Carbon offsets in credibility crisis warns Fitch

Voluntary carbon markets (VCMs) have been warned  they face a credibility test in 2023, with the development of insurance products seen as key to unlocking future markets.

In a report by Sustainable Fitch, part of the global rating firm, it warns there has been a noticeable increase in negative journalistic and industry participants’ reports on the quality of “many, perhaps most, carbon credits over recent months, as well as about the lack of quality control or additionality/leakage”.

It added the multiplication of standards, marketplaces and new services around VCMs are adding confusion to an already opaque market, which could erode confidence in those markets until best practices are well established. Attempts to establish standards are making slow but steady progress and should standardise VCMs and give them credibility in the long run.

“A key trend of 2023 and beyond is the heightened examination from investors and regulators of carbon accounting practices, net zero claims, and credible transition plans, and increased efforts from authorities to tackle greenwashing,” it added. “As a result, corporations could keep a cautious approach regarding offsetting, which suffers from a growing lack of credibility. Companies that wish to make credible efforts towards their net zero commitments are likely to reconsider or reduce their reliance on offsets in the near term and will need to focus to a greater extent on actual emission reduction within their operations and supply chains. This is likely to require larger investment than buying offsets. Those that continue to rely on low priced offsets risk a reputational backlash, and potential litigation as regulators increase their efforts to stymie greenwashing in 2023.”

Author of the report, Aurelia Britsch, senior director, Sustainable Fitch said the media have had a real impact.

“A condemning article published by UK newspaper The Guardian in January 2023 has stirred considerable debate among market participants and the general public,” she explains. “The investigation by The Guardian and other newspapers claims that 94% of the rainforest offset credits verified by Verra, the world’s leading carbon standard, are likely to be ‘phantom credits’ that do not represent genuine carbon reductions. Those ‘Redd+’ projects (Reducing Emissions from Deforestation and Forest Degradation) are among the most commonly used by companies and have been criticised on their actual effectiveness.

“The articles alleged that the projects’ underlying deforestation rate baselines against which the projects’ results are measured are not estimated correctly, leading to the over issuance of unjustified credits and to overinflated carbon avoided claims by buyers.”

However the articles have prompted several rebuttals by market participants.

Sylvera, a carbon offsets ratings provider, estimated in a 2022 study of over 85% of REDD+ credits on the market that 31% of them are high quality and have sound and credible baselines.

“While this is significantly higher than the 6% figure quoted by The Guardian, it still means that about two-thirds of this type of offset are subpar,” said Britsch. “Many other market participants have also defended the key role of VCMS to fund the conservation of forests, which are natural carbon sinks, at a large scale. There is seems to be a consensus that deforestation has been very low within REDD+ projects, regardless of the volume of credits based on them.”

The report added insurers can play a key role in stabilising the market and its risks for businesses.

“The development of insurance services to cover credit buyers against fraud is another sign of product innovation in the VCMs,” Fitch said. “It shows VCMs are slowly becoming more sophisticated. Insurance products could reduce risks for buyers.

“ International insurance broker Howden launched in 2022 a carbon credit insurance product providing cover to companies purchasing credits for third-party negligence and fraud in what the insurer said was an industry first. However, given the voluntary markets’ credibility woes, insurance services could be slow to pick up as they are likely to be associated with high costs.

“Insurance companies have been reticent to cover carbon credits given the range of risks associated with them, including the lack of data on past losses, weak legal systems in some of the large providers of projects.”