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Assessing Quality: the Nascent Role of Credit Ratings in the Carbon Market

Carbon markets have rapidly emerged as one (of many) promising solutions to climate change.

By allowing companies and individuals to meet their climate goals by investing in projects that generate carbon credits — like reforestation or energy-efficient technologies — much-needed capital is being driven to critical greenhouse gas mitigation efforts.

We’ve seen the popularity of carbon markets skyrocket over the past few years. With that kind of  growth and attention comes greater scrutiny — and that’s a good thing. As demand for carbon credits grows, so does the need for transparency and accountability in the market.  

One idea gaining traction looks at what’s working elsewhere in the world of finance — and in particular at one crucially important tool for evaluating the risk of investing in various financial products: credit ratings.  

Credit Ratings in the Carbon Market?

The independent assessments of credit risk provided by credit rating agencies — like Moody's, S&P Global, and Fitch Ratings — can have a significant impact on the cost of borrowing money or the perceived safety of a financial investment.

What role might credit agencies play in the carbon market? That’s already starting to take shape. As the market becomes more complex and diverse, credit ratings are being used to help investors evaluate the risk and quality of carbon credit projects.

Aspiration CEO Olivia Albrecht recently addressed the idea at the GreenBiz23 conference in Scottsdale, Arizona:

“[Credit rating agencies] are very, very important to the functioning of financial markets” in their role as “third party independent adjudicators of the quality,” she said. “The same thing’s got to come to the carbon credit market, with independent bodies that create rating systems for carbon credits.”

In the same way that not all bonds are priced the same or made the same, carbon credits can vary in quality and effectiveness. Rating agencies could prove essential in providing a measure of quality and transparency in the carbon credit market.

“Not all carbon credits are created equal,” Albrecht said. “Over the next three to five years, you're going to see more and more regulatory involvement in this asset class. And I think that's a super good thing.”

Diligence and Effort Still Required

Albrecht also emphasized the continued importance of investors and companies doing their own research on carbon credits — even highly-rated ones.

“That doesn’t mean we don’t have to do our homework,” said Albrecht. “Just the same way that at an investment house, even if you’re looking at a good credit rating, you still do your homework.”

The rating agencies provide a measure of comfort and help promote transparency and accountability in the market, but it’s ultimately up to individual investors to make informed decisions.

That means proactive due diligence on some of the same things the ratings agencies take into account — factors like the quality and transparency of emissions reductions, the project's additionality, the likelihood of the emissions reductions being sustained over time, and the project's overall governance and management.

That’s why Aspiration has a whole team of experienced climate and carbon experts dedicated to that kind of diligence and research, Albrecht explained.

“We’re looking to rewrite the standards and expectations of what is high-quality, and create our own standards across many different dimensions,” including independent assessments of a project’s methodology, permanence, leakage, and its environmental, economic and social impact, “and we apply those standards and expectations to all project developers.”

“It takes a long time to build carbon credit projects that generate carbon assets that are high quality, high impact, and high integrity,” added Albrecht. “It doesn't happen overnight.”

A Constantly Evolving Market

The use of credit ratings in the carbon credit market is still relatively new, and there are ongoing debates about the best way to assess the quality and effectiveness of carbon credit projects.

And just like any other investment there are risks involved, so it's important to use every tool available to evaluate the quality and transparency of the project before committing money.

But as the market continues to grow and mature, credit ratings are likely to play an increasingly important role in promoting transparency and accountability, helping investors navigate the complexities of the market and make informed investment decisions.

That can build much-needed trust and confidence in the market, and ultimately drive more investment in projects that can help to mitigate climate change.

“We're still evolving,” said Albrecht, “and will continue to evolve, as this marketplace gets better, with higher integrity, greater expectations, and better standards every year. We all collectively will continue to push this industry further and farther than we thought it could go.”

Olivia Albrecht is CEO at Aspiration, a climate finance company offering consumers, businesses, and investors access to a portfolio of high-quality climate assets. She was appointed to her role to expand and transform Aspiration’s market position as a leader in the carbon market industry. In her prior role as Aspiration’s Chief Sustainability Officer, Ms. Albrecht led the development of one of the largest and highest quality portfolios of carbon removal projects in the industry.

Before joining Aspiration, Ms. Albrecht spent 10 years at PIMCO where she was most recently Head of ESG Business Strategy leading a diverse and integrated team of over 50 investment professionals across departments and functions. She also helped lead PIMCO’s Global Fixed Income product strategy team representing $100bn assets with clients spanning Asia Pacific, EMEA and the Americas split across institutional and retail investors.