VCM frameworks and carbon ratings

Carbon credits and net zero transition

When effective, carbon credits can be used alongside a company’s credible decarbonisation strategy. They can help accelerate the transition to net zero.

A large number of companies are however reluctant to use carbon credits. They are considered a peripheral part of a number of net zero roadmaps and frameworks. This is typically driven by concerns over the quality of these credits and fears that making claims about carbon neutrality based on them could be seen as greenwashing.

Similar concerns are being raised about the disclosure requirements for those that do buy and retire credits. Particular attention is being paid to the lack of consistency or transparency surrounding the types and amounts of credits retired.

A recent report by Bloomberg NEF suggests that only one-fifth of Voluntary Carbon Market (VCM) buyers self-reported credit purchases in 2021. This makes it hard for external stakeholders to assess the quality of the company’s net zero strategies. Most disclosure is coming from buyers that allow their customers to offset their products such as crypto currencies, travel and fashion.

New frameworks to address VCM issues

Establishing frameworks that the VCM abides by is an important step to ensuring carbon credits can be trusted and utilised to their full potential. Companies rely on such guidance to have confidence in what they are purchasing and a playbook for how to report. It also standardises the information to enable other stakeholders to assess their performance.

A host of new, consultative initiatives have sprung up to try and provide clear guidance on issues such as carbon credit quality, and reporting best-practice. They can be used by companies in one of three ways:

1. Making informed decisions around the credits they purchase

2. Demonstrating performance against their transition plans and credit purchases

3. Reporting transition plans with integrity and transparency

These are welcome developments. Their goal is to scale the Voluntary Carbon Market and help enshrine best practices to make it an efficient market for capital, and effective market for climate action.

The BeZero team, like many other industry participants, are busy responding. We believe that the terms of reference and nature of these frameworks only goes so far. Other market mechanisms, like independent ratings, are also a vital part of the industry’s development.

Making informed decisions around the credits they purchase

The Integrity Council for the Voluntary Carbon Market’s (ICVCM) Core Carbon Principles (CCPs) provides a framework for accredited carbon projects. The purpose of their framework is to improve the integrity of carbon credits by setting a higher threshold for credits than what is current common practice. The principles aim to bring integrity to the VCM by signposting buyers to credits that have been assessed as CCP-eligible. In other words, the CCPs should provide a standardised measure of carbon credit quality with the goal of bringing additional confidence to corporates to use them for their net zero transition.

Demonstrating performance against their transition plans and credit purchases

The Voluntary Carbon Market Integrity initiative (VCMI) is a multi stakeholder platform, co-funded by the UK Department for Business, Energy and Industrial Strategy (BEIS), to drive credible, net zero-aligned participation in the Voluntary Carbon Market for companies.

The VCMI’s Claims Code-of-Practice aims to communicate guidance on how voluntary carbon credits can be used and claimed by businesses and others as part of credible net zero strategies. They prioritise decarbonisation with credit claims allowed only on residual emissions. Claims are rated (Gold, Silver & Bronze) based on the progress against a company’s net zero strategy.

Reporting transition plans with integrity and transparency

Sustainability and emissions reporting frameworks at the regulatory or investor level have been part of most companies’ annual process for a while now. Companies are increasingly expected to report on their climate-related risks and opportunities and long-term scenario planning, through frameworks such as the Taskforce for Climate-related Financial Disclosure (TCFD). This puts them under greater scrutiny from their stakeholders to demonstrate they have credible transition plans.

The International Sustainability Standards Board’s (ISSB) IFRS Exposure draft for climate-related disclosures and the U.S. Securities and Exchange Commission’s (SEC) draft rules on climate-related data disclosure both request information on carbon credit purchase as part of a transition plan. They ask for information on the amount of credits, credit type and source of credits used.

All of these frameworks could complement each other, and together provide a holistic approach, ensuring that carbon credit purchases are transparently reported.

How could the frameworks fit together?

What makes a good framework?

BeZero Carbon is actively engaging with these recent consultations with the aim of helping the VCM scale with integrity. In light of these consultations, we have considered what makes a good framework, and whether these frameworks go far enough to inspire trust in the VCM.

Clear guidance

The challenge in creating a framework is that it must allow flexibility, while also providing guidelines that are simple to understand and act on. Many of the frameworks rely on other guidelines and frameworks to give consistency to the already crowded arena.

For example, the VCMI looks to the Science Based Targets initiative (SBTi) for guidance on how to set 1.5°C aligned corporate decarbonisation targets.

This could have the unintended consequence of excluding some of the highest emitting and hardest to abate sectors, such as oil and gas and shipping, for which target methodologies haven’t yet been developed or approved.

Consistency of definitions

In an area that is still very new to many companies, and has been hindered by scepticism, frameworks need to be consistent when talking about how to use carbon credits.

For example, the IFRS definition of a certified carbon offset is confusing, specifically around the role of using avoidance and/ or removal credits.

Certified carbon offset credits are carbon offsets that take the form of transferable or tradable instruments, certified by governments or independent certification bodies, representing a removal of emissions of one metric tonne of CO₂, or an equivalent amount of other greenhouse gases.

This links to the Kyoto Protocol, which included three market-based mechanisms (Article 6, 12, 17)—emissions trading, the clean development mechanism and joint implementation giving the parties a degree of flexibility in meeting their emission-reduction targets. (ISSB - Exposure Draft IFRS S2 Climate-related Disclosures).

