Paper on International Marketing

7/29/2019 Paper on International Marketing

1/10

BANKS IN CARBON FINANCING: CASHING IN ON CARBON

M.Saravanan, Assistant Professor, Post Graduate Department of International Business,

Sree Narayana Guru College, KG Chavadi, Coimbatore 641 105

Email.: [email protected] Mobile No.: +91 99434 37749

WHAT IS CARBON FINANCING?

Carbon financing is the term used for carbon credits to help finance Green House Gas (GHG)

reduction projects where industrialized countries can make up for their carbon reducing

obligations under Kyoto (industrialized countries collectively agreed to reduce GHG emissionsby 5% by 2012 compared with 1990 levels) through purchase of emission reduction credits from

projects in developing countries.

Under Kyoto Protocol, governments are separated into two general categories: first,

developed countries, referred to as Annex I countries which have GHG emission reduction

obligations and second, developing countries, referred to as non-Annex I countries which have

no GHG emission reduction obligations but may participate in the Clear Development

Mechanism (CDM). Failure on the part of any Annex I country to meet its Kyoto obligation will

incur penalization resulting in submission of 1.3 emission allowances in a second commitment

period for every ton of GHG emissions in excess of cap in the first commitment period (2008-

2012). So as to avoid penalization, Annex I countries can purchase GHG emission reductions

from financial exchanges, from CDM projects of non-Annex I economies, from other Annex I

countries under the Joint Implementation (JI) or from Annex I countries with excess allowances.

1


2/10

When non-Annex I countries with no GHG emission restrictions undertake GHG emission

reduction projects under CDM they receive carbon credits which can then be traded/exchanged

with Annex I countries in the world market.

ROLE OF BANKS

The growing sense of urgency among countries worldwide to combat the impending catastrophic

effects of global warming has paved the way for the birth and growth of a multimillion dollar

international market for carbon emission trading of buying and selling Greenhouse Gases

(GHG). The global carbon trading market is unique in the sense that the sellers are from India or

other developing nations, while the buyers are from industrialized countries. The objectives of

both the parties are quite contrary; while buyers want carbon credits at cheaper rates, sellers want

to maximize the value. Being unknown to each other, they will be carrying preconceived notions

and misgivings about the genuineness of the contract. This is where banks have a pivotal role to

playact as financiers of emission reduction projects and bring together buyers and sellers on a

common platform through credit mechanisms such as:

Letter of Credit (L/C) is one such financing mechanism, where a buyer guarantees payment

through his banker for goods received from the seller. L/C is an assurance to the seller that he

will receive the payment and the same can be availed through an escrow account with the bank.

This apart, Carbon Delivery Guarantee is another mechanism through which banks provide

guarantee to the buyers of carbon credits that the same will be delivered by sellers as per the

terms of the contract (quantity, delivery schedule, etc.) This enables buyers and sellers to enter

into long-term future contracts. Banks can thus tap the investment potential of receiving huge

amounts by way of advances to these projects from overseas buyers.

Apart from financing CDM projects and providing loans against carbon credit receivables,

banks offer a single point delivery of services such as advisory services, value-added products

like securitization of carbon credit receivables, delivery guarantees, escrow mechanism, etc. to

their customers.

Indian Banks rush in to capitalize on the high-risk, high-return carbon financing trade.

In China, European companies buying carbon credit enter into agreement at the beginning of the

project and also provide finance for project development. But in India, since the project size is

small; many companies are seeking finance from financial institutions. Domestic banks such as

ICICI, IDBI, HDFC and SBI are gearing up to tap this new high risk and high-reward business of

2


3/10

carbon financing, where the margins are quite lucrative in the range of 1-3%, higher than for

other projects. Apart from generating high margins that include commission, brokerage, etc.

from the carbon credit transactions, banks cite broadening of the product portfolio as key

incentive to enter this market. Carbon trade provides scope for other businesses like

technology transfer, capital investments, cross-border funding products and remittances and also

enables banks to provide an international platform for buyers and sellers and increase the scope

of allied business.

"Financing of CDM projects becomes an extension of banking services that we provide to retain

our customers." PV Anantha Krishnan, Executive Vice-President and Country Head, HDFC

Bank, Discovering carbon finance as a lucrative business opportunity, Banks have started

latching on to the carbon credit bandwagon. They feel financing clean development mechanism

(CDM) projects a good and feasible business proposition. A few banks have joined the carbon

credit bandwagon, for instance:

In October 2002, The World Bank entered into an agreement with Infrastructure Development

Finance Company (IDFC) wherein IDFC is to handle carbon finance operations in the country

for various carbon finance facilities. The agreement initially earmarked a $10-million aid in

World Bank-managed carbon finance to IDFC-financed projects that meet all the required

eligibility and due diligence standards.

