Big money stands to be made from the environmental sector and banks are rushing to get their clean technology and environmental financing teams together. But how quickly are banks getting in on the carbon trading game, is the market maturing, and will it make a difference

Talking about environmental issues in trade finance, “there clearly is a great opportunity on the other side of the risk,” says Richard Burrett, head of sustainability at ABN Amro in London. The bank has pulled its green businesses together under an eco-markets banner and created an umbrella organisation that looks at carbon trading, investments in clean technology and some of the commodities around those that it thinks will be influential.

Fortis meanwhile financed 12 clean energy projects worth US$1.4bn in 2006, helping it top the New Energy Finance league table for syndicated financing that year. It was also recently appointed as the financial services provider for UNDP’s Millennium Development Goals (MDG) Carbon Facility, which will help to extend the Kyoto Protocol’s Clean Development Mechanism (CDM) into developing countries.

All talk

“It’s just like the IT boom – we’re going through an environment/alternative energy boom, and there’s lots of sexy money wanting to flow into this sector,” says David Sullivan, CEO of Trade Finance Corp in Hong Kong. However, “carbon trading is still very much a talked about development rather than a done development.”

An “embryonic” secondary certified emission reductions (CERs) market is however beginning to emerge, with some “decent clips of half a million to a million tonnes,” says Gavin Tait, commodity derivatives trader at ABN, which has been active in carbon trading for three years.

Instead of just utility companies, whose purchases go straight against their shortfall, European compliance buyers – large steel or packaging companies for example – are starting to exploit the differential between allowances and credits, he says. “It’s very good news.”

The market has however developed well since it started and an active futures market could be around the corner, agrees Thorsten Ansorg, managing director and global division head of Noble Carbon Credits.

However, while trading volumes of EUAs have significantly increased, with on average a couple of million tonnes traded per day, the number of CERs issued so far represents just 3.5% of the needed compliance supply until 2012, he says. The shortfall is due to many projects being delayed, a rigid UNCER issuance policy and even a shortfall on technical staff to audit and verify projects.

Fortis estimates it has a 10% share of the current carbon trading market, which it entered in 2004. “We were one of the earliest movers, certainly among financial institutions,” says Stany Schrans, head of energy and environmental markets at the bank.

Since then the traded market has grown to around 5mn-7mn tonnes per day – approximately 10 times the volume needed for pure compliance trading, he says.

Activation this or early next year of the International Transaction Log (ITL) will create an even stronger link between the CDM and ETS market and that will lead to continued growth, Schrans predicts.

In the next six to 12 months, increased buying from Japan should emerge, while the first credits from joint implementation will be issued, he adds. “In the longer term, we expect a post-Kyoto global cap and trade system.”

Japanese students

In Japan, JBIC has organised a study group to set up the Kyoto Credit Exchange Platform, a financial infrastructure for the administration of carbon credits, says Kohei Toyoda, JBIC’s representative in London. It will facilitate carbon trading in Japan by reducing the administrative burden and transfer/settlement risk and consequently should increase participants to the market.

This framework will allow the trade of carbon-linked securities issued by Japan’s ‘trust banks’, which combine traditional banking services with asset management.

It will also enable the trade of CERs from CDM projects and emission reduction units from joint implementation projects.

By utilising the CDM framework, the carbon trading markets in Japan and internationally have strong potential to expand, Toyoda argues.

“CDM itself is economically quite persuasive. We have many developing countries who need to put more weight on economic growth than tackling climate change. By utilising the CDM framework we can give them an incentive to consider the environmental aspects.”

Dry market

Many challenges however remain and a fully liquid carbon trading market remains some way away.

A lack of understanding has led some companies to approach carbon trading as more of an operational factor than a treasury function, notes Tait. “The ones that saw it as more of an operational task that the factory manager should be looking at are the ones that typically are still sitting long and are down about €10 a tonne,” he notes. “The moral of the story is that some companies just haven’t taken it seriously enough. And the ones that have are typically doing a lot better out of it.”

“The utilities as the main compliance buyers are still on slow speed, but might face in the future a huge carbon bill – the governmental allocation has set the utilities extremely short,” adds Ansorg. RWE for example is reportedly in need of 70mn tonnes per year.

Banks have also been slow to enter the market and are now playing catch-up, says Sullivan.

They will only come in when it is mature and better understood, he adds, noting that in the 1970s “there wasn’t one bank trading alumina futures. Today the majority of alumina brokers are banks.”

With carbon allowances, “the utilities cottoned on long before the banks did. And I think one of the major problems was utilities are traditionally clients of the bank, but in this case they were leading the charge,” says Tait.

Within carbon credits however, “there’s more of a natural role for the banks,” he argues. A lot of project developers are ABN’s natural clients, meaning it needed to be involved early on to service clients.

No need yetThe trade platform that IFC has could be used for carbon trading but while the organisation does see potential, it “hasn’t seen any need for it yet,” says Georgina Baker, senior manager, global financial markets department, at IFC in Washington, DC.

“IFC has been involved in the carbon market at many levels from providing long-term financing to projects that abate greenhouse gases to acting as an agent of the government of Netherlands by providing offtake for emission reductions from projects,” she says.

It has been increasing carbon market access for projects by using its balance sheet to guarantee delivery of project-based credits through 2012 to buyers in Europe and Japan who value certainty of delivery.

Carbon credits are finally beginning to be introduced into trade finance deals, says Noble’s Ansorg.

“Banks and insurance companies are beginning to accept carbon credits as a commodity and as collateral. Nevertheless, the market is in its early days and especially the involved performance risks in the CER business might delay a fully functioning market for structured finance products nearby.”

“There’s a lot more heat than light in carbon trading at the moment,” says John MacNamara, managing director, structured commodity trade finance, Deutsche Bank, in Amsterdam. However, “certainly we’ve been working on it – in our Global Markets area we’ve got a big team trading carbon credits. And on the trade finance side we’ve come across a number of projects, particularly in say Brazil, where part of the objective of these clients is to generate carbon credits.”

“The trouble is with connecting the two. It does seem that with some of the clients in the emerging markets it’s sufficient that they do something to offset their carbon emissions. They’re not terribly interested in the next step, trading,” he adds. “I’m sure you will see deals come up which will be able to generate carbon credits and the repayments will be from the sale of the carbon credits, but we haven’t got there yet.”

Ultimately, a carbon trading team can be a vital back-up for other banking businesses, as well as boosting an organisation’s environmental credentials, and despite the regular bashing it receives, is making a difference, traders say.

Carbon trading means that the bank can offer a “natural hedge” on many of its project financings, says Tait. With “a lot of the environmental financing that we do, it’s important to have a capability here to be able to deal with the compliance instruments.”

The fact that the bank is there to make markets for its clients also helps them focus on the environment more, he argues. “And ultimately, in terms of our own green objectives, we are seeing companies change their behaviour significantly once they realise there’s a bit of money to be made out of it.”

Some clients are already focusing on the cost of carbon when they look at internal financing prospects, he says. “You’re not going to find every company overnight suddenly factoring in the efficiency of a new boiler ? but some of the really clued up guys are starting to factor that into their investment decisions,” he says. “That economic carrot really does seem to be working.”

  • Helen Castell reports.