Reducing carbon emissions is one of the most important issues facing individuals and governments today. This is evident as governments focus on ESG investments while creating costs through carbon credits to account for their climate impact.
What is ESG Environment, Society, GovernanceAmong investments, it refers to the consideration of these factors by investors in the companies they invest in.
Many ESG investors focus on environmental factors and choose to eliminate environmental pollutants from their portfolios.
Instead, they choose to invest in businesses working to reduce their dependence on fossil fuels.
Meanwhile, the government limits companies’ carbon emissions through carbon credits. But these credits can also be used as a source of income.
So what are carbon credits and how can they become the new currency for ESG investing to meet environmental regulations?
This article answers this question by explaining ESG investing and the role of carbon credits in this investment space.
Changes in the environment surrounding ESG investment
It is now widely recognized that non-financial factors can provide information about performance to investors. As such, there is growing interest in the importance of ESG topics in the investment world.
And businesses today are being impacted by climate change, disrupting operations and supply chains. More notably, climate change will also affect markets and demand.
As a result, the market is adapting to climate change and all companies need to adapt. Otherwise, it becomes both operational and commercial risk.
- Investors therefore have a role to play in ensuring that companies manage climate risks responsibly.
This shift is influencing investment strategies as investors move from risk-conscious investing to opportunity-conscious investing.
More and more companies are looking to invest in sectors that will benefit from climate change. And most notably, most of them are interested in investing in sustainability-focused strategies.
The sustainability boom has brought in trillions of dollars through ESG funds.
- Companies can take advantage of this changing trend by demonstrating a robust climate strategy through ESG reporting.
This change is very new, but it’s quickly becoming mainstream. This may be due to evidence that climate-friendly investment strategies such as ESG produce positive results.
The evolution of ESG also reflects changing public perceptions of climate change.
In recent years, ESG policy has moved away from the simple principle of doing no harm in positively impacting a company’s bottom line.
Add to this the growing need for transparent and robust ESG reporting. This is driven by regulations such as the Green Deal case as an EU reporting directive.
Companies that comply with reporting requirements tend to earn higher sustainability ratings. Similarly, their investment performance also tends to be higher than companies with lower reporting standards and lower credit ratings.
But policy aside, stakeholders are putting greater pressure on companies to obtain more information about their ESG performance.
This will encourage companies to have a stronger ESG strategy. Communicate these to your employees, investors and customers.
Finally, securing sustainable financing is another key factor in how companies seek to differentiate themselves through ESG investing.
- Investors now favor ESG performance as a proxy for good management.
In fact, big four – PwC, Deloitte, EY and KPMG – hope ESG will be the key to rebuilding consumer trust after many scandals and millions of dollars in payouts.
Therefore, companies that can demonstrate strengths in ESG are likely to secure better financial support and outcomes.
And this changing landscape of ESG investing will only grow as ESG becomes more integral to business. But what role do carbon credits play in the field of ESG investing?
The implications of carbon credits in ESG investing
carbon credit standard
In the US, the regional coin is the US dollar and in the EU it is the euro. In the ESG world, it’s carbon credits. This is a unit of 1 tonne of CO2 removed/avoided.
A carbon credit is a permit that allows its holder to emit a certain amount of CO2 or other GHG. In voluntary carbon markets, carbon credits are known as carbon offsets.
Carbon offsets occupy a relatively small space in the ESG area. However, as more countries and companies commit to achieving net zero, carbon credits are becoming more prominent in his ESG investments to accelerate carbon reduction.
In fact, rising demand has led to record high prices in some markets.
But why should investors care? Because the carbon credit market is growing exponentially.
- Significant increase in carbon credits 164% in 2021 at the nominal value of $851 billionAnd the market forecast is even more impressive.
Research firms predict the market will grow 30-fold by 2030 and 100-fold by 2050.
If these estimates are correct, the carbon credit market will be as large as the NASDAQ stock market by 2030.
