What are Carbon Offsets and How Do They Fit into the Greater ESG Picture?


Carbon offsets_their pros and cons_impact on ESG

Carbon offsets are a controversial market – albeit one predicted to exceed $50 billion by 2030. On the one hand, they provide funding to environmental projects, anywhere in the world, that may not secure it otherwise. They also offer an avenue for businesses that aren’t in a position to reduce emissions as speedily as they’d like. On the other hand, carbon offsets are tricky to accurately calculate, poorly regulated, and run the danger of being treated as a substitute for genuine ESG and low carbon policies. 

What are carbon offsets?

Carbon offsetting programs allow both corporations and individuals to invest in environmental initiatives worldwide to balance or “cancel out” the greenhouse gas emissions produced by their activity – rendering them carbon neutral. A European airline, for example, might invest in reforestation or carbon capture projects in South America in order to remove as much carbon from the atmosphere as they put in as a result of operations.

A brief history of carbon offsetting

The United Nations established the world’s first offsetting market in 1997 under the Kyoto Protocol, ratified by 192 countries committed to individualized carbon reduction targets. Its first project involved investment in a commercial timber forest in Guatemala in 1989. 

Though the Kyoto Protocol has now been superseded by the Paris Agreement, the carbon offset market it created remains the largest in the world, having administered carbon credits representing 2 billion tonnes of carbon dioxide reduction or avoidance.

Compliance vs Volunteering

Carbon offsetting can be categorized into voluntary and compliance-related schemes. Anyone wishing to offset their carbon footprint – whether an organization, non-profit, university, neighbourhood or even an individual – may purchase carbon credits to offset their emissions. Pet owners, for example, can buy packages to offset the carbon footprint of their animal companion.

Businesses may also have to purchase offsets in order to comply with federal laws governing maximum allowable emissions. Government cap-and-trade schemes set the maximum allowable emissions output for various industries, which businesses can then trade among themselves. 

Currently, twenty-seven countries, among them Canada, the EU bloc and the UK, impose a carbon tax on industries should they exceed an emissions cap. Article 6 of the Paris Agreement allows countries to transfer carbon credits, earned through emissions reductions, to other countries who might need them. Additionally, various carbon pricing initiatives operate around the world at the national and regional level. 

The pros of carbon offsets

Most environmental offsetting projects are based in the global south, thus attracting capital to areas of the world that would not ordinarily be able to fund such initiatives. This is especially pertinent given that the developing world bears the brunt of the consequences of climate change, with fewer resources to tackle them. 

Carbon offsets are also relatively cheap. While this does beg the question of how they are calculated and regulated, it nevertheless allows individuals and businesses to at least begin tackling the issue of their carbon footprint. This is especially so for industries for whom transition to net zero is a longer process. 

The cons of carbon offsets

Carbon credits are tricky to calculate. And because the industry itself lacks proper oversight, it runs the risk of falling prey to greenwashing claims. At the moment, the only entities regulating the market are known as carbon offset registries, third party organizations that attest to the validity of offsetting projects. These entities, however, face no oversight themselves, and can even receive funding from companies selling offsets. 

As a result of this lack of regulation, critics of carbon offsets say that they allow corporations to buy their way out of polluting without genuinely reckoning with their carbon output, all while making bold claims in their marketing materials.

Carbon offsets and ESG

Carbon offsetting may be part of an overall climate and ESG plan, but it cannot replace one. As countries around the world continue to adopt and propose ESG legislation, embedding low carbon policies into the DNA of businesses is important not only to comply with regulation and investor demand, but to create public buy-in from Millennial and Gen Z consumers for whom such concerns affect patronage. 

Cracking down on greenwashing is a significant part of the consolidation of ESG laws. Europe’s Sustainable Finance Disclosure Regulation (SFDR), which functions in tandem with the bloc’s “green taxonomy” classification system, is a rigorous pushback against greenwashing. In the United States, in addition to the SEC’s ground-breaking proposal to mandate climate reporting aligned with the Taskforce on Climate-related Financial Disclosures (TCFD), the regulatory body also announced plans this year to tighten rules around misleading ESG claims. Given the lack of accuracy and oversight around the carbon offsetting market at present, relying solely on this avenue could leave organizations open to legal risk. 

Moreover, the International Sustainability Standards Board (ISSB), a private-sector body created as a result of 2021’s COP26 climate summit, recently announced that its own disclosure standards will mandate the reporting of Scope 3 emissions (emissions resulting from a business’s supply chain). Coupled with greater political will to transition to clean energy, exemplified by the historic passing of the Inflation Reduction Act, carbon accounting and reduction is critical – simply offsetting isn’t enough. 

Carbon Calculator

While carbon calculation can be an expensive and time-consuming process, ESGTree’s Carbon Calculator was devised to simplify and streamline this necessity. Now staff members themselves can generate Scope 1, 2 and 3 emissions data using basic information about company operations. Our clients have reported a 70% reduction in the time it takes to calculate this information.

Automated frameworks

Launched in 2019, the Partnership for Carbon Accounting Financials (PCAF) is a global partnership of financial institutions that aims to standardize the data collection, assessment and reporting of greenhouse gas emissions associated with their loans and investments i.e., their financed emissions.

PCAF is just one of several ESG frameworks that the ESGTree platform automates for clients. The PCAF standard is ideal to implement because it comes from within the finance industry itself. Rather than reinvent the wheel, its recommendations and requirements complement existing frameworks such as TCFD, the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB). 

Private equity and venture capital firms play a unique role in helping their portfolio companies grow. Therefore, we believe it is imperative for private capital firms to build carbon accounting into the very foundation of their investments.

ESGTree’s Carbon Calculator, automated PCAF and other ESG frameworks, and various ESG reporting tools, simplify the otherwise expensive and arduous task of carbon footprint reporting. By inputting readily available information into our system, corporations can streamline climate reporting and effectively comply with investor reporting requirements.

Click here to learn more about ESGTree’s ESG Data Management & Reporting Software for Financial Institutions

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What are carbon offsets?

What are voluntary offsets vs compliance and cap-and-trade schemes?

What are the pros of carbon offsetting?

What are the cons of carbon offsetting?

How are carbon offsets regulated?

How do carbon offsets fit into an ESG plan?