Banks use voluntary carbon credits, or offsets, as a key tool to reduce reported carbon emissions, but a lack of regulation, standards and transparency makes the carbon market risky. How can banks ensure that their efforts do not backfire?

Voluntary carbon credits have long been embraced to reduce corporate carbon emissions. Recently, however, concerns have been raised that many credits do nothing to reduce emissions, enable firms to make misleading environmental claims (known as “greenwashing”) and have a high potential for fraud. The Commodity Futures Trading Commission (CFTC) recently established an Environmental Fraud Task Force charged with investigating voluntary carbon markets, which could expose issuers, traders, and purchasers of credits to additional regulatory scrutiny.¹ Banks utilizing carbon offsets must ensure they understand and manage the associated risks.

A Market Lacking Transparency

In contrast to highly regulated markets for emissions permits issued under cap-and-trade systems, such as California or the European Union (EU), the voluntary carbon credit market operates with minimal oversight or transparency and has been described by one research report as “the wild west.”² This is likely due to fragmented trading liquidity, inconsistent standards, and a lack of transparency on the effectiveness of projects issuing credits to third parties. 

In theory, each carbon offset represents one metric ton of carbon emissions removed or avoided, but recent reports suggest that many credits have no real-world impact on emissions.^3,4  Credits issued by renewable energy projects are seen as particularly weak because such projects are usually profitable without the extra revenue generated by selling credits. If the project would have been built profitably without credits, then the credits did not lead to any change in real-world emissions. Credits tied to forestry management practices have also been questioned as a recent study estimated that only 6% of these types of credits actually reduce emissions.⁵ In any case, accurately determining the true impact of specific credits is difficult for third parties given limited transparency into the economics of projects. 

Risks are Not Limited to Traders

Carbon offset trading is currently concentrated in specialist and commodity firms, although that could soon change following the recent introduction of guidelines for voluntary carbon futures products by the CFTC, which could enable broader futures trading by promoting confidence. At the moment, however, most banks’ exposure to carbon offsets is as buyers, which can still bring significant regulatory and reputational risk as news media and activists have named and shamed firms that make sustainability claims based on ineffective credits, including leading global banks.³ In addition to negative publicity, unfounded green claims have led to lawsuits by customers claiming they were deceived by greenwashed marketing.⁶ 

Regulators are also taking a closer look into the offset market with the CFTC’s task force “address[ing] fraud and other misconduct” in voluntary carbon markets, alongside a call for whistleblowers to come forward.⁷ The agency also recently issued guidelines for voluntary carbon futures products and exchanges,⁸ which could be a preview of more stringent requirements in the future. Buyers and traders of fraudulent credits already face fines and penalties under existing regulations, in addition to private lawsuits, potentially resulting in significant financial impacts. 

How to Mitigate Risks

Firms that choose to buy credits are not helpless since tools exist in the market that can address some of the risks, and new developments appear almost daily. Third party certification by programs that research, verify and sell credits are one of the best options currently available. Verifiers like Verra, Gold Standard, Climate Action Reserve, and American Carbon Registry certify the validity of carbon credits with their own frameworks and standards, offering buyers a source of trust and improved transparency. Unfortunately, these programs have faced criticism that some certified credits are ineffective, and newer certification organizations appear to have been established specifically to provide cover for low-quality credits.⁹ While verification can increase confidence in a credit, buyers still need to research and understand the organization and framework behind the certification to ensure they understand what they are buying. 

The good news is there are further developments on the horizon that could help reduce risk. For example, carbon credit insurance – which is still in its early stages – insures carbon credit purchasers against loss by safeguarding credit transactions against issues after sale, such as failure to deliver or future invalidation of the credits by certifiers. Firms are also beginning to explore digital ledger technology like blockchain solutions to bring decentralization, transparency, and immutability to improve trust in the way carbon credits are recorded, certified, and distributed. In the end though, the data on any blockchain solution is only as good as its source, meaning it can improve trading transparency, but it cannot guarantee the underlying credit actually removes carbon from the atmosphere. 

Best Practices for Buyers

The Voluntary Carbon Market Integrity Initiative (VCMI) recently released standards for carbon offset claims, but a study found that only 5% of offset purchasers meet the guidelines.  Whether or not a bank formally adheres to the VCMI standards, the best practices provide guidelines for firms looking to build appropriate carbon scaffolding.

1. Start with transparency and accountability: Before buying credits or making emissions reduction claims, companies should establish transparency by publishing a baseline carbon footprint, and accountability by setting science-based targets for reductions.  This will boost the credibility of any efforts and enable outside observers to validate progress. 
   
2. Credits are only part of the puzzle: Firms can work to achieve real-world impacts by reducing their direct carbon footprint, and saving credits to offset remaining emissions that cannot feasibly be eliminated.¹⁰ 
3. Buy high-quality credits: Credits should be certified by a reputable third party like those listed above, while considering the known limitations of certification programs. Price can be another indicator of quality – higher-quality credits command a premium in the marketplace relative to those with less verifiable impact.¹¹
4. Make credible claims: Any marketing claims should be based on concrete evidence of impact as less ambitious, but strongly supported claims are less risky than expansive claims made from weak offsets. For example, some companies have started walking back previously announced carbon neutrality claims based on offsets after facing increased scrutiny. 
5. It may be worth waiting: Regulators are starting to take a closer look at this space with clearer guidance and standards likely coming soon. Given this, it may be better to wait for surer requirements rather than jump in and risk backtracking later on. 

Although voluntary carbon markets can pose significant risks to offset buyers, they do not have to. By implementing best practices for using carbon credits, firms can gain credibility, avoid greenwashing, and ensure that they get credit for real impacts. Given the complexity of decarbonization, carbon offsets will need to be a part of a firm’s net-zero plan for the foreseeable future. As a result, it is vital to both purchasers and the planet that they represent real improvements, and not merely convenient marketing and accounting. 

References

¹ https://www.cftc.gov/PressRoom/PressReleases/8736-23
² https://www.bloomberg.com/news/articles/2023-06-28/new-rules-for-carbon-offsets-aim-to-clean-up-company-climate-claims?srnd=premium
³ https://www.bloomberg.com/graphics/2022-carbon-offsets-renewable-energy
⁴ https://www.wsj.com/articles/renewables-carbon-credits-do-not-cut-emissions-united-nations-verra-gold-standard-11662644900
⁵ https://www.bloomberg.com/news/articles/2023-08-24/junk-offsets-are-feeding-mass-wave-of-greenwashing-study-shows 
⁶ https://apnews.com/article/delta-airlines-lawsuit-carbon-credits-carbon-neutral-469f2671010ba7f40c934cc23d62149a 
⁷ https://www.cftc.gov/PressRoom/PressReleases/8723-23 
⁸ https://www.cftc.gov/PressRoom/PressReleases/8829-23 
⁹ https://www.wsj.com/articles/rebuilding-trust-in-carbon-offsets-faces-uphill-battle-d7811603
¹⁰ https://vcmintegrity.org/vcmi-claims-code-of-practice/ 
¹¹ https://www.washingtonpost.com/business/energy/2023/06/29/kitkats-are-no-longer-carbon-neutral-that-s-good/67aa0018-1670-11ee-9de3-ba1fa29e9bec_story.html