Insurance and the VCM: Kita’s response to IETA report

‘The Evolving Voluntary Carbon Market’, a report by IETA’s members, provides a comprehensive summary of the current state of the voluntary carbon market (’The State of Play’), the expected trajectory (’The Path We are On’) and how the market should progress (’The Way Forward’), across 4 headings:

• Corporate Net-Zero Guidance and Inclusion of Offsetting

• The Relationship Between the VCM and Country Actions Under the Paris Agreement

• Consolidation or Proliferation of Crediting Approaches

• Governance and Increasing Regulation

Kita has put together some of our key takeaways, focusing on how insurance can play a part in ‘The Way Forward’.

Corporate Net-Zero Guidance and Inclusion of Offsetting

IETA’s paper highlights that corporates need to trust in the VCM and not be afraid of external scrutiny. Recently, there has been increased criticism of the VCM which has, understandably, led to feelings of uncertainty and a lack of trust in the market. IETA’s paper correctly states that ‘the antidote to a lack of trust is quality’. It is important that the market reaches a uniform definition and standard of high quality, to reassure stakeholders and reinstate trust in the market. Measures, such as the ICVCM’s Core Carbon Principles, are working towards a high quality threshold by providing a framework to identify high-integrity credits.

At Kita, we believe that insurance is another measure with the potential to instil trust in the market. Insurance is usually found within traditional and standardised markets, such as capital markets (As explored in our piece written with BeZero). The fact that insurers are participating in the VCM indicates that the market can move towards a more standardised and traditional structure, which is familiar and trusted by corporates. Delving deeper to the project level, insurance can indicate to market participants whether specific projects meet or exceed key conditions required by an insurer. This can further motivate carbon actors to buy from and invest only in high quality carbon projects.

The Relationship Between the VCM and Country Actions Under the Paris Agreement

The intricacies of the relationship between the VCM and country actions under the Paris Agreement are an ongoing discussion. However, IETA’s report explains that the VCM can help to ‘pave the way for countries into compliance and Article 6 mechanisms’ via ‘increased capacity building, credit fungibility, and an expanded pool of buyers, alongside a reduction in market barriers and transaction costs.’ We agree that such developments would both benefit the VCM and help make way for a robust market under Article 6 of the Paris Agreement. Insurance is one key mechanism which can help with these developments.

Insurance can support by reducing market barriers. For example, delivery risk has been a barrier to entry for market participants. The chance that a forward purchase/investment may not result in the carbon credits promised is a risk which is deemed too high for many organisations. A lack of forward purchases also prevents project developers accessing the investment required at the beginning of a project lifecycle to develop and scale their project. Kita’s Carbon Purchase Protection Cover protects buyers of forward purchased carbon credits against delivery risk, giving purchasers/investors the confidence to buy, and thereby unlocking capital flows required by carbon projects. By reducing market barriers, the pool of buyers can expand and the number of projects accessing finance and being developed can increase, helping to build capacity.

Consolidation or Proliferation of Crediting Approaches

We agree with IETA’s members that the increasing number of standards and crediting approaches represents a ‘healthy, growing, innovative, and competitive market’. In such a nascent market, exploring new ideas and approaches is important.

However, we also agree that consolidation across crediting approaches is equally important. In particular, the report references the importance of digital infrastructure to enable market growth. As identified, the market is currently constrained by a lack of ‘comprehensive, easily searchable project data’. At Kita we strongly agree that easily accessible digital infrastructure is required across the VCM to produce clear, machine-readable, and identifiable data. Consistent data outputs from all market participants makes it easier for insurance companies, in terms of comparisons, processing, and costs. Insurance companies rely on data patterns to determine risk and produce robust policies. Therefore, consistent and useable data is necessary to enable mechanisms such as insurance to function effectively, helping the market to grow.

One key element of digital infrastructure, mentioned within the report, is standardised contracts. Such contracts would help to bring structure to financial transactions and enable mechanisms such as insurance to perform effectively. For example, certain insurance products, such as Carbon Purchase Protection Cover, act as a backstop to the carbon contract. Therefore, insurers look for certain contractual terms. Standardised contracts could include terms which enable insurance. This would help a greater number of projects and buyers/investors to access insurance and mitigate their risks.

Another key element is enhanced Measurement, Reporting and Verification (MRV). Accurate, robust, and uniform MRV techniques are necessary across project types to increase trust and confidence in the market. Enhanced MRV can also bolster insurance. Continuous, accurate monitoring of a project allows risks to be assessed over the policy term, enabling insurers to create bespoke policies and premiums, and pro-actively understand when a loss has taken place.

Governance and Increasing Regulation

Finally, IETA’s report recognises the importance of governance to ‘provide high levels of scrutiny’ with the caveat that it should not inhibit the ‘nimbleness and flexibility of the VCM’. The VCM has so far largely been a self-regulated market, which brings both positive and negative aspects.

At Kita, we recognise the importance of governance and regulation. However, we agree that room must still be given for flexibility, to allow the nascent market to grow. Existing and new organisations such as ICROA, ICVCM, and VCMI greatly benefit the VCM by introducing a required level of oversight, structure, and scrutiny without compromising flexibility. As recommended by the report, they are ‘independent organisations collaborating with industry experts’. We look forward to future developments such as these.

We wish to thank IETA’s members for this insightful paper and look forward to future publications.