International Finance Bank LTD

Carbon Credits Accounts with IFB

Europe: The EU Emissions Trading System (EU ETS)

1. Regulatory Framework:

The EU ETS operates under the Directive 2003/87/EC, amended several times, most notably by Directive (EU) 2018/410, which governs the reduction of greenhouse gas emissions in the EU.
The system covers over 10,000 power stations and industrial plants, as well as airlines operating within the EU, accounting for around 45% of the EU’s greenhouse gas emissions.

2. Cap Setting and Allocation:

The cap represents the maximum allowed emissions, decreasing annually to ensure a gradual reduction in overall emissions. This is defined in phases; for instance, Phase 4 (2021-2030) aims to reduce emissions by 43% compared to 2005 levels.
Allowances are either allocated for free (to avoid carbon leakage, i.e., the transfer of industries to countries with laxer emissions rules) or auctioned. The majority of the allowances are auctioned, with the remainder allocated based on benchmarks related to the efficiency of installations.

3. Project-Based Mechanisms:

The EU ETS allows the use of international credits from the Clean Development Mechanism (CDM) and Joint Implementation (JI) under the Kyoto Protocol, although their use is limited and declining.
These mechanisms allow companies to invest in emission reduction projects in developing countries (CDM) or other developed countries (JI) and receive credits (CERs or ERUs) in return. However, these credits are now largely phased out within the EU ETS due to concerns over their environmental integrity.

4. Market Stability Reserve (MSR):

To address the surplus of allowances and ensure the stability of the market, the EU introduced the Market Stability Reserve (MSR) in 2019. This mechanism adjusts the supply of allowances in the market, thus preventing extreme price volatility.

United States: Regional and Voluntary Programs

1. California Cap-and-Trade Program:

Established under the California Global Warming Solutions Act of 2006 (AB 32), California’s Cap-and-Trade Program is the most comprehensive carbon pricing system in the U.S., covering approximately 85% of California’s emissions.
The program sets an economy-wide cap on GHG emissions and allows covered entities (e.g., large industrial facilities, electricity generators, and fuel distributors) to trade allowances. Each allowance permits the emission of one metric ton of CO2e.

2. Allowance Distribution:

Allowances are distributed through a combination of free allocation (to protect industries at risk of carbon leakage) and quarterly auctions conducted by the California Air Resources Board (CARB).
Companies can also generate offsets by funding projects that reduce or remove greenhouse gases outside the capped sectors. Examples include forestry projects, methane capture, and destruction of ozone-depleting substances. These offsets are verified and approved by CARB, with specific protocols in place to ensure they represent real, additional, and permanent emission reductions.

3. Regional Greenhouse Gas Initiative (RGGI):

RGGI is a cooperative effort among 11 Northeastern and Mid-Atlantic states, established in 2009. It focuses on CO2 emissions from the power sector.
Each state in RGGI issues CO2 allowances in quarterly auctions, and the proceeds are often reinvested in energy efficiency, renewable energy, and other consumer-benefit programs.
The cap on emissions declines by 2.5% annually, ensuring continuous pressure for reductions.

4. Voluntary Carbon Markets:

Beyond compliance markets, voluntary carbon markets (VCMs) operate globally. They allow companies, governments, NGOs, and individuals to purchase carbon credits to offset their emissions voluntarily.
Credits in VCMs are generated through projects such as reforestation, renewable energy, and community-based initiatives. Standards like the Verified Carbon Standard (VCS), the Gold Standard, and the American Carbon Registry (ACR) govern these projects to ensure integrity.

Trading of Carbon Credits

Marketplaces and Trading Mechanisms:

1. Primary Market:

EU ETS Auctions: In Europe, allowances are primarily distributed through auctions. The European Energy Exchange (EEX) and ICE Futures Europe are the main platforms for these auctions. These exchanges conduct regular auctions where allowances are sold to the highest bidder, providing a transparent mechanism for price discovery.
California Cap-and-Trade: In California, CARB conducts quarterly auctions through an online platform managed by Markit, where entities bid for allowances. These auctions are closely monitored to prevent market manipulation and ensure compliance with state regulations.

2. Secondary Market:

Spot and Futures Trading: Carbon credits are traded on secondary markets, where they can be bought and sold like any other commodity. The most liquid and transparent markets are on platforms like the EEX and ICE. These exchanges offer spot contracts, futures, and options, allowing companies to hedge against price volatility or speculate on future price movements.
Over-the-Counter (OTC) Trading: In addition to exchange-based trading, many transactions occur in the OTC market. Here, companies trade directly with each other, often through brokers who match buyers and sellers. OTC trades are less transparent but offer flexibility in terms of contract structure and delivery terms.