SBI in September 2007 entered into MoUs with MITCON Consultancy Services

Ltd., Ecosecurities India Private Ltd., and Cantor CO2e India Private Ltd. to provide one-

stop destination to industries for CDM projects and emissions trade. It has also recently entered

into a MoU with KFW (a German firm) carbon fund for jointly exploring financing of

sustainable CDM opportunities in various development and industrial sectors. The bank has also

cleared one such loan valued at Rs.8cr, against the receivable to a biomass-based power plant in

Indore. Also in the offing are 3-4 such loans pending clearance which will be considered once

they complete purchase agreement formalities with their buyers.

ICICI Bank in June 2008 signed a $200 million line of credit from Japan Bank

for International Cooperation (JBIC) to fund carbon credit-related projects. The bank is involved

at all stages of carbon credit project cycle and look forward to providing full range of services in

this space. Services offered by the bank include assistance to clients in identification of CDM

projects and registration of the same and finally issuance of carbon credits in association with

3


4/10

our partners by funding and private equity syndication for CDM projects and structuring carbon

credit transactions. Also, the bank is working with SMEs for carbon credit market. Apart from it,

the bank has formed a dedicated vertical to work on opportunities arising to Indian SMEs from

climate change and carbon credits. The bank has a multi-pronged approach as it has tied up with

consultants to help extend advice on setting up carbon credit linked projects and on energy

conservation etc to the clients. The bank is also putting in place shortly an awareness program

for their clients on the need to be energy efficient. These would also include programmes

to showcase successful energy conservation and CDM projectsall this would create

a facilitative support system for SMEs keen to take advantage of the CDM mechanism to reduce

their power costs as also contributing in their own way to a clean environment.

ICICI Bankhas also signed a MoU with Agrienergy Consultancy (the Indian arm of the UK

based consultancy, Agrienergy Ltd.) to promote carbon credit business in the

country. Agrienergy's services will include participation throughout the carbon credit project

cycle, right from assistance to clients in identification of CDM projects, their registration

with UN Executive Board and recurring verification, while ICICI will provide services in

the areas of commercialization of Certified Emission Reduction Certificate

(CERC), coordination and banking services and debt-financing of CDM projects.

Similarly, IDBI has set up special desk offering end-to-end solutions to corporates of carbon

credit business. The bank has certain tie-ups for technical and financial assistance, and the

products developed include providing guarantees for carbon deliveries and escrow services for

payment.

Going a step further, both ICICI Bank and IDBI Bank have plans to form alliances, "We have

formed a dedicated team for carbon credit. Efforts are also taken to forge alliances for this

initiative. The bank has launched `Go Green'a program which gives SMEs an opportunity to

reduce their carbon footprint," said Sanjeev Mantri, GM, Small Enterprises Group of ICICI

Bank.

THE WORLD BANK & CARBON FINANCE:

The World Bank Carbon Finance Unit's (CFU) initiatives are part of the larger global effort to

combat climate change, and go hand in hand with the World Bank and its Environment

Departments mission to reduce poverty and improve living standards in the developing world.

4


5/10

The CFU uses money contributed by governments and companies in OECD countries to

purchase project-based greenhouse gas emission reductions in developing countries and

countries with economies in transition. The emission reductions are purchased through one of the

CFU's carbon funds on behalf of the contributor, and within the framework of the Kyoto

Protocol's Clean Development Mechanism (CDM) or Joint Implementation (JI).

Unlike other World Bank development products, the CFU does not lend or grant resources to

projects, but rather contracts to purchase emission reductions similar to a commercial

transaction, paying for them annually or periodically once they have been verified by a third

party auditor. The selling of emission reductions - or carbon finance - has been shown to increase

the bankability of projects, by adding an additional revenue stream in hard currency, which

reduces the risks of commercial lending or grant finance. Thus, carbon finance provides a means

of leveraging new private and public investment into projects that reduce greenhouse gas

emissions, thereby mitigating climate change while contributing to sustainable development.

As per reports, World Bank carbon funds and facilities have 186 projects with an estimated asset

value of $2.3 billion.

RISK-REWARD TRADE-OFF

As a developing country, India does not have any emissions reduction target, but it is able to sell

certified mission reductions (CERs) pursuant to the CDM, to large emitting countries that have

emission reduction targets under the Kyoto Protocol. Some of the banking institutions in India

are engaged in these types of projects whereby they could earn net income spreads ranging from

1-3% after careful analysis of the projects.

However, despite huge potential, the initiative taken by banks to fund carbon finance projects is

moving at a snail's pace, further aggravating the risk factors for new financial institutions which

are entering the carbon market. While the industry has huge growth potential it also has high and

varying degrees of risks associated with carbon credit financing which depend on the nature of

the project and the level of its financing.

Financing a project that has the potential to earn carbon credits has varying degrees of risk

depending on the stage at which you finance such a project. Thus, such a financing is quite

challenging, more so in the case of clients that do not have a strong balance sheet to support the

project. The returns can be good if a bank is present across the complete cycle of such projects,

5


6/10

right from financing to CDM registration and finally trading of the issued carbon credits," says

Sanjeev Mantri, GM, Small Enterprises Group of ICICI Bank.

