From optional to probable: How redemption behaviour is reshaping RMBS pricing

Hosted by LSEG in partnership with S&P Global Energy and the UN Sustainable Stock Exchanges (UN SSE) Initiative. 

LSEG hosted a closed door round table discussion during London Climate Action Week to discuss the role of voluntary carbon markets and compliance in a world increasingly focused on energy security. This was the latest in a series of international roundtables under the SSE–S&P Global Energy Carbon Currents collaboration, bringing together exchanges from around the world, alongside leading market experts, to discuss carbon market developments, opportunities, and challenges across their respective regions.

Participants discussed the relative success of market initiatives like the Core Carbon Principles (CCPs) as a means of driving market confidence going forward, as well as how the European Union’s apparent thawing towards crediting mechanisms could shape the conversation.

The discussion was focused on the following four questions:

The discussion was focused on the following four questions:

1) What is carbon “missing” relative to other successful global benchmarks?

• What makes a successful benchmark?
• Can a carbon benchmark exist in a voluntary environment? In a fragmented one?

2) What might emerge as the global carbon benchmark?

• Is CORSIA an adequate benchmark? Can it adapt to capture the variability of carbon crediting?
• What role if any can CBAM play in the development of a global carbon benchmark?

3) How can carbon markets scale in time to meet expected demand while also maintaining credibility?

• Are there enough of the “right” credits to meet variable sources of demand?

4) Are carbon markets still relevant in today’s environment?

• What role do carbon markets have in a world focused less on collective action over unilateral action? 
• Energy transition vs. decarbonisation: does this change the conversation around carbon market?

While the voluntary carbon markets have struggled to coalesce around a single pricing benchmark, they have managed to build more niche positions around smaller ones, and the expansion of the ICVCM’s Core Carbon Principles (CCPs) should help to alleviate credit credibility concerns from possible buyers. However, the absence of benchmarking across a wider swathe of carbon projects greatly impacts market scalability and will continue to weigh on demand, absent a sufficiently robust framework ecosystem — including greater political ambition. While there has been progress in building this ecosystem through the overlapping guidelines of the ICVCM, VCMI, Article 6 and CORSIA — with an additional oversight mechanism provided by ratings infrastructure — the system remains immature and disjointed. Further, there is still significant variability across CCP inclusion and ratings which, separate to an additional mechanism, have done little to further the process of standardisation.

The attendees agreed that there is nothing about carbon markets that make them different from other commodities markets, but they fundamentally lack the consistent demand that stabilises the market and manages significant forward risk. This is, in some ways, a policy question — should there be some greater regulatory oversight to require use? — but it is also about building a compelling business case for carbon offsetting. Many businesses are still interested in engaging with offsetting but have shied away from the significant risk that it presents to reputation, particularly in the absence of a larger enforcement mechanism. Additionally, absent stronger enforcement mechanisms, many buyers have become increasingly self-limiting about the credits they are willing to consider, which often penalises otherwise effective, but much smaller project. This has meant that many buyers have flocked to CORSIA as a guarantee of credibility, even if they are not part of the airline industry or have begun to demand Correspondingly Adjusted-credits. In addition to creating another pricing variable within the already highly-variable credit pricing environment, this creates additional supply challenges for Correspondingly Adjusted-credits, potentially undermining a key component of what makes Article 6 work within the Paris Climate Agreement. Additionally, corporate reluctance to engage more openly with carbon markets means that the necessary financing to drive decarbonisation in local communities will fail to materialise.

A recent thawing by the European Commission towards crediting mechanisms has potentially created a crucial policy signal that could allow for the development of a pricing signal needed to help to support the development of demand. While the EU Commission is unlikely to integrate voluntary or Article 6 carbon credits in the EU ETS directly, the European Union is integrating removal credits within the 2040 90% target, and has even discussed them potentially playing a in its Carbon Border Adjustment Mechanism (CBAM), which creates a trade-driven enforcement mechanism to standardize certain aspects of carbon accounting. However, it is too soon to tell if introducing carbon crediting to CBAM, for example, would create a global carbon market linked to the EU price. CBAM, while useful in creating standardisation in some things is inherently designed around European markets, which will limit its broad applicability for decarbonisation across other markets and may even create incentives that increase industrial emissions in specific jurisdictions. However, the attendees agreed that the discussion of carbon credits within this context means that now is probably the right time to try and address these questions around standardisation.

Recent steps by the Eruopean Commission towards introducing crediting mechanisms into the EU ETS has potentially created a crucial  policy signal that could allow for the development of a pricing signal needed to help support the development of demand. While the EU Commission may be unlikely to integrate voluntary or Article 6 carbon credits in the EU ETS directly. Still, the room agreed a long-term carbon price signal remains a necessary regulatory "fail-safe," especially for the harder, higher-priced industrial transition ahead. Further, the global conversation around decarbonisation has already become more prescient in the wake of the global energy crisis following the closure of the Strait of Hormuz during the recent conflict in the region. Because carbon is also an accounting instrument, both financially and as a quantification tool for emissions overall, the “market” element provides the crucial pricing signal for particularly hard-to-abate industries to invest in often costly upgrades to lower overall emissions. However, this is not always a prefect signal and has meant that carbon leakage remains the prescient challenge. As prices must rise to bite on industrial emissions, leakage and competitiveness concerns have pushed governments toward either cost containment linking to the voluntary market or CBAMs, which could risk further trade distortion.