Introduction

On 30 March 2022, the Carbon Market Workstream of the Green and Sustainable Finance Cross-Agency Steering Group (“CASG”) co-chaired by the Securities and Future Commission (the “SFC”) and The Stock Exchange of Hong Kong Limited (the “Stock Exchange”) released a paper on the potential opportunities in relation to carbon market in Hong Kong (the “Paper”). With Hong Kong’s financial infrastructure, the Paper discusses the opportunities for Hong Kong to develop its carbon markets.

Market demand in carbon credits

In the Paper, it is stated that there are generally two major kinds of carbon markets globally, which are generally categorised as voluntary carbon markets (“VCMs”) and compliance markets.

On the one hand, there is a rapidly growing interest in VCMs amongst international investors. VCMs include mostly corporate buyers who seek to neutralise their greenhouse gas (“GHG”) emissions by purchasing carbon credits generated from projects that reduce emissions. Meanwhile, listed issuers have incentives to decarbonise given the emphasis on environmental, social and governance (“ESG”) practice disclosure by the Stock Exchange (see our January 2022 newsletter issue “Stock Exchange reminds IPO applicants the importance of CG and ESG practice disclosure”).

On the other hand, compliance markets, such as the European Union Emissions Trading System, provide a platform for participants to trade carbon allowances, which are issued by the regulators to permit carbon emission of certain quantity. Corporations will have the incentives to reduce emissions to minimise the cost of purchasing allowances. Hong Kong may seize the opportunity in relation to the compliance markets by connecting foreign investors with the Mainland through a Greater Bay Area (“GBA”) platform.

Benefits and potential issues

Developing an on-exchange VCM

It is cited in the Paper that the Taskforce on Scaling Voluntary Carbon Markets (“TSVCM”) led by the private sector plans to introduce threshold quality criteria to standardise the trading of carbon credits. By leveraging the financial expertise, CASG suggested that Hong Kong should refer to the TSVCM guidelines to build a centralised and on-exchange VCM, thereby supporting a transparent channel for buyers across the globe. Meanwhile, Hong Kong may become the bridge between Mainland China’s carbon credits and the China GHG Voluntary Emission Reduction Programme and the world.

Developing the GBA Unified Carbon Market

Due to the unique institutional advantages of Hong Kong serving as the gateway between the Mainland and international markets, the CASG believed that Hong Kong could help to overcome the existing limitations of Emissions Trading System (“ETS”) in the GBA, such as low participation incentives due to high entry thresholds and transaction costs, and complications in opening non-resident bank accounts and remitting trading profits outside of China. Therefore, it is expected that Hong Kong should proactively facilitate the national and GBA carbon market developments. Although the economic structure and emissions standards vary across different GBA cities, the CASG held the view that this could be resolved by closer cooperation and dialogue.

Benefits of developing carbon markets in Hong Kong

The CASG believed that development of carbon markets in Hong Kong can bring the following three main benefits to Hong Kong:

·         Job creation: Development of carbon markets in Hong Kong will require creation of trading platform for carbon markets, advisors for market participants, and financing provider and facilitator for developers of projects that generate carbon credits, which will in turn increase job opportunities in banks and capital market. Carbon trades will also inevitably require the provision of facilitating services from verifiers, auditors, legal and advisory professionals, and technology experts.

·         Green economy, technology, and innovation: GBA Unified Carbon Market may help promote opportunities mentioned in the Hong Kong’s Climate Action Plan 2050, such as innovation, technological development and re-industrialisation, and facilitate the application of decarbonisation technologies and green research and development, which will ultimately support sustainable development and enhance the competitiveness of Hong Kong.

·         Fintech development: It is expected that as robust trading infrastructure is needed for the listing and trading of carbon-related products, this can promote the Fintech development in Hong Kong, such as (1) the use of blockchain technology in carbon market transactions, (2) the use of smart contracts for the automated generation and trading of carbon credits, (3) the use of distributed ledger technology to digitalise the full carbon credit lifecycle, and (4) the use of fiat money, stable coins or Central Bank Digital Currencies for effecting payment.

Suggested regulations and standards for regulating carbon markets in Hong Kong

In the Paper, it is suggested that VCMs are largely unregulated and there is a lack of standardisation in accounting perspective for recording carbon credits and emission allowances in their financial statements. Although carbon derivatives may potentially fall within the SFC’s regulatory remit, depending on the details of a derivative and its underlying asset, carbon credits and emission allowances are currently unregulated in Hong Kong as well. The CASG pointed out that provisions of carbon credits, emission allowances and carbon derivatives may potentially be included in the legislative regime of the Securities and Futures Ordinance (“SFO”) by the Financial Secretary exercising the power pursuant to section 392 of the SFO, or alternatively, setting up a separate regulatory regime targeting carbon products.

Conclusion

As a concluding remarks, the CASG opined that carbon market is feasible in Hong Kong, but to maximise the benefits of it, Hong Kong should make good use of its connection with the Mainland to facilitate global capital flows into the Mainland’s carbon markets and to enhance the quality of the carbon markets by taking advantage of its internationally reputable green certification services and familiarity with both Mainland and international standards. Looking to the future, the CASG will consider steps to develop Hong Kong into a regional carbon trading centre by developing Hong Kong into a global high quality VCM, collaborate to facilitate the building of and trading in the GBA Unified Carbon Market, and to strengthen cooperation with the Guangzhou Futures Exchange on carbon market development.