Memorandum from Cheyne Capital Management
Credible and rigorous internationally accepted
standards, such as Voluntary Carbon Standard Version 1("VCS"),
should govern the otherwise unregulated voluntary offsetting industry
to insure that buyers and sellers have financial and legal recourse
and accountability. Voluntary markets have traditionally been
fragmented, illiquid, inefficient and lacking market mechanisms
that ensure quality and promote standardization. We are proponents
of internationally accepted transparently created, high integrity
standards, such as the VCS, that have been developed through an
extensive consultation process involving multiple stakeholders
and an independent steering committee with expertise in the voluntary
carbon offset markets and the appropriate climate science background
that ensure credibility and global buy-in.
The Voluntary Carbon Standard Version 1 ("VCS")
was launched by The World Business Council for Sustainable Development,
the World Economic Forum, The Climate Group and The International
Emissions Trading Association in March 2006.
Creation of the VCS and a standardised emission
reduction unit, named a Voluntary Carbon Unit ("VCU"),
as a fungible, uniform, tradable and standardised emission reduction
offset unit has removed the barriers to entry in the voluntary
emission reduction space allowing financial institutions and large
industrial companies to manage their reputational risk and participate
in the mitigation of their long-term carbon liabilities with real,
quantifiable, permanent and additional VCUs.
The VCS concept has created a new commoditised
asset class accepted by the financial community. The VCU helps
create a benchmark pricing mechanism for certified voluntary carbon
units. The voluntary carbon standard and voluntary carbon units
have established the first voluntary high quality commoditized
assets certified in accordance with a credible performance standard.
All verification and certification protocols
for every VCU as specified in the VCS. For example, baseline settings
and monitoring must be evaluated and interpreted only by officially
United Nations Framework Convention on Climate Change ("UNFCC")
accredited Designated Operation Entities ("DOEs"). The
Fund uses the top 3 of the 9 internationally accredited DOEs,
which adds significant costs but creates certainty, reduces risk
and adds an additional layer of performance insurance.
The Cheyne Carbon Fund stores its VCUs in a
secure global custody service at The Bank of New York's VCU Registry
where VCUs are assigned serial numbers to avoid double counting
and ensure transparent reporting of retired VCUs. The Department
of Environment, Food and Rural Affairs ("Defra") should
adopt the VCS and VCUs as its code of best practice for carbon
offsetting and endorse The Bank of New York ("BNY")
VCU Registry.
Defra's January 2007 launch of "Developing
a Code of Best Practice for carbon offsetting"" is a
positive step in the right direction towards creation of a government
scheme that accredits providers and promotes international standardisation.
However, many concepts, references and definitions in the 56-page
Defra document are scientifically incorrect, requiring revision
and causes the initiative to lack all credibility.
Much confusion exists regarding Defra's understanding
of exactly what VERs and CERs are, the existing voluntary market
mechanisms and the purposes and differences of each market. Defra
has concluded, before their "consultation" to publicly
endorse only certified emission reductions ("CERs")
generated for the EU ETS regulatory mechanism in their "Developing
a Code of Best Practice for carbon offsetting", which some
assumed was a genuine consultation.
EU ETS CER emission reductions generated from
destruction of HFC-23 in China, now represent more than 60% of
all pipeline emission reductions in the EU ETS CER pipeline. These
are produced for pence on the pound and sold for €15.00 on
a forward basis. Purchase of these HFC-23 reductions does not
promote capital market investment. It does not promote creativity
or drive innovation critical to the development of new technologies.
It makes no contribution towards sustainable development in the
local economy where the destruction occurred. While HFC-23 is
a potent greenhouse gas, it is a minor part of the global warming
problem. Emissions from carbon dioxide ("CO2"), methane
("CH4") and nitrous oxide ("N2O") constitute
more than 95 percent of all greenhouse gas emissions. Based on
the magnitude of the problem and given the high quality and scale
of some existing VER projects and standards it seems illogical
to arbitrarily exclude VERs before the Defra "consultation"
"Developing a Code of Best Practice for carbon offsetting.
Purchase of VERs such as VCUs, certified in accordance with the
VCS, can contribute substantially more towards the creation of
permanent solutions that mitigate the majority of GHGs impacting
global warming and climate change than the purchase of the abundant
HFC-23 destruction CERs generated from projects in China, as suggested
in the Defra Code of Best Practice for carbon offsetting. Contained
in the tables within Defra's "Developing a Code of Best Practice
for carbon offsetting" Defra uses an overly crude model to
forecast the emissions benefits resulting from 5 different "options"
associated with a voluntary vs. mandatory, VER vs CER offset standard.
