Voluntary Carbon Markets Are On The Rise

As corporations and countries plot their net-zero plans, carbon markets have become one of the most-talked-about components in the realm of sustainable finance. To hear more about this burgeoning corner of the markets, IncubEx Founder, President and COO Dan Scarbrough joins the show to share his insights. Dan outlines the growth carbon markets have enjoyed thus far, explains growing pains that have arisen and shares the details of a platform IncubEx is set to launch -- The Voluntary Climate Marketplace (TVCM) -- that aims to optimize the buying and trading process.


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Transcript

(Note: This transcript was created using artificial intelligence. It has not been edited verbatim)

Colin Hogan  00:14

Hello everyone and welcome to the Modern Money SmartPod. I'm Colin Hogan.

Sean McMahon  00:18

And I'm Sean McMahon.

Colin Hogan  00:19

Today, we're really excited to talk to Dan Scarborough, president and chief operating officer of IncubEx. Dan's gonna share with us some insight on how things are going in the voluntary carbon markets and the role IncubEx is playing in that sector.

Sean McMahon  00:33

Before we get to our talk with Dan, be sure you check out the episodes were released last week from the International Futures Industry Conference. We think those will provide a great way for you to catch up on all the hot topics from this year's FIA Boca, we actually bumped into Dan and the IncubEx team at the event. It was great to see him and we think you'll enjoy this conversation. So let's get to it. Hello, everyone, and thank you for joining us for this episode of The Modern Money SmartPod. I'm your host, Sean McMahon, and I'm joined by my co host, Colin Hogan. Our guest today is Dan Scarborough, the President and COO of IncubEx. Dan, how're you doing today?

Dan Scarbrough  01:12

Doing great. Yeah. Thanks a lot, Sean. Appreciate you having me on board today.

Sean McMahon  01:16

Great. We're looking forward to having an exciting conversation about voluntary carbon markets. But before we get into that, just spend a minute or two letting our audience know about who you are and what your team does at incube X.

Dan Scarbrough  01:25

Yeah, no, absolutely. And again, thanks. Thanks again for the invite to participate. Been in the environmental markets, myself now just over 15 years, started at a company called Chicago Climate Exchange. Working with Dr. Richard Sandor and Dr. Michael Walsh, were the co founders, they're going back to the early 2000s. And many of our team comes from Climate Exchange in many other leading brokerage houses and exchanges in the industry. Over time, Climate Exchange was acquired by intercontinental exchange ice in 2010. And I went over to ice and work there from 2010 to 2014. We formed inky Beck's in 2016, really, as a specialist, environmental product developer in the exchange space

Sean McMahon  02:11

Alrighty, so a lot of our listeners know that we've done a lot of episodes about sustainable finance, and topics of that nature. So let's dive into the voluntary carbon markets. What are the basics of these markets? And how do they function?

Dan Scarbrough  02:21

Yeah, absolutely. And Chicago Climate Exchange started as a voluntary carbon market around 2000, and ultimately grew to over 450 members 20 of the largest utility companies in the US, IBM, Motorola, International Paper. And really, at the time, in early 2000s. There were no compliance markets for carbon at that time, so everything was voluntary. And you know, since that time, we've had the European Union emission trading program go live in 2005. We've had the California cap and trade program as a compliance market in North America along with the Regional Greenhouse Gas Initiative in North America as well. So really, you have compliance markets that have spread in geography, about 10%, just to use a rough number of global emissions are covered under compliance markets. And voluntary markets have really, you know, as I said, been around about 20 years or more in some cases. But generally speaking, these are privately financed, developed projects that reduce or mitigate greenhouse gas emissions of some variety, some kind of technology, some are nature based. And so there's really a wide array of these projects that are issued and tracked by major registries. And right now there are about four leading registries, but many others out there.

Sean McMahon  03:43

Okay, Dan, real quick, can you give our listeners just the basics on the difference between compliance markets and voluntary markets.

Dan Scarbrough  03:49

So generally speaking, a compliance market is going to be set by a government or government agency. And so in the case of the US, that could be the US Environmental Protection Agency that would implement a market based mechanism to address a specific environmental issue could be the state of California through something like a b 32, where you had cap and trade program, and many other accompanying environmental programs that went live dating back to 2006. And so these are really state, federal government and in some cases, international linkages that are created to create these market based mechanisms to address an environmental issue, in this case, greenhouse gas emission. So the compliance market is generally set by a government or government agency, a voluntary market. Generally speaking, these are private finance projects. These are run by third parties, in many cases, nonprofit registry providers that are issuing these projects, setting methodology setting protocols that govern the creation of these voluntary offset credits.

Colin Hogan  04:57

So then what's participation like in the voluntary party Carbon markets right now, what kinds of entities? Are you seeing the most get involved with that?

