A robust carbon market in Hong Kong would accelerate global decarbonisation efforts, contribute to Hong Kong’s own decarbonisation 2050 commitment, and be great for business.
Climate change is a global imperative that requires action and collaboration at every level on an unprecedented scale. The additional investments needed to achieve net zero emissions by 2050 is huge, most estimates forecast between USD 1 to 2 trillion per year – that’s every year, for 30 years. Governments have committed to decarbonization targets through the Paris Climate Agreement and subsequent national net zero commitments even though only a fraction of the spending requirement can be met by public funds. This necessarily ties our collective ability to tackle climate change to our ability to mobilise the private sector through global financial centres to pay for it, and that requires policy, incentives and innovation to make it a profitable business. This is the essence of green finance. The opportunity for financial centres to contribute to and profit from decarbonisation is compelling and obvious and while collaboration and the building of ecosystems are key, we operate in a highly competitive landscape where competitive advantage remains just that. Green finance is big business and the prominent international financial centres of the future will be the leading international green financial centres.
Accelerate Global Decarbonisation Efforts
China, the biggest CO2 emitter on the planet, has committed to reach peak carbon emissions by 2030 and become net zero carbon by 2060. After a 10-year trial carbon market scheme in selected pilot cities, the first on-spot trading of allowances in the Chinese national carbon market (ETS) will begin in Shanghai this month. This will mark the launch of the world’s largest compliance carbon market (which could potentially become three times larger than the entire EUA), initially targeting 4 billion tons of emissions from energy utilities alone. The national ETS will be extended to include other sectors in the future during the Fourteenth Five-Year Plan. A properly functioning carbon market needs a sophisticated carbon futures market, which is critical for risk management and price discovery. This is a hallmark of leading international carbon markets such as the Chicago Climate Exchange (CCX) which was acquired by the Intercontinental Exchange (ICE) in 2010.
Demand for carbon offset credits (VERs) is growing rapidly in response to national and corporate net zero carbon commitments and from international traders long on carbon, and is predicted to soon outstrip supply. At the same time, news articles and media reports continue to highlight the challenges and dangers associated with the unregulated voluntary market. As evidenced by the mission statement and recommendations of the Mark Carney-convened Taskforce on Scaling Voluntary Carbon Markets, building a robust and reliable voluntary offset market that adheres to international best practices is a global priority.
Enter Hong Kong, a leading international financial centre and gateway interfacing China and international markets. Hong Kong has the potential to become a global hub for carbon trading, and with its abundant experience and competitive advantages, it could serve to amplify China’s efforts to decarbonise through its national ETS (a regulated national allowance futures contract listed in Hong Kong benefits China), as well as global decarbonisation efforts.
A Carbon Market is Important for Hong Kong’s Decarbonisation Strategy
A robust carbon market in Hong Kong can also make an important contribution to the Hong Kong government’s carbon neutrality 2050 target announced in last year’s delayed Policy Address. This announcement essentially commits Hong Kong’s major corporates to achieve net zero carbon whether or not they have made, or intend to make, their own commitments. The real estate, energy and transportation sectors will be most impacted because they are our three main polluting sectors.
With a predominantly service driven local economy, most corporates will have little scope to significantly reduce their Hong Kong carbon footprint and therefore the purchase of offset credits will feature in many, if not all, corporate net zero strategies. Providing access to high integrity offset credits needs to be a priority and Hong Kong is a natural marketplace to promote and facilitate trading of high integrity VERs (including China-originated VERs, known as CCERs), a marketplace that would also serve Hong Kong’s growing need for carbon offsets.
Some of the largest companies (many of which are PRC companies) listed on HKEX are planning to offset their carbon footprints with CCERs. With regulators in Hong Kong and globally mandating higher environmental-related disclosure standards and acting to prevent greenwashing, and institutional investors seeking qualifying investments consistent with their ESG strategies, companies choosing to buy sub-prime CCERs should expect scrutiny and fallout.
We continue to eagerly anticipate the updated Climate Action Plan which is due any time now. Proactive strategies and measures to reduce carbon emissions were promised in last year’s Policy Address and the 2021-2022 Budget. A robust carbon market in Hong Kong listing contracts for high integrity CCERs and national allowance futures will provide a carbon reference price for the Hong Kong government’s carbon strategy, whatever the chosen strategy may be.
