UK – London Stock Exchange’s Proposed Voluntary Carbon Market.

Further to the London Stock Exchange’s (“LSE”) announcement during COP26 that it was developing a market offering to support publicly traded carbon funds, the LSE launched a consultation last week on its new Voluntary Carbon Market (“VCM”).

The consultation period closes on 11 July 2022 and the final rules are expected to be published by the end of September 2022.

What is the proposed VCM?

The VCM is not a dedicated market for publicly traded carbon funds. Instead, it is a designation which will be granted by the LSE to closed-ended investment funds which have an investment policy focussing on carbon reduction and/or removal projects that are expected to yield carbon credits.¹

It is therefore conceptually similar to the Green Economy Mark, which recognises funds investing into green sectors that are contributing to environmental objectives and has been granted to more than 30 funds with a combined market capitalisation of £1.7 billion. The proposed VCM designation is different since it recognises Listed Funds that are investing in climate change mitigation projects with the objective of generating carbon credits on behalf of investors, with the intention of either distributing them to investors or retiring them on behalf of investors.

What are the eligibility requirements?

The VCM is only available to closed-ended investment funds which are listed or admitted to trading on the Main Market (including the Specialist Fund Segment) or AIM (“Listed Fund”).

In order to be eligible, a Listed Fund must satisfy the following requirements:

• It should be managed² by a firm suitably authorised by the FCA, the Guernsey Financial Services Commission, the Jersey Financial Services Commission or the Isle of Man Financial Services Authority;
• Its investment policy should be limited (excluding cash and cash equivalents)³ to investing in a combination of Qualifying Projects, Proposed Projects and investments whose revenues can be mapped to the Tier 1 or Tier 2 micro sectors within FTSE Russell’s Green Revenues Classification System. For these purposes, a “Qualifying Project” is a project which has been certified and appears on the register of a Qualifying Body,⁴ and a “Proposed Project” is a project in which the Listed Fund is investing with the reasonable expectation that it is, or will be, a Qualifying Project; and
• Where the Listed Fund proposes to offer the service of retiring carbon credits on behalf of the shareholders, the Listed Fund: (i) must be registered at all times with a carbon offset registry to which it will retire the carbon credits; and (ii) appoint and maintain an FCA-authorised depositary.

How can a Listed Fund seek the VCM designation?

The VCM designation may be sought by a newly established Listed Fund concurrently with seeking admission to listing/trading, with certain prescribed disclosures being made in the Prospectus or Admission Document (as appropriate). Listed Funds which are already admitted to trading may seek the designation by publishing a shareholder circular containing the prescribed disclosures.

The prescribed disclosures include (but are not limited to):

• the fund manager’s estimated target carbon credit yield for the Listed Fund;
• the fund manager’s track record in respect of carbon credit projects including details of any failed carbon credit projects or investments;
• the mechanism(s) to be used for distribution or retirement of carbon credits; and
• risk factors relating specifically to: (i) Proposed Project investment risk; (ii) the initial and ongoing risk that all or any carbon credits may not be awarded; and (iii) the risk that Proposed Projects may not become Qualifying Projects.

What are the continuing obligations?

The proposed rules also prescribe continuing obligations which apply to a Listed Fund which has obtained the VCM designation. These require that:

• the eligibility requirements set out above should be complied with on an ongoing basis;
• the Listed Fund must have invested in at least one Proposed Project or Qualifying Project by no later than three years following receipt of the VCM designation; and
• the annual report must include among other matters/information certain prescribed disclosures in relation to the Listed Fund’s investments in Qualifying Projects or Proposed Projects, the details of any carbon credits produced and/or retired in the reporting period, a restatement of the target yield for the carbon credits and a description of how the Listed Fund performed in relation to the previously stated target yield of carbon credits.

The Listed Fund must also maintain on its website details as to its fund manager and depositary, the status of its Proposed Projects (and, if relevant, disclosure in respect of the project milestones) and details of any Qualifying Projects. Further, the Listed Fund is also required to notify via an RIS any material events relating to its Qualifying Projects or Proposed Projects (including any material delays or inability to meet the standards set by the relevant Qualifying Body).

The LSE proposes to retain wide-ranging powers to refuse to provide or remove the VCM designation where the eligibility requirements or continuing obligations are not complied with or in certain other situations.

¹A “carbon credit” is defined as “A tradable permit or certificate which represents the Independently Certified (by a Qualifying Body) removal or avoidance of one ton of carbon dioxide or the global warming equivalent of another greenhouse gas“.

² The proposed rules refer specifically to portfolio management, but require that this be carried out by a firm which is suitably authorised to manage an AIF. The final rules may need to be clearer on whether the AIFM needs to be suitably authorised by the relevant regulators or whether the entity carrying out portfolio management (which may not be the AIFM) needs to be so authorised (or both).

³ In relation to cash equivalents, the proposed rules require that the Listed Fund should seek, as far as is reasonably possible, to invest cash equivalents in a manner that is compatible with the principle of climate change mitigation.

⁴ The International Carbon Reduction & Offset Alliance (ICROA) or the Integrity Council for the Voluntary Carbon Markets (ICVCM), once its Core Carbon Principles are issued. The LSE may at its absolute discretion and from time to time, add to or remove from the list of Qualifying Bodies.