Co-authored with Paddy Sutton

With the intensification of carbon-control efforts all over the world, there has been a growing focus on the development of tradeable voluntary carbon credit markets. While several Asian countries only just instituted them, emissions trading markets in other parts of the world are well-developed and voluntary carbon credit trading has been going on for many years.

Given the tradeable nature of voluntary carbon credits, market participants are increasingly looking to use such credits as a form of collateral for loans or other forms of financing, as they represent a valuable and liquid asset that can be sold or transferred in case of default, similar to shares or commodities. Such financings may provide working capital secured on carbon credits currently held by the borrower (such as via a borrowing base or margin loan structure) or may fund projects that reduce emissions (for example, renewable energy or forestry) secured on the value of a future stream of carbon credits.

In spite of their obvious potential, raising financing using carbon credits has its challenges. Financiers have to contend with the uncertain and volatile nature of carbon markets and put mechanisms in place (e.g., hedging or the ability to call for further collateral) to ensure that their exposure is always adequately covered. In addition, the legal nature and treatment of carbon credits varies by jurisdiction, and so a jurisdiction-by-jurisdiction approach must be taken in determining how a valid security interest may be granted over the carbon credits and ensuring that on an enforcement of that security, the financier will, as a practical matter, be able to take possession and sell the carbon credits in order to recover its capital.

For example:

• In the UK, the courts have determined that EU allowances (EUAs), which are carbon credits used in the EU Emissions Trading Scheme, are a form of intangible property. However, the courts have not yet considered the legal nature of UK allowances, which are carbon credits used in the UK Emissions Trading Scheme, or whether the EUA is a “chose in action” (that is, a debt or rights under a contract). This may affect the type and effectiveness of the security interest that can be taken by a financier.
• In the EU, whilst the EU courts have determined that EUAs are a form of "other intangible property", the EU does not have a harmonised regime for taking and registering security interests over intangible property, and the rules may vary depending on the jurisdiction where the EUAs are held. 
• In New Zealand, New Zealand units, which are carbon credits used in in the NZ Emissions Trading Scheme are treated as personal property and can be transferred by electronic means. However, uncertainties persist about the priority and enforcement of security interests over carbon credits, especially in the event of insolvency or default.

Many other jurisdictions, particularly those that have only recently developed voluntary carbon markets or are still in the process of doing so, may not yet have established a clear legal position on whether security can be effectively taken over carbon credits.

In conclusion, financings secured by carbon credits are becoming increasingly popular, but taking security over carbon credits is a complex and evolving area of law that requires careful consideration of the legal and practical aspects in each jurisdiction. Financiers and borrowers should seek local legal advice and tailor their security arrangements to the jurisdiction, specific characteristics and risks of the carbon credits involved.