Clear The Air News Blog Rotating Header Image

Merrill’s Green Financier Sees Mission In Emissions

Abyd Karmali’s role in carbon trading could help save planet

Eric Ng – Updated on Aug 18, 2008 – SCMP

Climate change and global warming have become hot topics as more extreme weather – from droughts to cyclones – is witnessed across many regions of the world.

The drive to reduce greenhouse gases – and prevent what many fear will be a global catastrophe – is creating increasingly sophisticated emission trading schemes and attracting the attention of the world’s biggest finance companies.

Abyd Karmali, appointed global head of carbon emissions of Merrill Lynch in August last year, has a ringside seat to the unfolding developments. A member of a new breed of environmental financiers, he is responsible for developing carbon-related businesses at the United States-based investment banking giant.

Major investment banks have set up carbon emission trading desks and investment products in recent years to tap the fast-growing market. Emission trading allows companies to buy and sell permits for emissions or credits for reductions in emissions of certain pollutants.

Prior to joining Merrill Lynch, the 40-year-old Briton worked for climate change consultancy IFC International in Washington, Toronto and London, where he served as European managing director. From 1996 to 1997, Mr Karmali was climate change officer at the United Nations Environment Programme’s (UNEP) Industry office in Paris where he worked on negotiations on the landmark Kyoto Protocol. He was recently elected president of the Carbon Markets and Investors Association, a carbon finance industry body.

The emission trading industry is set for big changes. Reduction commitments under the Kyoto Protocol are due to expire in 2012 and negotiators want to seal a new pact at a United Nations conference in Copenhagen in December 2009.

Bringing on board major polluters such as the US, China and India is widely believed to be the key to a global deal and prevention of catastrophic fallout from climate change.

In addition, more signatories to the global emission reduction pact will bring about opportunities for more trading of emission rights, which have become an investment asset on their own, besides being a compliance tool.

In his spare time, the African-born Mr Karmali has volunteered to work on projects for development agencies such as the Aga Khan Development Network and Focus Humanitarian Assistance Europe Foundation. These organisations provided him with a scholarship to attend the Massachusetts Institute of Technology (MIT). London-based Mr Karmali holds a Master of Science degree in technology and policy from the MIT. His hobbies include running, football, world music, adventure travel and gastronomy.

You have had a 17-year career in climate change and carbon markets. What drove you to this industry in the first place?

My interest in climate change stemmed from a landmark book published in 1987 called Our Common Future, which was the report of the Brundtland Commission on Sustainable Development. The report made a compelling case for a need to shift to a more sustainable mode of development and began to identify the adverse impacts on the environment under a business-as-usual scenario. During my undergraduate degree I discovered that I was interested not so much in pure engineering but in the social and market dimensions of technology and this led to my doing the masters programme in technology and policy at MIT.

You participated in the Kyoto Protocol negotiations during your stint in Paris. What was your role and most memorable experience in the Kyoto Protocol negotiations in 1996-97?

The negotiations in Kyoto were incredibly intense and came close to a complete breakdown on several occasions, particularly on the last night. As a UNEP person rather than a country delegate, my role was to work with several government delegations to improve understanding about the key technical and policy issues. I was in a privileged position to be sitting at the UNEP desk during the early morning drama and was present when the deal was reached at 6am on December 11, 1997.

How has your upbringing affected your views?

Perhaps by virtue of being born in Africa of Asian ancestry with parents who instilled in me a strong sense of social consciousness, having my formative education in Europe and obtaining significant professional experience in North America, I have been able to develop an international perspective. This has also attracted me to work on such a global issue as climate change that requires solutions to be designed across disciplinary, cultural and geographic boundaries.

What is Merrill Lynch’s role in the carbon emission rights market?

We work with different types of buyers such as those that need to comply with emission restrictions in Europe and Japan. We can also sell to investors who are interested in a portfolio of different categories of carbon credits. We have credits from Chinese wind farms to Russian natural gas pipelines emission reduction projects. You can create a portfolio representing different carbon risks.

Merrill has launched the “Green & Gold” initiative to drive proactive voluntary emission reduction. Companies tend not to spend a lot on emission reduction until they are required to do so. How do you convince companies to buy into the carbon strategy concept? As there is little or no regulation over voluntary emission offset programmes launched by corporates, how can consumers trust what they are told when they buy such emission reduction add-ons to, say, their air tickets?

This is true but we also think that there are a growing number of companies which are looking to take proactive action to reduce emissions, including through buying carbon offsets because of pressures from consumers and because of the opportunity to develop a leadership position in their sector. Merrill Lynch’s view is that carbon strategy is becoming an area where companies increasingly have to compete, just as they do on choice of technology, research and development efforts, labour costs, and supply-chain management.

How mature is carbon credits as an investment class? Carbon credits are being aggregated into asset-backed investment products as did subprime mortgages. Are there risks of over-securitisation in this nascent sector?

Carbon is a relatively new commodity that has been around only since 2005. Its growth trajectory is quite remarkable, with a market value of US$65 billion last year, possibly reaching US$1 trillion in 2020 if all of the right scenarios play out. But it is more policy-driven than any other commodity we have ever seen. There is massive policy uncertainty in this market.

We think it’s unlikely to appeal to a really broad set of investors. It’s fine for sophisticated investors who are aware of the policy risks. We have developed structured emission products with those investors in mind, but it’s unlikely to reach a point where it is something which can be distributed to the mass market.

Do you think carbon will one day become a hot investment product given the increase in carbon emission awareness?

