Environmental, Social and Governance(ESG) and Carbon Credits

‘A management and analysis framework to understand and measure how sustainably an organization is operating’

What is E, S, and G?

A. Environmental

The environmental impact(s) and risk management procedures of an organization are referred to as environmental factors. These include the firm’s overall resilience to physical climate threats, management’s stewardship of natural resources, and direct and indirect greenhouse gas emissions (like climate change, flooding, and fires). 

B. Social

The relationships a company has with its stakeholders are referred to as the social pillar.  Human capital management (HCM) indicators, such as fair salaries and employee engagement, as well as an organization’s influence on the communities in which it operates, are examples of elements that a corporation may be judged against. 

The social impact expectations that have been extended to supply chain partners, particularly those in developing economies where environmental and labour regulations may be less stringent, is a distinguishing feature of ESG.

C. Governance

Corporate governance describes the direction and management of a company. In order to better understand how shareholder rights are perceived and upheld, how incentives for leadership are aligned with stakeholder expectations, and what kinds of internal controls are in place to encourage leadership accountability and transparency, ESG analysts will look at these and other factors.

India has some of the lowest per capita emissions in the world, but it is also one of the top emitters and has the fastest-growing economy, all of which make sustainability reporting in India crucial.

Globally, the landscape of ESG reporting is evolving quickly. Considering the expanding global concerns related to the environmental, social, and governance (ESG) components. Indian business leaders believe it would be beneficial to refocus their organization’s mission and go beyond wealth creation to address issues that are important to its main stakeholders.

India has emerged as a conscious aspirant and has demonstrated promise and capability to take significant initiative in paving the way for combating climate change and meeting the Sustainable Development Goals (SDGs) of the United Nations in many of its internal regulatory schemes, such as the introduction of the Business Responsibility and Sustainability Reporting (BRSR) by SEBI in 2021 and the sustainability reporting format is based on the nine principles of National Guidelines for Sustainability Reporting.

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One of the most important challenges today for both individuals and governments is the reduction of carbon emissions. This is demonstrated by the focus on ESG investing while governments set a cost through carbon credits to pay for the climate effect. 

Many ESG investors give the environmental factor a lot of attention and choose to exclude environmental violators from their portfolios. Instead, they decide to fund companies that are reducing reliance on fossil fuels. 

Through carbon credits, governments restrict the carbon emissions of businesses. However. These credits may also be sold to generate revenue.

In order to comply with environmental regulations, what are carbon credits and how did they come to be the new currency of ESG investing? This article will provide an explanation of the relatedness of ESG and carbon credit, as well as the significance of carbon credits in the financial world.

What Do Carbon Credits Mean in ESG Investing?

What are Carbon Credits?

Thought of as a unit of measurement, carbon credits, also known as carbon allowances, also include a “tradeable” element. The regulating body generates carbon credits and distributes them to specific businesses in that territory. 

‘A single credit represents one tonne of CO2e (or carbon dioxide equivalent) that the company is allowed to emit.’

How Do Carbon Credits Work?

A corporation or organization’s emissions cap is represented by the number of credits it has received. (or “cap” from cap and trade). 

If a management team is successful in keeping corporate emissions below their cap, the firm will have extra carbon credits, which they can either keep for later use (or sell) or sell right away into the compliance carbon market, which is regulated by the regulatory body. A management team is considered non-compliant and is required to make up the difference if they are unable to keep the company’s emissions within the limit. In order to purchase carbon credits from an “under-emitter” within their cap and trade network, over-emitters turn to the carbon market.

Are Carbon Credits the Same as Offsets?

Not at all. Since offsets and credits are categorically distinct concepts, the fact that both are calculated in tonnes of CO2e can be confusing to individuals. 

Offsets are neither produced nor distributed by a particular regulatory authority, unlike carbon credits. Additionally, unlike carbon credits, they are not constrained by specific regulatory countries. Instead, they are free to trade on a variety of international “voluntary markets.”

Credits vs. Offsets

Any organization (public, private, governmental, etc.) has the option to choose to take part in carbon reduction projects. This can be done for a number of reasons, including management/conviction leadership that it is the right thing to do or the desire to produce carbon offsets that can then be sold on the carbon markets. 

Projects to reduce carbon often fall into one of two categories: mechanical or natural. Reforestation and wetland restoration activities are examples of natural solutions that “naturally” sequester carbon in the environment. Investments in new technology that result in higher efficiency or lower emissions typically constitute mechanical solutions (like renewable energy projects or direct carbon capture technologies).  

Carbon offsets can be thought of as a measurement unit to “compensate” an organisation for investing in green projects or initiatives (whether natural or technological) that eliminate emissions. Carbon credits are a measurement unit to “cap” emissions (meaning permitted emissions). 

Once an offset has been produced, it can either be kept by the company that carried out the project or traded on a voluntary carbon market. 

On the ESG spectrum, carbon offsets take up a relatively limited amount of area. But in order to speed up carbon reductions, carbon credits are attracting increased interest in ESG investment as more nations and businesses promise to reach net zero. In fact, rising demand has driven some markets’ prices to all-time highs. 

But why should investors care? Because the carbon credit market is growing exponentially.

