How to scrutinise carbon offset funds

LPs considering allocating to carbon-credit generating funds should consider additionality, permanence and co-benefits in order to assess the quality of projects, according to Bfinance. The recommendation is part of a white paper on the natural capital investment landscape, released yesterday.

To compile the report, Bfinance analysed a globally representative selection of 32 funds that are seeking to produce carbon credits, which are collectively looking to raise $19 billion.

Credit types

Until now, most carbon offset projects (71 percent) have sought to generate REDD+ credits for avoided emissions, however this has changed following recent concerns relating to their quality. Last year, an investigation into REDD+ avoided deforestation credits generated using the Verra standard, carried out by newspapers The Guardian and Die Zeit and investigative non-profit SourceMaterial, called into question the value of the credits being issued.

“Among managers we’ve seen so far, there’s very little REDD+,” Bfinance ESG director Sarita Gosrani told New Private Markets. “They don’t touch it because there’s so much controversy around it.”

As a result, strategies are usually more focused on removal credits generated through afforestation, reforestation and Improved Forest Management (IFM), though the quality of these credits is far from guaranteed. IFM credits in particular pose difficulties for investors, though Gosrani was more optimistic that these could be overcome. She said: “IFM methodology needs to be airtight [in relation to] baselines, what you measure as avoided, and what that means for leakage. So if you reduce your harvest, does that mean somebody else is increasing their harvest? So there’s this knowledge gap that I think is going to get filled quickly as people get more sophisticated.”

To ensure quality, Bfinance recommends that investors scrutinise strategies based on three criteria:

• Additionality: Whether emissions reductions or removals exceed “business as usual”;
• Permanence: This includes the duration of a managers holding period and its strategy for exit;
• Co-benefits: The impact of the strategy on issues such as biodiversity and community inclusion.

Returns profile

How managers use the carbon credits their strategies generate also varies. Folium Capital and Gresham House are both combining traditional timberland strategies with carbon credit sales. Climate Asset Management, the joint venture by HSBC and Pollination, has two strategies: one, mainly targeting corporate LPs, that will distribute credits directly to LPs. CAM’s other strategy, like that of Stafford Capital Partners, involves selling credits to distribute income to LPs.

Overall, the majority (84 percent) target a conventional base financial return, supplemented with carbon credits, according to white paper. Only for a small number of funds (16 percent), do credits represent virtually the entirety of target returns.

Regardless of how firms are using the credits, there is a need to forecast how the price of carbon offsets is going to develop. In that regard, most are taking a “conservative, cautious” approach, said Gosrani, with the more sophisticated developing internal models leveraging both external data and on the ground expertise in carbon projects.

Editor’s note: This article has been updated to reflect that LPs in Climate Asset Management’s Nature Based Carbon Strategy are not free to onsell carbon credits at their own discretion.