← Risk in Context Podcast
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- [00:01]
A
Welcome to Risk in Context, which features conversations with Marsh colleagues, risk professionals and others intended to help you better understand key risks, build more effective insurance programs and think creatively about risk. I'm Aaron Bailey, Global Energy and Commodities Group leader within Marsh's credit specialties practice. Carbon credits have become an increasingly important part of the broader climate transition, particularly for organisations such as seeking to address residual emissions while continuing the longer term work of decarbonisation. But the market around those credits is no longer just a sustainability discussion. What was once seen primarily as a tool for meeting climate commitment is increasingly being viewed through the lens of finance, risk and asset development, as buyers, investors and lenders take a closer interest in how carbon projects are structured, funded and brought to market. In today's episode of Risk in Context, I'm joined by my colleague Lara Whitmore, Carbon credit Strategic Advisor. We will discuss the increased use of carbon credits in carbon projects, how the market is evolving and where insurance fits in. Lara, great to have you on the show. Please start by telling us a little bit about your background and your work in carbon credits.
- [01:12]
B
Thanks, Aaron. Great to be here. So I lead Marsh's carbon credit insurance practice within our FINPRO team. It's a relatively new initiative, but one that has grown pretty quickly because the market itself has grown quickly around it. My background sits at the intersection of property insurance and the energy transition, so I spend most of my time working with the full range of carbon market participants. Airlines, project developers, lenders, investors, and also the registries and the standards bodies that tend to govern the markets. What drew me to this space, though, is that it feels genuinely important. Carbon markets are one of the few mechanisms that can mobilize private capital into climate action at the scale that the science requires. And we're also now seeing that insurance is a piece of the puzzle, piece of the infrastructure that makes that mobilization possible. My day to day tends to be a mix of structuring insurance solutions for transactions, but also engaging with registries, insurers to develop new products, and of course, helping clients understand the market as it evolves.
- [02:29]
A
Okay, a lot to unpack. So to set the scene before we get into the conversation, could you give listeners a simple overview of carbon credits and how the market's evolved over the past few years?
- [02:38]
B
Yeah, of course. So at its simplest, a carbon credit represents 1 ton of carbon dioxide, or carbon dioxide equivalent. There's either been prevented from entering the atmosphere in the first place or actively removed from it. So it's a token that has been verified by an independent third party and registered In a public registry. The market has two broad pillars. The project based carbon markets where companies tend to buy credits to meet their own net zero commitments, and compliance schemes or compliance markets where regulated entities must buy credits to meet legal obligations. So examples of this at the moment are the Corsia scheme which we'll talk about for the aviation industry, the EU ETS for the European industries. Singapore's carbon tax as well are some of the most prominent MSCI carbon markets. The analyst projects that the market could grow from anywhere between 7 to 35 billion US dollars in total value by 2030. So only you know, three and a bit years time and as much as 45 to 250 billion by 2050. And this is really driven by an increase in corporate demand for removal credits as well as the convergence of what we see as those project based and, and compliance markets as more regulation comes in. Another thing to note is that the quality agenda, so to what standards carbon credits are generated has really been defining the story of the last few years. The Integrity Council for the voluntary carbon market, the ICVCM launched its set of core carbon principles a couple of years ago or in 2023. And what that's really done is establish a global corporate quality floor that is quickly becoming the minimum requirement for institutional buyers and lenders when they're on the search for carbon credits. What I would say though is changed the most fundamentally and to set up this discussion is who is in the market. So it's really evolved even in the time that we've been involved, from a relatively niche space that's dominated by project developers and NGOs with a really great understanding of the carbon science to a market that's much larger than that, that involves major banks, institutional investors and global corporates that are now engaging with carbon credits very seriously and at some scale.
- [05:22]
A
Thanks, Lara. For listeners, please see the show notes for Marsh's carbon credits page for more information on carbon credits and the market as a whole. So Lara, you've talked there about growth. So as we dive into that in a bit more deeper detail, the conversation on carbon credits has moved beyond tradition traditional commodities and is now drawing on more attention from insurers, lenders and investors. As you've outlined, what are the trends we're seeing in the market now?
- [05:43]
B
Yeah, thanks Aaron. I think the most important trend at the moment is that increasing institutionalization of the market. So carbon credits we're now seeing not being treated just as a philanthropic gesture, but more as a financial asset with a price delivery obligations dictating it and A risk profile that needs to be managed accordingly. And so with that, we are seeing lenders advance project finance against future carbon credit revenue. I'll talk about it a little bit later, but the landmark JP Morgan loan to chestnut carbon of US$210 million last year, which Marsh placed the insurance for, is a great example of structured project finance at scale that is mobilizing the carbon markets. Importantly for us, as Marsh, and also for the wider market. It established a template that now every bank in that ecosystem is trying to replicate on its different scales. I mentioned the compliance schemes before as well, and really that increase in regulation is accelerating this movement. So Corsia, for example, the airline mandatory set of regulations that's asking all international airlines to purchase certain quantities of carbon credits is becoming mandatory across the industry from January 2027. And this creates a hard regulatory deadline that is forcing airlines and their supply chains to engage with the market in a way that voluntary commitments just haven't done before. And then of course, underpinning all of this for us is a growing recognition that insurance is the missing piece of the infrastructure. We know essentially that you cannot treat carbon credits as a financial asset without the accompanying risk management tools that every other asset class takes for granted.
