Financial Services and Markets Bill

Baroness Worthington Excerpts

Committee stage
Thursday 23rd March 2023 Grand Committee

Moved by

[Baroness Worthington]

241FC: After Clause 71, insert the following new Clause—
“Climate and nature offsets
In Schedule 2 to FSMA 2000 (regulated activities) after paragraph 9 insert—“Climate and nature offsets(9ZA) Selling, or offering or agreeing to sell, climate and nature offsets.””

[Baroness Worthington (CB)]

My Lords, I am grateful to the noble Baroness, Lady Sheehan, for lending her name to this amendment. I am not at all wedded to the exact wording of it. I would welcome discussions with the Government about approaches to this issue; however, I stress that this is a really important issue that needs regulatory approaches.

Currently, my amendment would add these activities to Schedule 2 to the Financial Services and Markets Act 2000:

“Selling, or offering or agreeing to sell, climate and nature offsets”.


This would make them regulated activities and enable the setting of minimum standards by the FCA, the regulator. By “off-sets”, I have in mind the voluntary carbon market and the nascent market in biodiversity, where an entity voluntarily seeks to compensate for the greenhouse gas emissions or loss of biodiversity arising from its activities by reporting an equivalent amount of emissions reduction or removal, or biodiversity gains, outside of its boundary that it has purchased through a credit or a financial mechanism.

There are more formal markets, particularly in carbon, where participants are required to participate. These are compliance markets. It is not my intention to focus on those, although there have been incidents in such markets, where there may well also be a need for more oversight. Despite the mandatory nature of the market, there have been examples of fraud and mis-selling. There is a lack of transparency even in these markets.

I return to the voluntary market. By making the trade in climate and nature off-sets a regulated activity, the FCA could make rules setting out principles, standards or regulated guidance that off-sets must then meet. I am not seeking to tie the FCA’s hands by setting out what rules it should make; it is a complex issue. It will need to invest in relevant expertise and be led by evidence, but it does need to invest in that expertise.

This amendment is supported by financial market participants. I put on record my thanks to Scottish Widows; Railpen—the Railways Pension Scheme; the Brunel Pension Partnership, which manages the assets for local government pension schemes in the south-west; and employees of the Environment Agency and the Church of England Pensions Board. These organisations collectively are responsible for more than £250 billion in assets; they have written to me in support of this amendment, and I am sure would welcome a meeting with government to discuss it further. They tell me that it is widely known that this market is not functioning well at the moment, and that the voluntary certifications and quality codes are not delivering the transparency, reliability and quality of off-sets for financing to flow freely into projects that could make a real difference in the fight against climate change and nature loss.

Given that, to achieve net zero, the majority of firms will have to rely on some form of tradable off-set or tradable credits for their residual emissions, which could be impossible to eliminate through actual investments, regulation of this market would serve the purpose of building trust for firms to allocate finance in this area—and I agree with them. Currently the market is relatively small, but it is growing and has increased fivefold since 2018, and many have called for it to scale further, including the former Bank of England Governor, Mark Carney. The Climate Change Committee estimates it to be a $2 billion a year market, accounting for 300 megatonnes of carbon dioxide per year—around 1% of global emissions and not far from the total contribution of the UK to the climate change problem, so it is not insignificant.

However, this market in climate mitigation or activities will not scale or endure without better regulated standards that can underpin confidence in the market. As the need to demonstrate a response to the growing climate risks increases, more and more companies and individuals will be tempted to buy their way to a cleaner carbon footprint or a cleaner reputation. Already, one-third of FTSE 350 companies include off-sets in their emissions reduction plans. Off-sets account for between 35% and 80% of their pledged emissions reductions—so it is a significant piece of financial architecture that people are relying on to get to net zero.

Companies will want to be seen to do the right thing, but this will be challenging. It is extremely difficult to assess whether emissions reductions being purchased are both real and durable. This offers an opportunity to unscrupulous providers to market poor-quality products to unsuspecting companies and investors. As I said, even the regulated carbon markets have seen examples of fraud and poor-quality off-sets entering markets. In the EU Emissions Trading Scheme, the Europe-wide carbon market, the market had to be closed to overseas investments in credits, partly in response to an oversupplied market but also partly due to persistent questions about the quality of the credits entering the market.

The potential for mis-selling in this market is high. Some noble Lords may remember that, in 2011, a listed company on the Canadian stock exchange, the Sino-Forest Corporation, went bankrupt after an investigation revealed that the company’s claims were vastly out of line with reality on the ground. The case related to a standard forestry offering; it is far easier to verify whether the land has been purchased and the trees are there than it is to verify whether those forests are actually absorbing or storing carbon—an invisible commodity that we are essentially turning into a tradeable commodity. Similarly, how much biodiversity the forest may hold is a far harder thing to verify.