3. Pricing Dynamics:

Prices in carbon markets are influenced by regulatory developments, the overall cap level, economic activity, and the availability of offsets. The price of EUAs, for example, has seen significant volatility, influenced by factors like the economic downturn in 2008, reforms in the EU ETS, and expectations around future climate policies.

Exchanges for Carbon Credits:

1. European Energy Exchange (EEX):

Based in Leipzig, Germany, the EEX is the leading exchange for trading EUAs and other carbon instruments in Europe. It offers a wide range of products, including spot and futures contracts for EUAs, CERs, and ERUs.
EEX also hosts auctions for EU member states, ensuring the transparent allocation of allowances under the EU ETS.

2. Intercontinental Exchange (ICE):

ICE Futures Europe, based in London, is another key platform for trading EUAs and other carbon derivatives. ICE offers a liquid market for both EUAs and California Carbon Allowances (CCAs), facilitating global participation in carbon markets.
ICE also provides futures contracts for RGGI allowances, making it a central hub for trading carbon credits in the U.S. compliance markets.

3. Chicago Mercantile Exchange (CME):

The CME has ventured into the carbon markets by offering futures contracts linked to voluntary carbon credits. These contracts are standardized, making it easier for participants to trade voluntary credits in a regulated environment.

4. Voluntary Carbon Market Platforms:

Platforms like the Carbon Trade Exchange (CTX) and Xpansiv CBL provide marketplaces specifically for voluntary carbon credits, supporting the growth of VCMs by offering transparent pricing and transaction mechanisms.

Transfer of Carbon Credits Between Banks

1. Registry Systems:

In both the EU ETS and U.S. programs, carbon credits are tracked through electronic registry systems. In Europe, the Union Registry, operated by the European Commission, tracks the ownership and transfer of allowances. Each member state has its own registry connected to the Union Registry.
In the U.S., California uses the Compliance Instrument Tracking System Service (CITSS), while RGGI utilizes its own CO2 Allowance Tracking System (COATS). These registries ensure that every carbon credit is uniquely identified and cannot be double-counted.

2. Account Management:

Entities, including banks as well as us, IFB, must open registry accounts to hold and transfer carbon credits. These accounts are similar to bank accounts but are specifically for the holding and trading of carbon instruments.
We often act as custodians, holding carbon credits on behalf of clients, or as market participants, trading on their own account to manage risk or speculate on price movements.

3. Transaction Process:

When carbon credits are transferred, the process is executed through the registry system, ensuring a secure and transparent transfer. For example, in the EU ETS, if a company sells EUAs to another, both parties’ registry accounts are debited and credited accordingly, reflecting the new ownership.
The transfer typically occurs in real-time, with the registry updating balances immediately upon confirmation of the transaction.

4. Cross-Border Transactions:

Cross-border transfers of carbon credits can involve different registry systems, depending on the jurisdictions. In such cases, coordination between registries is required to ensure that the credits are correctly debited from one system and credited to another, maintaining the integrity of the credit.
For instance, transferring credits between the EU ETS and Switzerland’s linked carbon market involves synchronization between the Union Registry and the Swiss Emissions Trading System registry.

5. Clearing and Settlement:

For trades executed on exchanges like the EEX or ICE, clearinghouses (e.g., European Commodity Clearing, ICE Clear Europe) manage the clearing and settlement process. This ensures that the buyer and seller meet their obligations, mitigating counterparty risk.
The clearinghouse acts as the central counterparty, guaranteeing the transaction and ensuring that the carbon credits are transferred only after payment has been confirmed.

Exploring Financing Mechanisms for Carbon Credits

In the evolving landscape of sustainable finance, carbon credits have become a vital asset class for funding climate-positive projects. As part of our commitment to fostering innovative solutions, International Finance Bank (IFB) recognises the need to explore diverse financing mechanisms that can unlock the potential of carbon credits. This article delves into the primary financing models, their benefits, limitations, and how they can be effectively utilised. We also highlight the emerging trend towards technical carbon credits, offering greater control over emission reductions.

Carbon Credit Financing Mechanisms

1. Credit Facilities Secured by Carbon Credit Revenues

Credit facilities, such as revolving credit lines or term loans, are tailored to leverage the future revenue streams generated by carbon credits. These facilities provide immediate liquidity to project developers, enabling them to fund operations while awaiting revenue from carbon credit sales.

How it Works:

The borrower pledges anticipated revenue from verified carbon credits as collateral.
Drawdowns are permitted based on expected or pre-sold credits, with repayment linked to realised credit sales.

Pros:

Provides short-term liquidity to sustain or scale operations.
Reduces dependency on upfront equity investment.
Escrow arrangements ensure secure repayment mechanisms.

Cons:

Limited borrowing capacity due to market volatility of credit prices.
Requires robust verification and marketability of credits.