- [07:48]
A
Interesting. So with this rapid increase in scale and the types of carbon projects you are seeing, is that also changing?
- [07:56]
B
Yeah, definitely. I think for the first few years and much longer of the project based carbon market, nature based solutions were really what dominated. So we see REDD plus types of projects protecting tropical forests, afforestation, reforestation projects, soil carbon management, and then also more avoidance types like cook stoves for example, really being first and foremost in the market. These projects were popular because they were cheap to develop and could generate large volumes of credits pretty quickly. We still see many of these and they're developed to a better and better quality standard. However, the dominance of nature based solutions is now beginning to be challenged partly by the quality crisis that hit the markets a few years ago, and partly by a growing recognition that these nature based solutions alone, though they are great, cannot deliver the scale of carbon removal at the level the Paris Agreement requires. And so what we're now seeing is a shift towards technology based or engineered carbon credit removal. So carbon dioxide removal projects like direct air capture, bioenergy with carbon capture and storage, enhanced rock weathering, ocean alkalinity enhancement, you name it. Projects that offer higher permanence and greater measurability, but at a dramatically higher cost. And so you can see where I'm going with this. The challenge with These technologies is that they're expensive and they're capital intensive at exactly the point where they're also the least proven. A direct air capture facility, for example, or a Beck's plant. That bioenergy and carbon capture and storage requires hundreds of millions of dollars of upfront capital before it's even issued a single credit. And so for this element of the energy transition to work, this is where significant finance and insurance becomes even more important for these types of projects. A tech based carbon dioxide removal project just cannot attract project finance without a bankable offtake agreement. And a bankable offtake agreement cannot really exist in most cases without delivery insurance that guarantees that credits will perform.
- [10:28]
A
Okay, so now that we've set the scene and explored the current state of the carbon markets, let's move on to the challenges that organizations tend to face. Laura, can you share what our clients are mostly struggling with as the markets mature?
- [10:40]
B
Yeah. So our clients really span the entire range almost of carbon credit stakeholders across the market. So firstly for project developers, we find that their most fundamental challenge is access to capital, especially at early stages. Their credits from their carbon projects mostly don't exist yet. And so the revenue that can be generated from their sale is years away. And the projects need financing now to get up and running in the first place. And this is where we see insurance being a mechanism that can bridge that gap by making the future revenue stream bankable. For lenders, the secondary challenge for developers is the buffer pool. So this also puts a massive crunch on capital right at the beginning of a project because developers need to contribute between 10, 20, sometimes even 30% of their credits to a registry reserve that cannot be sold. And this is a significant drag on their project economics. We're now seeing that insurance can actually stand in as a reputable replacement for that buffet pool scenario. For corporate buyers of credits, they often face a delivery risk they do not often fully appreciate. So for buyers that are forward agreeing the delivery of carbon credits on a multiple year basis, for example, they may pay a deposit or a contracted price and assume the credits will arrive. If the project fails, the registry revokes credits or a methodology change and validates them. The buyer has a compliance gap and no recourse unless they have insurance. And then, Aaron, as you know, we work increasingly as well with investors and lenders. We're working with a few different corporate lenders and banks who want to lend into the carbon market because the deal sizes here are growing. Their client relationships are there as well, but they struggle to get their credit committees comfortable with the risk profile, which is again, when we get involved, I think we can talk more here about the different types of insurance solutions that can help. So I know Aaron, we've worked together in the past where we have needed more traditional forms of credit and political risk insurance to support carbon credit transactions. But in your experience, Aaron, how can these credit risk insurance products be used to support carbon credit transactions?
- [13:22]
A
So to take a step back, first I'll explain at a high level what credit and political risk insurance is and then how the products work. So in short, they're products and a marketplace which many have never heard of, but one which in reality sits at the nexus of trade and investment, playing a crucial role in facilitating trade growth, protecting global investment and optimizing working capital. For credit insurance, it provides protection against non payment of amounts due under a contract, be that an energy trader covering a single cargo of LNG or a financial institution's 10 year project finance loan to support the construction of a data center. Political risk, on the other hand, is an insurance product that provides protection against a foreign country, discriminative action such as confiscation, forced divestiture, license cancellation, political violence and war resulting in an investment loss. So whilst these tools have historically been deployed across traditional asset classes, in the commodity and finance space, we are increasingly seeing demand to support financing in carbon projects and carbon trade. For example, a commodity trader may pay a producer or a project in advance to secure future offtake of carbon credits therein, creating potential delivery, credit and political risk exposures. A bank lending into a project may utilize credit insurance to unlock a larger longer term facility which is into a sector that they're newer to and that comes with additional internal borrower constraints. So without these solutions, the potential or perceived risks could otherwise constrain investment, particularly when we consider the unregulated nature of the voluntary credits and the majority of projects being in high risk jurisdictions. But ultimately credit and political risk insurance solutions are tied to contractual obligations, be that payment performance and so on. So depending on the client's specific need, they can sometimes fall short of the complete solution. That is, these are not all risk policies. So Lara, given the rapidly developing carbon market and insurance solutions therein, could you provide the audience with some insight as is the solutions available?