Dan Scarbrough  05:05

Yeah, it's interesting, because, you know, as I mentioned, the the compliance markets, you know, there are some stats that were put out recently, I think even by ICE, that about a trillion dollars notional traded in compliance markets last year in 2021. In the same year, ecosystems marketplace, which is really a leading kind of trade reporting and advisory service. And the market has indicated that voluntary carbon transactions were about a billion dollars in notional in 2021. So there's still a very wide gap between transactions and compliance markets and voluntary markets. That being said, you know, the participation in the markets consists of project developers, banks, hedge funds, physical energy trading companies, utilities, oil and gas majors, really a broad mix of in other industrials as well. Brokers play a key role the intermediaries, your your ICAPs evolution markets, BGC, those kind of firms that intermediate trades in the market as well. And so, you know, you really do see a very wide range of participation. And, you know, based on the private netzero commitments, we would expect that that billion dollar of transaction value in 2021 would would be looking to grow over the next, you know, five to 10 years.

Sean McMahon  06:23

And speaking of that growth last November, in and around cup 26, we heard a lot of talk about carbon markets, right? Voluntary Carbon markets, compliance markets, and things like that. So tell us why these markets are so important to the future of sustainable finance?

Dan Scarbrough  06:36

Well, you know, it's it's a very interesting dynamic from the standpoint that we do expect many more compliance markets to come online in new geographies, new industries, to be covered by compliance markets, but just let alone your just by the sheer number of companies that privately are taking net-zero commitments 24/7 renewable commitments, really just a very, very increased focus on sustainability generally, for those markets and kind of those commitments to be met. We're gonna need to see the voluntary carbon markets in particular, and the voluntary rec markets and other voluntary environmental commodities grow significantly. And that scale on the voluntary markets is underway as we speak. Some of that is really predicated on how these credits are tracked. In many cases, compliance markets and voluntary markets are not mutually exclusive as well, where you have compliance instruments and some states or geographies, recs, carbon certificates that are also purchased for voluntary sustainability commitments.

Colin Hogan  07:44

So with compliance markets, we know that there are several of these across different jurisdictions, are there any that you think do it better than others? What's an example of a jurisdiction that set up compliance markets? Well?

Dan Scarbrough  07:56

Well, the longest standing environmental program, really is the acid rain program, going back to the mid 90s, for the reduction of ESA to emissions. And that really was the poster child in many ways for cap and trade programs and compliance markets that really set a cap on emissions and a market based mechanism to reduce greenhouse gas emissions. The European Union emission trading program is by far and away the longest standing going back to 2005 covers the largest footprint of emissions, about 1.6 billion tons of co2 are covered currently, under the EU emission trading program. Just to put that in perspective, the California cap and trade programs, about 500 million tons that are covered, and that's the second largest. So you know, the EU ETS is the longest standing market on the compliance side. You've got two regional programs in North America and California. And the Regional Greenhouse Gas Initiative. Reggie, as many in the market would first refer to it as you have cap and trade programs in New Zealand, South Korea, a number of developing markets around the world, but by far and away the EU ETS is the largest at the moment.

Colin Hogan  09:10

And so in terms of accomplishments and what the world gets out of these, I mean, what do you think these markets are doing a good job of accomplishing right now?

Dan Scarbrough  09:18

Well, generally speaking, I would say that environmental markets and market based mechanisms are good at attracting investment capital to the market that allow for the increased project, you know, sort of innovation in the space, new technologies, new projects that are going to be greenhouse gas, reducing or capturing in some way. And we're really seeing that innovation before our eyes at the moment with things like carbon sequestration and other technologies that are evolving on a rapid scale. And these market based mechanisms, generally speaking, as well have had a very strong track record of success in addressing these environmental issues. Use at the lowest cost and, you know, penalties in many ways. If you look at a taxation, structure versus incentives that you have in these market based mechanisms of putting a finite cap on emissions, you actually have, you have that certainty, you have the certainty that the emissions will not exceed the cap. And so it's a slightly different way of looking at things if you look at a tax versus a market based mechanism. And really, those are more incentive based, you know, market based mechanisms that bring in new participants, new capital, to the markets, which is really critical to to scale, and really to achieve the environmental objectives and accelerate those objectives.

Colin Hogan  10:39

So as someone who's worked so long in carbon markets, what do you think could be improved about them and how they currently function?

