Introducing W&I insurance for carbon

Last week my team at Howden announced that we have created a new type of insurance policy for the carbon market and I want to explain here why I think it is such an important development for the industry.

A lot of controversy surrounds carbon markets. Do they actually deliver the good they are supposed to? Are companies using carbon credits to carry on polluting, or so called ‘greenwashing’? Are local communities being cut out of promised profits? Or worse, are developers using forced labour? ….the list goes on. For those whose day job is in carbon they will know all too well that the entire market is dependent on solving these issues. Our mission is to increase the ‘quality’ of carbon projects. 

If people can’t trust that the carbon credits they are buying do the things they are supposed to do then those credits have no ‘integrity’ - and therefore there is no basis to build a market.

What do we mean by "integrity"?

Market integrity has been called into question by all stakeholders, but what really is being questioned? Broadly speaking the key issues with carbon can fall into three main buckets:

• Environmental: did the project actually do the good it was supposed to do for the environment?
• Social: does the project benefit the people it's is supposed to benefit?
• Financial: are the right parties, and only the right parties, able to sell the credits on the one side and able to claim the credits in the other?

If any one of these points are called in to question then the whole project falls down. Trust collapses.

The integrity of projects is the foundation of the market and the reason everyone is obsessed with the quality issue is because everything else flows from there: if the quality of the credits being generated are in question, any nobody can be sure of what is a good project and what isn't, then the market can’t go anywhere....which is what we've seen for years.

In my mind there's no point trying to build a career in carbon if the foundations of the market are that shaky. I got burnt by that once - back in 2010 when the EU ETS collapsed and I'm not going there again. Building products or services that do not address these core foundational issues is pointless. For me, solving the integrity issue is the single most important problem to work on.....so that's what we've been doing at Howden.

Warranties and Indemnities

A lot of people talk about how to raise the bar on quality. A lot of helpful work has been done on what defines good quality, but until now very little has been done in actually enforcing it.

At Howden we talk about using insurance as a force for good. How can insurance be used as an enabler? How can risk transfer be used to unlock financing that would not have otherwise been possible? How can markets be created to facilitate risk financing?

With this in mind, we have developed a form of insurance, known as warranties and indemnities (W&I) insurance, for carbon markets. The idea is to use insurance as a governance mechanism to dictate quality.

This is how it works...

Typically when a seller sells something - such as a product, a service or even a company - they provide warranties. They warrant that their product will work, that the service they provide will meet certain standards, or the company they are selling hasn't got any skeletons in the closet - undeclared debts, upcoming court cases, etc.

These assurances (which are the warranties) can be backed up with insurance that says that should anything nasty happen then you, the buyer, can be compensated - which is the indemnification.

We have taken these well established principles and applied them to carbon credits.

Carbon W&I

As previously mentioned, most issues with poor quality carbon projects falls into three buckets: environmental, social and financial.

What we can do is define the conditions that need to be met in each bucket and write that into a legally binding sales contract and back that with insurance.

In this way we do two things:

1. Define in legal language what the seller of carbon credits has and has not done.

• In other words we take the stipulations that others in this space, such as ICVCM and VCMI, have agreed upon to define quality and written them into the sales contract as warranties.

2. Use the insurance market as a third party stamp of approval.

• ie. An underwriter, which by definition is an entity that specializes in managing risk, not only does additional due diligence but goes one step further by putting money on the table to back their position.

This is an extremely simple and elegant solution because it takes a well known concept - warranties - which has a mature market developed via M&A insurance for the buying and selling of companies, and tweaked it for the buying and selling of carbon. W&I insurance is designed to facilitate smoother transactions by enabling trust and confidence between a buyer and seller. By pinning the insurance policy to the project sales agreement you are effectively addressing the structural issues with carbon at source - prevention not cure. In the future I see a world where credits that are sold with W&I insurance being the benchmark for quality. Buyers can buy with confidence knowing that third parties with skin in the game have done their due diligence. This will smooth transactions, making them quicker and cheaper, whilst also raising the value of the credits. A virtuous circle where everyone benefits.

We hope this W&I policy will be a vital innovation for market infrastructure. For now it is aimed at issued credits but we will be agreeing our first forward sale as a second iteration very soon. There will be a series of press releases over the coming weeks detailing how we scale this up but this is exciting times and I am optimistic the market has turned. We have seen positive demand signals from the likes of the White House, Big tech making moves in nature based solutions and now innovations that can unlock this wall of capital. We know this W&I policy won’t solve all the issues in the market but we think it’s a giant leap forward. These things can always be iterated on and  improved so I welcome feedback and thoughts.

Big thanks to my amazing colleagues Thomas Kelly , Sachin Kucheria and Grace Bennett who worked so hard on this with MERE PLANTATIONS LIMITED and Michael Rawlinson KC .