A brief on Carbon Credit

Background  : The carbon market can be divided into two: the voluntary market and the regulatory (compliance) market.

In the compliance market, carbon credits are generated by projects that operate under one of the United Nations Framework Convention on Climate Change (UNFCCC) approved mechanisms such as the Clean Development Mechanism (CDM).Credits generated under this mechanism are known as Certified Emissions Reductions (CERs). In the voluntary market, carbon credits are generated by projects that are accredited to independent international standards such as the Verified Carbon Standard (VCS). These credits are known as Verified Emission Reductions (VERs). Carbon Trade Exchange supports the trading of both voluntary and compliance credits. It is important to note that carbon credits differ from carbon allowances although the term carbon credit is interchangeably used to represent both.

Carbon Credit : A permit that allows the holder to emit one ton of carbon dioxide. Credits are awarded to countries or groups that have reduced their green house gases below their emission quota. Carbon credits can be traded in the international market at their current market price.

The carbon credit system was ratified in conjunction with the Kyoto Protocol. Its goal is to stop the increase of carbon dioxide emissions.

For example, if an environmentalist group plants enough trees to reduce emissions by one ton, the group will be awarded a credit. If a steel producer has an emissions quota of 10 tons, but is expecting to produce 11 tons, it could purchase this carbon credit from the environmental group. The carbon credit system looks to reduce emissions by having countries honor their emission quotas and offer incentives for being below them.

How do carbon credits impact global emissions?

Carbon credits are an immediate answer to reducing the amount of Green House Gas (GHGs) emissions in the atmosphere. The generation and sale of carbon credits funds carbon projects which would not have gone ahead i.e additional to business as usual. Carbon credits also help lower the costs of renewable and low carbon technologies as well as assisting in the technology transfer to developing countries.

What are the different types of carbon projects?

Carbon credits can be generated from various types of projects including:

Renewable energy: a switch from fossil fuels to a ‘clean’ energy e.g. wind and solar energy

Forestation and Afforestation: The planting of new trees as trees sequester and store CO2 e.g. forest regeneration

Energy efficiency: reducing emissions though an increase in energy efficiency e.g. installation of energy-efficient machinery

Methane capture: avoiding methane emissions through capture and burning to create energy e.g. landfill methane capture

Project eligibility for carbon credits depends on whether a project follows one of the Kyoto Protocol’s project-based mechanisms or an independent voluntary standard.

How it works

Investors are usually called out of the blue by salespeople promoting carbon credits, but contact can also come by email, post, word of mouth or at a seminar or exhibition.

You may be offered carbon credit certificates, or an opportunity to invest directly in a ’green‘ scheme or project that generates carbon credits as a return on investment.

The caller may claim carbon credits are ‘the new big thing’ in commodity trading, industries now have to off-set their emissions, the government is focusing on green developments or that it is an ever growing market.

You could lose money on your investment by not being able to sell, or at least get a competitive rate, when trading a small volume of carbon credits.

How to protect yourself

Beware that VERs certificates are often labelled as ’certified‘, but this certification is voluntary and involves a wide range of bodies and different quality standards that are not recognised by any UK compensation scheme.

Also keep in mind that the projects generating VERs are usually based overseas and authorities in the UK have no way of controlling the quality or validity of the schemes.

We do not regulate carbon credits as a product in the same way as shares or units. This means a firm promoting or selling them does not necessarily have to be authorised by us.

But if you buy an investment product from a firm that is not authorised by us, you will not have access to theFinancial Ombudsman Service (FOS) or Financial Services Compensation Scheme (FSCS) if things go wrong.

We are aware that some firms authorised by us are involved in the sale of carbon credits. They may act as a ‘custodian’ or ‘nominee’, opening an account with a carbon credit registry to hold the credits on behalf of investors. The salesperson may also claim the credits are provided by a ‘supplier’ authorised by us.

However, even if a firm involved in the sale or trading of carbon credits is authorised by us, as we do not regulate carbon credits you will not have access to the FOS or FSCS. This includes where you cannot sell or trade carbon credits.

We might also be interested in carbon credits where they are sold as a collective investment scheme (CIS) or a futures contract. For this reason, please tell us about the sales process if you are offered or buy carbon credits or a similar investment.

You can find out more about what to consider before investing in carbon credits.

Accounting guidelines in India

Accounting guidelines on carbon credits comes into force from 1st July 2009.

Carbon credits are “intangible assets” and they need to be treated as “inventory” in the balance sheet till they are sold.

The note classifies CERs as `assets’ of the generating entity. However, since issuance of CERs is subject to the verification process under the UNFCCC, CERs can be treated as contingent assets, only after it comes into existence, i.e. after the entity has been issued CERs by the UNFCCC. After this, CERs can be recognised in the financial statements.

(Article is written by Mr. Ashish Sharma, who can be contacted on [email protected])