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Carbon finance

There are several ways for carbon buyers to source their carbon credits, one of them being to set up an investment vehicle that will finance emissions reductions projects or trade carbon credits. It responds to the demand from investors to have a professional managing their carbon offsetting (which is usually not part of their business), and to benefit from economies of scale, risk diversification, regulated vehicles.

Luxembourg: the centre of excellence for Carbon Investments Vehicles (CIV)

Following the introduction of the SICAR (Société d’Investissement à Capital à Risque) and SIF (Specialised Investment Fund) laws in 2004 and 2007 respectively, Luxembourg has become the place of choice to launch sophisticated investment funds which meet the specific needs of carbon finance (including the distribution of carbon credits in kind). A wide range of corporate vehicles in Luxembourg are suitable for structuring compliance or voluntary carbon investments including both regulated (SIF, SICAR, etc.) and unregulated (securitisation vehicle, commercial company, etc.) vehicles.

A major competitive advantage of Luxembourg, as a country of domicile, is the ability of the CIV to distribute carbon credits “in kind”, directly in the form of remuneration to the investors.

As a result, CIV investors may be carbon credit buyers, who, in return for their investment, receive carbon credits, traded directly through the CIV. They are therefore able to benefit from the reduction in number of intermediaries, the risk mitigation offered by an investment vehicle and the collective use of skills that a specialist carbon investment manager possesses.

The existence of appropriate investment vehicles and regulatory structures is further reinforced by the presence of a highly skilled and educated workforce, with experience in the carbon credit fund industry. The vast majority of the world’s financial institutions, law and tax advisory firms are present in Luxembourg, offering world-class services to a global client base.

Overview of Carbon markets

Carbon emissions trading is a way of reducing the greenhouse gases (GHGs) produced by polluters. For example, in the EU, there is a cap and trade system, where a limit (cap) is set on CO2 emissions and permits are given to emitters to release a certain amount of CO2. If a company exceeds its allowance, it has to purchase additional permits to cover the excess. If a company does not exceed its limit, then it can sell its unused allowances.

Emissions’ trading, or cap-and-trade, is a market-based approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants.

A central authority (usually a governmental body) sets a limit or cap on the amount of a pollutant that may be emitted. The limit or cap is allocated or sold to firms in the form of emission permits, which represent the right to emit or discharge a specific volume of the specified pollutant. Firms are required to hold a number of permits (or allowances, or carbon credits) equivalent to their emissions. The total number of permits cannot exceed the cap, limiting total emissions to that level. Firms that need to increase their volume of emissions must buy permits from those who require fewer permits.

The transfer of permits is referred to as a trade. In effect, the buyer is paying a charge for polluting, while the seller is being rewarded for having reduced emissions. Thus, in theory, those who can reduce emissions most cheaply will do so, achieving the desired reduction in pollution at the lowest cost to society.

However, a parallel market also exists, known as the Voluntary market, where the carbon credits exchanged are based on the will of one buyer to offset its GHG emissions without being obliged to. These credits are called VERs – VERs stands for Voluntary Emissions Reductions or Verified Emissions Reductions.

Useful links:

United Nations Framework Convention on Climate Change (UNFCCC)

European Union Emissions Trading Scheme (EU-ETS)

International Emissions Trading Association (IETA)

Updated on 12/02/13  
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