The difficulties of verifying this market make it very attractive for unscrupulous actors and, as excitement and financial flows increase in this market, that attractiveness to potentially rogue actors will only grow. One UK-based carbon market ratings agency has already reported that it believes that only 30% of offsets on the market are high quality, and 25%—one-quarter—could effectively be classed as having junk status. The Swiss-registered offset provider, South Pole, one of the largest in the market, had the integrity of its offering called into question by an article in Tages-Anzeiger in February this year. This sent shock waves through the industry, and a lot of attention has now been placed on the question of integrity.

Most of the focus of the carbon market quality checks is on credits generated in the biosphere—so-called nature-based solutions. Trees are the most common product to which you will find financial instruments attached, but carbon is stored in other ways, too, and it is even more difficult to verify some of those other sources of carbon store because they are far harder to count and track. Below-ground carbon in soils is one example: it is notoriously difficult to get a handle on exactly what is happening in the carbon cycle in soils. It is even harder with below-water carbon—blue carbon—stored in sea grasses and other marine ecosystems, where you cannot even see the commodity being sold. These difficulties are pronounced.

The Minister may say, “Don’t worry; normal regulations against fraud and corruption will be sufficient to protect against outright fraud and corruption”, but these markets are uniquely complex. Often the problem is not that actors are wilfully seeking to do wrong but rather that there is an unhelpful lack of independent standards in the market to help determine what constitutes an additional or biodiversity benefit. In that uncertainty, it is not just investors who will potentially find that their investments are not delivering what they expected; the whole planet is being short-changed. This is because the sale of an offset permits the continued emission of greenhouse gases, minus the guilt; and, if the offset purchase is not genuine, atmospheric concentrations, already at dangerously high levels, will continue to rise. As we saw in the latest assessment report from the IPCC, this is starting to imperil us all.

Independent observers of the integrity of this market have highlighted concerns. A report published on this topic by IOSCO, the International Organization of Securities Commissions—the global standard-setter for investment securities—explains in detail the issues with the quality of carbon credits and the lack of a uniform definition of what constitutes high quality. I will not run through them; there are at least 10 reasons why this market is complicated.

At the top line, there are questions about additionality—whether this action is genuinely additional to what would have happened anyway—and about permanence and the risk of reversal. There are risks of leakage: you may be protecting something in one area, but that activity is just displaced to somewhere else and the emissions still occur. There are concerns about double counting, registry and transparency. There are potential conflicts in the market, and there is a lack of legal clarity, no standardisation, poor data and, overwhelmingly, a very large risk of greenwashing and, from that, legal risks and potential litigation cases. We are not in a good situation today. The market is small now, but it will grow, and it is really timely to be considering whether the Government should take powers now to regulate it.

This is a volatile market, as you can imagine, such is the uncertainty, with the mis-selling of fraud and the mistaken assumptions. There have been plenty of studies into why that might be the case. I will touch on an example of why regulations are needed: pension funds. In the UK, they are now investing in forest carbon offsets for the long term. This relates to both defined benefit offerings, where there are some protections for savers, but defined contribution schemes are increasingly entering this market too.

The long-term future of the biosphere in a changed climate is deeply uncertain and pension fund advisers and managers need better guidance. They simply should not have to determine whether something they are being sold is correct with no guidance from government and no regulation. There could be risks from litigation, as I mentioned: should vendors of these products be hit with legal claims or go bankrupt, savers will be hit by that outcome.

--- Later in debate ---

[Baroness Worthington (CB)]

I thank the Minister for her response and I am encouraged and reassured to know that those powers already exist. I will go away and consider that.

I am going to come back on a couple of points. It is true that some initiatives have been launched—I was involved in one—but they have no statutory basis at all. It is a group of individuals—business leaders and some academics—fighting it out with no governance or democratic representation. It will come out with standards, but the quality control over that process is not being led by sovereign nations. It was launched at COP 26, but there was absolutely no involvement of negotiators, member states or anything with public sector status. Although we look forward to their outcomes, something in that process may lead to less than favourable outcomes.

I ask the Minister: if we are to proceed internationally, which part of the architecture of the UN or any multilateral fora does she see acting as the holder of this important set of regulations? It cannot be left to industry to mark its own homework, nor to the voluntary sector, with its general lack of resources or certainty of funding. It needs to be led truly internationally, through member states and a multilateral process.

Perhaps the Minister would agree to write to me, because I am interested to understand how this can be done internationally. Individual member states have to lead; one or two progressive countries have to start the process, as we have seen with the green taxonomy: Europe started and now the UK has done ours. You do not always have to wait for a UN or international process, but can move forward and take leadership, especially if you are trying to make the City of London the centre of green finance.

Although I am encouraged, there are still some large questions to be answered about how we ensure quality, get the right standards, and involve democratic processes and member states—but I am pleased to withdraw my amendment.

Amendment 241FC withdrawn.