The Taiwan Banker

Carbon trading has been hot topic recently, but the opinions differ widely, causing many businesses to feel at a loss. This article introduces some mainstream international norms. Under the Climate Change Response Act, carbon credits can be divided into two types, in accordance with the timing of the government’s greenhouse gas policy: reduction credits and emission credits. We are currently in the first stage. Officially, Taiwan’s credits are called “reduction credits.” If a company’s reduction performance exceeds the requirements, it can apply to the Environmental Protection Agency (EPA) for issuance of a reduction credit in accordance with the voluntary reduction provisions. This has been done for many years. Of course, the EPA’s review procedures are rigorous, requiring that the applicant plans to comply with greenhouse gas reduction methods and meet “additional” requirements. Put simply, required actions do not qualify; the company must exceed the government’s requirements before applying. In addition, these applicable carbon reduction actions must not happen naturally, and require credits as incentives in order to be done. In addition to domestic carbon credits, the government will also create international-quality carbon credits and allow them to be traded on a soon-to-be-established carbon exchange for domestic use. What can be offset through carbon credits, and how? At present, many companies disclose their net-zero carbon reduction or carbon neutrality goals in their sustainability reports. In fact, most companies find it difficult to achieve net zero emissions on their own, and must rely on external reduction. Therefore, in addition to striving to reduce their own emissions, businesses can also purchase carbon rights to offset external emissions. For example, in the past, a certain industry's emissions were 100,000 tons. After process improvements or use of clean energy, emissions are 50,000 tons. Thus, 50,000 tons of credits can be purchased in exchange for declaring carbon neutrality. In addition to introducing a carbon tax, the Climate Change Response Act passed at the beginning of this year also stipulated that for credits purchased abroad, a certain percentage of taxes can be deducted if the credits meet the regulator’s requirements. This system is controversial, and may be the greatest concern of many businesses. Foreign carbon credits can be divided into two types: private voluntary credits and statutory or Kyoto mechanism credits; the Act does not clearly stipulate which one it refers to. This is probably intentional in order to maintain flexibility. However, only Chile and Colombia allow private voluntary carbon credits to offset carbon taxes. Singapore’s current carbon tax rate is S$ 5 per ton. After the tax is eventually raised to S$ 25, voluntary credits can be used to offset 5% of emissions. Later, Singapore expects to increase the tax to S$ 50-80. In fact, when the price of carbon credits is higher than the tax rate, no one will use credits to offset the tax. Therefore, this system is designed to reduce the burden of carbon taxes on businesses. Previously, some domestic businesses hoped that the government would coordinate with the EU to offset emissions with credits in order to reduce the burden the domestic industry after the EU implementation of the Carbon Border Adjustment Mechanism (CBAM). But now that the EU has announced the CBAM calculation method, taxes cannot be offset by carbon credits. The purpose of CBAM is to allow goods imported into the EU to bear the same carbon pricing as local products. Because the EU is the country with the highest carbon emission costs, many high-carbon emission industries have been relocated to countries that do not have to bear the carbon costs, causing the companies remaining in the EU to face unfair competition. The purpose of CBAM is to level the playing field, so allowing carbon credits to offset taxes would undermine its original purpose. In addition, international voluntary carbon trading and allowances are two independent systems. The statutory carbon management mechanism does not accept private voluntary carbon credits, but businesses can voluntarily use statutory credits to declare their own neutrality. Functions of carbon trading It must be emphasized that emissions trading does not directly reduce emissions, but rather aims to achieve a country’s emission targets with minimal social cost. In other words, after setting a national emission reduction target, targets are first allocated to each carbon-emitting business, who will be allocated a certain allowance according to various conditions. Companies that do not use them can sell them to those that need them. However, the total amount that the entire society can emit is fixed, and is reduced according to national targets which are lowered each year. Since each company has different carbon reduction costs, if those with lower costs reduce more emissions and then sell their credits to those with higher costs, global emissions do not increase, but the overall social carbon reduction cost will be reduced. Observing past experiences, exchanges are only active when the government implements a cap & trade system. With only allowances and carbon credit trading, the exchanges are mostly deserted, and thus often provide additional consulting services related to carbon reduction. In other words, the establishment of a carbon rights exchange is only the first step; further challenges are encountered when ratcheting up carbon reduction. In 2022, IFRS released the draft S2 Climate-related Disclosure standards, which only stipulate that companies disclose their original carbon emission data before offsetting. If they want to further claim to be carbon neutral, they should carefully choose high-quality carbon credits to offset their emissions, and not confuse them with their internal reductions. Carbon credits cannot be used to obscure emissions However, the official standard published on June 23, 2023 specifically regulates the use of carbon credits. This corrects the frequent past abuse of credits, having even been reduced to a greenwashing tool. IFRS S2 stipulates that enterprises must disclose their original emission data if they do use carbon credits; they cannot be used to obscure true emissions. In addition, the integrity and reliability of credits must be clearly explained, and companies must explain whether the source is nature-based or technological carbon removal. IFRS S2 stipulates this so tirelessly mainly because many companies now aim for net zero. However, most ordinary companies cannot rely on their own reduction to achieve net zero, so they must use carbon offsets, achieving net zero only on the books, not in substance. Therefore, society should pay more attention to internal reduction, and credits should only be an auxiliary last means, otherwise the world will never reach net zero. In addition, many question the quality of carbon credits, and their excessive issuance is why they are often ridiculed as indulgences. Therefore, the US Securities and Futures Commission (SEC)’s corporate carbon disclosure requirements and the Science-Based Targets (SBTs) also maintain the same position and regulations as IFRS S2. Returning to the original meaning of carbon pricing In fact, the purpose of either emissions trading or a carbon tax is to make people feel the responsibility for carbon emissions. This is a core indicator for measuring carbon reduction efforts, not only affecting the incentives for carbon reduction, but also determining whether carbon reduction equipment can be popularized. The initial cost of capital investment is high, so no reasonable carbon price allows emitters to bear the corresponding cost, then no one will adopt the new technology. Therefore, when the government implements any carbon management system, it should avoid distorting the pricing, or creating space for arbitrage between different systems. The government must be as cautious in issuing carbon credits as when the central bank issues currency, because each ton of issuance means that someone can legally emit carbon. Credit issuance must be less than the actual reduction. Otherwise, not only will emissions get even more out of control, but the credits may also become as worthless as hyper-inflated currency. In the past, some voices criticized the government for being inactive in promoting carbon trading, affecting the incentives for carbon reduction. The fact is that people have many ideas for emissions reduction, but it not yet clear whether these ideas have substantial practical emission reduction potential, so companies are eager to apply for credits in the meantime. Nowadays, the market contains a lot of exaggerated and false advertising hype, and many businesses worry about carbon emissions. However, some are anxious about missing out on clever ways to avoid emissions costs, or of bearing higher emissions costs than their peers. In fact, the risk of out-of-control warming is more worthy of our anxiety. Failure to master advanced carbon reduction process technologies and lack of competitiveness in carbon emission efficiency may prevent companies from surviving into the future. Governments’ emission requirements will get stricter, and the price of carbon will get ever higher. At the same time, consumers will focus on low-carbon products, and demand for high-carbon products may disappear, never to return. The author is the sustainable finance head of TABF