According to independent firm Katusa Research, the total carbon market (compliance and voluntary) could be as big as the oil market…
Source: Katsusa Research
Businesses have relied on carbon credits to avoid or reduce emissions.
Companies regulated under a “cap-and-trade” program (compliance carbon market) have no choice but to purchase credits when they exceed their emission limits (caps).
Those who voluntarily offset their emissions can purchase carbon credits from various projects. The most popular are nature-based projects such as afforestation and afforestation.
Markets and rules are beginning to merge
Carbon credits continue to evolve as a unique asset class. But as regulators and industry bodies help codify regulation, carbon markets are starting to take shape for the better.
Indeed, various initiatives and regulations have emerged to guide the investment decisions of ESG investors. So are carbon standards and verifiers.
They are stricter in ensuring the quality and integrity of the credits that credit buyers and investors choose.
- Increasing guidelines and investor awareness are helping carbon credits gain momentum.
In the United States, the proposed SEC disclosure rule on climate change impacts mandates accounting and reporting of carbon credits. This is a big step towards promoting spatial transparency.
Investors are more aware of the role of credit in ESG
Investor interest in carbon credits is growing as corporate environmental pledges are emphasized.
As the world fights global warming, ESG activities will further expand in the coming years.
On the “E” factor, more and more investors are recognizing that carbon credits can have a direct impact on a company’s cash flow, reputation, and other standings.
So when the report showed 100 global companies to blame, 71% of total emissionsthere are greater reasons for ESG investors to push carbon reduction measures.
As such, we can expect further increases in carbon offset transactions.
Here are some reasons why carbon credits are important in ESG investing:
Assessing carbon credits: some key factors to consider
There are various projects that generate carbon credits. Therefore, ESG investors should evaluate them well to know which one to choose.
Local stakeholders are more likely to prefer carbon reduction projects with local co-benefits such as job creation and biodiversity. However, these credits tend to be more costly, but less risky and potentially more permanent.
There are certain metrics to consider for choosing a quality offset. These include additionality, persistence, measurability, and scalability.
It may be some time before carbon credits become the primary asset allocation option for the average investor. But more transparency, better pricing and market standards have given it the spotlight it deserves an offset.
If implemented correctly, offsets can play an important supporting role in the fight against global warming. This is especially true when reducing our carbon footprint is not an overnight fix, but an incremental battle.
We believe it is worth actively considering it in the wider context of ESG investment. Their global abundance will particularly facilitate the flow of capital to stakeholders in developing countries and help facilitate broader achievement of the SDGs.
How can companies benefit from ESG investments using carbon credits?
The importance of the “E” factor in ESG investing has never been greater. The world is experiencing extreme weather events such as floods, droughts and heat waves.
Climate change is impacting every sector of the economy. All businesses must withstand the environmental impacts associated with their operations.
As such, companies are pledging to reduce their carbon footprint in order to slow the rate of global warming. More companies are committed to achieving net zero emissions by 2050 or earlier.
- Leveraging carbon credits as a currency for ESG investing puts companies in an advantageous position.
Carbon credits are created by investing in projects that reduce GHG emissions or by avoiding dependence on fossil fuels. Companies with surplus credits can sell credits to other companies that fail to meet their carbon reduction targets.
This provides more measurable incentives for companies to contribute to the fight against climate change.
Even more surprisingly, ESG investors prefer to invest in greener business models.
A carbon credit represents a fixed amount of GHG emissions that are reduced or avoided.
In other words, investors are more likely to follow suit if carbon credits are linked. Common examples include using renewable energy, adopting clean technology, and making energy efficient investments.
Carbon credits are now commonly traded and not just for corporations. Some investors trade carbon credits in a manner similar to physical commodities.
But ESG investors need to make sure that carbon credits are actually reducing emissions. If this is validated, companies will find all his ESG investments with carbon credits worthwhile.
