Banks in Carbon Financing: Cashing in on Carbon
What is carbon financing?
Carbon financing is the term used for carbon credits to help finance Green House Gas (GHG) reduction projects where industrialized countries can make up for their carbon reducing obligations under Kyoto (industrialized countries collectively agreed to reduce GHG emissions by 5% by 2012 compared with 1990 levels) through purchase of emission reduction credits from projects in developing countries.
Under Kyoto Protocol, governments are separated into two general categories: first, developed countries, referred to as Annex I countries which have GHG emission reduction obligations and second, developing countries, referred to as non-Annex I countries which have no GHG emission reduction obligations but may participate in the Clear Development Mechanism (CDM).
Failure on the part of any Annex I country to meet its Kyoto obligation will incur penalization resulting in submission of 1.3 emission allowances in a second commitment period for every ton of GHG emissions in excess of cap in the first commitment period (2008-2012). So as to avoid penalization, Annex I countries can purchase GHG emission reductions from financial exchanges, from CDM projects of non-Annex I economies, from other Annex I countries under the Joint Implementation (JI) or from Annex I countries with excess allowances. When non-Annex I countries with no GHG emission restrictions undertake GHG emission reduction projects under CDM they receive carbon credits which can then be traded/exchanged with Annex I countries in the world market.
Role of Banks
The growing sense of urgency among countries worldwide to combat the impending catastrophic effects of global warming has paved the way for the birth and growth of a multimillion dollar international market for carbon emission trading of buying and selling Greenhouse Gases (GHG). The global carbon trading market is unique in the sense that the sellers are from India or other developing nations, while the buyers are from industrialized countries. The objectives of both the parties are quite contrary; while buyers want carbon credits at cheaper rates, sellers want to maximize the value. Being unknown to each other, they will be carrying preconceived notions and misgivings about the genuineness of the contract. This is where banks have a pivotal role to playact as financiers of emission reduction projects and bring together buyers and sellers on a common platform through credit mechanisms such as:
Letter of Credit (L/C) is one such financing mechanism, where a buyer guarantees payment through his banker for goods received from the seller. L/C is an assurance to the seller that he will receive the payment and the same can be availed through an escrow account with the bank.
This apart, Carbon Delivery Guarantee is another mechanism through which banks provide guarantee to the buyers of carbon credits that the same will be delivered by sellers as per the terms of the contract (quantity, delivery schedule, etc.) This enables buyers and sellers to enter into long-term future contracts. Banks can thus tap the investment potential of receiving huge amounts by way of advances to these projects from overseas buyers.
Apart from financing CDM projects and providing loans against carbon credit receivables, banks offer a single point delivery of services such as advisory services, value-added products like securitization of carbon credit receivables, delivery guarantees, escrow mechanism, etc. to their customers.
Indian Banks rush in to capitalize on the high-risk, high-return carbon financing trade.
In China, European companies buying carbon credit enter into agreement at the beginning of the project and also provide finance for project development. But in India, since the project size is small; many companies are seeking finance from financial institutions. Domestic banks such as ICICI, IDBI, HDFC and SBI are gearing up to tap this new highrisk and high-reward business of carbon financing, where the margins are quite lucrative in the range of 1-3%, higher than for other projects. Apart from generating high margins that include commission, brokerage, etc. from the carbon credit transactions, banks cite broadening of the product portfolio as key incentive to enter this market. Carbon trade provides scope for other businesses like technology transfer, capital investments, cross-border funding products and remittances and also enables banks to provide an international platform for buyers and sellers and increase the scope of allied business.
'Financing of CDM projects becomes an extension of banking services that we provide to retain our customers.' PV Anantha Krishnan, Executive Vice-President and Country Head, HDFC Bank, Discovering carbon finance as a lucrative business opportunity, Banks have started latching on to the carbon credit bandwagon. They feel financing clean development mechanism (CDM) projects a good and feasible business proposition. A few banks have joined the carbon credit bandwagon, for instance:
In October 2002, The World Bank entered into an agreement with Infrastructure Development Finance Company (IDFC) wherein IDFC is to handle carbon finance operations in the country for various carbon finance facilities. The agreement initially earmarked a $10-million aid in World Bank-managed carbon finance to IDFC-financed projects that meet all the required eligibility and due diligence standards.
SBI in September 2007 entered into MoUs with MITCON Consultancy Services Ltd., Ecosecurities India Private Ltd., and Cantor CO2e India Private Ltd. to provide one-stop destination to industries for CDM projects and emissions trade. It has also recently entered into a MoU with KFW (a German firm) carbon fund for jointly exploring financing of sustainable CDM opportunities in various development and industrial sectors. The bank has also cleared one such loan valued at Rs.8cr, against the receivable to a biomass-based power plant in Indore. Also in the offing are 3-4 such loans pending clearance which will be considered once they complete purchase agreement formalities with their buyers.
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