At the beginning of August, I wrote an article about a reforestation-linked bond issued by the World Bank (WB). The security accomplished the interesting feat of aligning the interests of all the participants in the transaction chain. Sustainable investors sought both impact and returns, which the WB facilitated thanks to Brazilian for-profit company Mombak. Mombak develops native reforestation projects to remove carbon dioxide from the atmosphere. Mombak’s ability to achieve this goal is measured in Carbon Removal Units (CRUs), which are certified and sold off to a corporate partner, namely Microsoft.
The WB reforestation-linked bond is part of what is know as outcome-linked bonds, a family of debt securities which most commonly refers to sustainability-linked bonds (SLBs). In those bonds, extra-return for the investors is included as a clearly defined coupon step-up in case the debtor fails to meet some sustainability goal. The WB bond differs from standard SLBs as the investors stand to gain from the success of the project, thanks to the sale of CRUs to third parties instead of the issuer incurring a penalty.
This is the very definition of a win-win scenario. If so inclined, one could even see Adam Smith’s invisible hand at work here. As I reached the end of the transaction chain, however, I was left wondering why Microsoft (or any other company for that sake) was so keen to buy these CRUs.
What’s in it for Microsoft?
Carbon Removal Units is a particular form of carbon credits which are often criticised by environmental and development experts. They rightly point out that using carbon credits allows companies to pass the burden of carbon neutrality to projects often located in developing countries rather than looking for better, more environmentally friendly business processes.
Corporates, on the contrary, tend to embrace these instruments. On the occasion of the bond issuance, Microsoft made this clear. “Microsoft’s journey to become carbon negative by 2030 involves pioneering projects with partners like Mombak and their Amazon Reforestation Fund. Our carbon removal work with partners such as Mombak is paving the way for new investors in conservation,” said Brian Marrs, Senior Director for Energy & Carbon Removal at Microsoft.
As the deadline for many of these strategies continues to approach, we’re likely to see more and more companies pursuing this path. Researching the motivations behind corporate purchases of carbon credits, it appears that net-zero strategies are perhaps the least bad reason a company would have, as opposed to simply window-dress or greenwash.
Can Companies Gain from the System?
I can’t help but wonder whether a more direct financial benefit couldn’t also be part of the motivation for agreeing to buy Mombak’s CRUs. Theoretically speaking, is it possible to realise an arbitrage (meaning a profitable risk-free trade) by buying cheap carbon credits from emerging markets and selling them expensively in Europe, for instance?
In this specific transaction, it doesn’t look like risk can be entirely eliminated for the trade. What is possible, however, is to look at forward carbon trading prices and conclude an attractive deal, adjusting for the risk that isn’t entirely free.
The WB deal doesn’t clearly disclose the prices at which Microsoft will be buying the Mombak CRUs. We do know, however that 1 ton of CO2 currently trades at approximately €71 in the EU Emissions Trading System (ETS), and that the price of CO2 in the EU ETS is the highest of any other ETS. If different types of carbon credits are considered equivalent on CO2 balance sheets regardless of their geographical origin, then global companies could profitably exploit the inefficiencies in the global ETS.
Shareholders may or may not applaud this ingenious way of profiting from a still relatively illiquid an inefficient global carbon trading system. For sure, this will not impress environment and development experts nor will it have any positive outcome for the reputation of carbon credits more generally.
A Theory of Moral Sentiments
While there is an important moral argument to be made about the way carbon credits move the burden of climate change mitigation to the developing world, the fact is that there are still more low-hanging carbon-saving or carbon-capture fruits there than in developed markets. Funding of these projects remains difficult to find at the local level, and often the world is still better off if these projects are realised than if they are not.
A system channeling funding towards carbon projects in both developed and developing markets remains a good idea, in theory, but it presupposes the existence of efficient and well-regulated markets. It is crucial that it doesn’t leave space for covert profiteering. While the EU’s emissions trading scheme allows companies to trade CO2 and even profit from this market, the issue becomes more complicated if multinational corporations can take advantage of good deeds in poor countries to cash in big bucks. That would be a win-win indeed. Perhaps not exactly how Adam Smith had imagined.
