The importance of Environmental, Social, and Governance (ESG) considerations in the business landscape continues to escalate. Carbon credits and emissions trading schemes (ETS) have come to the forefront as instrumental tools in mitigating climate change. In New Zealand, these mechanisms are not just opening up opportunities for carbon offsetting but are also paving the way for the next frontier – biodiversity enhancement. I’m still learning in this space, but can see that as an alternative investment class, carbon may carve out a place in an everyday portfolio soon.

The nature of carbon credits is somewhat akin to equity. Corporations aren’t purchasing debt, but rather a stake in a project or activity that has a quantifiable environmental impact. For instance, a landowner could commit to planting indigenous trees on their land. While this activity primarily serves as a carbon sink, it also has the co-benefit of enhancing biodiversity.

While the land remains with the owner, this commitment to fostering an indigenous forest creates a property right that can be bought and sold. However, it’s vital to recognise that different pieces of land may not offer equivalent environmental benefits, raising fungibility concerns.

Moreover, unlike equities, these property rights don’t involve securitisation. Instead, the system relies heavily on accurate and timely disclosure. Both prior and ongoing disclosures are crucial for this system to function, as the ex-post revelation of information doesn’t suffice in this context.

The Emissions Trading Scheme (ETS) in New Zealand is a formalised market for purchasing carbon sequestration activity. When a corporation buys a carbon credit, they’re effectively buying ownership of an environmentally friendly activity that can offset their own carbon emissions. However, the ETS operates under a policy that aims to gradually reduce the availability of carbon credits. This approach encourages corporations to address their own emissions instead of relying on offsets.

Carbon credits are essentially a commodity, bought and sold per tonne, but their market is somewhat nebulous. Companies often bundle ETS credits with international credits, which may or may not have a tangible link to underlying environmental activities.

The Taskforce on Nature-related Financial Disclosures (TNFD) is pushing large corporates to consider their “nature balance sheet”. It’s worth noting that companies resisting the ESG movement may tend to underperform, and many predict they will eventually be compelled to compensate for their environmental impact. This is early days, and we’d need to see a longer timeframe to be sure.

In terms of regulatory involvement, the New Zealand ETS Market is regulated, but the voluntary, informal carbon market is still developing, along with the regulation required to support it. This lack of regulation in the voluntary market may be due to the Financial Markets Authority (FMA) not currently viewing carbon credits as a financial instrument. For the FMA to adopt a similar approach to countries where carbon credits are considered financial instruments, such as Australia, it may require new legislation.

In this evolving landscape, the Ministry for the Environment (MFE) are helping navigate the complexities of carbon credits and emission trading. The future of ESG in New Zealand seems intertwined with these mechanisms, promising a greener future for corporations and the environment alike.

So, is this something for the everyday investor?

Here are three things to consider:

1. Diversification and Returns: Carbon credits and ETS add variety to portfolios and offer potential returns due to growing climate awareness and regulation.

Risk: Market and Regulatory Uncertainty. This is massive. Carbon credit values can fluctuate wildly based on regulatory changes and climate policies. The lack of global regulation standards adds to unpredictability.

2. ESG Alignment: Carbon credit investment aligns with ESG values, appealing to eco-conscious investors seeking positive environmental impact.

Risk: Verification Issues. Transparency and legitimacy of carbon credits can be problematic. Credits tied to ineffective projects can undermine environmental goals.

3. Future-Proofing: The growing expectation for corporations to offset emissions suggests a growing market for carbon credits, offering investment resilience.

Risk: Corporate Demand Dependency. Carbon credit values hinge on corporate offset demand. Changes in company policies, public perception, or emission reduction technology could impact demand and thus, credit value.

In summary:

The increasing importance of Environmental, Social, and Governance (ESG) considerations in the business world is driving the growth of carbon credits and emissions trading schemes (ETS). In New Zealand, these tools present opportunities for environmental preservation and biodiversity enhancement. While the ETS market is regulated, the informal carbon credit market is not, sparking discussions about the need for legislation. Carbon credits operate similarly to equity, offering a stake in a project or activity rather than a debt instrument. The purchase of these credits allows corporations to offset their own carbon emissions, encouraging environmentally friendly practices. However, the market faces challenges such as transparency, verification, and dependency on corporate demand. Despite these risks, investing in carbon credits offers potential for diversification, alignment with ESG principles, and future-proofing investments, making them a unique asset class for everyday investors.

 

Disclaimer: This article was created by converting an actual conversion using AI-tools. Please do your own research before acting on anything contained here: This is not financial advice or an endorsement of this asset class.