FAQ
What are ratings?
Ratings have been successfully used in the financial services markets for over 50 years as designations which give relative indications of a company’s or a government agency’s credit history – their likelihood of default.
Why does the carbon market need ratings?
According to IDEAcarbon, the carbon trading market could be as big as €1 trillion by 2020, with project-based carbon offsets contributing at least €200 billion, but the market needs substantial improvements in transparency and risk management in order to reach this level.
Ratings are a tool for assessing the risk factors associated with the delivery of a financial instrument. The recent news of delays in carbon project registration and credit delivery highlight the fact that the risks inherent in project based carbon offsets have often been underestimated. While there has been awareness of potential regulatory concerns, market-internal problems in development have been largely ignored. If we ignore the HFC and N20 projects which account for 75% of CERs issued to date, CDM projects have a credit issuance success of just over 70%.
If we are to attract the levels of finance necessary to make the carbon markets mainstream, we need to have tools acceptable to financiers which show that the risks of investing in carbon offset projects have been understood, articulated and minimised (or hedged against). By providing clarity and transparency in the market, ratings can help attract further investment into the sector.
Project ratings will help to standardise carbon as a commodity and create a new asset class. Rated projects will no longer be unique but comparable to other projects with the same rating.
Who will use the carbon ratings?
Ratings are important for both the buy-side and the sell-side. Buy side clients are within the compliance or voluntary market and have an interest in both delivery and the social development benefits of the projects. Sell-side clients include project developers looking to get the best price for their credits and investors looking to invest in high quality projects.
What are the limitations of ratings?
While The Carbon Rating Agency identifies unsolicited (market initiated) ratings with adequate disclosure under the ‘rating type’ section on the rating rationale, it should be recognised that such ratings are carried out on a best-efforts basis and are dependent upon publicly available information. While The Carbon Rating Agency invites the rated entity to participate in the rating process and provide it with relevant information, the extent of such participation is completely at the discretion of the entity. In light of that, the level of information available for analytical inferences is largely limited to public sources.
In some instances The Carbon Rating Agency may issue a market initiated rating that includes a formal qualification to this rating.
How do carbon ratings work?
Like standard credit ratings, the new service will award scores ranging from AAA for the highest quality, lowest risk projects, through to C and D for the highest risk projects which are least likely to meet their stated goals.
Every project will be rated according to the likelihood of it delivering the stated number of offsets in the stated time period, as well as by its economic and social development benefits. By rating a broad range of project types across different sectors, we will be able to compare like with like.
Can market participants consider Ratings as recommendations?
No. Ratings are opinions and are designed to be additional inputs to the system. They are an information enhancement rather than recommendations.
How can reliable ratings be developed in such a new and rapidly developing market?
The Carbon Ratings Agency combines the science of benchmarking with the art of collective judgment. Other rating processes are based on a depth of past data from which correlations can be extrapolated in a fairly predictable manner. This is not the case for the rating of CDM projects. While our model is loaded with past performance data, we emphasize that the carbon market is still in a growth mode not only in terms of volume but more importantly in terms of the regulatory system. Past experience is therefore not necessarily a reliable predictor of the future. Our rating combines statistical benchmarking with the collective best judgment of our ratings committee.
Does the Carbon Ratings Agency rate projects or carbon credits?
The Carbon Ratings Agency rates the offset asset, not the underlying project. While it is clear that a sound underlying project is critical to the production of a mitigation asset, not all sound underlying projects will produce mitigation assets. Our ratings focus on the likelihood of the project’s producing the intended volume of certified emission reductions, and do not in any way represent an investment rating of the underlying project.
Do ratings cover sustainable development?
Sustainable development is an important objective of emission reduction projects. The Carbon Rating Agency asseses the sustainable development impact of projects in a separate analysis. However, to the extent that sustainable development issues may affect carbon delivery they are factored into the main rating. (For example, unaddressed environmental concerns may delay project implementation) The Carbon Ratings Agency’s sustainable development rating covers four areas: water (blue), ecosystems (green), pollution (brown) and social (red).