Introduction
In a series of green standards and guidelines issued recently by the State Council and central bank, China has reaffirmed the role that carbon markets will play in its carbon neutrality transition. These markets include carbon sequestration. This is welcome: science affirms that as much as one-third of global climate mitigation outcomes can come from carbon sequestration.
Markets can help. Private sector financing that contributes to conserving and restoring forests and other ecosystems enhances the wellbeing of people, and creates new economic opportunities through new green wealth assets can generate badly needed conservation financing. There’s no question more effective financing is needed to protect forests, halt deforestation and advance ecological restoration. Evidence from the World Meteorological Organization Showing the Amazon basin has shifted from a net sink to a net source of carbon emissions underscores the urgency of leveraging public and private financing to stop deforestation.
Carbon sequestration markets are surging. Estimates by Ecosystem Marketplace show a 60% jump in the value of carbon markets during the first eight months of 2021, reaching US$748 million. They are on track to hit a cumulative value of US$6 billion soon. Trades in carbon sinks have taken place in some 80 countries: most buyers are from companies located in OECD markets, while most of the market supply originates in tropical developing countries[1]. The first report of the Taskforce on Scaling Voluntary Carbon Markets anticipates that carbon offset markets could exceed US$50 billion by 2030.
Such growth leaves little doubt that markets are keen to monetize, invest and trade in carbon offsets. Unfortunately, the same markets are far less adept in valuing ecosystems beyond their carbon densities. As the 2021 Dasgupta report concluded, ecosystem values are immense but require reforms in measurement practices like economic statistics, financial accounting, and performance auditing. Such standards and rules are especially important to ensure the quality, integrity, and transparency of carbon sequestration markets. Such standards are needed to do no harm to wider ecosystems, support local communities, and stop greenwashing.
China has long supported local carbon sequestration projects and markets. Building on years of Clean Development Mechanism (CDM) project finance, the China Certified Emission Reduction Exchange (CCER) has been operating as a voluntary certified carbon credit exchange mechanism for several years.
Four documents issued by the China State Council and the People’s Bank of China in late October and early November 2021 are important to formalize the detailed rules and standards to scale-up carbon sequestration finance. The State Council’s Climate Plan identifies ten priority sectors and areas, of which carbon sequestration is one pillar, that will drive carbon peaking and carbon neutrality goals. That Plan confirms that ‘the market mechanism is the key’ towards carbon neutrality, and that ‘carbon sink trading’ will be part of the national carbon market.
The People’s Bank of China issued detailed standards requiring mandatory climate risk disclosure. This is an important step, by codifying earlier voluntary practices largely based on TCFD recommendations (to date, TCFD standards have been adopted by six of China’s leading banks.)
In addition to their important details about the coverage and practices of mandatory reporting, PBOC standards also send an important signal that China’s green financing standards will continue to be comparable and interoperable with emerging international green norms. For example, China’s mandating climate risk disclosure rules complement the June 2021 G7 promise around mandatory reporting. In a further signal of standards convergence, the first report of the China-European Union working group on Green Taxonomies was issued in early November 2021, identifying specific areas of common ground between Chinese and EU green taxonomies.
Each of these policies is immensely important. Together, they help set the foundations, principles, standards, and rules of China’s carbon market system. While the main focus of PBOC green standards involves tools like stress testing, estimating the carbon footprint of operational and asset holdings, scenarios, and other tools to disclose in real-time climate risk information, both the PBOC and State Council documents also emphasize the emerging market opportunities of green investment financing. If it is notable that the China-EU Green Taxonomy report identifies forestry and ecosystems as a ‘high priority’ green asset investment opportunity.
Scientific Integrity:
To date, investments in forestry and other ecosystems are the main focus of carbon sequestration markets. The October 2021 State Council Guideline is helpful in identifying which ecosystems are subject to carbon offset markets, as well as the sequence of financing. Guidelines emphasize the importance of first stabilizing existing carbon sequestration services of forests, grasslands, wetlands, seas, soils, permafrost, and karst areas, and secondly, in expanding carbon sequestration functions through afforestation, returning marginal farmlands to forests and grasslands, and improving the carbon stocks of mangroves, sea-grass beds, salt marshes, and other ecosystems.
This priority on protecting existing forests and ecosystems first, before investing in large-scale afforestation or related projects, sends an extremely important signal to carbon sequestration investors that asset purchases need to be based foremost on science.
Science confirms that carbon densities differ widely among different ecosystems and their location. For example, among the highest carbon densities are mangroves and boreal, temperate, and tropical peatlands. Middle range densities comprise marshes, boreal and tropical moist forests, while lower range systems include grasslands and seagrass.
Differences become even sharper in carbon density recovery periods associated with afforestation, reforestation, and broader ecosystem restoration efforts. For example, tropical grasslands have the fastest carbon recovery timeframe of 19 years. By contrast, most tropical forests take 60 years to recover their carbon densities; marshes 64 years, boreal forests more than 100 years, mangroves more than 150 years, and peatland carbon recovery up to 1,000 years.
There is a risk that carbon sequestration credits derived from large-scale afforestation projects inspired by well-intentioned initiatives like the Trillion Tree Campaign may overstate the short-term value of carbon offset assets, thereby shifting financing away from the conservation of existing ecosystems, and towards investments in projects with carbon density recovery times far longer than carbon offset contracts.
