mitigation and sequestration opportunities, particularly in markets and sectors where financing is needed. They could also incentivise investments in critical technologies that will be required to achieve net zero pathways in emission-intensive industries.
However, legitimate concerns have been raised around the quality of certain offset projects, i.e. whether each transaction in carbon credits generates real and durable emission reductions that would not otherwise have occurred. There are also concerns that using carbon credits may distract from companies’ efforts to reduce their own emissions, and direct investments away from necessary and measurable emission reductions in energy and industry. Companies that purchase low-quality carbon credits also risk overstating their achieved emission reductions to stakeholders, including investors.
The lack of transparency on how companies are using voluntary carbon credits in the context of their climate commitments presents a challenge for investors when evaluating the credibility and progress of companies’ climate commitments and achievements. Investors holding portfolios with widespread use of low-quality carbon offsetting may underestimate the climate risk they are exposed to.
Key elements of credible corporate use of carbon credits
1. Companies should reduce their own emissions first, and not rely on carbon credits to reach near-term targets
Following the mitigation hierarchy, companies should prioritise reducing GHG emissions from their own operations and value chains. Companies can supplement their decarbonisation efforts with carbon credits to signal high climate ambitions. Carbon credits should not be counted towards progress on near-term science-based emission reduction targets.
2. Carbon credits should represent additional and verified emission reductions
Companies should opt for carbon credits validated by a recognised standard-setting body. The credits should be additional, which means that they should only be issued for activities that would not have been carried out without the financing raised through the carbon credits.
The mitigation activity should follow best practices on social and environmental safeguards, including respecting the rights of indigenous peoples and local communities, and avoiding negative impacts on local biodiversity and valuable ecosystems. Companies can consider buying credits with co-benefits beyond the reduction and removal of emissions, such as positive impacts on biodiversity and/or local communities.
We support the efforts of the Integrity Council for the Voluntary Carbon Market (IC-VCM) to improve the integrity of the carbon market. We encourage companies to purchase carbon credits that are in line with its Core Carbon Principles.
3. Over time, carbon credits should represent durable removal of CO2 from the atmosphere
Over time, companies should move towards carbon credits that represent removals with durable storage. Companies that will need to offset residual emissions with carbon removals to achieve net zero, should start planning and investing early to be prepared for their net zero target year. This will also send demand signals that will help develop the carbon removal market.
4. Investors would benefit from transparency on companies’ use of carbon credits and their cost
More transparency in VCMs would enable investors and other stakeholders to understand and evaluate how carbon credits contribute to companies’ climate commitments and achievements. Any use of carbon credits should be clearly identified in corporate reporting. We also encourage companies to disclose the price, or price range, of carbon credits they have purchased in VCMs. This will help investors assess the robustness of companies’ approaches and enable efficient price discovery for market participants.
The suggested disclosure template below includes the core data points we consider to be most relevant:
|Volume (credits retired)
|Price (or price range)
|Description of mitigation activity
Developments to follow
Our view on corporate use of voluntary carbon credits may evolve over time as markets, standards and technologies develop. Increased investment and increased scrutiny of VCMs have catalysed major efforts to improve the integrity of voluntary carbon credits. We will closely follow the ongoing work of initiatives such as the Voluntary Carbon Markets Integrity Initiative (VCMI), the Integrity Council for the Voluntary Carbon Market (IC-VCM) and the Science Based Targets initiative (SBTi).