A carbon reference price will support financial institutions in pricing climate risk into the cost of capital. When businesses feel the financial benefit of their sustainability choices, others will be incentivised to adapt thereby creating material additionality.
A carbon reference price is a pre-requisite to the greening of the financial system and a must-have for all aspiring international green financial centres.
Competitive Landscape
There is nothing new about carbon markets or market-based solutions to tackle emissions problems. The US Clean Air Act of 1990 imposed a cap and trade scheme on SO2 emissions to tackle acid rain, with SO2 allowances and allowance futures traded on the Chicago Climate Futures Exchange. Carbon futures have been trading on CCX, now ICE, since 2003.
Despite the powerful policy context, Hong Kong’s abundant competitive advantages and the carbon market opportunity, enthusiasm remains tepid. One can only speculate why.
The recent policy announcements in respect of decarbonisation as well as the launch of China’s national ETS provide compelling reasons for Hong Kong to add carbon markets to its offering. Hong Kong should want to seize the unique opportunity to support decarbonisation and expand its offering, but with carbon markets developing in other seemingly more ambitious jurisdictions, Hong Kong will need to act quickly before the window of opportunity closes. The fact that Hong Kong does not have a particularly active commodities futures market should act as motivation to embrace the carbon opportunity, and the ghost of the Hong Kong Mercantile Exchange (which evidently continues to haunt over 10 years later) needs to be laid to rest.
Meanwhile in Singapore, a joint venture between DBS Bank, Standard Chartered, Temasek and the Singapore Exchange recently announced the launch of Climate Impact X (CIX), a global exchange and marketplace of high-quality carbon credits. CIX is Singapore’s second carbon exchange following AirCarbon’s launch in 2018.
A carbon market in Hong Kong would provide an opportunity to diversify Hong Kong’s commodities offering and exchange landscape and generate regional and international competition. Competition is important for an active secondary carbon market. Greater choice helps market participants better manage price risks and increases liquidity.
Let the Market Decide
Subject to obtaining the appropriate authorisation from the Securities and Futures Commission, there is no barrier to establishing a regulated marketplace in Hong Kong for high integrity CCERs and national allowance futures. Naturally, new contracts would need to be designed for the China carbon context but this is standard procedure for experienced practitioners and there are precedents. Market forces and applicable regulations should determine whether a marketplace for carbon should be established in Hong Kong and by whom. Typically, environmental commodities futures contracts have been developed by startups, thereby fostering competition in the exchange and clearing sectors. In Hong Kong there are clearly advantages to developing and accelerating a carbon market through collaboration that combines the best of Hong Kong’s existing market infrastructure, domain expertise and financial services innovation. Specific government policy support would be welcome, but should not be a pre-requisite to action.
Time is of the Essence
The authorities in Hong Kong continue to take their time to understand carbon in the context of their net zero carbon 2050 strategy, including the pros and cons of Carbon Connect[1], a Hong Kong stand-alone ETS, ETS “opt in” options, carbon tax and other related policy considerations.
Unrelated to the Hong Kong government’s carbon strategy for the SAR, Hong Kong can immediately play a major role in support of the China national ETS and global decarbonisation efforts by establishing a regulated marketplace for high integrity CCERs and national allowance futures. By so doing, Hong Kong would be well positioned to become a leading international carbon trading hub. Hong Kong has an abundance of competitive advantage and deep skill-sets. Some decisive action and much needed ambition seem to be the only missing ingredients to making this opportunity a reality.
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About the authors:
Ben McQuhae is the founder of sustainability focused law firm Ben McQuhae & Co based in Hong Kong (www.bmcquhae.com). He is a co-founder and Executive Committee member of the Hong Kong Green Finance Association (www.hkgreenfinance.org) and represents Hong Kong on the United Nations Financial Centres for Sustainability network (www.fc4s.org).
Jeff Huang is the founder of AEX Holdings Limited, a company developing carbon and power markets based in Hong Kong (www.aexmarkets.com). He was previously Managing Director at the Intercontinental Exchange (ICE) for the Greater China Region having graduated with a Master’s Degree from the Beijing Foreign Affairs University.
[1] A scheme to potentially provide international traders access via Hong Kong to trade physical allowances under the national ETS
