Michael Azlen, founder and CEO of Carbon Cap Management, explores the evolving role of carbon markets in shaping global climate agreements, while sharing his insights on innovative investment strategies and risk management opportunities.
Michael Azlen: Carbon Cap Management LLP currently manages the world's largest multi-market carbon fund, the World Carbon Fund. This fund invests globally in liquid and regulated carbon markets using exchange-traded futures and options, and physical carbon allowances; its objectives are to generate absolute returns with a low correlation to traditional asset classes and to have a direct impact on climate change.
Cap and trade systems - often referred to as emissions trading systems (ETS) - are regulated, liquid (the value traded is currently around USD 65 billion monthly) and transparent markets. ETS set emissions caps that decline annually to meet a policy target over time. This market-based solution provides environmental certainty in terms of the amount of emissions produced, whilst allowing the market to set the price. Carbon allowances equal to the emission caps are then either allocated or auctioned to emitting entities who may then trade these allowances between them.
Allowance trading is a key benefit of ETS as it incentivises least-cost abatement, as firms with a low abatement cost will abate and sell their allowances to firms with a higher abatement cost. ETSs also provide entities temporal flexibility by allowing firms to "bank" allowances, holding them for use in the future compliance years. This mechanism to cap and trade emissions is now one of the preferred policy instruments in the world.
Policy and technology risks are two key risks that can disrupt investment activities within compliance carbon markets. As part of Carbon Cap's disciplined investment process, the investment committee actively monitors both the political outlook and impending legislative changes across all compliance carbon markets. The committee also monitors technological developments amongst compliance entities for reducing carbon emissions, such as the cost per tonne of carbon removal and other technologies capable of impacting abatement options available.
The carbon markets display a low level of cross-correlation and by maintaining positions across multiple markets, the impact of policy shocks or technological developments specific to a market are mitigated through holding a diversified portfolio. In addition, the World Carbon Fund is able to mitigate risk by increasing convexity to provide downside protection while still participating in price moves; reducing or closing exposure to a particular market, and where applicable, taking a short position to benefit from market drawdowns.
The World Carbon Fund invests in regulated carbon and environmental markets and as such, all instruments traded are related to curbing carbon emissions. The Fund holds Article 9 status under the EU's Sustainable Finance Disclosure Regulation (SFDR). Through its investment activities, it seeks to contribute directly to the reduction in global CO2 emissions.
Placing a price on carbon emissions is the single most effective climate policy ever implemented.
In addition, Carbon Cap has committed to having a direct impact on climate change by using 20 % of the performance fees generated by the Fund to purchase and permanently retire carbon allowances and other CO2 emission reduction initiatives and activities. In addition to this quantitative commitment to sustainability and carbon reduction, we also focus on sustainability through stakeholder engagement and raising awareness in the asset management industry on the issues that surround climate change, including the role of the carbon markets as a successful policy tool with a strong track record of success.
Emissions trading is a regulatory policy and, along with carbon taxes, can be described as "carbon pricing". Placing a price on carbon emissions has been the single most effective climate policy ever implemented. Today, only about 25 % of global emissions are being priced, but this is set to rise dramatically in the coming years as many new countries have plans to launch regulated carbon markets or carbon taxes.
The implementation of the Carbon Border Adjustment Mechanism (CBAM) by the EU is bringing climate ambition and carbon pricing to many new countries. The CBAM will charge a carbon tariff for all imported goods based on the embedded carbon footprint of each product, creating a level playing field for European manufacturers who are subject to the EU ETS carbon price. This provides a strong incentive for exporting countries to price carbon at home already and to collect those carbon pricing revenues rather than paying them to the European government in Brussels. As a larger share of major countries adopt emissions trading, we will see regional markets join forces. Eventually, a global carbon price will be created, but this may be ten to 20 years in the future. As an asset class, carbon has moved from being a monthly value traded at USD 10 billion per month five years ago to USD 60 billion per month today, and we foresee this passing USD 500 billion per month within ten years, eventually overtaking crude oil as the most heavily traded commodity on the planet.
Michael Azlen is the founder, CEO, and CIO of Carbon Cap Management, an alternative asset management firm operating in the global carbon and environmental markets. Since the beginning of 2018, he has been researching climate change and environmental investment with a deep focus on regulated carbon markets. This culminated in the authorship and publication of a full academic paper on carbon as a liquid and investable asset class. Based on this research, Michael formed Carbon Cap Management LLP and launched the World Carbon Fund in February 2020. The fund invests into multiple liquid and regulated carbon markets. The fund has generated strong uncorrelated returns and a direct impact on reducing carbon emissions.
