Investors are discovering different ways to harness EUA carbon credits, enhancing their ESG and sustainability credentials, say our UK Commercial Director, Capital Markets, Dennis Stone and Global Head of Capital Markets, Cliff Pearce
Carbon credits known as European Union Allowances (EUAs) are becoming mainstay assets for portfolio managers who want investments that meet Environmental, Social and Governance (ESG) standards.
Effectively, EUAs are tokens that give holders permission to release carbon into the atmosphere. Usually they are used by industrial companies. But they are also traded on public and private exchanges and play an increasing role in investment portfolios.
As ESG rises up the public policy agenda, demand is growing for “green bonds” – tradeable debt instruments with first-rate climate change credentials. Many alternative fund managers are now exploring how to include EUAs in their green bond strategies.
The EU carbon market was established in 2003 by a European Parliament Directive that established a scheme for trading allowances in greenhouse gas emissions. The world’s largest mandatory emissions trading scheme, it has come to be seen as a bellwether for global carbon pricing, according to the Financial Times.
As that article explained, EU authorities issue carbon credits to companies, often industrial or power firms, to control pollution. One credit allows the holder to emit one tonne of CO₂. Businesses can buy more credits and sell any surplus on the secondary market.
Custodians play pivotal role in EUA green bond trades
But some investors who are unwilling or unable to hold EUAs directly need alternative entry points, leading to the creation of flexible fund structures that allow exposure without direct ownership of EUAs.
EUA-linked green bonds are often built around the services of financial custodians – independent entities that keep many types of financial assets safe – such as Intertrust Group.
The role of custodians is becoming pivotal: they help create and maintain fund structures that can facilitate novel and bespoke trading strategies.
These structures are built to accommodate clients’ specific needs. In general, however, the process can be split into four stages.
- Custodians open accounts with the various registries across Europe and further afield if necessary.
- A client deposits EUAs in a foundation established for the purpose.
- Economic rights attached to the EUAs are assigned to a Special Purpose Vehicle (SPV).
- Economic rights held within the SPV are used as collateral to issue green bonds, which can be privately placed or traded on public market platforms.
Custodians have ultimate control over the EUA assets and, as independent third parties, minimise potential conflicts of interest. The EUAs are not controlled by either the asset originators or funders. This detached custodial status gives assurance to all parties.
However, the EUAs and bonds derived from them are traded at the instigation of asset managers who follow investment strategies that suit the beneficial owners.
Carbon credit trading around the world
Bonds issued by the SPVs help pension, endowment and other institutional funds meet ESG goals, especially net zero carbon targets. This mechanism has been around for some time but is being reinvented as ESG goals shoot up the public agenda.
EUAs are attractive ESG assets because they are pure “green” plays, undiluted or compromised by the historical and commercial realities inherent in, say, a corporate entity.
Intertrust Group counts some of the world’s largest investment banks among its clients and third-party EUA custodians are filling a gap in a market once dominated by banks. Some banking institutions still work in the sector but many now focus on other areas.
As well as EUAs, similar fund structures can be built around other carbon trading schemes. Intertrust Group has expertise in the UK Renewable Obligation Certificates (ROCs) and has explored the California Carbon Allowances (CCAs). Similar programmes from around the world are also on the radar.
Who joins EUA trading contracts?
Tri-party contracts are drawn up between client companies and entities acting as EUA custodians and a security trustee (both Intertrust Group roles).
These services can be organised from several EU financial centres. Intertrust Group’s EUA custody business is based in Amsterdam because the Dutch regulatory authorities have developed a relatively advanced set of operational skills.
The EUA custodian role aligns with Intertrust Group’s own sustainability goals, which may reinforce service users’ ESG credentials. Intertrust Group is committed to promoting a strong and sustainable economy with economic opportunities for all and joined the UN Global Compact initiative in 2020. The company has adopted both global and local goals and initiatives to make a difference in the world, whilst helping our clients flourish responsibly.
Why Intertrust Group?
- We help with the administration of more than $470bn of client assets and have over 4,000 employees across the world, combining global and local expertise.
- We have expertise in all private capital asset classes, focussing on bespoke corporate, fund, capital market and private wealth services, thus enabling our clients to invest, grow and thrive anywhere in the world
Insights | Private Capital & Hedge Fund Services
18 steps to futureproof your private capital operations
25 January 2023
Insights | Corporate Client Services
Prepare now for changes to the Overseas Vendor Registration rules in Singapore
21 December 2022
direct to your inbox
Subscribe to receive the latest news and insights, personalised to your role, location and areas of interest.