Sure. The reason why Merrill has developed a global carbon price index, renewable energy index, energy efficiency index and carbon leaders index, is because we realise that institutional investors want to pursue carbon as an individual asset class. It appears from our analysis that carbon as an asset class is not well correlated to many other investments, so from a portfolio diversification point of view, it makes a lot of sense.

This is particularly so given carbon pricing affects the value of other asset classes such as stocks of listed companies. Companies can be directly affected, such as those in the power, cement, steel, paper and refining sectors, or indirectly affected, like aluminium smelters that use a lot of electricity.

Merrill Lynch has invested US$9 million in a deforestation prevention scheme in Aceh, Indonesia. Can such a project be implemented in China where deforestation is also a big problem?

We have had some preliminary discussions with mainland government officials about the interest in doing such a project.

This is under the so-called “Reduced Emissions from Deforestation and Degradation” category of project with the potential to generate carbon credits under a financial mechanism being discussed by the United Nations.

Eventually, this may be fully fungible with carbon credits from the UN’s Clean Development Mechanism scheme.

Why is it easier to start in smaller nations?

This is an area where we need strong government support. There needs to be clarity about legal title of carbon credits to be generated. One of the biggest questions here is who owns the carbon rights to a particular area, and are governments willing to grant licences for credits to be sold to external counter-parties. In Brazil, there were different opinions between central and state governments about who owns carbon rights in the Amazon. While Merrill is interested in being involved, we don’t think it’s the right time due to lack of clarity about who owns title. Aceh has some degree of autonomy, which makes it an easier party to work with.

The Kyoto Protocol will expire in 2012. How likely is it that some form of agreement will be struck by the December 2009 target for mandatory and voluntary carbon emission reductions to continue?

Our view is that we are likely to see a breakthrough in the international negotiations in December 2009 in Copenhagen, but we are also realistic that that would be only one year after a new US president will be in office. Maybe it is more appropriate to look toward 2010 for an agreement. That said, we are of the view that the carbon market cannot afford a gap period between the end of the first commitment period ending 2012 and whatever happens next, be it a second commitment period of Kyoto or an alternative agreement. It would be a disaster if there is this gap during which carbon credits have no value. We are reasonably optimistic about the prospect of a breakthrough partly because Australia has ratified Kyoto Protocol. It is probably the country experiencing the physical impact of climate change the most. China understands its vulnerability with regard to the impact of change in precipitation on agricultural productivity, and the potential of the eastern coast being affected by rising sea levels. We also believe India understands its vulnerability, and what a shift in monsoon timing and location would do to Indian infrastructure.

What if some small nations hold out and do not join the eventual agreement? Are you worried that pollution-prone activities will move to these nations?

This is a valid concern, but given a small number of large nations are responsible for most of the emissions, this is not a major problem. Also, economic activities shift around the globe not just based on costs, but also technology, legal environment, labour cost, productivity and environmental standards.

Do you think the United Nations’ Clean Development Mechanism (CDM) that allows developed nations to help finance carbon emission reduction projects in developing ones will be retained?

There is consensus that a carbon market mechanism absolutely has to be at the core of a global emission reduction agreement, and that the market mechanism does deliver emission reduction in a cost-effective way. I can’t think of any country that would oppose the continuation of CDM or emission trading.

How do you assess the success and shortcomings of the CDM?

There is no question that CDM is imperfect. It’s a very new mechanism. Inevitably there are some teething problems. But we are overall very satisfied with the market mechanism. One of the mechanisms Merrill and other financial institutions are advocating is that there be some kind of private sector-oriented advisory board, given this is a US$65 billion market. This is something the CDM executive board recognises. The board is primarily made up of government officials who may have little experience in implementing projects on the ground, and also little experience from the financial perspective.

What other changes do you envision should the CDM be retained?

I see increasing performance benchmarking, especially for the larger developing nations like China and India. This will mean higher qualifications requirements for projects and a reduction in the number of credits granted to these nations. There was precedence. In the phasing out of ozone-depleting substances under the Montreal Protocol, initially individual projects were proposed, and each was evaluated painstakingly. Eventually, the administrators realised they did not have enough resources to evaluate each project and also wanted to raise the bar. They came up with benchmarks for each project category and it worked.

Many countries and regions in Asia are vying to set up carbon exchanges. Are there significant first-mover advantages and can only a few survive?

One of the challenges to figuring out an answer for this is that there is a heterogeneous set of nations. Japan is a signatory to Kyoto Protocol. Australia is a recent signatory but will be the first country which will have an emission trading scheme within the country. You also have small country like New Zealand eyeing to set up an exchange. Then there are China and India, big sellers of carbon credits under CDM, as well as regional trading hubs like Singapore and Hong Kong. Our view is that initially you will probably see several attempts to have exchanges.

Do you think Hong Kong’s proximity to the world’s largest carbon credit generating market, mainland China is an advantage?

It is difficult to say whether geographical proximity actually makes any difference. It’s more a function of market participants’ comfort with the rules of the exchanges, the clearing mechanism and the contracts. For example, the European Carbon Exchange is a virtual platform that is not physically situated in any one place. Similarly, New York’s Nymex Green Exchange has managed to attract reasonable amount of liquidity of the European Union’s emissions allowance market without even being in Europe.

Do you think Hong Kong will succeed in having a successful carbon exchange?

Hong Kong has a well-established track record for being a regional financial centre. If I was to look into the crystal ball, I’d say that Hong Kong and Singapore would be the natural best prospects to be the regional emission exchange hubs. But part of it depends on the degree to which how they link emissions to other related commodities.

eric.ng@scmp.com

Leave a Reply

Your email address will not be published. Required fields are marked *