Hardly a day goes by without climate change making headlines just as much as the expected slump in the world economy as outlined in the UK’s Stern report.

But while in some circles it is still being debated why and whether it is happening, public policy makers as well as the markets have started to accept climate change and begun to move into a cleaner, more environmentally-friendly direction, creating investment opportunities in their wake.

The Kyoto Protocol, which set binding national greenhouse gas emission targets for industrialised countries from 2008-12, spurred the creation of emissions markets, whereby companies are allowed to sell their surplus carbon allowances or buy extra allowances.

The protocol also encourages so called CDMs - clean development mechanisms - that enable companies or groups in industrial nations to identify a source of greenhouse gas emissions and to finance a project in a developing country to reduce those emissions. In addition it fosters JIs - joint implementation projects - that reduce emissions of sources or increase carbon removals through the provision of sinks in industrialised countries, such as reforestation projects.

Both CDMs and JIs can be traded under the Kyoto protocol mechanisms. The certified emissions reductions (CERs) created under CDMs can be sold or be used to offset emissions of nations that ratified the Kyoto Protocol.

Emissions reduction units (ERUs), which result from JI projects, will be issued for a crediting period starting in early 2008.

The EU Emissions Trading Scheme (EU ETS) came under attack in its first phase between 2005-07, the piloting phase, for what many felt was an over-allocation of emission targets, which led to tumbling prices for carbon emission credits. The new national allocation plans (NAPs) set by the European Commission for the second phase between 2008-2012 are much stricter and likely to support liquidity and prices.

This improved scarcity may in turn attract more investors who can invest in trading schemes or CDM or JI projects.

But are the mounting concerns about climate change and tighter legislation only hot air to institutional investors or have some of them started to take action?

Both the Dutch healthcare fund PGGM, with assets under management of over €80bn, and the giant civil servants’ fund ABP with €200bn, have invested in the second carbon fund of the UK investment banking group Climate Change Capital (CCC). They were joined by the UK-based international energy group Centrica and a global emerging markets banking group.

CCC is a specialist investment manager that invests in global projects that reduce carbon emissions such as CDMs and JIs as well as in emissions trading schemes such as the EU ETS. The objective of the fund is to generate good returns by acquiring a diversified portfolio of carbon assets and derivatives.

It is the world’s largest private sector carbon fund, according to CCC spokesperson James Burnham, and managed to raise €800m by its final close at the end of March 2007.

PGGM’s head of responsible investments Marcel Jeucken says: “The objective of our responsible investment policy is to integrate environmental, social and governance (ESG) issues into all our investment decisions and asset classes. ESG is a range of issues and we have decided to focus on five core themes, of which climate change is one. We are looking for special thematic investments as well as engagement on climate change issues. Our engagement on climate change runs through F&C’s Responsible Engagement Overlay, but we are getting directly involved as well. For example, we very recently became a member of the IIGCC, the Institutional Investors Group on Climate Change. And as part of our thematic investments we committed €250m to CCC’s Carbon Fund II in 2006.”

Jeucken believes that PGGM’s investment is one of the largest investments in a climate change fund, especially as it invests in climate change projects rather than in large-cap companies involved in climate change issues.

He adds: “The reason behind the investment is firstly an expectation of attractive returns. On top of that, it fits very well with our long-term investment horizon. And thirdly, it also fits very well with our responsible investment ambition.”

PGGM reviewed the risk-return profile of the carbon fund before deciding upon the investment, but would not comment on its expected returns. Jeucken is confident that the investment will pay off. However, he points out that with such a new fund, returns as well as the investment level are too early to predict. He explains that the fund has a long-term horizon until 2012 and intends to monitor closely CCC’s carbon fund investments.

Apart from market, credit and operational risks, investing in the fund also presents investors with political risks due to the political nature of the Kyoto protocol and the EU ETS. While the EU ETS will continue after the second phase, uncertainty is still lingering for Kyoto-related project finance in the period after 2012, although negotiations have just started about a new phase post-2012. But Jeucken points out that even within the 2008-2012 period uncertainties still exist, like the ability to bank or carry over allowances or the way CDM projects are fielded, for example.

PGGM has always kept an eye on the developments of the EU ETS. Jeucken says: “We have, of course, followed the national allocation plans and the price developments in the first phase of the European trading scheme. We expect the second phase to be different, with improved liquidity and higher prices, and for that reason we have decided to primarily invest only in the second phase of the ETS.”

He adds: “We simply took the horizon until 2012 for these investments - they could potentially still deliver the emission reduction rights after that period. Investors need a knowledgeable, specialist house that really has an understanding of how this innovative market works. And as the market is still relatively new, there aren’t of these many around. That’s why we decided to work with a specialist player such as Climate Change Capital.”

But issues arising from this new market such as the finding of a specialist investment manager and investing according to a long-term horizon may leave other pension funds hesitant about investments in carbon reduction.

Jeucken says: “Globally there is a growing understanding that climate change is a real concern for investors. This is also reflected in the attention paid to climate change by the media, politics and corporates.”

But while plenty of people talk about climate change as an increasingly important investment theme, Jeucken admits that he has not seen that many investments.

PGGM, however, has a strong appetite for these types of investments, not just on climate change, but also others with different characteristics to the more conventional parts of its portfolio. The pension fund has separated its investment organisation in alpha, beta and alternative beta. And in terms of alternative beta, PGGM looks for innovative investment ideas and vehicles that promise to deliver good returns like the Carbon Fund II within its portfolio of strategies.

Jeucken does not comment on whether PGGM will invest in another carbon fund after 2012. He says: “We have just started this investment. We will monitor the market and continue to evaluate the risk and return characteristics of potential opportunities that fit in our portfolio.”


Background to climate control legislation


❏ The Kyoto Protocol to the United Nations Framework Convention on
Climate Change (UNFCCC) was adopted on 11 December in 1997 by
members of the United Nations and came into force on 16 February 2005. Some 171 parties have ratified the protocol to date, of which 35 countries and the EU are required to reduce six different greenhouse gas (GHG) emissions
specified for each of them in the treaty.

❏ The protocol set binding targets for Annex I parties, industrialised countries that were OECD members and countries with economies in transition, to reduce GHG emissions in the commitment period of 2008-2012. These add up to a total cut in GHG emissions of at least 5% from 1990 levels.

❏ The Kyoto Protocol defined three mechanisms to lower the cost of achieving the emissions targets. They were emissions trading schemes, clean development mechanisms and joint implementation projects eligible to Annex I

❏ The emissions trading scheme of the European Union was set up to help EU countries meet their Kyoto emissions targets and began in January 2005. It is based on Directive 2003/87/EC, which entered into force on 25 October 2003.

❏ Talks addressing measures following the first commitment period were held by all 189 contracting parties to the UNFCCC in Berlin in May.