A key framework being ratified at COP29 could restore confidence in carbon credits and unlock billions of dollars of funding, says Michele Morra, senior portfolio manager and head of ESG investing at Moneyfarm.
The annual climate conference currently taking place in Baku did not get off to the best start. Donald Trump has won the US elections with the slogan ‘Drill, baby, Drill’, supported by a platform that certainly does not prioritise the fight against climate change. If the US were to withdraw from the Paris Agreement, it would mark the third time in its history that the country has backtracked on a major international climate treaty.
Fortunately, the fight against climate change is not just a matter for diplomacy. The COP conference takes stock of the many initiatives undertaken by governments, international organisations and private entities. This year, the initiative that deserves the most attention is the implementation of the Article 6.4 of the Paris Agreement, which establishes a single, independent and global market for carbon credits.
Negotiators at COP29 have ratified a key framework for creating this new market, which will be regulated by a UN body. Once operational, this market could unlock billions of dollars in funding and restore confidence in carbon credits, which have faced heavy criticism in recent years.
How carbon credits work
Article 6 of the Paris Agreement provides governments and private entities with tools to internationally finance projects to meet their emission reduction targets. The system theoretically mobilises resources from high-polluting countries to developing countries, which have fewer resources and incentives to undertake such projects. Another theoretical objective is to increase investment efficiency. Advanced economies may find it more efficient to fund reduction projects in third countries rather than invest heavily in domestic measures that yield limited environmental benefits.
So far, credits under the Paris Agreement system can only be traded and compensated through bilateral agreements between states. Projects from recent years have highlighted challenges, including the complexity of implementing such agreements and questions about their integrity and effectiveness. These regulatory challenges, particularly for voluntary emission compensation programs, often undermine the credibility of the system. Companies purchasing credits for self-imposed sustainability goals face increasing scrutiny over the quality of projects and accusations of greenwashing.
The Baku agreement, which establishes a global carbon credit market under Article 6.4, aims to address these issues. It includes rules to enhance market integrity. Participation in the UN-backed market should guarantee credit quality, potentially attracting companies back, boosting demand, and increasing credit value to incentivise emission reductions. The system’s independence from government participation further enhances its appeal.
A global market would be a significant step forward for voluntary carbon credit systems and could mobilise $250 billion annually for emission reduction projects, a small but vital step considering the $6.5 trillion annually estimated as necessary to meet Paris Agreement goals.
Diplomatically, the US repositioning cannot be underestimated. Every significant climate agreement, including the Paris Accord, hinges on a US – China consensus. China, the world’s largest emitter, has also recently surpassed Europe in historical emissions and is soon expected to surpass the US. It remains committed to Paris Agreement goals, emerging as a global leader in renewable energy with billions invested in green projects at home and abroad. This strategy strengthens China’s economic and geopolitical influence, making it the key partner for poorer nations seeking to transition from fossil fuels.
Conclusion on ESG investments
From a portfolio perspective, while we closely monitor the evolution of diplomatic developments and assess their potential impact on various sectors, this does not change our long-term view on ESG investments. We believe this investment approach will remain important over the long term and are convinced it represents a sound choice not only from an ethical standpoint but also from a financial perspective.
It is important to note that our ESG portfolios are not solely focused on investments tied to the energy transition, whose short-term performance is more volatile and influenced by political decisions.
While the tension surrounding the future of the Paris Agreement concerns us as citizens, it does not alter our medium- and long-term positioning on ESG portfolios.
Main image: armando-ascorve-morales-jEXR62jw34Y-unsplash
