The EU’s carbon emissions trading scheme (ETS) was a world first when it launched in 2005 and it is now in its fourth iteration, generating nearly 8bn euros in revenue in the first half of 2020 alone.
The European initiative, like its Tokyo ‘cap and trade’ equivalent which came online in 2010 are compliance-linked markets, meaning they are a product of the 1997 Kyoto Protocol and the 2015 Paris Agreement which requires signatory states to reduce their carbon use.
But when carbon credit trading kicked off on the Tokyo Stock Exchange in early October it meant that firms and individuals in the world’s fifth largest Co2 emitter had an easier way of acquiring voluntary carbon credits (VCCs). That is, ones they are not obligated to purchase and which don’t count towards a country’s carbon target.
Instead, they are produced by projects which create additional carbon credits – in contrast to compliance markets which are essentially based on paying for the right to produce carbon – and include initiatives such as renewables or developments which improve energy efficiency.
The compliance linked carbon market is now worth roughly US$230bn a year globally, according to power firm Eon, but the voluntary market is growing at a slower pace, only puncturing the US$2bn mark in 2021, according to McKinsey.
Bringing certainty
With worldwide carbon emissions exceeding 37 trillion tonnes in 2021, there is clearly room for growth.
Vipul Shetty, Director of Natural Resources Asia at Howden Specialty, estimates that Asian volumes account for about US$100m to US$200m of the global VCC total and he says that insurance will play a critical role in helping the region’s market mature.
“The VCC market is a relatively new concept, especially here in Asia: voluntary carbon markets (VCMs) and ETSs are at different stages of growth in Europe, Asia, North America and in the Middle East but the sector is developing steadily. We realised that insurance solutions are critical for participants, firstly to bring certainty to buyers of carbon credits and improve the market’s trustworthiness.
Vipul Shetty
Director of Natural Resources, Asia at Howden SpecialtySecondly it is important to give peace of mind to developers as well, who offer their products to the purchasers of those carbon credits.”
Howden launched VCM invalidation insurance in September last year in conjunction with Respira International, and Nephila Capital in order to help support the predicted US$50bn a year demand globally by 2030 for VCCs.
While VCC insurance is one of Howden’s lines, London-based Kita Earth is a pure-play carbon outfit, and its Head of Insurance James Kench, tells (Re)in Asia that the UK headquartered firm sees a big opportunity in North America, but it is also eying Asia.
“It’s an evolving market, and we’re seeing a lot of traction in Asia. We’re working through our expansion plans at the moment, and Singapore is definitely high up on our priority list, given that it has positioned itself as a carbon trading hub for the Asian market.”
James Kench
Head of Insurance at Kita EarthSoutheast Asia Onboard
Shetty also says that there is increasing noise about VCCs in Asia citing demand from Thailand, Malaysia, and Indonesia, as well as Singapore to trade in this market.
“In this part of the region, these countries are leading the discussions around procuring insurance for VCCs,” says Shetty.
One reason for the interest in insurance says Kench, is the lack of high-quality projects which is challenging for those looking to enter the market, and requires that firms lock in a supply of carbon credits via a forward purchase agreement, which adds a layer of risk.
According to the Head of Insurance, Kita’s initial product was aimed at giving corporates greater certainty that the carbon credits they had bought would be delivered.
“The vast majority of that supply at the moment is in the Global South in Nature-based Solutions. But there’s some uncertainty as countries continue to evolve their regulatory frameworks, for example, we are seeing encouraging developments in Indonesia.
Will governments change the regulatory framework in two or three years, or increase the royalties due on those credits? Insurance helps to de-risk those transaction objectives and Kita is trying to build products to help investors get comfortable putting money into these projects.”
Accidental Deforestation
Shetty says that one of the main issues Singapore-based investors and carbon credit purchasers cite about the VCC sector, is ‘accidental deforestation’.
“That happens, for example, if a village has no idea that a piece of neighbouring land has been protected and is being used for the development of carbon credits, and the villagers engage in the deforestation of that area unknowingly or for their needs.
Because, again, when we look at Asia, there’s limited regulations and poor policing and it’s hard to convince locals of the concept of carbon credits and the need for forest preservation. We are looking to come up with a parametric solution that provides developers with an insurance payout if this type of damage occurs.”
Kench says that it is not possible to give an accurate trajectory of the carbon market’s likely development but he says there is a tangible increase of interest in the sector and a marked improvement in the quality of reports, and the volume and detail of data, now available.
“Will the market develop in five years or longer? We believe so and there is definitely increased traction this year. There are also many new entrants to the carbon market which are looking to solve different parts of the problems it faces.
There are a lot more institutional investors getting involved: the big banks, funds, and traders – that’s a good sign of a developing market.”
James Kench
Head of Insurance at Kita EarthBlue Carbon
Keech says that Asia will be a major supplier of carbon credits, he cites Indonesia’s large reserves of blue carbon – Co2 which is absorbed by the ocean – with the island state holding 17% of the world’s capacity.
He points to tech as a potential source of growth. Direct air carbon capture has received a lot of press but Keech highlights biochar and enhanced weathering, as also having the potential to scale beyond the three billion tons a year of carbon that can be captured naturally.
“I can see the tech developments happening anywhere there’s already existing engineering and infrastructure knowledge. There’s a lot of expertise that can be redeployed into those types of investments in countries in the regions such as: Japan, Korea, China, Thailand, Malaysia, and many others.
It’s not all about new technology.
The Monetary Authority of Singapore recently put out a paper calling for innovative insurance solutions to enable the early retirement of coal fired power stations (CFPPs), despite the island state not having any of this type of power plant.
Shetty says that if CFPPs are retired early through the use of transition credits, it will act as a fillip to the renewables sector and one that insurance can play an important role in supporting.
Vipul Shetty
Director of Natural Resources, Asia at Howden SpecialtyRetiring CFPPs
“Insurance solutions here will be critical for the uptake of these transition credits as buyers have that extra level of assurance that there are avenues for recourse if there is a miscalculation of these credits that might reduce or nullify their value.”
He also says it is this type of leadership which is required to deal with climate change. “The MAS’s move on CFPPs is a forward thinking endeavour, because achieving carbon neutrality as an individual nation is not enough, it needs to be a collective endeavour and hence we need to help those outside of our borders to decarbonise in order to reach net zero.”