- [15:30]
B
Yeah, of course. So insurance solutions for carbon credits are very similar in that we need to understand the key contractual obligations dictating any deal and from there the insurance we can place is actually pretty flexible. Non payment insurance can be used to protect a carbon project developer default on a loan, but other solutions have also been created specifically to mitigate the risks associated with carbon credits, including most prominently delivery insurance, which covers the non delivery of contracted carbon credits for any reason. And this includes damage from extreme weather or business interruption from political disturbances, e.g. pestilence, political violence, methodology changes. We also have forms of political risk insurance as well, which is generally used to address sovereign interference with project operations or corresponding adjustment withdrawals. And then on the other side, once carbon credits have been issued, we've got reversal and cancellation insurance, which covers physical permanence failures and registry revocations for buyers to make sure that the carbon credits that are bought stay intact. And excitingly, as I mentioned earlier, we're now seeing this permanence insurance start to actually replace registry buffer pool contributions for developers who in some cases are able to take out insurance instead of contributing to the buffer pool. So these products are currently written primarily by specialist managing general agents MGAs within the Lloyds of London market. But we're also seeing a growing number of Lloyd syndicates and wider London and global markets getting involved as well. Our role at Marsh is really to access and structure this capacity across all of these as the markets expand. And then also I guess just to mention again, the Chestnut Carbon and JP Morgan deal, because this is really the best illustration of how these products work together in practice. To give you some context on the deal, JP Morgan planned to lend this 210 million US dollar loan on a non recourse basis against Chestnut's future carbon credit revenue from their deal with Microsoft, which was agreed over a 25 year period. For that to work, the lender needed certainty that the credit revenue would actually materialise and that certainty that only insurance could provide. And so we placed a carbon delivery insurance policy that guaranteed that Chestnut would deliver the carbon credits to Microsoft as expected year on year. And what this did was essentially convert a more speculative future carbon income stream into a surefire bankable cash flow that a major bank like JP Morgan and their credit committee could approve.
- [18:47]
A
Okay, and you know, I think that's what differentiates Marsh and where our industry focus really can deliver tangible financial value for clients. So the Chestnut placement involved a few different teams across Marsh. Lara, can you talk about our cross Marsh collaboration and why does specialist advice matter and how does Marsh help clients navigate the options?
- [19:07]
B
Yeah, it's a great point and I think it's one of the genuine advantages that Marsh has in this space. The ability to bring together expertise from across the firm in a way that a smaller broker or advisor simply can't. So another good Example of this is our current work that we're doing on Corsia, where our FINPRO carbon credit insurance team is working closely alongside our aviation practice to make sure we're advising our airline clients, especially on the compliance obligations they're beginning to understand. And that cross practice collaboration means the client gets both their insurance expertise and their sector expertise in the same conversation, rather than having to educate their broker from scratch on what Corsia actually means or doing the research themselves. And then Aaron, as we've talked about, we also collaborate pretty closely when structuring solutions for carbon projects, especially for project finance structures and where we need in depth political risk expertise for carbon projects that are based in territories across the world. And then on the advice point, this matters more in carbon credit insurance than in almost any other line of business at the moment, simply because of how new and how quickly developing this market is. And whilst it's great that the insurance market is developing quickly and our own product development we're doing at the moment is an example of that, it requires a constant finger on the pulse to dissect and really understand what each of the insurers solutions are doing and therefore what is right for our client. For example, we talk about non delivery insurance where the trigger is non delivery of carbon credits and that's one thing, but it's another thing to understand what that means in terms of what it, how it actually manifests for your project. Different insurers, for example, define a non delivery event as in slightly different terms. And so placing an insurance policy for carbon credits can require a deep knowledge of registry mechanics, of how methodology standards work, corresponding adjustments for example, as well as the overall transaction and just the underlying carbon project. And then I guess to end as well by saying the stakes are only going to get higher as the market grows and the compliance deadlines approach. So getting the wording right, the trigger right, the placement right, it's not just a box ticking exercise, it's actually the difference between a client having a robust compliant position and not.
- [22:01]
A
Thanks, Laura. So we've covered a huge amount in a short space of time on a complex subject matter and I think it's clear that there's the growth there, but also with the growth comes the increasing complexity and potential challenges. So what's the one message you would like listeners to take away from today?
- [22:16]
B
Yeah, I would just say that the market's maturing and insurance can help unlock finance and that instead of a blocker, insurance is an enabler.
- [22:26]
A
Absolutely. That's it for this edition of Risk in context. Thank you for listening. Listeners can rate, review and subscribe on Apple Podcasts or in their preferred podcast app, and also follow Marsh on LinkedIn or X. For more episodes and additional insights, visit marsh.com until next time. Thanks again for listening.