The central factor that Defra uses in determining the estimated
emissions avoided as a result of the voluntary offset market is
the "consumer uptake" assumption. It concludes that
issuing its proposed voluntary-CER code will increase the net
emissions reduced by the voluntary offset market in the UK from
5.4 Million Tonnes per Year ("MT/yr") to 32.1 MT/yr,
and uses this as quantifiable justification for its proposal to
reject high-quality VERs as an eligible source of supply. The
numbers chosen by Defra are completely arbitrary and are not supported
by any market research or rigorous analysis.
In particular, Defra assumes that under the
status quo or voluntary code accepting VERs (options 1 and 2a),
consumer uptake will be 5%, whereas under its proposed voluntary
CER code (option 3a), consumer uptake increases six-fold to 30%.
No real argument or justification or market research is given
to back up these random assumptions. Defra simply assumes that
the introduction of its voluntary CER standard "might have
a positive impact on consumer confidence in the offsetting market,
and could therefore increase the take-up of offsetting products".
How this is quantifiably translated to a 30%
consumer uptake is not explained, undermining any confidence or
credibility in the conclusions drawn from the Defra Regulatory
Impact Assessment ("RIA") exercise. As a result, without
any documented justification or quantified market research, Defra
should retain a 5% consumer uptake figure for its voluntary CER-only
code scenario. In that case, the total emissions benefit to the
environment will be the same as the status quo, at 5.4 MT/yr.
While having a Government-endorsed code may increase consumer
confidence and uptake in the market, it is not clear why a CER-only
code as opposed to a VER-included code would not have a similar
effect. And furthermore, differences in VER and CER prices are
not incorporated into the consumer uptake analysis, a critical
omission in any market impact assessment. A doubling in the cost
of procuring carbon will undoubtedly have a downward effect on
consumer uptake.
Below are summary answers to the questions raised
by the Committee's voluntary carbon offset market inquiry
(2) Should there be a compulsory UK or European
accreditation scheme for carbon offset projects or companies?
If so, how should this operate?
Yes, a UK government accreditation program should
be implemented ensuring that the companies involved in the purchase
and sale of VERs are creditworthy companies who may be held legally
and financially accountable for the offsets they sell. This program
should compliment the existing regulatory cap and trade scheme.
This presents an enormous opportunity for the UK government to
shape broad based international policy consensus regarding the
creation and acceptance of internationally accepted high integrity
performance standard, the VCS and fungible high quality certified
VCUs stored in a industrial strength registry at The Bank of New
York's VCU Registry. All verification and certification protocols
for VCUs, including all baseline settings and monitoring reports,
must be evaluated and interpreted only by United Nations Convention
on Climate Change ("UNFCCC") accredited Designated Operation
Entities ("DOEs") before the DOE can certify the VERs
as VCUs under the VCS. This process adds significant costs but
creates certainty, reduces risks and adds an additional layer
of performance insurance regarding the robustness and permanence
of each certified VCU. The BNY VCU Registry was created to suit
the most stringent requirements of institutional clientele in
the financial services community and should be adopted as the
registry for the UK's voluntary program. The BNY is the world's
largest provider of custodial services to the financial markets
and is the first bank to provide a robust and credible registry
for the voluntary carbon markets. BNY requires proof of title
and evidence of ownership chain back to the point of origination,
as well as a warranty by the depositor that the emission reductions
have not been previously sold or double-counted elsewhere; each
VCU has a unique serial number similar to a financial instrument.
BNY holds physical custody of the title certificates and the project
documentation.
The international voluntary markets may soon
evolve as the largest and most effective internationally accepted
solution in the mitigation of CO2 and CO2e (CO2 equivalent).
(3) Should offsetting become mandatory for
some of the more carbon-intensive activities?
Yes, offsetting should be mandatory as this
will create an internationally recognised market mechanism that
can quantify the "cost of carbon" while discouraging
additional investment in high carbon infrastructures and making
a strong business case for increased capital market investments
that will drive innovation in new technologies which can foster
the transformation towards a less carbon intense global economy.
Participation in a robust voluntary scheme such
as the VCS should reward early action and investment in new technologies.
This same mechanism should severely penalise any additional or
new investment in carbon-intense activities and infrastructures.
Voluntary offsets may supplement the regulatory caps set by a
comprehensive government scheme. A combination of both offset
classes should be mandatory in offsetting carbon-intense activities.
(4) Is there enough clarity within the offset
market to allow customers to make informed choices based upon
robust information about different schemes at different prices?