On the one hand, their definition here speaks only about credits that remove carbon emissions, and not avoidance. Credits certified by the main certification bodies within the voluntary carbon market can be both avoidance and removal credits and therefore both should be included within this definition. A clearer definition would be:

Certified carbon offset credits are carbon offsets that take the form of transferable or tradable instruments, certified by governments or independent certification bodies, representing an avoidance or removal of emissions of one metric tonne of CO₂, or an equivalent amount of other greenhouse gases.

Why both avoidance and removals matter

Avoidance credits reduce emissions by preventing their release into the atmosphere, while removal credits represent the extraction and sequestration of carbon from the atmosphere. Some credits simultaneously exhibit avoidance and removal properties.

Both avoidance and removal credits have a role to play in a corporate transition roadmap.

Both forms of carbon credits can be used by companies to demonstrate commitment to climate change mitigation beyond their own operations, and counterbalance their own residual emissions as they progress towards their carbon reduction targets.

The evidence on discriminating quality purely based on project type is unclear. For instance, the IFRS guidance states that reporting on avoidance or removal can be used as a good proxy for a carbon credit project’s additionality.

However, our analysis shows that across the 250+ projects we have rated, 81% of avoidance credits have a notable to significant additionality risk level, while 50% of removal credits also have notable to significant additionality risk. This, and many other arguments demonstrated by our research, suggests that it’s not simply a matter of project type. Additionality, like other risk factors, are highly variable from project to project - see chart below.

A key short term benefit of avoidance credits is that they are also more readily available in the market and mature. For every nine avoidance credits in the market, there is one removals credit. Nature-based removals projects, such as ARR (Afforestation, Reforestation, and Revegetation), are rising in volumes and popular with corporates. What’s interesting is that in many instances, we find NBS (Nature-Based Solutions) projects are actually a blend of avoidance and removal. By contrast, the market for technology-based carbon removal is still nascent - see Removal reconsidered: Carbon Dioxide Removal in the Voluntary Carbon Market going forward.

The Corresponding Adjustment Conundrum

COP26 saw clarification on Article 6 of the Paris agreement, which has paved the way for countries to use carbon credits to help meet their Nationally Determined Contributions (NDCs) through corresponding adjustment credits. Corporates need guidance to understand how these credits can be used for their own carbon compensation.

Neither the VCMI nor the ICVCM give clear guidelines on using corresponding adjustment credits (CAs). Credits that do or do not have a corresponding adjustment are likely to diverge in perception and value. Corporate claims should acknowledge differentiation in the regulatory labels associated with their credits purchased.

However, the process of differentiation is likely to be driven by evolving regulatory regimes at multilateral and national level. The VCMI and ICVCM should be followers, and complement the regulatory environment, rather than the other way around. While it is still unclear how this will develop, these frameworks make the right judgement in asking companies to report clearly on which type of credits they have purchased.

The role of ratings

The BeZero Carbon Rating (BCR) of voluntary carbon credits represents BeZero Carbon’s current opinion on the likelihood that a given credit achieves a tonne of CO₂e avoided or removed.

The purpose of ratings, and fundamental research in general, is to move beyond seeing quality as binary, or a threshold.

Industry frameworks, such as the ICVCM, aim to raise the standards of reporting, data disclosure and standardise some of the tests applied by projects in order to be accredited. This should help improve the number of projects who pass our eligibility requirements to be rated.

Ratings will always be complementary to improving standards. Above the minimum bar, there is always a significant range of outcomes around carbon efficacy. It’s this distribution that ratings can help market participants to navigate.

Ratings should also be part of a broader suite of standardised carbon credit disclosure requirements for companies. This is essential to both ensuring robust reporting by corporates on the quality of their broader climate strategy, but also to raising VCM disclosure standards.

With so much scepticism around the quality of carbon credits, and in particular avoidance credits, there is a clear need for companies to report on the quality of the credits they purchase. Not every carbon credit achieves a tonne of carbon removed or avoided. This is inherent to the methodology for developing a carbon project and there is ample evidence of this.

Disclosing that any carbon credits purchased and retired have been accredited is a necessary step to detailing the quality of approach, but in our view doesn’t go far enough. Data labels on the credit, credit type (avoidance, removal or both), accreditor, country, sector and vintage should be expected from reporting companies. As a proxy for quality from a carbon efficacy perspective, highlighting a credit’s rating could bring an extra layer of integrity to the reporting process and a feedback loop to assessing net zero transitions.

The ICVCM CCPs can provide a level of assurance that the credits meet their eligibility criteria, but CCP eligibility will be assessed only at the credit type level (defined as mitigation activity and methodology under a carbon crediting programme). Therefore, by reporting individual credit ratings, including project specific analysis, companies can demonstrate that they are going one step further and not just purchasing the minimum quality credits. A combination of all of these reporting criteria will enable better scrutiny of the use of credits across different sectors and countries, both at a project and a market level.

Conclusion

The latest frameworks are helping investors and companies assess the quality of purchased carbon credits, communicate how their offsetting strategy fits within their net zero roadmaps, and report effectively and transparently on their transition plans.

Ratings are a market mechanism that complement these initiatives. In a market with such heterogeneous project types, where quality is not binary, they allow participants to assess carbon credits in more probabilistic terms.

Combining the two will help ensure carbon credit ratings fulfil their potential to accelerate net zero transition, and build confidence by allowing stakeholders to have a detailed understanding of their risks.