There are several project specific risks which include: underperformance, capital/operational

costs overrun, currency risks caused by inflation and market risks such as the insolvency of

counterparty, and banks need to develop proper financing mechanisms factoring in the unique

risks presented by CDM projects.

Regulatory risks at central and state levels form the core element of commercial risk which can

be overcome with effective approval rules.

The other risks include failure of technology, procedural delays, political risk, credit risk,

negligence in dealing with carbon instrument delivery risk, etc. Balancing the risk-reward trade-

off forms the crux of carbon financing. Financing projects that are not supported by strong

balance sheet pose significant challenges and entail additional risks, such as operational risk,

price risk, default risks, project registration risk, execution risk, policy risk, etc.,

Another hurdle is the exchange risk. While banks can apply hedging tools for forward contracts

involving huge amounts to mitigate the risk, effective regulatory clarity will strengthen and

encourage banks to actively participate.

As an Annex II country, India has generated US$3.5 billion in carbon revenue since 2001,

according to the National CDM Authority, Ministry of Environment and Forests, Government of

India. This implies significant opportunity for Indian banks. This opportunity is bounded by

limitations imposed by the lack of clear accounting guidelines. Carbon financing is a

groundbreaking concept, and by and large banks are still learning how to judge risk and therefore

determine financing structures.

WHAT MORE NEEDS TO BE DONE

Despite being the second largest seller of carbon credits in the world, India still lags behind

China as the price expectations of sellers in India are much higher than those across the globe.

World Bank spokesperson.

While India has a relatively well-developed banking system, it seems project proponents have

been unable to access carbon finance due to lack of suitable project finance instruments for this

purpose and a conducive policy framework for project entities to optimize utilization of this

6


7/10

window. There is a potential for the market share to go up through market-based initiatives such

as developing the Carbon Finance Fund (CFF) and integrating it with the ongoing efforts.

The CFF would act as a platform for financial resource management, carbon trade, information

collection & dissemination, and technical support through extensive domestic and international

cooperation. In addition, Novel financing instruments, such as special purpose vehicles, CDM

bonds, etc., can be developed with efficient and transparent procedures. Regulatory risks at

central and state levels form the core element of commercial risk which can be overcome with

effective approval rules.

Also, there need to be a robust structure with simplified procedures, creating awareness

and providing updated information about related benefits to project owners, promoting

local expertise on project development and encouraging international participation of buyers and

investors, and providing tax incentives to banks for financing CDM projects which in turn

will cost-effectively reduce GHG emissions, while contributing to the growth of economy in

a sustainable manner. That will further spawn new opportunities for banks.

REFERENCES / SOURCES:

ICAFI University - Press - www.books.iupindia.org

www.financialexpress.com

images.google.com

7
http://www.books.iupindia.org/http://www.financialexpress.com/http://www.books.iupindia.org/http://www.financialexpress.com/


8/10

ANNEXURE I

COUNTRY TARGET (1990** 2008 / 2012)

EU 15*, Bulgaria, Czech Republic, Estonia, Latvia,

Liechtenstein, Lithuania, Monaco, Romania, Slovakia,

Slovenia, Switzerland

-8%

US*** -7%

Canada, Hungary, Japan, Poland -6%

Croatia -5%

New Zealand, Russian Federation, Ukraine 0

Norway +1%

Australia +8%

Iceland +10%

* The 15 States who were EU members in 1990 will redistribute their targets among

themselves, taking advantage of a scheme under the Protocol known as a bubble, whereby

countries have different individual targets, but which combined make an overall target for thatgroup of countries. The EU has already reached agreement on how its targets will be

redistributed.

** Some EITs have a baseline other than 1990.

*** The US has indicated its intention not to ratify the Kyoto Protocol.

Note: Although they are listed in the Conventions Annex I, Belarus and Turkey are not

included in the Protocols Annex B as they were not Parties to the Convention when theProtocol was adopted.

Upon entry into force, Kazakhstan, which has declared that it wishes to be bound by the

commitments of Annex I Parties under the Convention, will become an Annex I Party under

8


9/10

the Protocol. As it had not made this declaration when the Protocol was adopted, Kazakhstan

does not have an emissions target listed for it in Annex B.

ANNEXURE II

There are 23 Annex II countries and the European Union. Turkey was removed from the Annex

II list in 2001 at its request to recognize its economy as a transition economy. These countries are

classified as developed countries which pay for costs of developing countries:

1. Australia

2. Austria

3. Belgium

4. Canada

5. Denmark

6. Finland

7. Germany

8. France

9. Greece

10. Iceland

11. Ireland

12. Italy

13. Japan

14. Luxembourg

15. Netherlands

16. New Zealand

17. Norway

18. Portugal

19. Spain

9


10/10

20. Sweden

21. Switzerland

22. United Kingdom

23. United States of America

10

Documents

Paper on International Marketing