A while ago, I was approached by a specialized social network to help them assessing how their platform could be used for building up smarter cities and monitor investments from a sovereign investor.
Here are some hints about how this might work:
The idea is to check the potential contribution of said social network platform to four building blocks supporting the implementation of the sovereign investor’s urban strategy:
- Knowledge programs, product development and dissemination
- Financing strategies
- Partnerships platforms and cities alliances
- Results management , f.i. based on the Global City Indicators Program  www.cityindicators.org)

Investments in non-Annex I countries are mainly done through Kyoto’s flexible Clean Development Mechanism (CDM), where a valid project is granted carbon credits under the form of Certified Emission Reduction units (CER’s). Those CER’s being thereafter tradable on specialized exchanges: Bluenext or ICE ECX.
Hereafter are some issues that might potentially be addressed by a social network platform, with regard to both external stakeholders and cities’ inhabitants:
1. Tools for external stakeholders
a. The baseline is to organize CDM projects successful application, financing, follow-up and redistribution of carbon credits. To a certain extent, a network of investors should get access to a pool of generated carbon credits in order to manage their carbon neutrality.
1. Funding/collection: obviously the idea being here to structure the CDM application process, one could easily build up teams and schedules/milestones in order to improve success rate; a typical sequence being:
Feasibility assessment / Carbon assessment / Construction / Validation & registration / project implementation / Carbon transaction (primary) / Verification & certification / Issue of CER’s
2. Organize/rationalize an exchange around candidate CDM projects (investors meet projects initiators)
3. An exchange platform where initiators of smaller projects might group their efforts or meet investors demands
4. Projects financial performance/benchmarking: once a CDM projects has been approved and started, access to ad-hoc KPI’s for interested parties should be made available. Aside from the project contribution to the 22 themes of the Global City Indicators program, the actual additionality of the project and the carbon credit potential to investment should be tracked as well, that ideally related to the footprint evolution of the entity (see below).
5. Risk management, related to point 1, f.i.: Credit risk / certification risk / counterparty risk/ business interruption / political risk / CER price-volatility risk / natural disaster / technology risk / CER quantity risk.
6. Securitization of CDM projects: as several funds already exist that are focusing on climate change and energy matters, it is plausible that such a fund could be dedicated in the future to urban development CDM projects. Some portfolio management investment network sites being already present on the web, a social network platform might consider going in a similar direction, although dedicated to ‘carbon’ related projects. This would greatly help leverage said dedicated funds by getting additional participation from the network.

b. Miscellaneous:
1. Footprint evolution: a link with a repository in the like of the Carbon Disclosure Project  www.cdproject.net) might prove useful in order to track cities initiatives and results.
2. Empowering charity fund collection in emergency cases related to natural disasters.

2. Tools for inhabitants
a. Resources management/benchmarking
b. ‘In house’ trading of carbon credits
c. E-learning
d. Profit sharing and redistribution

This part will be further developed in a future post.

So far, the only alternative to Cap & Trade schemes seems to be plain taxation of emitted GHG’s.
Still, there are several problems associated with taxes:
- An expected tax might simply be included in the production price, hence potentially triggering inflation and generating immediate windfall profits for the emitters.
- Choosing and measuring emissions subject to taxation could also prove a difficult issue when it comes to myriad of small businesses (scope, baseline, sector comparison, benchmarks)
- Another consequence is that such taxes may double existing taxes, for instance excise on fuels, or more generally VAT on any consumable. Hence, curbing consumption by this means might eventually compound into less public revenues.
- Although apparently straightforward (the polluter is the payer), taxes may also trigger escape behaviours, hence generating carbon leaks.
- Carbon taxes also pose the problem of a fair re-using of the levied amounts.
All in, carbon taxes may very well end-up in making the poorest cleaner (and poorer) while the wealthiest would either simply do with the additional burden or shift their activity under less demanding skies.
A third way might however exist, which would incidentally cope with those critics: encouraging greener behaviour and investments through tax immunity.
Indeed, such a system – the Tax Shelter – already exists in Belgium for the sake of supporting the (not too profitable) movie industry. The basic idea is for any company to invest a proportion of its annual profits in said industry, with the benefit of immunizing 150% of the invested amounts for the final computation of its taxes.
Such a system applied to carbon reduction investments would indeed constitute a clever alternative to plain taxation or even to Kyoto’s flexible mechanism. The latter is indeed often confronted to the growing difficulty of identifying the real additionality of the projects benefiting of the system, making the generated carbon credits sometimes disputable.
A well designed Tax Shelter scheme would encourage businesses to dispose of part of their profits for the sake of selected environmental projects and create solidarity at national and European level between mature businesses and developing/not yet profitable green ventures.
This by the way would also solve the problem of national subventions, usually badly perceived by the EC for obvious competition distortion reasons.
Needless to say, should such a system be promoted, it will be the subject of political initiative and dedicated legislation.

Since the financial crisis stroke some 18 months ago, substantial discussions have taken place both on Climate change and on how to globally save the financial industry, albeit few have tried to link both themes.

Consider the financial crisis as a result of a chain reaction triggered by such key elements as the massive facilities once granted to the real estate market in the US combined to the transformation of those credits into tradeable securities – the subprimes – and the use of those (at the time) hugely liquid instruments by banks as a collateral into their funding operations, through Repo’s operations. The very disappearance of this liquidity is what actually helped interbank funding grounding to a brutal halt.

Consider, on the other hand, the still emerging market of offset transactions under Kyoto’s flexible Clean Development Mechanism (CDM). Whenever an Annex I country decides to invest in a certified CDM project, it can expect a certain amount of carbon credits to be generated by this project at a certain date in the future, or over a certain operating period. Those carbon credits, referred to as ‘primary market’ carbon credits, can then be traded on financial exchanges, albeit usually at a discount against EUA’s reflecting the relative uncertainty associated with their future existence.