Ideal Use Case: Renewable energy or forestry projects with steady, predictable credit generation and sales agreements.

2. Revenue Streams from Forward Contracts

Forward contracts enable project developers to sell future carbon credits at a pre-agreed price to secure financing. This approach assures buyers of a reliable supply of credits while giving sellers access to upfront funding.

How it Works:

A buyer commits to purchasing a specific volume of credits at a set price, typically below the anticipated spot market price.
Lenders use these contracts as collateral to issue loans.

Pros:

Mitigates price volatility by locking in a guaranteed rate.
Provides early-stage funding for project development.

Cons:

Locks the seller into a fixed price, potentially missing higher market prices.
Relies heavily on buyer creditworthiness.

Ideal Use Case: Early-stage projects needing predictable cash flow to cover initial costs.

3. Loan-to-Value (LTV) Financing

IFB may extend loans against the value of carbon credits at a specific LTV ratio. This mechanism ensures lenders are protected against price fluctuations while borrowers can capitalise on existing credit stock.

How it Works:

The value of pledged credits is assessed, and loans are issued at a conservative percentage (e.g., 50%-70% of the credit value).
The loan amount fluctuates with market price trends.

Pros:

Provides flexible borrowing capacity aligned with asset value.
Limits borrower exposure to additional collateral requirements.

Cons:

Lower LTV ratios may limit the capital accessible to borrowers.
Credit price volatility could require adjustments in loan terms.

Ideal Use Case: Mature projects with verified credits in liquid markets (e.g., EU ETS)

4. Specialised Climate Funds

Dedicated funds focus on financing projects that generate carbon credits, offering loans, equity, or hybrid structures.

Pros:

Tailored to projects with strong environmental impacts.
Often provide technical support to maximise credit generation.

Cons:

Limited availability in certain jurisdictions.
Higher cost of capital compared to traditional financing.

Ideal Use Case: Niche projects with high environmental and social returns, such as reforestation or methane capture.

5.Green Bonds

Green bonds are debt instruments issued to finance or refinance eligible climate-positive projects, with repayment linked to project revenue or general cash flow.

Pros:

Attracts a broad base of ESG-focused investors.
Typically offers lower interest rates due to strong demand.

Cons:

Requires detailed reporting and certification.
Initial issuance costs can be high.

Ideal Use Case: Large-scale projects with diversified revenue streams, such as renewable energy or infrastructure developments.

6. Securitisation of Carbon Credits

Securitisation pools carbon credits into an asset-backed security (ABS) sold to investors. This model diversifies risk and provides upfront funding.

Pros:

Reduces individual project risk by pooling assets.
Attracts institutional investors seeking exposure to carbon markets.

Cons:

Complex structuring and regulatory compliance.
Requires sufficient volume of credits to justify costs.

Ideal Use Case: Aggregators or large project portfolios with multiple credit sources.

Emerging Trend: The Rise of Technical Carbon Credits

Recent developments have seen a shift towards technical carbon credits, derived from projects where emission reductions can be directly controlled and quantified. Unlike nature-based credits (e.g., reforestation), technical credits are generated through engineered processes such as carbon capture and storage (CCS) or direct air capture (DAC).

Advantages:

Greater precision and transparency in quantifying reductions.
More predictable and scalable compared to nature-based solutions.
Higher demand from industries seeking compliance-grade credits.

Challenges:

Higher upfront costs for technology deployment.
Limited availability in voluntary markets compared to traditional credits.

Potential Use: Technical carbon credits are increasingly favoured by investors and regulators due to their reliability, making them ideal for projects seeking stable, long-term revenue streams.

How IFB Can Support Your Carbon Credit Financing Needs

At International Finance Bank, we offer tailored solutions to create and monetise carbon credits created by IFB through innovative financing mechanisms and , supported by our expertise in global carbon markets.

Whether you require structured loans, access to climate funds, or assistance in green bond issuance, we are here to partner with you.
For projects with technical carbon credits, we provide dedicated support to navigate regulatory compliance and secure competitive financing aligned with market trends. Our team is committed to driving sustainable growth while ensuring the financial success of your initiatives.
Climate finance is a rapidly expanding area within the financial sector, focusing on funding initiatives that combat climate change or facilitate a transition to sustainable business models. Among the key instruments are transition bonds, designed specifically for companies making strategic shifts from high-carbon to low-carbon operations. Additionally, carbon offset investments and blended finance models—which combine public funding with private investment—are gaining traction. These tools align financial markets with global sustainability goals, offering investors opportunities to support impactful environmental projects. However, challenges persist in ensuring measurable and verifiable outcomes, as well as standardising the frameworks for assessing impact. As demand for sustainable investment grows, climate finance instruments are playing a crucial role in bridging the gap between economic growth and environmental stewardship.