Carbon credit trading – get your data in order

Across the globe, a growing number of jurisdictions are developing mandatory carbon emissions trading schemes, reduction & offsetting goals, or carbon reporting. Organisations that are not currently subject to any of these activities are likely to find that they are included in their scope in the future as they develop further. And they may also choose to join the growing list of companies committing to voluntarily reduce their carbon emissions to net zero outside of any legislative pressure.

There are a growing number of mandatory offsetting and emissions trading schemes already. These include California and the European Union’s ETS, where proposals have been put forward for expansion, as well as the UK equivalent. There are several regional schemes in China which are due to undergo a nationwide expansion, and several schemes/carbon taxes in Canada, the USA, Argentina, Japan, Singapore, South Africa, and other countries.

Organisations that find themselves subject to these emissions trading schemes need to calculate their carbon emissions and link these to the offsets that they purchase and retire. Other organisations may be required to understand their carbon emissions only for the purpose of reporting them, such as large UK companies that need to include emissions in their Directors’ Reports. And any business that makes a commitment to voluntarily reduce or offset its emissions needs to be able to track these emissions over time.

However, emissions data is the minimum requirement for organisations looking to efficiently offset their environmental impact, protect against the changing cost of carbon credits, or make a profit from trading these credits. Each organisation has different data management and reporting needs depending on what they are looking to achieve from their participation in environmental markets. But for all organisations, understanding positions, inventory and exposure are critical.

Data for risk management

Carbon pricing is volatile and has been rising rapidly, with credit prices in the EU’s Emissions Trading Scheme increasing over 200% since the start of 2021 and approaching $100/tonne of CO₂. Prices in voluntary markets have also been predicted to rise, with several commentators discussing how the current prices are too low to be credible or sustainable, although estimates of future costs per credit vary widely.

As with any volatile market, organisations need clear and up-to-date position reports if they are to understand their exposure and hedge against it. Any organisation exposed to carbon prices, whether an end buyer or trader, needs to manage their contracts and positions to protect against market risk.

Indeed, of the organisations that use internal carbon pricing, eg to assess their portfolios, procurement or investments, two thirds do so as a risk management tool. There is a lot of data to manage to hedge against market risk; businesses may need information from several markets, depending on their operations, and their exposures will change over time as their business develops, on top of the need to manage the credits’ unique attributes.

Liquidity is growing in compliance markets, and the standardisation of credits in these markets means they function in some ways like a commodity market. This means that the organisations with the most accurate and closest to real-time view of market conditions, their positions and inventories can make the best decisions with regards to price moves and market risk. And combining this with better control over operations and allocations provides the greatest opportunities for profitability.

Pricing carbon credits

In voluntary markets, there are many variables that can impact pricing. Credits can have a different price based on their impact on local communities, whether they support UN Sustainable Development Goals, demand for particular types of projects, and many other factors. For credits to be priced accurately and profitably, trade participants need data on each of these factors that affect each credit, and the impact they have on its price.

It is therefore vital to have the systems in place to manage pricing data accurately and in a timely fashion; not only so that the organisation can respond to the volatile market, but so that they can realise the right prices for the extra value their assets provide. And pricing credits accurately is not all; it needs to work in tandem with effective inventory management, so that credits are accurately matched to clients and reported on correctly, with auditable traceability.

These credits’ additional benefits provide both financial and reputational advantages to organisations managing their data accurately but mean that risk management needs to be even more thorough. The operational risk of mistakes if manually updating records, and the potential damage from fraud risk are greater when there is more complexity in the data around each credit and its price. Businesses therefore need the data management systems in place to properly manage, allocate, trace, and verify credits on a granular level.

Reducing the risks of carbon credits

There are several risks involved in purchasing carbon credits, particularly for organisations operating outside the regulated markets. As mentioned above, lack of standardisation in voluntary offsetting means that some credits can provide additional value, but it also carries the risk of low-quality or fraudulent credits being circulated.

Improving transparency at each stage of the credit lifecycle can help to prove which projects add value, and take fraud prevention beyond KYC to ensuring the veracity of individual credits. But this transparency is not always easy to achieve.

Brokers often purchase credits from a range of projects to create a portfolio that can be resold or distributed amongst end buyers. They must therefore manage data across their entire operation, ensuring that the information associated with each purchased credit is translated and passed on to their clients, no matter how it is transformed. They also need to manage portfolios and inventories to ensure their allocated products are meeting the specific terms of each contract and that they have an auditable log in place to prove this provenance in future.

End buyers also have to conduct proper KYC and due diligence, ensure they have all the data they need on each credit and ensure credits are accurately mapped to their real-world emissions. This not only protects against financial risk, wasted investment and the potential for low-value credits that create a net harm by diverting money from beneficial projects, it also helps the business protect against accusations of greenwashing and reputational risk.

Taking transparency further

Delivering transparency through data has benefits beyond just risk management and compliance with mandatory schemes. Many stakeholders are already asking for more transparency over business’ ESG actions; clients are increasingly concerned with their indirect carbon emissions and the societal impact of their supply chain. Investors are also increasingly likely to assess companies on their ESG criteria, and organisations showing they meet certain ESG criteria may also receive preferential trade finance agreements.

Being able to monitor and verify data across your operations and trace it back to its original source is therefore an essential competency and will only grow in importance as other businesses expand their ESG requirements. In voluntary markets, where contracts are more likely to be OTC, data transparency can help businesses become the supplier of choice. And as compliance markets mature, transparency and traceability may well become crucial to even participate in the market.

When it comes to technology to support environmental offsetting activity, it is therefore essential to ensure this technology has data management at its core. The more granular the data an organisation can manage without creating an administrative burden, the greater their risk management and agility. Giving organisations the ability to break their exposure down by individual products allows end buyers to develop a robust and comprehensive resilience strategy and brokers and traders to better understand the factors impacting their profitability and make better, data-driven decisions.

Find out more about this technology for environmental markets.