To create liquidity for VCC holders , clearing houses for VCCs need to be developed and financially supported in the same way that share exchanges or commodity exchanges are financiers to get comfortable with , for example , the enforceability of the parties ’ respective rights in or title to the VCC ( s ) being transferred . Standardisation of contracts would allow for improved aggregation of price signals , which can then form a reliable valuation basis against which financiers can lend .
• Data transparency and pricing – Having standardised audit parameters for each type of VCC-producing project would allow for much better pricing of each VCC produced – this doesn ’ t necessarily mean that all VCCs would have the same price , but a common approach in the market would allow for consistent pricing differentiation between different grades of VCC .
• Market infrastructure and clearing – Market infrastructure needs to develop further to facilitate liquidity of trading . A liquid market provides comfort to financiers that the asset base they are financing can freely be converted into cash to repay the debt . To create liquidity for VCC holders , clearing houses for VCCs need to be developed and financially supported in the same way that share exchanges or commodity exchanges are . Such developments are already taking place ( for example the Global Carbon Market Utility which aims to address exactly this issue ).
Security / collateral considerations The availability of debt finance in the global commodity markets is possible because borrowers and lenders customarily create security to support the debt . In a typical structured commodity financing , the financier will expect to receive a security interest from the borrower in the underlying assets , which will principally be the financed commodity , relevant bank accounts and / or the rights of the borrower in any commercial contract ( s ).
Broadly speaking , under English law an asset will be capable of being secured whether or not it is tangible or intangible , as long as title to it is capable of transfer by way of security to a creditor , or if it is otherwise capable of being encumbered in the creditor ’ s favour . In practice , there is little difference between a transfer of title or an encumbrance in this context – the effect , for example , of an English law mortgage and a fixed charge is largely the same , even if the legal nature of these security interests is quite different ; in the case of an English law mortgage , the secured creditor will receive either “ equitable ” or “ legal ” title in the secured asset , whereas an English law fixed or floating charge simply creates an encumbrance in the creditor ’ s favour , with no associated title transfer .
Impact on finance All of the necessary improvements in the VCC market mentioned above will give financiers greater certainty as to the bankability of VCCs and will encourage more financing backed by VCCs .
In particular , the establishment of clearing houses and formal market infrastructure allowing the clear identification and valuation of VCCs will allow the creation of existing forms of security interest over or in connection with this relatively new type of asset – it should be possible for a financier to take a security interest over a trader ’ s or carbon credit aggregator ’ s account with the clearing house , in much the same way that it is possible currently to take a charge over a CREST depository account in the case of dematerialised listed shares .
The effect of this will be to allow financiers to base the provision of debt finance solely on VCCs – including lending against large blocks of VCCs aggregated from different projects – rather than having to look through them to the generative emissions-reduction project , cutting down the amount of diligence required and making finance more widely available .
Improvements to liquidity generated by the proper regulation and financing of clearing houses and market infrastructure will allow financiers to be confident that , in the event of a default by the borrower , the underlying assets they are financing can be sold easily , quickly and at a readily determined value .
By the same token , VCCs traded using recognised and largely standardised documentation will permit financiers to syndicate their risk on the secondary market , as well as to have confidence that their borrower has title to the secured VCCs and that that security is enforceable .
Ultimately , increasing the availability of significant amounts of structured debt finance will unlock significantly more carbon reduction projects and thereby help achieve net-zero faster . •
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64 Project Finance International May 9 2024