Green finance: Cleaning up in China

CHINA IS RENOWNED for its opportunism but it takes a special kind of entrepreneurial zest to make money out of your own pollution. In the curious world of carbon trading, China accounts for perhaps half of all credits traded with the west, as unseen utilities half a world away effectively pay to build wind farms and clean up freon plants the length and breadth of China.

China is at the heart of the clean development mechanism, or CDM. This is one of the key initiatives that came out of the Kyoto Protocol, and is aimed at reducing greenhouse gas emissions while encouraging sustainable development in emerging markets. The idea is that any company or institution can invest in greenhouse gas-reducing projects in the developing world, for which they earn credits that can be used to offset their own emissions, or be sold in the open market. These credits are formally known as certified emissions reductions, and are often called carbon credits.

In essence: build something beneficial to the environment in China, offset your own pollution in the UK or the US. And while it might sound odd, it does make sense. Greenhouse gas emission hurts the environment just the same regardless of where it comes from, and a reduction of pollution in industrializing new economies is obviously for the greater good. If that creates a market in which some people, whether developers or brokers or banks, get rich, then so be it. And for Chinese businesses, it’s a bonanza: the rest of the world is paying them to clean up their act.

They have not passed up this opportunity. Today, estimates of the proportion of the CDM market that China accounts for vary between 40% and 60%. That is partly a reflection of the amount of emissions the country produces in the first place (officially second in the world, and well on track for the top spot, probably by 2009), and consequently the many ways of achieving reductions. In particular, China produces and uses more coal than any other country. "If you build a windmill in China you can generate a lot of carbon credits because what would have happened otherwise is they’d build a coal plant," says Roger Raufer, director of engineering services at International Environmental Trading Group. "You could build a windmill in Costa Rica too, but the carbon credit is going to be much smaller."

The Chinese were initially wary about the CDM. "At first, [Chinese] project owners were in complete disbelief," recalls Leigh Fitzgerald, a senior specialist at Arreon Carbon, part of a growing private sector industry of project developers and brokers that has grown up in China to match buyers and sellers. "They said: ‘People are going to pay us money to do this, are you kidding?’ They were almost suspicious." That initial bafflement was quickly replaced by a voracious appetite, then sophisticated opportunism.

It would be churlish, though, to call it a scam. Even if Kyoto were to fall apart, and no carbon credits were ever traded again, there is a great deal of renewable energy infrastructure in China that otherwise would not be there. More to the point, despite looking from a distance like a sure-fire recipe for an easy buck and a bit of manipulation, the system is in fact rigorously policed, by the United Nations Framework for Conventional Climate Change.

"The registration process is lengthy. It’s onerous. It’s not trivial by any stretch," says Paul Ezekiel, head of global carbon trading at Credit Suisse in New York, and formerly the president and co-founder of a specialist merchant bank and advisory firm in the environmental industry called Antipodean Partners. "Some people view it as potentially having a random construct behind it: I plant a tree and generate a credit. It’s nothing of the sort. It’s an environmentally rigorous market. And without that, there’s no way a financial institution like Credit Suisse would invest one dollar."

Getting from signing a contract to seeing a credit takes 18 months to two years (which has already created a vibrant forward market). When a group like Arreon Carbon takes a look at a potential CDM project, it first asks its technical department to assess if it has a strong chance of UN approval. If it does, the technical department writes a brief called a product development document in English and Chinese. The Chinese one goes to the government, which then has to approve it for submission to the UN, and provides a letter of authorization. Whichever foreign party is lined up to buy the credit has to do the same with its own government. There also has to be a third-party validator – designated by the UN – which goes in and writes a report on the project, assessing its viability. The whole lot goes back to the UN which, having approved it as being eligible for carbon credits, then goes back every year to check on it. (Arreon, active in this business for several years, is only now getting its first projects registered.)

Efficient, not ethical markets

Consequently, if there’s a criticism of the system, it’s that it is overly strict, expensive and inefficient, not that it is laissez-faire or opaque. "From a liquidity provider’s perspective it is far more important for it to be very onerous than for it to be very lax," says Ezekiel. "It’s good that it’s strict. I’d like to see it more streamlined, of course, but if it’s going to go one way or the other it’s better to be more strict than less."

Raufer adds: "One thing Kyoto has done is take all the compliance and put it outside of the host countries. You can do a project anywhere in the world, Asia or Africa, and [the verification] will be issued by an agency in Bonn. It’s obviously more expensive to do transactions that way, but it does mean there is internationalized compliance."