I was the ‘dummy’ in the room at the ISDA® Annual Legal Forum in London at the end of January, until a great panel of experts (Peter Werner, Senior Counsel at ISDA®; Ingo Ramming, Head of Carbon Markets BBVA; Deepak Sitlani, Derivatives Partner at Linklaters; and Ingrid York, Partner at White & Case) set about explaining the Voluntary Carbon Credit Market. So, I thought it only fair to share my learnings with you.
Voluntary carbon markets (VCMs) enable carbon emitters to offset their emissions by purchasing voluntary carbon credits (VCCs) which are instruments that represent the removal or reduction of 1 tonne of carbon dioxide or greenhouse gas from the atmosphere.
Every corporate or financial institution is ‘short carbon’ on the back of regulatory requirements or ‘voluntary commitments’ to reduce emissions. As a result, the VCM allows market players to voluntarily purchase a carbon credit to fulfil a climate goal (like achieving net zero). These are usually purchased off the back of a project whose aim is to reduce carbon emissions and is driven by methodologies which are overseen by private carbon standards. A VCC can then be transferred to a country to help them reduce their emissions and achieve their climate targets. VCCs are not only climate market related instruments though, but they also represent a market that drives nations’ budget and spending.
Article 6 of the Paris Agreement has enabled the growth and development of the VCM as it allows countries to cooperate to achieve emission reduction targets in line with their Nationally Determined Contributions. The idea is to cut compliance costs and encourage investments in the host countries. A country would ‘transfer’ VCCs earned from reducing greenhouse gas emissions to help another country achieve its climate targets.
As a product, a VCC is very specific as it is not fungible and therefore not easy to physically settle. The legal nature of VCCs in terms of English law is like a digital asset and emissions in that it is treated as intangible property rather than a bundle of legal rights. Other jurisdictions would need to determine how they would categorise the legal nature of a VCC, and it would be useful to standardise the legal treatment of VCCs globally given that this is a global market.
To standardise the VCM, ISDA® published a set of definitions (The 2022 ISDA® Verified Carbon Credit Transactions Definitions) which can be bolted onto a standard ISDA® Agreement in order to govern primarily spot, option and forward VCC transactions. ISDA® are currently working on version 2 of these definitions which were released to the market for comment at the end of 2023.
With South Africa’s energy crisis precipitating the need to install green energy solutions like solar and wind farms, is South Africa capitalising on the ability to create VCC instruments off the back of these large-scale, green-energy projects?