CARBON CREDITS discharging the prepayment debt facility . This prepayment facility between trading house and producer , is often then back-to-back financed by third party banks lending to the trader with a limited recourse model focused on the underlying prepayment facility between the trader and producer .
All of the above financing solutions are built around the relevant commodities but allow for finance to flow through to support the underlying projects that generate them – they are thus widely used where the type of commodity , the subject of the financing , its market and the financing structure , are considered “ bankable ”.
Financing certificates While the financing of projects producing VCCs is often referred to as carbon financing , a VCC is not a physical commodity itself . Its value is derived from its certificated form as a representation of the physical carbon removed or abated from the atmosphere .
The voluntary nature , and the associated free market determination of price for VCCs means that the temptation to draw analogies with the financing of other carbon credits such as EU ETS or Renewable Obligation Certificates or the US tax equivalent Q45s , falls short .
A better comparison to draw is the financing secured against share certificates that are held or cleared through the accounts of depositories . The depositories and clearing houses providing the necessary market infrastructure to facilitate the title-based financing of bundles of shares of different companies as collateral for lending ( rather than the direct share security more familiar to project financiers ).
The certainty of the legal title in the share instrument , together with the robust accounting of each instrument , provides the basis on which the shares can form acceptable collateral to support the associated financing .
Features of commodity financing There are many features of commodity markets that make them bankable :
• Fungibility of commodities – C ommodities of the same type can be fungible or mutually interchangeable , easing supply chains and trade flows . Agreed audit and testing methodologies exist to ascertain grades of commodity being financed , for example assaying methodologies to determine the quality of metal ore . Assets that are fungible can be easily sold to liquidate a debt , or in a security enforcement scenario .
• Contracts and documentation – Many instruments that are used to facilitate global trade , such as bills of lading or letters of credit and related contractual frameworks such as Incoterms or Uniform Customs and Practice for Documentary Credits ( UCP ), are understood and recognised in the international commodity markets and in courtrooms worldwide . Commonality and consistency of documentation gives financiers comfort that they will get good
All of these features provide reassurance to financiers who wish to take asset-based security to reduce their financing risk
title to secured assets and that they are lending against or on the basis of legally enforceable documentation , as well as opening up opportunities for secondary market participants to participate in financings on terms that are widely recognised and therefore portable .
• Data transparency and pricing – International indices are widely available to provide transparent data points , assisting market participants in accurately determining the relative value of underlying commodities .
• Market infrastructure and clearing – A multitude of exchanges and clearing houses such as ICE or the LME exist for the trading of commodities , in the same way that other platforms such as CREST exist for the settlement of dematerialised shares . This infrastructure provides certainty for market participants and a free , regulated exchange on which to trade and liquidate financed assets .
All of these features provide reassurance to financiers who wish to take asset-based security to reduce their financing risk . Financiers that participate in the commodity markets are able to take security over physical commodities or , in the case of derivative instruments such as shares , over the representative instrument that is cleared through an exchange or held in accounts .
Features of the VCC market In contrast with other types of commodity , certain features of VCCs make them harder to bank :
• Fungibility of VCCs – Most VCCs are currently traded directly or over-the-counter between the buyer and the seller . This is because there is no common standard or taxonomy that defines a carbon credit on the voluntary market . There are various verification standards and auditing bodies whose role is to assess emission reductions and the quality of underlying projects , but each has a different set of standards that make it difficult for a third-party financier to treat any particular VCC as a fungible asset . The robustness of verification and audit processes needs to be significantly improved and harmonised to improve the fungibility of VCCs .
• Contracts and documentation – Although in 2023 the International Emissions Trading Association ( IETA ) published model form documents relating to the sale and purchase of carbon credits , there is little consistency in the terms that sellers and buyers negotiate in the VCC market , and it is therefore harder for
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