April 19, 2022
As discussed in Shearman & Sterling’s previous Energy & Infrastructure Insight, there is significant pressure on companies and governments to reduce their carbon emissions, not only driven by mandatory regimes but also increasingly, internal ESG strategies.
Where a company is unable to eliminate all of its carbon emissions by using alternative technologies and inputs in its activities, it can use carbon credits to “offset” some or all of these and thereby achieve a net emissions reduction across the totality of its activities. A carbon credit is a certificate or permit representing the right to emit a certain amount of carbon dioxide (or the equivalent amount of a different greenhouse gas).
Carbon credits can be traded within the context of compulsory carbon markets such as the European Union’s Emissions Trading System. Increasingly, they can also be created and traded on voluntary carbon markets around the world, examples of which have been established in Singapore, Sydney, New York and London.
Abu Dhabi Global Market (ADGM) is now set to launch a voluntary carbon market.
On 29 March 2022, ADGM, the international financial centre in Abu Dhabi, announced the formation of the first fully regulated voluntary carbon trading exchange and clearing house.
ADGM is partnering with AirCarbon Exchange (ACX), a digital carbon trading exchange, to form the trading exchange and clearing house. ACX will be established as a recognised investment exchange and will be regulated by ADGM.
ACX intends to offer customers a regulated, transparent price discovery mechanism and efficient trading once launched later this year. This will allow companies to trade and finance carbon credits in a similar way to conventional financial assets, which will allow for greater investment in global carbon emission reduction and offset programmes (such as afforestation and new renewable energy projects), in line with global decarbonisation goals and treaty commitments.
ADGM will be the first jurisdiction in the world to regulate carbon credits and offsets as emissions instruments in a voluntary market.
In the initial stages, ACX intends to make use of its distributed ledger technology to produce digital tokens for carbon credits which will be used for spot market trading. The digital tokens will be custodised by the recognised clearing house, ACX Clearing Corporation, which will settle and clear all digital tokens using blockchain smart contracts.
There are also plans for ACX to offer carbon credit futures as commodity derivatives for trading in the future.
What differentiates this exchange from other voluntary carbon exchanges is the regulatory aspect. Voluntary carbon exchanges are unregulated, in contrast to compulsory carbon exchanges. Whilst all voluntary carbon exchanges offer entities the opportunity to purchase carbon credits to mitigate their carbon emissions, there are reports of customers on such voluntary carbon exchanges encountering difficulties finding carbon credits of a high quality and complaining of the opacity of prices. Similarly, buyers on the voluntary carbon market are said to sometimes be faced with limited transparency surrounding the development of the offsetting project. This has led to concerns that voluntary carbon credit systems can be a form of greenwashing—i.e. the acquisition of poor quality carbon credits by a company can mislead stakeholders, including consumers, into believing that its business activities are less environmentally harmful than they really are. As explored in previous publications, there have been calls for greater regulation of the voluntary carbon market, prompted by concerns relating to inconsistencies in verification processes and uncertainty surrounding the true environmental impact of certain initiatives, so it is hoped that the regulatory robustness of the ADGM-ACX partnership will bring greater certainty and integrity to the trading of carbon credits.
As noted by the Taskforce on Scaling Voluntary Carbon Markets, which was initiated in 2020 by Mark Carney, the UN Special Envoy for Climate Action and Finance Advisor to the U.K., the establishment of an active secondary market could increase the transparency and lower the volatility of pricing of carbon credits, as well as allow customers to manage risks. Therefore, companies considering participating in carbon credit exchanges, may find that the ADGM-ACX carbon credit exchange eases some of the risks and challenges mentioned in this article and elsewhere.
Special thanks to trainee Yvonne Addai who co-authored this publication.