So basically, one invests in a particular project and expects returns under the form of future tradeable credits. This is actually very close to lending money and expecting reimbursements in the future.

Considering at last the huge money transfers at stake in climate talks between Annex I and non Annex I countries, there is a reasonable chance that a fair deal of those will be made via offset programs. The logical next step will then be for senior banks to issue tradeable securities backed by those carbon credits – genuine Asset Backed Securities (ABS), thus – hence generating an alternative investment vehicle that could eventually as well be used by banks to fuel their funding operations. QED!

This post attempts to see beyond the Climate change emotional ‘layer’ and tries identifying the basic mechanics at stake in Copenhagen talks.
Let us start with CO2 emissions, representing the biggest part in volume of designated Greenhouse gases (GHG’s). Considering our biosphere as a closed container, all potential CO2 is already present in one form or another. It is thus the rhythm at which it is released in the atmosphere (by human intervention), prior to being absorbed or recycled again, that may influence the global climate equilibrium. In financial parlance this is referred to as maturity transformation, or playing different durations against one another. Under Kyoto, these anthropogenic emissions have been quantified and translated in value terms, in effect creating a genuine economical lever with which regulatory authorities can play at will to influence not only climate change but where to put economical efforts and how to finance it.
To that extent, cap & trade schemes being so far based on grandfathering principles, they actually provide the industry with the possibility to trade emissions they will have to curb over time, hence providing them right now with a cost of carry advantage. The time to maturity will then enable those industries to improve their value chain, making them less dependent on fossil energies, thus leading to less GHG emissions. Indeed, as long as an industry is not in a position to control this dependency, it faces substantial risks of energy supply scarcity, turning out into potentially rocketing prices for the whole value chain. Consumers might as well not be willing to indefinitely cough up more money for products/services that are not deemed essential. The timeframe for accessing/using this (still cheap) fossil energy is of course what is really at stake for all nations, especially if put in perspective with the marginal cost associated with making  the whole value chain greener.
One can thus see the whole concept as an alternative way to finance economical development/ recovery, to be compared for instance with military investments or state subsidies being merely injected into legacy industries.
Combined with the offset possibilities under Kyoto’s Clean Development Mechanism, this should as well further develop funds/technology transfer towards non-Annex I countries, which probably explains why non-Annex I countries are now so pushy about even more ambitious global emission reduction targets.
So by defining a global GHG emission envelope complete with its planned reduction over time, cap & trade schemes, offset mechanisms and exchange trading platforms, one has actually created a virtual asset repository, for which all stakeholders are now fiercely negotiating to get a fair chunk of.
One should also consider that, historically, international monetary policy and inflation control was done by referring to a gold standard. As such, all countries were detaining and managing gold reserves in order to stabilize their currency.  Yet, since the end of the Bretton Woods system – following Mr. Nixon administration’s abandoning of the dollar/gold parity in 1971 – the US Dollar became in effect the reserve currency of the world, resulting in other economical powers being somehow deprived of their free monetary will, or at least less independent.
The next step could than well lead to the general adoption of a new gold standard, namely a carbon standard, the t CO2e (tonne CO2 equivalent, or rather the potential to spare it). This new ‘reserve currency’ could then enable all economies to henceforth compare their added value (reflecting their fight against fossil energy dependence), without being linked to a particular currency. As this t CO2 e unit is quoted on specialized exchanges it now has a universally recognized market value. Hence, current talks are somehow equivalent to sharing out gold (carbon) reserves between nations. Of course, in contrast with actual gold reserves and their physical limitations or with the US Dollar being exclusively managed by the US  Federal Reserve Bank, the size of such a carbon repository can be adjusted (read negotiated) more or less at will, albeit only through international consensus…in the like of Copenhagen talks.
Should all this prove being more than sheer fantasy, than why not imagine the World Bank acting as a central reserve bank, with the IMF adding offsets to its panoply of development and support tools?

One key point associated with a Cap & Trade scheme is that concerned corporations are actually in a position to trade their granted envelope of allowances on specialized climate exchanges (Bluenext or ECX). Obviously, this is what happens in most cases, leading to some bearish pressure on the ETS spot valuation, mostly at the beginning of the review period. Now, since those allowances will need to be bought back again at the end of the review period – in order to remain within the cap – corporate treasurers mainly go for a hedging on the ETS future markets. Well, this makes certainly sense, albeit it could be less interesting from the tax perspective since selling an asset that one received for free just translates into as much realized profit. And although there will be a repurchase in the future, the two operations are not linked. The strange thing about this is that EU allowances are actually equivalent to a commodity (tCO2e). And looking at more mature commodity markets, a complete range of structured ownership operations have been devised in order to meet the demand of hedgers and investors. Take for instance the well known ‘Repurchase agreement’ (Repo): usually a transaction where a seller of an exchange quoted asset (bond, commodity) immediately agrees to buy-back said asset on an agreed date in the future, at a price determined by the cost of carry on the period for the buyer (equivalent to an interest rate). This type of transaction bears a lot of advantages for both parties; for one it constitutes an easy way for the selling party to ‘borrow’ cash against a natural guaranty (the asset), hence at a lower rate. On the tax side as well, as the Repo is considered a two-legged single transaction, the taxation normally only applies on the differential between the selling and buying-back prices (or the interest), which of course represent a much lower amount.

Now for commodities and aside Repo’s there are plenty of other possibilities, like Cash and Carry transactions or Total return Swaps for instance. And although those are quite common stuff for others commodities, it seems banks are still reluctant to develop such a market for carbon allowances and/or credits right now, despite all conditions being reunited. Something to expect in a near future?