No, transparency and capital adequacy should
be requirements for accreditation of all emission reduction offsets
providers to clarify their financial and legal accountability
and ensure that what the offset solutions they provide are exactly
what they is represent them to be. This makes credible initiatives
such as the Voluntary Carbon Standard a significant step forward
in the international standardisation and advancement of the voluntary
carbon markets. Offset providers are currently using proprietary
protocols lacking the necessary components found in the VCS. These
include: verification and certification of all reductions by DOEs,
registration of all VCUs at The Bank of New York VCU Registry,
transparent reporting of retired VCUs and more stringent accountability
of the companies participating in the VCU markets. As this is
an emerging market commodity asset class it is essential to create
additional, robust, fungible internationally accepted VCUs that
are generated from projects certified by DOEs and stored at The
Bank of New York's VCU Registry. The Cheyne Carbon Fund contains
globally diversified VCUs generated from many different project
types and categories.
(5) Many offset projects involve afforestation
or reforestation. Is the science sufficiently coherent in this
area accurately to assess overall long-term carbon (or other GHG)
gains and losses from such projects?
The VCS does not include GHG emission reductions
generated from sectors where long term performance and permanence
may be questionable such as: forestry, certain agricultural gasses,
forward GHG reductions that have not yet occurred and therefore
cannot be verified/certified, and emission reductions generated
from project categories that have no existing certification protocol.
Emission reduction projects receiving official development assistance/subsidies
and or grants are also excluded from the portfolio.
(6) Is there sufficient data available to
guarantee accurate amounts of carbon or other GHG mitigation in
the sorts of schemes that offset projects finance?
Verification and certification data of VCUs
is extremely comprehensive and based on the CDM methodology including
baseline settings, monitoring reports and any other relevant data
the UNFCC accredited Designated Operation Entities ("DOEs")
may require to evaluate, interpret, guarantee and certify the
exact quantity of GHG mitigated in accordance with the VCS protocol.
This process may add significant cost but shall create the necessary
certainty needed, adding an additional layer of performance insurance
regarding the robustness and permanence of the exact amount of
GHG mitigated by the VCUs certified by the DOE.
(7) What impact will the voluntary carbon
offset market have on the compliance market if the former continues
to grow as steadily as it has done over the last few years?
The voluntary and regulatory markets have completely
different dynamics and characteristics and each market was created
for a different purpose. The Kyoto protocol provided a tradable
cap and trade framework on which the EU ETS was designed in conjunction
with the UNFCCC. The EU ETS was the first large-scale internationally
coordinated cap and trade system that allowed for GHG emission
reductions to become freely traded as commodities. The extreme
price volatility has illustrated the nature of this emerging market
asset class. Random and arbitrary factors greatly influence and
determine the arbitrary price action of emission reductions traded
in the EU ETS. Governmental rules, artificially created allocations
and timelines governing Phase I, II and III are major price determinants
in the EU ETS. Any additional credits at the end of a crediting
phase mean that the price falls to zero and all additional reductions
are meaningless.
In the voluntary markets the corporations or
individuals can determine what type of projects to purchase emission
reductions from. Investment in verified and certified VCUs can
promote investment in high quality sustainable development and
drive investment in new technologies. Regulatory uncertainty is
a powerful driver in early recognition, evaluation, disclosure
and mitigation of climate change risk. Failing to address climate
change issues opens corporations up to regulatory scrutiny, investor
scrutiny, as well as several other competitive and reputational
risks.
(8) What evidence is there to show that offsetting
helps to change the carbon behaviour of the customer?
Recent opinion polls conducted indicate rapid
public awareness and concern about climate change and global warming.
The surveys indicate that 85% of the respondents believe action
should be taken to mitigate the impacts of climate change and
global warming and a further 61% said they would be willing to
purchase offsets to mitigate the impact of their actions. The
evolution of a voluntary universally credible, fungible, robust,
commoditized and verified emission reduction unit or VCU will
empower and motivate individuals and corporations to take responsibility
for their actions. The substantial increase in volumes of voluntary
carbon offsets purchased during the past twelve months provides
evidence that global awareness and responsibility is rapidly increasing.
As the science improves and receives more press, individuals and
corporations take climate change, global warming and their responsibility
to contribute to a solution more seriously.
(9) To what extent are the schemes and projects
funded by offset companies more broadly sustainable, in an environmental,
social or economic sense?
The Carbon Fund maintains a well-balanced and
globally diversified portfolio of emission reductions that are
generated from projects with genuine environmental benefits and
facilitates additional investment towards sustainable development.
It is important to differentiate between making
a strong business case for capital market investment in new technologies
that can significantly impact mitigation of CO2 and CO2e and charitable
contributions period. Many of the offset providers blur the line
between these two.
As a participant and interested stakeholder
in the voluntary carbon markets Cheyne will be available to provide
further detailed evidence as requested by the Committee regarding
either current or future questions pertaining to this inquiry.
Thank you in advance for your consideration.
January 2007
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