In 2021, the theoretical value of carbon credits increased by a staggering 164 percent to $851 billion. Furthermore, market estimates are even more astounding. According to research firms, the industry might expand by up to 30X by 2030 and 100X by 2050. According to these projections, the carbon credit market will reach parity with the NASDAQ stock market by 2030. The whole market for carbon (both mandatory and optional), according to the independent company Katusa Research, may be as large as the market for crude oil. 

Carbon credits have been used by organizations to avoid or lower their emissions. Companies governed by the “cap-and-trade” scheme (compliant carbon market) are compelled to purchase credits if their emissions exceed the limit (cap).  Those who are voluntarily offsetting their emissions can purchase carbon credits from various programs. The most well-liked ones are those that focus on nature, such as planting trees and afforestation.

Markets and rules are beginning to blend

As an independent asset class, carbon credits are still developing. But as regulators and business associations work to formalize the regulations governing carbon markets, they are beginning to take better shape. In reality, a number of programs and rules are being developed to direct ESG investors in their financial decisions. For carbon standards and verification organizations, the same holds true. To assure the integrity and quality of the credits investors and purchasers choose, they are becoming increasingly stringent.

‘Carbon credits are gaining popularity because of regulations and rising investor awareness. ‘

The developed world is required to account for and report carbon credits under planned SEC transparency requirements about the implications of climate change. This is a significant step in fostering transparency in the industry. Investors more conscious of Credit’s ESG Role 

‘Investor interest in carbon credits is increasing along with the focus on corporate climate promises.’

As the globe confronts global warming, ESG activism will increase much more during the next years. More investors are now aware of how carbon credits can directly affect a company’s cash flow, reputation, and another status, which is known as the “E” factor. According to studies, 100 global corporations are responsible for 71% of all emissions, which gives ESG investors more justification to push for carbon reduction efforts. As a result, we can anticipate seeing an increase in the market of carbon offsets. 

The importance of carbon credits in ESG investing is explained here. 

Evaluating carbon credits: Some key factors to consider

The projects that produce carbon credits vary.  ESG investors must carefully evaluate them in order to decide which ones to select. 

Projects that reduce carbon emissions and provide local stakeholders like job development and biodiversity are more likely to be supported by local stakeholders.  Although these loans frequently cost more, they are less risky and might provide more permanence. 

There are certain metrics to consider to select quality offsets. These include additionality, permanence, measurability, and scalability.

Before carbon credits are considered important asset allocation possibilities by the typical investor, significant time may pass. But the offsets got the attention they deserved because of increased openness, more competitive pricing, and market rules. 

Offsets are a crucial component in the fight against global warming when used properly. This is particularly true if cutting carbon emissions requires a war of small victories rather than a quick cure. 

We believe they’re worth actively exploring within a broader ESG-investing context. Their global abundance can especially encourage flows of capital to stakeholders in developing countries and help facilitate the broader attainment of SDGs. In the context of broader ESG investing, we think they merit careful investigation. Their widespread abundance can, in particular, boost financial flows to stakeholders in developing nations and aid in the more comprehensive achievement of SDGs. 

How Companies Can Benefit from ESG Investing with Carbon Credits?

In ESG investment, the “E” component is becoming more important than ever. Floods, droughts, and heat waves are just a few examples of the extreme weather events the world has been experiencing. 

Every area of the economy has been impacted by climate change. Every company is responsible for the environmental effects of its operations. As a result, businesses have committed to reducing their carbon emissions in order to slow the rate of global warming. More businesses make the commitment to achieve net zero emissions by 2050 or earlier. 

All governments must immediately push for mass clean-ups of water bodies, zero waste to landfill, waste segregation at source and incentives for full-scale circularity initiatives. At companies and NPOs, from the board to the last employee in the organisation, all must speak only one language of sustainability and climate action.

Only policy formulation will not make the cut anymore. Implementation is the need of the hour. Progress on implementation must be measured, monitored and reported adequately, accurately and communicated transparently. Data and analytics must be available for the world to see in real-time.

We have no time, we can’t take pride and relief in committing to net zero by 2050. While we should have taken action yesterday, all we have now is today and every day.

‘This is where leveraging carbon credits as the currency of ESG investing puts a company in an advantaged position.’

Carbon credits are produced when money is invested in initiatives that lower GHG emissions or when fossil fuels are not used. Companies that have extra credits can sell them to other businesses that fall short of their carbon reduction goals. As a result, businesses will have more quantifiable incentives to contribute to the fight against climate change. 

More surprisingly, ESG investors favour investing in greener company models. A particular amount of averted or decreased GHG emissions is represented by carbon credits. 

Investors are therefore more likely to direct their capital toward areas where carbon credits are associated. Utilizing renewable energy sources, implementing greener technology, and making energy-efficient expenditures are common examples. Carbon credits are now often traded, and not just by companies. In a manner akin to trading physical commodities, some investors are trading carbon credits. However, ESG investors must confirm that carbon credits are indeed cutting emissions as claimed. Companies would understand that ESG investing with carbon credits is worthwhile once this is confirmed. 

Author: 

Dr. Yogita Deshmukh 

DIRECTOR (ADVISOR) RESEARCH & PROMOTIONs GANAR BIOFUELS

Biochar Scientist and Researcher

[email protected] 

Co-Author

Rishikesh Deshpande

Director, Sustainable Biobrikets Private Limited

[email protected]

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