The PBOC green standards covering green investment assets, under which carbon offset credits would fall, will require measurement of the ‘green effect of the issuance or operation of green-themed asset management products.’ Since experts in private finance are seldom also experts in conservation science, additional standards, safeguards, and guidance will be needed to assure these measurements are sound. Certainly, there is no lack of IPCC-based methodologies to measure carbon fluxes. But their application across projects can differ sharply.
The October 2021 State Council climate Opinion mandates the creation of a ‘complete, accurate, and continuous database’ to backstop carbon markets. This is immensely important in ensuring that carbon projects and markets are based on a common, science-based, and granular climate data system. This climate database in turn can provide more detailed technical guidance needed to estimate carbon offsets. One useful example in this regard is the 2019 EU Technical Report to its Green Taxonomy, which sets out accepted methods to calculate carbon sequestration baselines, flux estimations, the contribution of practices like sustainable forest management in conserving above, and below-ground carbon stocks, and other details. Similar technical frameworks are provided for agriculture and other systems.
Project Integrity
Just as green taxonomies are converging, so too should individual project safeguards align with multilateral norms and standards. The IUCN Global Standard for Nature-Based Solutions was developed for users largely outside of the conservation area, to ensure project outcomes are of high integrity from a social, environmental, and economic feasibility lens. The eight criteria set out in the IUCN standards, complemented by 28 indicators, should be the standard reference for emerging nature-based solution-oriented projects, of which carbon sequestration is one of the several outcomes.
It is notable that the first criterion of IUCN standards involves social inclusion, gender equity, respect of indigenous and other communities so that projects contribute to human wellbeing. Too often, carbon-offset deals have bypassed local and indigenous communities: recent reports for example suggest foreign recently investors purchased offset credits from two million hectares in Borneo, without proper consultation with people living in this area.
From China’s vantage point, this social dimension of green investments merits further work. The China-EU Green Taxonomy notes that two pillars of the EU taxonomy, Do No Significant Harm and social provisions like core labor standards, human rights, and other issues, have yet to be covered in a common green taxonomy. At the same time, that report notes the welcome contribution of the European Commission’s International Platform on Sustainable Finance (IPSF) and the UN Department of Economic and Social Affairs (DESA) to its ongoing work. An overarching conclusion of the September 2021 IPSF green investments report is the need for green investment projects to contribute widely to sustainable development priorities like health and safety, gender equity, inclusive workforce, human rights, and tackling corruption[2], thereby echoing IUCN standards.
In this context of ensuring carbon sequestration markets benefit local peoples, work by the Voluntary Carbon Market Initiative (VCMI) is especially welcome. In late October 2021, VCMI together with VERRA and others issued a roadmap to help ensure high-integrity, credible and transparent carbon sequestration markets.
Financial Integrity: Reporting and Accounting
A final aspect of high-quality carbon sequestration markets involves financial accounting standards. In theory, financial accounting ought to be easier than meeting scientific and project integrity standards. In practice, the proliferation of standardization and certification bodies with varying financial assurance and attestation standards has eroded confidence that carbon offsets are trustworthy.
The IMF counts more than 200 climate-related standards bodies. International examples include the SASB, CDSB, CDP, and IIRC, as well as GRI, PRI, Science-Based Climate Targets, the Impact Measurement Project, the Capitals Coalition, and international third-party certifiers like CICERO. Within China, certifiers like Zongcai Green Financing, China Quality Certification Center, and roughly 18 other approved entities exist.
This proliferation of expertise to support markets is welcome. A proliferation of divergent standards is not. Earlier this year, the International Organization of Security Commissions called for urgent action to improve the ‘consistency, comparability, and reliability of sustainability reporting for investors.
A welcome step in building conformity among standards comes from the IFRS Foundation. IFRS financial accounting standards based on its International Accounting Standards Board (IASB) are widely accepted worldwide, outside of the US (which uses GASS standards[3]). In the past year, the IFRS has been preparing to launch a new International Sustainability Standards Board (ISSB) intended to provide greater coherence around ESG reporting. The initial focus of ISSB standards will be the climate. Their finalization and uptake are years away, underscoring the need to continue using TCFD and IFRS-derived accounting frameworks as well as specific practices like attestation from the UN-based CORSIA framework.
Adopting common standards to measure the value of carbon sequestration asset holdings, their relationship to other company asset inventories and the development of commonly accepted practices and norms about the fair value treatment of offset assets can enable project and company auditors to verify offset claims made by companies.
Conclusion
CCICED will soon begin a new Special Policy Study on Nature-Based Solutions, building on earlier scoping work. Detailed international rules for carbon markets in specific areas like additionality, the avoidance of double-counting, and the permanence of offsets, have largely been settled at Glasgow. These rules can help China as its carbon market system advances to support complementary goals of carbon neutrality, nature protection, and broader sustainability.
[1] The big push behind this market growth is private sector climate pledges: the Energy and Climate Intelligence Unit and the University of Oxford estimates that one-fifth of the world’s largest companies have now made net zero promises. Offsets provide part of the pathway to meet those promises now and are expected to keep growing.
[2] In addition to noting the positive contribution green finance should make to multiple sustainable development goals, the IPSF report highlights other green finance attributes such as Do No Significant Harm, being science-based, the dynamic so as to be reviewed and updated, and being transparent and verifiable.
[3] IFRS financial standards are used widely in China, while senior Ministry of Finance and China Accounting Standards Committee members are active within groups such as the IFRS Taxonomy Consultative.