Dan Scarbrough  10:47

So from our perspective, you have to really take a look at the infrastructure that surrounds the markets. And that goes all the way down to how our credits created, how are they tracked? What is the verification methodology? In the case of an offset? Really then go to okay, what is the trading infrastructure? What is the market infrastructure? And do you have best in class infrastructure that's available generally to the financial markets and the broader commodity markets? Do you have that infrastructure in the environmental markets and in the voluntary offset markets? And I think the answer to many of those questions are no, that that infrastructure is not there. At this point, for the proper scale. There are many private initiatives underway to do that many, many government initiatives to create a more credible way to track these credits, you know, deal with things like invalidation risk, some of the inherent risks that you have in dealing with, you know, voluntary offsets. And so, you know, really, I think, the infrastructure all the way down to the tracking of certificates, how they're traded the regulatory structure, the oversight of the markets, you know, having government oversight and regulator oversight in the case of, you know, like the Commodity Futures Trading Commission, CFTC, when these become futures contracts, as opposed to OTC markets that have no regulatory oversight, or very little regulatory oversight, really a multi pronged situation, with respect to what it's going to take to properly scale these markets. But but most of it, in our view, kind of relates to the market infrastructure that is available.

Sean McMahon  12:26

What are some of the other pain points or things that need to be fixed? You know, I was doing some reading and advanced the show, and I saw a few stories about how, you know, the rights of some of the local people, right, you got these, you know, carbon credits that, say, a forest in some faraway country, local indigenous people there, you know, they have rights to that land. And so there's questions being raised about whether they're being taken care of via financially or just being physically protected. Are there any kind of safeguards in place for that?

Dan Scarbrough  12:50

Yeah, absolutely. I think if you go back even to the Chicago Climate Exchange days, we had many offset protocols that were developed under that program, and it was a member based, you know, approach where we were a private market, private company that was operating the CCS market. And in many ways, you know, relying upon things like an offsets committee, a trading committee, and a member based approach to trying to develop these protocols. And, you know, over the course of the last 20 years, many of these protocols have been refined greatly from where they started. And, you know, I think having the right arm's length relationships, and the right independence, oversight, verification are key. And I think the registries have done a nice job of that and setting up, you know, really protocols that have been, you know, publicly vetted, vetted by project developers vetted by market participants over the years and continuous improvement, you know, kind of cycle and it depends on which project you look at, the risk profile is gonna be very different. And so, you know, there's always inherent risk in dealing with offsets, you know, putting the right tools in the hands of participants to really evaluate what those risks are. And if you look at an ag, you know, an ag methane digester capture project at a dairy farm versus a forestry project, the risk profile is going to be very different, but these credits are issued in the registries, really on a carbon, you know, co2 equivalent basis. And so whether you have a one tonne certificate for a forestry project, or a one ton carbon equivalent for an ag methane project, that's still one tonne of emissions that you're getting a certificate for. So, you know, allowing participants to take a look at the registry standards, the protocols, the geography, verification documents of the project, all the different factors that go into making these investments in carbon offsets and not only investments if you're buying carbon offsets, to meet a sustainability commitment as a corporate, there's inherent risk as well. reputational risk. You need to really take a look at what you're buying And there are many people, I think out there in the market that, you know, the interest level in voluntary offsets is at an all time high. I mean, I don't think there's any disputing that we had a hard time I think getting people to pick up the phone, and even answer a phone call at Chicago Climate Exchange 1520 years ago, and that now, there are many incoming phone calls. But with that being said, you know that there are many attempts to make a complex issue very simple. And that is just not the current reality of of the voluntary carbon market, in our opinion.

Sean McMahon  15:32

So what kinds of things are you and the team at IncubEx working on to perhaps enhance these markets,

Dan Scarbrough  15:37

as I said, you know, kind of generally, our focus has been really on innovating new products, developing new solutions for the environmental markets specifically. And so we've launched a number of futures contracts with our partners at E X group, and nodal exchange in the US, these are regulated futures contracts, you know, which are now the broadest set of environmental contracts on any exchange, and a really nice achievement, not only for the IncubEx team, but also for our partners that IEX group, and Nodal Exchange. These are carbon allowance contracts, these are renewable energy certificates. These are renewable fuels contracts, in the case of the federal renewable fuel standards and the red markets in North America. And all these markets have their own unique challenges, all the way down to the infrastructure of how they're tracked to how they're traded. But generally speaking, we've had kind of a mission that and sort of a viewpoint that the only way to really see these environmental markets scale, and attract the right participation, bring in the flow of investment capital, is to have the right infrastructure in place. And so we play a role in trying to accelerate, you know, the the development of these products, and each market has its own solution. So we've rolled out many of these futures contracts, in the case of Recs, in the case of carbon. And then we're also working on an initiative called the Voluntary climate marketplace, that will be a platform for trading specifically voluntary offsets in a very bespoke more over the counter fashion.

Sean McMahon  17:15

So how is that platform going to function, The Voluntary Climate Marketplace.

