Will financial institutions pile in to the voluntary carbon market?

By Genevieve Redgrave

Winners of Environmental Finance's annual Voluntary Carbon Market rankings say institutional investors can play a key role in providing the "missing middle" of finance. Genevieve Redgrave reports

This is part two of Environmental Finance's annual Voluntary Carbon Market rankings. Please read part one here for coverage of annual demand and increasing convergence with the compliance markets. 

Full list of winners:

As the voluntary carbon market benefits from increasing levels of oversight and integration with compliance markets, it is hoped that this will bring more financial institutions to the table.

There are differing opinions among winners of Environmental Finance's annual Voluntary Carbon Market rankings about the extent to which financial institutions are currently willing to engage in the market. According to Sheri Hickok, CEO of Climate Impact Partners, winner of Best Offset Retailer, more financial institutions are "trying to figure out how to do it", but currently need more certainty of demand.

More 'triangle deals' – which involve an agreement between a project developer, a financial institution and a buyer – to purchase the credits would be welcome, she says. However, it would require an uptick in demand for these to become more prevalent.

Andre Fernandez, CEO of Invert, Best Project Developer, Forestry and Land-Use, adds that more financial institution involvement will be critical to scaling the market and providing the "missing middle" of finance. "Someone needs to step in and help with this portion of the market", he argues.

While "it feels like there's an uptick of institutions willing to step in and take more risk", a significant entry from financial institutions into the voluntary carbon is unlikely in the next year amid increasing political backlash against sustainability action.

"They don't want to get scrutinised for publicly working on this," he says, particularly in markets such as the US.

BioCarbon Partners CEO, Nic Mudaly, similarly calls for greater financial institution participation. The winner of Best Project Developer, Biodiversity, says: "If we want the voluntary carbon market to deliver on its promise, it must mobilise more capital towards community-based, biodiversity-rich projects" to help deliver impact for climate and nature.

However, this will require more innovative financial mechanisms, he says. Structures that "blend commercial capital with grants or concessional finance, to de-risk early-stage development and allow for replication at scale", are necessary.

In the short term, Fernandez predicts family offices are likely to play a larger role. Other financial institutions could also be persuaded to take smaller, more frequent bets, he says, "and then you'll be in a much better place".

An anonymous winner argues that the market is still too risky for a large financial institution and is dominated by small players at risk of becoming insolvent. A large institutional investor or bank is not going to be willing to put millions into such a risky investment, regardless of wider market dynamics, they say.

Growing financial infrastructure

As the market begins to adopt more traditional financial structures and financial institutions come to the table, many winners expect futures trading to become more common.

Currently, "corporate procurement teams are unable to underwrite a long-term, high-risk contract", says Abatable CEO, Valerio Magliulo. It won Best Market Innovation.

However, there is growing investor appetite and a shift towards a more long-term focus, he argues. "They're starting to get smarter and starting to sign forward offtakes with more interesting structures."

Michael Berends, CEO of ClearBlue Markets – winner of Best Advisory/Consultancy – sees a growing number of buyers "who want to lock-in long-term supply, rather than just buying in the spot market".

There is currently some futures trading already taking place, but this remains a nascent section of the market.

Ellery Sutanto, chief commercial officer of Singapore-based Climate Impact X (CIX), winner of Best Carbon Exchange, predicts the development of a fully-fledged futures trading market. The exchange is currently focusing on standardising contracts, to help meet this expected shift.

Insurance is also increasingly playing a role. Gold Standard, winner of Best Monitoring Report, recently told Environmental Finance that the use of insurance by carbon project developers is "growing quite considerably".

While political risk insurance is a growing area, it says, the number of policies for buyers looking to insure against non-delivery or under-delivery of credits is also increasing.

Many winners argue that increasing insurance coverage is important in delivering more certainty and turning the market into one that more traditional market players would recognise.

Berends argues that more financialisation, including long-term offtakes or credits being considered as collateral "is a sign of a maturing market. For us, it means supporting clients, not just on offset selection, but also on structuring deals that meet the needs of finance, legal and sustainability teams alike.

"The closer the market gets to traditional commodities in its mechanics, the more important it is to have reliable market intelligence, data and advisory expertise to navigate it," he says.

He adds that "carbon markets are starting to look more like mature commodities, and that's bringing both opportunity and complexity for buyers".

Triangle Digital, winner of Best Crediting Innovation (non-carbon), argues that increased digitalisation will allow more financial institutions to use carbon credits in traditional ways.

"Carbon credits are stranded assets today, as they can't be used for collateral or lending," says Darren Wolfberg, founder of the firm. However, turning the credit into a blockchain-based digital asset with 'smart contracts' based on real-time data would increase the likelihood of them being used within traditional portfolios, he claims.

This would also help facilitate the development of products such as insurance, as the data would be more transparent.

While the US has been a tumultuous market when it comes to sustainability-themed products, the Trump Presidency has been "very constructive on digital assets", meaning US carbon credits in future are likely to be a digital-native assets.

Europe has signalled it will allow credits within its 'Carbon Removals and Carbon Farming' framework to be blockchain-based.

While it is not clear if this will be the case for Article 6 credits, Wolfberg argues that it would be in their best interest to make them fit for the future.

Juan David Duran Hernandez, CEO of Ecoregistry, awarded Best Registry, also argues that the digitalisation process will help benchmark projects and enable comparability. Further standardisation of data will "enable a common information model to exchange data between technology providers, registries and rating agencies", he says.

This increased interoperability will "enable more finance to come and could lead to carbon credits being used as collateral", he says.

Winners also recognise that digitalisation continues to be rolled out in registry processes, although this could have contributed to delays in certifying projects.

Carbon Expert – winner of Best Project Developer, Public Health – founder Casiana Fometescu explains that "there are emerging standards and registries with more advanced technology, but their market acceptance is still limited". However, the newer standards will likely "gain traction over time, offering faster certification processes and easier access to capital for developers".

She, along with Abatable's Magliulo, calls for more digitalisation throughout the trading process as well as throughout auditing and third-party reviews.