Europe’s first physical carbon ETC
SparkChange, an environment-focussed technology and investment firm, is listing the Europe's first ETF that is backed by directly in carbon allowances, thereby tracking the price that European polluters must pay to pump greenhouse gasses to the atmosphere.
The SparkChange Physical Carbon EUA ETC (CO2P) will be the first ETF to be fully backed by the EU’s carbon emission allowances (EUAs), which aim to put a gradually increasing price on CO2 emissions. Carbon allowances permit one tonne of CO2 to be emitted. Polluters are required to surrender each year sufficient EUAs to cover their pollution.
The goal of the EU’s policy is to slowly strangle CO2 emissions. The strategy can be thought of as like the mayor of a congested city worried wanting to get rid of cars. So they steadily reduce the number of carparks available.
Carbon allowances are not easy for most investors to trade and settle. Instead records of who owns them are held in the EUs registry in Luxembourg, which is kind of like a digital wallet at the EU. SparkChange has set up an account with this registry such that the ETC is physically backed by these EUAs.
The people participating in this market include polluters, investment banks and some hedge funds here and there.
There are futures markets over these allowances already, in Leipzig and Amsterdam. The futures are more liquid and trade billions of euros a day. However emissions futures are very different to equity index futures. For one, they are physically deliverable rather than cash settled, meaning some financial institutions don’t like them. They are also non-UCITS-eligible.
The ETC has the added benefit for impact-focused investors in that reducing the availability of carbon allowances can help force decarbonisation.
CO2P charges a 0.89% annual fee.
Bernie’s commentary – fascinating; how’s it different from CARB?
We already have a carbon ETF course, the WisdomTree Carbon fund (CARB). So what makes today’s listing different?
As it turns out, quite a lot. CARB works much like a swap-backed commodity ETC, of the kind used to track broad commodities indexes. WisdomTree has an investment bank provide a swap, that allows CARB to track a carbon index. ( I like CARB and own it myself as I believe that Carbon is the new improved ESG)
CO2P by contrast works a bit like physical gold ETCs. From what I understand, it runs a two-tiered structure. First, a Jersey-based special purpose vehicle spits out notes backed by carbon allowances. Second, an Ireland based fund swallows them up and coughs out ETC units. Again, quite like gold ETCs.
There are also differences around fee structures. If you looked at CO2P superficially, you’d get the impression it is very expensive while CARB – which charges a 0.35% management fee - is very cheap. However this is arguably misleading.
While CO2P may seem a lot dearer, CARB’s stated 0.35% management fee excludes the swap fee of 0.50%. Meaning its real fee is more like 0.85% and the two are similarly priced. However futures can also come with additional costs, like contango, meaning CARB could even be more expensive once everything is tallied up.
The final differences concern market making. Getting an EU account that lets you hold these allowances directly is a bit of an effort for anyone--including market makers. So market makers haven’t made markets in physical carbon allowance ETFs before. I understand that the market makers have had to work very hard indeed to be ready for this new launch.
Still, this is a fascinating launch. I’ve never seen anything like it. A lot of thought has clearly gone into this.
Speaking with SparkChange, they say they’re finding it very easy to get meetings with fund buyers, as physical carbon is a hot topic and their structure is new. I believe them.
Disclosure: Two of the principals of Sparkchange, Anthony and Elliot are colleagues of mine from the days of creation of Xtrackers / CS ETFS, so I maybe slightly biased.
NB: I asked them if they had launched this specifically to coincide with COP26, they admitted that" Financial regulators run to their own timescale, this was just good fortune"