Dan Scarbrough  17:19

So we entered into a partnership with Trayport, to develop this voluntary climate marketplace, and Trayport. We've known for many years going back to, you know, the days that climate change and ice and tray port has always been one of the leading ISV providers, or one of the front end providers, a broker trading platform as well. That really is a great aggregator of markets, across exchanges across brokerages. And really that aggregation, and being one of the leading energy trading platforms globally with, you know, over 6000 traders, on the Trayport platform really gives a really unique distribution, you know, to the broader energy markets. And so we work with trade poor to develop this voluntary climate marketplace, which we thought, you know, mutually between us and trade port, that we had a good team of product developers on the IncubEx side, a good domain expertise in the environmental markets. And they had a great piece of technology and a great distribution in the energy market. So we've really developed the voluntary climate marketplace to be a platform for the matching of offsets and other bespoke environmental attributes. It really in a transparent, you know, marketplace, a level playing field, very market, neutral platform, and open access to those that want to participate in the marketplace. And, and as I said, from a distribution perspective, from day one really made available to that universe of 6000 energy traders they have on that platform already.

Sean McMahon  18:52

So say I'm a corporate or a bank, or someone like that is looking to buy credits. What does that interface look like? For me, when I go into that marketplace? What's the look and feel of it?

Dan Scarbrough  19:01

Yeah, so you would, as a corporate, you can join the voluntary climate marketplace, you get access to the trading platform, you could, there are several different paths that you can use to come to the market, you could go to a broker that you have an existing relationship with, you can come directly onto the platform, and place a bid for this specific type of offsets that you're looking for project developers on the flip side of it, as well can be offering their projects on the platform. And you get really into a very granular level of okay, what are all the underlying attributes of this project? What registry does it come from? What vintage is it, you know, and what year was the offset created or issued? What type of offset is it? What kind of technology? Is it? A renewable energy project is a nature based solution? And really, there's such a broad range of credits out there. But one of the keys to the platform is allowing buyers and sellers Have offsets to express those preferences they have and really to evaluate exactly what the offsets are that they're buying.

Sean McMahon  20:07

So when is this marketplace going to be up and running? Or is it still in development?

Dan Scarbrough  20:11

So we're actually going live on the 25th of March. So it's coming up here pretty soon.

Sean McMahon  20:17

Oh, okay. Yeah. So coming up right around the corner here.

Colin Hogan  20:19

So Dan, one thing we like to ask all of our guests here is if they have any bold predictions for the future, so I wanted to see where you think the size of this market will be in, say, five or 10 years?

Dan Scarbrough  20:31

Yeah, that's a really good question. Yeah, I think we're, we're better students of where things have come from and kind of market history, then. We are predictors of the future, but I'll try to try to dust off the crystal ball bit here. Give you a couple of observations anyways, maybe some predictions, but where we've come from looking at open interest as one proxy just said, the regulated futures markets on environmental commodities generally, we see record highs and open interest of over 3 million contracts across exchanges, in carbon markets, renewable energy certificates, renewable fuels, things of that nature. Of that over 3 million, less than 50,000 of those contracts are voluntary in nature, or primarily voluntary driven either voluntary offsets, or in the case of nodal exchange in our partners there, you've got about 30,000 contracts of open interest in Texas CRS are Greenie eligible wrecks that are primarily voluntary in nature. And two years ago, that was zero. So there was zero open interest, really in primarily voluntary instruments. You know, I think the trajectory is, is headed in the right direction, we're seeing a influx of participants, unlike we've ever seen, in environmental markets, I think, actually, ice commissioned a study not too long ago that pointed to, I think, over 800 participants. Now in the European carbon market, if you look at commitment, a trader reports the CFTC in the CCA market for California carbon, you've got well over 100 participants now in California carbon, you're starting to see you know, things like voluntary RECs on nodal exchange, show up on commitment, a trader reports now, you know, very promising developments that really show the breadth and kind of the scope of participation in the markets is really growing.

Sean McMahon  22:28

Anything else we need to look forward to concerning these markets? It sounds like there's a lot of runway for growth. But is there anything in particular you have your eye on?

Dan Scarbrough  22:35

Yeah, I think really a big, a big key here is really awareness of these markets, and the fact that really many of the audiences he go to whether it's, you know, something like the FIA, they're trying to really broaden awareness about environmental markets and sustainability ESG more broadly, kind of as a topic. But you know, I think the awareness for these markets and advocacy or you know, sort of the approach of market based solutions, to address these environmental issues, any forum that we can kind of get on to, you know, help spread the word on that and build a community of participation. I think that's really the key for these markets to continue to develop.

Sean McMahon  23:17

Alrighty, well, hopefully our show will kind of help raise that awareness.

Dan Scarbrough  23:21

Absolutely. And we really appreciate the opportunity to participate here and, and speak with you guys today. Really enjoyed it.

Sean McMahon  23:28

Thanks for coming on. 

Dan Scarbrough

Thanks, Sean. 

Colin Hogan

Thanks a lot. 

Sean McMahon

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