The market for voluntary carbon offsets is booming all over the world on the back of commitments at the last UN climate summit (COP26), as countries across the globe pledged to various net-zero targets. And Asia is no exception.
Singapore in February announced planned increases in carbon taxes from 2024 in its 2022 budget, as part of efforts to realise its net-zero emissions targets by or around 2050. Concurrently, the government also announced that businesses can use high-quality international carbon credits to offset up to 5% of their taxable emissions, which will boost demand for Asia’s voluntary carbon credits market (VCM).
Separately, China's carbon market, launched in 2021 and currently limited to the power generation sector, could see a faster-than-anticipated rollout in another eight different sectors, including refining and petrochemicals, chemicals, building materials, steel, and nonferrous metals. Buoyed by increased regulatory focus, the relative success and growth of China’s VCM could set a positive trend for the rest of the region.
Increasing carbon taxes and incentivising growth in VCMs are a step in the right direction in prompting businesses to reduce emissions. However, these mechanisms are not without risks and could have unintended consequences for businesses.
Offsets boom
Although carbon credits can be generated from a wide variety of projects, their growing prominence as the primary market-based solution to reduce deforestation will boost investments in natural resource management in Asia. In the coming years, much of the capital raised in Asia’s burgeoning carbon marketplace will go towards forestry and land-use projects, the most popular type of offset available on VCMs (alongside renewable energy projects).
Governments in recipient countries across Asia are keen to tap into growing financing opportunities, including in VCMs, to boost post-pandemic recovery. Southeast Asia’s VCM, for instance, will reportedly create US$10 billion in economic opportunities annually by 2030.
However, VCMs globally remain poorly conceptualised, weakly regulated, and lack the proper frameworks to validate prices and trade offsets. Their rapid expansion without robust global standards, accurate accounting, and transparent monitoring will expose companies and investors to a plethora of challenges, including reputational, operational and litigation risks.
Greenwashing risks
Despite the surge in demand for offsets, such schemes’ quality and integrity have been a critical concern for investors, exacerbated by the absence of internationally recognised standards for carbon offset accounting. Instead, numerous not-for-profit groups, such as Verra and Gold Standard, check and approve offset projects. These certification bodies are predominantly funded by their earnings from registering and generating offsets, and they are not monitored by third parties. The lack of regulatory clarity around offset projects has therefore occasionally led to accusations of “greenwashing” and miscounting, which undermine their integrity and credibility.
Further, without strict regulations, sellers and project developers often manipulate baselines to create large volumes of credits at low prices. These challenges are likely to be more pronounced in Asia’s fragmented markets. Here, the limited availability of quality assurance due to the high cost of (on-the-ground) monitoring further erodes the integrity of offset credits. This will heighten reputational risks for companies that participate in these projects.
ESG footprint and socio-political impact
In the coming years, mounting concerns over the impact of offset schemes on the rights of local communities, especially on those with unrecognised or contested claims to forest lands, will emerge as a critical challenge that can affect the commercial viability of projects.
Errant government officials could be motivated to bypass local consultations to capture the financial benefits of projects. For instance, local officials in Malaysia’s Sabah state in October 2021 signed a carbon trading deal worth an estimated US$76.5 billion with a Singaporean shell company to market carbon and other natural capital from more than 4.9 million acres of the state’s forests for the next 100 years. This profit-sharing agreement has been mired in public controversy for months, as indigenous leaders and activists have alleged that local communities were not involved in the decision-making process.
Some national governments could also claim that the urgency of reducing carbon emissions gives them the mandate to push ahead with projects with limited stakeholder consultation. However, without adequate community participation, land-based climate change projects will be vulnerable to frequent community protests and legal challenges over land ownership and disbursal of conservation-related incentives.
Such absence of robust government policies to safeguard community interests and to ensure full disclosure of forest and land permits can expose investors to significant reputational and operational challenges. Companies risk being embroiled in controversies related to human displacement, biodiversity loss, and vested commercial interests.
Recommendations
While VCMs appear fraught with challenges and potential pitfalls, carbon offsets are still an integral part of companies’ efforts to achieve their emission reduction targets. It will therefore become increasingly important for companies to conduct meticulous due diligence so as not to be blindsided by these risks.
Businesses will need to scrutinise whether the projects are designed with sufficient safeguards to mitigate adverse social and human rights impacts. Investors will need to verify projects’ integrity against several core principles and develop a thorough understanding of the local stakeholder landscape. Companies should particularly look out for any reports of intimidation or violence against people opposed to the project.
The boom in carbon offsets will also increase scrutiny of how projects calculate emission reductions. Such corporate carbon accounting scrutiny will cascade down the offsets value chain. Companies will face the challenge of ensuring that their offset strategy does not simply shift emissions to an underregulated location or sector. They will also be required to conduct rigorous due diligence to evaluate their choices of offsets and measure the impact of carbon reduction or removal.
That said, VCM emission reductions, despite their rising popularity, have been relatively limited compared with the mandatory cuts achieved by government compliance markets. There is a growing consensus among regulators and industry experts that companies need to focus on absolute reductions in emissions rather than offsets to shrink their emissions footprint.
An over-reliance on voluntary offsets without exploring other decarbonisation techniques risks exposing companies to further greenwashing accusations and eroding stakeholders’ trust in their net-zero commitments in the long run.
This article was originally published in The Business Times on 15 March 2022.