04 July 2024
Carbon Credit Contribution
As the aviation industry increasingly seeks to decarbonise, in light of evolving regulatory and stakeholder pressure, solutions such as carbon credits are gaining traction, bringing with them new and developing risks. Carbon credits are seen as a crucial part of the world's plan to limit global warming however the voluntary market (VCM) is unregulated and complex, exposing clients to challenging loss scenarios.
Why are carbon credits relevant?
Since last year, UK financial and listed firms have been required to report their strategies for transitioning to net zero. The EU’s Corporate Sustainability Reporting Directive will require companies to disclose their transition plans in the coming year. This also requires consolidated sustainability reporting for non-EU headquartered companies, at a global level, if a company generates a certain amount of revenue in the EU and has an EU subsidiary or branch that meets certain criteria. Meanwhile The International Financial Reporting Standards (IFRS) established the International Sustainability Standards Board (ISSB) in 2021, to develop a comprehensive global baseline of sustainability disclosure to meet investors’ information needs. These are just a handful of examples with many more requirements being implemented elsewhere globally - meaning that firms need to be transparent about how they will reach climate targets, and the purchase of carbon credits will play a crucial role in many businesses’ strategies.
Within the aviation industry itself, sector-specific initiatives such as the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), have been introduced.
CORSIA has required international airlines to report their CO2 emissions on an annual basis since January 2019 and introduced offsetting obligations from January 2021.
Offsetting is not intended to replace efforts to reduce the sector’s carbon emissions as part of the industry’s #FlyNetZero commitment, rather it is to help the aviation sector achieve its climate targets by complementing emissions reduction initiatives in the short to medium term.
From 2027, all international flights will be subject to offsetting requirements, with some airlines already purchasing carbon credits, including Delta Airlines, which reportedly acquired USD137 mn of carbon offsets. Exemptions will be made for flights to and from least developed countries, small island developing states, landlocked developing countries and states which represented less than 0.5% of the global international RTK in 2018, unless these states participate on a voluntary basis.
What are carbon credits?
Carbon credits are a carbon mitigation tool and are intended to complement emissions reduction initiatives. Some emissions are challenging to reduce due to factors such as cost, control or available technology. Alongside significant emissions reductions, we must also remove carbon dioxide that already exists in the atmosphere.
There are three basic types of carbon projects/credits:
· Those from reduced emissions (typically energy efficiency measures)
· Removed emissions (carbon capture and planting forests)
· And avoided emissions (for example refraining from cutting down rainforests).
Additionally, there are two key types of carbon markets, the compliance market and the voluntary market:
Compliance carbon markets are regulated markets which are typically in place to reduce emissions from heavy-emitting industries. Certain crediting schemes can also be viewed as Compliance Markets, for example, the CORSIA scheme however this crediting scheme allows voluntary credits to be used for compliance purposes.
The voluntary carbon market (VCM) is a fast-growing market in which organisations can voluntarily purchase and retire carbon credits. The VCM is currently unregulated and is guided by non-governmental/industry standards that set guidelines in the absence of formal regulation.
Insurance has increasingly been sought to provide a greater degree of certainty around carbon projects in the VCM, by assessing the quality of projects and insuring the buyers and/or sellers of quality projects.
How are they traded?
Carbon credits can be acquired directly from project developers Including direct investment in an offset project, a contract for delivery often referred to as an “Emission Reduction Purchase Agreement” (ERPAs) or a one-off transaction. They can also be acquired via a broker, retailer or exchange.
The IATA Aviation Carbon Exchange (ACE), is a centralised marketplace for CORSIA-eligible emission units allowing airlines and other aviation stakeholders to trade CO2 emission reductions for compliance or voluntary offsetting purposes.
ACE uses the IATA Settlement Systems and Clearing House for the settlement of funds. The exchange is open to all airlines, including IATA and non-IATA members, and other aviation stakeholders such as airports and aircraft manufacturers. The exchange is also accessible to carbon market participants wanting to list emissions reduction that are CORSIA compliant.
What are the risks?
There are a range of risks associated with carbon projects, and the carbon markets. From a buyer’s perspective, non-delivery represents a key concern as providers may be unable to deliver the reductions purchased, leaving businesses needing to find another solution at short notice, and higher cost, to meet their environmental commitments.
Additionally risks such as Invalidation – where a carbon credit or the project itself is invalidated on account of a fraudulent or negligent act, a significant reversal of carbon dioxide back into the atmosphere or a significant shift in methodology, thereby rendering the carbon credit or project invalid.
For clients, there is also an accumulation point at which they no longer feel comfortable holding the risk, at which point, they will look to transfer the liability onto their balance sheet with an indemnity value.
Insurance can provide several benefits, including risk mitigation, a detailed assessment of a carbon project’s risk and a stamp of confidence for those carbon projects that meet the insurer’s insurability standards.
How can we help?
Gallagher Specialty recently launched a dedicated carbon solutions service to advise clients on key risks associated with carbon solutions, including carbon capture, storage and carbon credits.
The carbon solutions team has partnered with Gallagher’s Aerospace team to address Aviation specific risks and concerns and is working with buyers and sellers of carbon credits to find the appropriate insurance solutions ahead of CORSIA’s mandatory offsetting requirements in 2027.
The team has a wealth of expertise and will help you navigate the appropriate insurance coverages available for your specific needs including risks of non-delivery and credit invalidation and stands ready to help with any enquiries you may have
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