SparkChange, an issuer of specialist carbon investment products, has teamed up with white-label ETF provider HANetf to launch the world’s first ETP providing physically-backed exposure to EU Allowances (EUAs), the world’s foremost carbon credit.
SparkChange and HANetf have partnered to introduce the world’s first ETP physically underpinned by actual ETS EU Allowances.
The SparkChange Physical Carbon EUA ETC has been listed on the London Stock Exchange and comes with a total expense ratio of 0.89%.
Each unit of the ETP is directly backed by allowances issued under the EU’s Emissions Trading Scheme (EU ETS).
Launched in 2008, the EU ETS is the largest carbon emissions trading system in the world and one of the EU’s principal tools to achieve decarbonisation. The scheme covers more than 13,000 entities – including manufacturers, power stations, and airlines – collectively representing over 40% of EU’s carbon dioxide equivalent (CO2e) emissions.
Often described as “permits to pollute”, each EUA entitles the holder to emit one tonne of CO2e. Polluters covered by the regime must obtain sufficient EUAs – which are sold via auctions or handed out to eligible entities for free – to cover their emissions or they become liable for significant fines. Polluters are thus given a choice: they can either reduce emissions or compete to buy more allowances.
To aid decarbonisation and the transition to net-zero, the supply of allowances is capped. This cap is reduced every year in order to drive down emissions. Fewer and fewer allowances mean that their scarcity value increases, driving up the carbon price, all else being equal. In turn, a rising carbon price incentivises polluters to invest in emission-reduction technologies as they become more economical than buying carbon allowances.
The market for these allowances was valued at more than €200bn in 2020, during which 8 billion EUAs changed hands, equivalent to approximately €2bn in daily traded volume. This trading volume provides substantial liquidity for financial market participants, who, lately, have been rewarded handsomely for their exposure to EUAs.
In fact, EUAs have been one of the best-performing commodities (they tend to be classified as a commodity) over the past three years, up roughly 190% since 2017, and their low correlation with mainstream asset classes (0.10 with 10-year US Treasuries, 0.32 with the MSCI World, and 0.30 with the S&P GSCI) makes them a useful portfolio diversification tool.
Currently, however, gaining effective exposure to EUAs is difficult for investors. One access route is to buy the EUAs outright, but this requires a high level of operational expertise and is impractical for most.
Another route is the EUA futures market, including investment products based upon EUA futures. Examples of these include the WisdomTree Carbon ETC (CARB LN) listed in Europe, the KraneShares European Carbon Allowance ETF (KEUA US) in the US, and the Shinhan SOL S&P Carbon Emission EUA H ETF (400580 KS) in South Korea. However, in periods when the futures market is in contango, which, in recent years, has been the norm, future-based strategies can suffer a degree of performance drag as futures are rolled from one contract to the next. Such strategies also do not typically withhold EUAs from the carbon market, thereby having no direct curbing influence on CO2e emissions.
Physical products backed directly by EUA overcome many of these challenges, which makes the new SparkChange/HANetf ETP a compelling proposition for investors.
That said, investing in EUAs is not always one way. EUAs can and do decline in price. Indeed, in the early days of the ETS, the market was haunted by an oversupply of EUAs which contributed to a collapse in their price.
Fast forward today, and while performance looks impressive in the rear-view mirror, there are many who believe that much of the recent increase in the EUA price is in part a by-product of higher natural gas prices which forced some power producers to temporarily shift to coal and, consequently, to buy up EUAs to cover their additional CO2e emissions – a temporary boost in allowance demand which could unwind if gas prices decline.
The influence of financial speculators – such as hedge funds – has also increased in recent years, which some argue has accelerated or brought forward price rises. On this, there are growing calls for the role of financial speculators to be constrained, something which is being looked at by EU authorities. Any watering down of investors’ power to purchase EUAs could potentially dampen future price rises.
Nonetheless, the overall investment case is strong, offering investors the potential for strong returns and diversification benefits while also having a direct positive impact on carbon emissions. With investors always on the lookout for new and uncorrelated returns, and climate considerations increasingly being woven into portfolios, the product appears posied to do well.
Commenting on the launch, Elliot Waxman, CEO of SparkChange, said: “[SparkChange CO2] gives investors convenient access to a product that is designed to stop carbon emissions and boost returns. Unlike carbon offsets, where investors must choose between creating environmental impact or achieving returns, they can now do both. When constructing a low-carbon portfolio, SparkChange CO2 can help investors meet their environmental goals without having to exclude companies that are not yet green.”
Nik Bienkowski, Co-CEO of HANetf, added: “The SparkChange Physical Carbon EUA ETC, SparkChange CO2, is a groundbreaking way for investors to participate in the EU carbon emission allowance market, helping to decarbonise the earth and help revolutionise the way asset managers meet their net-zero goals. The ETC has been designed to overcome the issues of investing in the physical carbon allowance market such as the complexity of opening an EUA registry account, and the contango costs of carbon futures – as a result, SparkChange CO2 has shown to outperform investments in carbon using futures.”
The ETP is listed on LSE with USD (CO2U LN), GBP (CO2P LN) and EUR (CO2 LN) share classes.