Should carbon credit ETFs count as ESG funds?

Responsible investing leader and founder of Carbon Streaming raise important questions to consider

Should carbon credit ETFs count as ESG funds?

Last month, Horizons ETFs and Ninepoint Partners managed to claim firsts in the Canadian investment space with the launch of two carbon credit-linked products: the Horizons Carbon Credits ETF (CARB) and the Ninepoint Carbon Credit ETF.

Both strategies offer Canadian investors the chance to participate in the growth of the global carbon credits markets. Amid the recent tightening focus on reducing greenhouse gas emissions and pressure on companies, including fossil-fuel firms, to reduce their carbon footprint, carbon credits have emerged as a desirable alternative asset class.

Carbon credits are a crucial piece of regulatory mechanisms aimed at limiting companies’ carbon emissions, which begs the question: can the newly launched carbon credit ETFs be considered as ESG funds?

“These ETFs are linked to carbon credit futures, which means they are a bet on the future growth of the carbon credit market,” says Dustyn Lanz, the former CEO of the Responsible Investment Association, who is now a Senior Advisor with ESG Global Advisors (pictured above, left).

According to Lanz, the carbon credit market is worth approximately US$850 billion today, and some analysts predict it could exceed US$22 trillion in the next 30 years. That rise, he says, will come on the back of a projected increase in both mandated and voluntary carbon markets, with the former being a venue for polluters to buy and trade the right to emit carbon into the atmosphere.

“So, do these ETFs provide investors with exposure to companies or entities that are driving down emissions? No,” Lanz says. “Does investing in these products actually reduce emissions in any way? No.”

However, the question of whether the ETFs fall under the broader umbrella of responsible or ESG investing is less straightforward.

Because they provide investors with exposure to a climate-related theme expected to undergo substantial growth in the coming years, Lanz says they arguably represent a thematic investment in a climate-related theme. However, he adds, the fact that the ETFs invest in carbon credit futures rather than in companies actively involved in driving down emissions means their impact should not be overstated.

The director and CEO of Carbon Streaming, which supports projects around the world that generate carbon credits by making a positive environmental impact, is also careful not to exaggerate the ETFs’ impact.

“The Ninepoint and Horizons ETFs are both ETFs that track compliance carbon allowance markets, broadly tracking the performance of the EU ETS, California Carbon Allowances, the RGGI and the new British ETS,” says Justin Cochrane, (pictured above, right).

Cochrane notes that both the Ninepoint and the Horizons ETFs offer exposure to carbon allowances from cap and trade programs; carbon allowances, in essence, represent the quantity of carbon companies in certain regulated markets are allowed to emit in a given year. That’s in contrast to carbon offsets that are produced from carbon projects that either reduce or remove carbon from the atmosphere, which are what Carbon Streaming invests in.

Because they don’t represent an active reduction or removal of carbon from the air, Cochrane says carbon allowances tend to have less of a direct impact than carbon offsets.

“That being said, the whole purpose of a cap and trade system is to reduce emissions over time by reducing carbon allowances each year,” he says. “So I would certainly argue that these cap and trade programs, of which the EU ETS is by far the largest, has a significant positive impact on the environment and in reducing emissions.”

From Lanz’s perspective, more questions must be asked about the merits of carbon credits. Do we know what price must be put on carbon to lead the world to net zero? Because of the lag between emissions and temperature changes, how can success be measured with precision? And given the need to drive down absolute emissions, is promoting 2,500% growth in the carbon market really the best solution?

But beyond those questions, there’s another reason why Ninepoint and Horizons’ carbon credit ETFs might, in the end, not pass some investors’ and advisors’ ESG litmus test.

“That [use of carbon allowances] only relates to the ‘E’ in ESG,” Cochrane says. “The Social and Governance is completely outside these cap and trade programs.”