Investors, employees, customers and consumers are requiring greater environmental sustainability from companies they interact with. Unsurprisingly companies are responding to the demand to be more environmentally responsible, one way or another. One of the important commercial responses is through the generation and trading of carbon credits.
Carbon credits have been gaining attention in recent years as a way for companies to generate income from their ‘green’ activities and for others to trade to offset their emissions. The trading of carbon credits is also a core tool for countries working to meet their international carbon emission reduction commitments. Carbon markets have the potential to do a lot of good work globally, however have also been criticised for being opaque and open to fraud. A key ESG consideration is to ensure that the activity concerned is genuinely effective in reducing, avoiding or removing greenhouse gas emissions and that ‘green’ claims are not merely a bunch of buzzwords and snazzy marketing.
What are carbon credits?
Carbon credits are created by investing in projects that reduce emissions – thereby acting as a mechanism to offset greenhouse gas emissions. Some recognised methods for generating carbon credits include carbon capture and storage; reforestation; and landfill and alternative waste treatment.
Specifically, a single carbon credit is a tradable certificate or permit that provides the holder of the credit the right to emit one metric tonne of carbon dioxide into the atmosphere. Carbon credits can be purchased by governments, or other individuals or businesses seeking to offset their carbon emissions through a carbon market. The prices of carbon credits vary depending on the market and the type of project that generated the credits.
How do carbon markets work?
There are various carbon markets around the world. In Australia, unlike in many other countries that operate mandatory schemes, the carbon market is voluntary. The Clean Energy Regulator (“CER”) administers and regulates the national carbon market in Australia, which enables businesses to earn Australian Carbon Credit Units (“ACCUs”) under the Emissions Reduction Fund through running eligible activities to reduce emissions. The CER is the primary purchaser of ACCUs (assisting the Australian Government to meet its international emission reduction commitments), however ACCUs earned can also be sold onto the secondary private market. Secondary private markets have developed in parallel to government/mandatory markets, giving businesses additional avenues to obtain benefit from their sustainable activities and offset emissions. The CER is currently developing an Australian Carbon Exchange to simplify the process for trading ACCUs.
The Emissions Reduction Fund also includes a ‘safeguard mechanism’, which requires Australia’s largest greenhouse gas emitters to measure and report on their emissions and keep emissions at or below a baseline set by the CER. This policy was designed to ensure that emissions reductions under the Emissions Reduction Fund are not offset by rises in emissions elsewhere. In the 2020-2021 reporting year there were 215 facilities covered by the safeguard mechanism. The current government is proposing changes to improve Australia’s climate target results by reducing the baselines in the safeguard mechanism.
Australia’s largest trading partner, and the world’s largest greenhouse gas emitter, China, launched its emissions trading scheme (“ETS”) in 2021. The ETS is regulated by the Ministry of Ecology and Environment (“MEE”) and is mandatory for (and currently limited to) onshore ‘covered entities’ in specific industries through which China Emissions Allowances (“CEAs”) are traded. CEAs are allocated free of charge and based on emissions intensity. After offsetting their actual emissions, covered entities can trade their excess CEAs on the Shanghai Environment and Energy Exchange to other covered entities. In addition, a number of voluntary ‘pilot schemes’ operate in China, each differing in terms of rules and processes for participation. The MEE introduced mandatory data reporting requirements for certain onshore organisations and is promoting a strict position on data accuracy and integrity. Already the largest carbon market in terms of emissions (the EU’s ETS is the biggest carbon market in terms of covered facilities), China’s ETS has the potential to grow at a significant pace when it extends coverage to other facilities and will play a key role in carbon reduction and reaching the net zero target globally.
The good, the bad and the ugly (carbon credit users)
Carbon credits provide a financial incentive for individuals, organisations, and governments to reduce their carbon footprint and create investment in projects that are reducing or avoiding greenhouse gas emissions. The projects can have other positive outcomes, such as providing growth to local communities and developing regions and generate innovation in business practices and technology. All of which looks pretty good on a company’s website or in its marketing material.
Critics of the carbon credits scheme have lamented it for allowing big polluters to continue as before, by purchasing credits to offset their emissions rather than taking any positive steps to actually reduce greenhouse gas emissions and change the way they operate. Further, a perceived lack of transparency and accountability in the industry has led to concerns that projects being used to generate carbon credits may not actually achieve a reduction of harmful emissions, and the potential risks for fraud and companies making misleading and vague ‘green’ claims.
The carbon credit industry is currently a fractured mix of voluntary, mandatory, government and private schemes without uniformity in the standards or requirements for participation. Accordingly, ensuring the integrity of carbon credit projects and the enforceability of carbon credits is a complex but increasingly critical task for stakeholders to navigate. There have been steps taken to address these concerns in a number of jurisdictions, with the introduction of guidance or standards for projects, and some schemes requiring independent verification to ensure that projects are actually achieving the emissions reduction target and effect as claimed. Examples of current international carbon standards include the Verified Carbon Standard and the Gold Standard. As general awareness, scrutiny, and enforcement and compliance action of the industry all continue to increase, the governance around carbon markets will also need to keep up pace.
A word of warning…greenwashing
It is near impossible to read any news at the moment without seeing a headline about greenwashing. Greenwashing has certainly become something of a global buzzword. In the Australian context, the competition authority the Australian Competition and Consumer Commission has announced that it will be investigating businesses for potential greenwashing following its findings from a recent review that “a significant proportion of businesses are making vague or unclear environmental claims”. The corporations regulator, the Australian Securities and Investments Commission, recently brought its first court action relating to alleged greenwashing activity of Mercer Superannuation (Australia) Limited, alleging that “Mercer made false and misleading statements and engaged in conduct that could mislead the public” when marketing its investment options as being sustainable and excluding certain industries when in fact the investments included those industries. These regulatory actions send a strong message to the carbon credits market to ensure that the activities being used to generate carbon credits are transparent, accountable and effective in reducing greenhouse gas emissions, and that any ‘green’ claims being made are accurate and supported by legitimate ‘green’ activities.
This memo presents an overview and commentary of the subject matter. It is not provided in the context of a solicitor-client relationship and no duty of care is assumed or accepted. It does not constitute legal advice.
© Moulis Legal 2023