Need for legal clarity to scale the voluntary carbon market

THE voluntary carbon market holds immense potential to attract sustainable finance to deliver climate impact at scale. There are, however, several pain points impeding the scale-up of the voluntary carbon market. One fundamental issue is the lack of clarity on the treatment of voluntary carbon credits (VCCs), and how the law recognises their ownership and transfer.

Legal clarity is one of the keys to scaling the voluntary carbon market. To understand the importance of the legal character of an object, consider the example of a property we are familiar with – an apartment.

Will you buy an apartment if it is uncertain that you will be the legal owner? What if this uncertainty results in a bank refusing to provide a loan because it is not confident that the apartment can be mortgaged as a security for the loan?

These questions do not arise when buying something like an apartment because its legal character as property is clear and certain. However, the precise legal character of VCCs remains elusive.

The lack of legal clarity as an impediment to further scaling of the voluntary carbon market is acknowledged by international agencies, including the International Swaps and Derivatives Association and the International Organisation of Securities Commissions.

Catalyse the voluntary carbon market and green finance

The ideal commercial outcome, based on current principles and case law applicable in Singapore, is for VCCs to be categorised as intangible property. This means that holders of VCCs can enforce their rights to the VCCs against anyone in the world who could interfere with them (also known as “a right against the world at large”). An apartment or intellectual property (such as trademarks) is a good example of a property right.

On the other hand, if VCCs are categorised as a bundle of contractual rights, holders of VCCs can enforce rights only against those they are contracted with (for example, who they bought the VCC from).

VCCs may change “ownership” multiple times before being retired. For the final buyer, establishing a valid claim against the original project developer or intermediaries becomes complicated due to the lack of a direct contractual relationship. Categorising VCCs as intangible property avoids this potential complication.

The legal categorisation of VCCs also helps financial institutions assess how to accept VCCs as collateral when providing green financing. For example, while security over property may take the form of a charge or pledge, a security over a bundle of contractual rights tends to be by way of assignment. If financial institutions can be confident of the kind of security to take over VCCs, they may be willing to provide more financing.

Thus, legal clarity not only protects market players, but it also has the potential to exponentially grow the voluntary carbon market by enabling more financing and a liquid market. Furthermore, there is a strong likelihood for the ecosystem to converge around jurisdictions where there is a higher degree of legal clarity. By articulating a position, Singapore can present a viable convergence point.

There are steady efforts underway with papers and joint work at an international level, but a definitive international position is not expected to be reached in the near term.

Singapore can play a helpful role

Rather than leaving the voluntary carbon market to sort itself out over time, there is a place for positive and considered action – all the more important, given the urgency to keep to the 1.5-degree celsius pathway.

Given Singapore’s ambition to be a carbon services and sustainable finance hub, the Singapore government should articulate a position on the legal characterisation of VCCs, which we think is best defined as intangible property.

Maintaining the status quo will only stymie development of a robust and liquid voluntary carbon market.

How are compliance and voluntary carbon credits different?

Compliance and voluntary carbon credits represent two distinct market-based mechanisms for addressing carbon emissions.

VCCs are purchased by organisations or individuals on a voluntary basis to offset their carbon footprint. These credits are typically generated from projects that reduce or remove greenhouse gas emissions and are not subject to the same regulatory oversight as compliance credits.

Compliance carbon credits are used towards a regulatory mandate, such as cap-and-trade systems or carbon taxes. Compliance carbon credits under cap-and-trade systems are allowances that are needed for organisations to meet regulatory emissions requirements. These are effectively permits to pollute.

Compliance carbon markets are also formed when the government allows carbon credits to be used to offset a portion of the carbon tax obligation. For example, Singapore allows taxable facilities to use qualifying VCCs to offset 5 per cent of their taxable emissions. Under Article 6 of the Paris Agreement, guidance is set out for countries to use carbon credits to meet their climate targets or nationally determined contributions. This also sets up a compliance carbon market at an international level.

Both mechanisms play a crucial role in addressing climate change. Compliance carbon credits drive emissions reductions at a regulatory level and is confined to the jurisdiction of the relevant regulation. VCCs offer additional opportunities for organisations and individuals to support climate-positive initiatives outside of the regulatory regimes.

The writer is general counsel and head of corporate services at GenZero