What role will capital markets and exchanges play in carbon abatement and tackling climate change?
Without coming over all Greta-like, we need to reduce carbon output significantly, with a net zero emission goal. That can best be achieved through efficient capital allocation, which will be imperative for implementing large-scale carbon abatement programs and measures. McKinsey estimates that $150 trillion will need to be spent on Capex to back projects to decarbonise (that’s mainly stopping using fossil fuels for energy and replacing them with renewable and green energy) and climate abatement (large-scale activity to take carbon out of the atmosphere – trees and forests, coastal and waterways, as-yet-uncommercialised carbon capture technology).
That’s a massive opportunity for innovative and credible trading instruments and markets that materially help solve climate issues. The ‘cost of climate change’ is, we believe, a significant opportunity for profits, not costs. The current market cap of all exchanges in the World Federation of Exchanges (WFE) is circa $100 trillion – climate abatement and decarbonisation spending will be 50% bigger than the current securities markets. There are parallels between NASDAQ and the American tech industry – in the 80s, when Apple, Microsoft, Sun, et al were starting, they listed and traded on NASDAQ, not NYSE. After buying Instinet’s trading engine and INET ATS in 2005, NASDAQ’s electronic market grew much faster than the NYSE floor trading market!
Even if you only look at replacing fossil fuels – currently 20% of global GDP – that’s circa $20 trillion a year. It’s clear that the market for hydrogen, solar, wind, tidal, green electricity from renewables and hydro – even possibly nuclear – is huge.
Given the massive potential market size, won’t climate trading gravitate to the existing major exchange groups?
The transition to climate markets will be as big an opportunity for disruption as the move to electronic trading was. Whilst at Instinet and Chi-X, we launched markets based on superior technology and customer services that gained more than 30% of NASDAQ trading and 20% in Europe and Canada. The David’s beat the Goliaths in the transition to electronic markets. Eventually NASDAQ and CBOE bought these businesses, reinforcing the quality of the markets we built. XBourse aims to emulate the superior technology and client partnership models from Instinet and Chi-X to become a first mover in the climate markets.
Why will we need new markets?
Climate markets will require a different technology stack and business model than today’s securities markets. Traditional securities instruments are homogenous and fungible, so lend themselves to batch settlement processing. Many climate instruments will be bespoke, requiring 1:1 delivery versus payment solutions. There are a few pioneers that have already established climate ‘exchanges’. In reality, these are more like over the counter broker-dealers with lit order books – similar to the model that Instinet had before it created INET in the USA and Chi-X in Europe and Global as dedicated exchange markets.
The independence of the traditional exchange model that XBourse is building will embrace and encourage participation from all banks and brokers with a model that does not compete with their advisory, issuance and servicing of institutional investors. The unconflicted exchange model is supplemented with ownership and pricing initiatives that share some of the upside success of the new markets.
Traditional exchanges primarily evolved from local statutory and regulatory monopolies concentrating on trading local securities. Climate solutions are global – climate markets must therefore be global. Like Chi-X, we can roll this out on a global basis.
Can you give examples of how climate markets will differ from traditional securities markets?
Traditional markets are based on corporations, and many corporations have multiple businesses and projects that roll up into the listed corporate entity. Climate markets require verification and certification (provenance) at the project level. The provenance needs to remain attached to the output from the project. That’s where TYMLEZ and their blockchain-based provenance tracking become an important link in the new markets.
TYMLEZ will enable XBourse Marketplace participants to have pre-trade verification of the carbon credit provenance via the immutable digital record of the credit certification process and the examination of the underlying credit characteristics. This process is currently fragmented and essentially paper and legacy technology bound. Digitising the process will remove significant frictional barriers to adoption and increase transparency.
The project-based provenance allows investors to invest directly in the project. This creates a virtuous circle – climate project managers need funding, and investors want access to good-quality projects and climate credits. New instruments – funds, trusts, bonds etc – can invest in the climate project with the ownership being managed via blockchain-based fractional ownership tokens. We are calling these Nature Based Tokens – the link between the capital needs for net zero and the investors wanting to invest in genuine solutions.
We’ve been looking at forestry management – a business that has existed for many years but is still in its infancy. The concept of carbon credits is more than planting a tree or not chopping down a tree; managing a forest is a specialist business. The best forestry managers will manage the trees through regeneration which involves planned cultivation where trees are replaced at an optimal age and replaced with new trees. The timber and pulp from the regeneration are a commercial output from the project.
Equally, a well-managed forest will generate more than carbon credits – there will increasingly be a focus on biodiversity and water rights. The carbon credits, biodiversity and water rights can be tokenised and distributed directly to the investors. Alternatively, the credits and rights can be sold on the XBourse platform, with the proceeds distributed to investors.
Decarbonisation involves replacing fossil fuels with non-carbon products, including batteries and electricity, hydrogen, and tidal generators. How do you see these markets evolving?
European electricity markets have been in turmoil with the Ukraine War and Russian gas supply problems. The electricity markets mostly trade in established futures markets until the day before delivery. Then they go into largely government-regulated micro markets of around 30 minutes to ensure guaranteed, balanced delivery as electricity has to be consumed the moment it’s created.
The European markets have become dysfunctional partly because the delivery price of some renewables is lower than the fossil fuel alternatives. However, regulations mostly price spot electricity on base load prices which are largely derived from gas or coal. Further complications arise when governments manipulate the market to deliver lower prices for consumers/voters.
Hydrogen is another game changer for markets. It can potentially replace some of the fossil fuels – possibly a $10 trillion a year market for hydrogen. There is no efficient market for hydrogen today as most trade is over the counter or bilateral agreements. Efficient planning for hydrogen will require transparent and robust spot markets to form the base prices for futures and derivatives which could be 10-20 times spot volumes.
At a molecular level, hydrogen is H2. H2 can be created by removing carbon from natural gas or coal – but then the resultant Carbon needs disposal or long-term storage – solutions that don’t exist today. Creating hydrogen from fossil fuels also consumes a lot of energy – so there is no real benefit.
Creating H2 from renewables – solar, wind, hydro etc is a nascent technology that requires significant cost reductions to become viable. But, the cost of wind and solar power production has dropped by 90% in the past decade, so there are reasons for optimism.
H2 can be produced from electrolysis utilising green electricity, which is produced entirely from renewables. The green H2 process must be verified and certified – something that TYMLEZ is working on. As green H2 is molecularly the same as other H2, a verifiable ‘guarantee of origin’ must be attached to green H2 products. This provenance needs tracking through to the end consumer – for example, cement production that wants to prove its carbon neutral.
All these processes will require a new type of digital market infrastructure. As Darwin would have said about the climate markets opportunity, ‘it’s not the biggest or largest that survive; it’s the ones that can best adapt that will prosper from these opportunities’.