Eco-governance key to carbon neutrality

Carbon neutrality cannot be achieved without different economic sectors, individuals and households, and the government making serious efforts. Climate finance in different forms including environmental, social and governance (ESG) investment and carbon emissions trading are used to measure the reduction in carbon emissions and place a monetary value on them, partly because people generally value only those things that can be measured.

Although market mechanisms do not reduce carbon emissions per se, they can potentially incentivize the invention and deployment of technologies and practices that do, which in turn could enable the market to achieve economic efficiency in climate mitigation and adaptation.

At this stage in the development of those market mechanisms, their effectiveness has been compromised by a lack of integrity in the monitoring/measurement, reporting and verification (MRV) of ESG performance and carbon emissions embedded in business operations.

Commercially operated third parties are contracted to provide carbon emissions data for green investors and the public (represented by regulators). But since it is difficult to monitor their work, those commercial consultation firms could take advantage of their principals as they possess specialized knowledge and technologies used to measure carbon emissions. Thus, the integrity of the information and data supporting system of the market mechanisms depends on how the principal-agent problem is dealt with, which is context specific.

An example of the principal-agent problem can be seen in China with respect to carbon and air pollution reduction. As both carbon and air pollutant emissions are caused by burning of fossil fuels, the emissions can be reduced concurrently. And to increase data accuracy, starting in 2013, the Ministry of Ecology and Environment centralized and contracted out to third parties the responsibility of operating and maintaining air quality monitoring stations in the national network.

In the past, this responsibility was given to local environmental protection bureaus. Similarly, the provincial environmental protection bureaus resorted to the market for operating and maintaining the provincial air quality monitoring networks.

According to our research, the centralization and marketization reform in air quality monitoring in 2013 was partly effective in addressing asset specificity and enforceability, but it also created temptations for collusion.

Emitters who engage with climate finance hope to be rewarded financially for reducing carbon emissions with minimum efforts or least disruption to their business operations. Because the commercial consultation firms need to work closely with the emitters for collecting and documenting data on energy activities for calculating carbon emissions, the de facto collaborative work offers ample opportunities for collusion.

Similarly, operating in the government responsibility system, the transboundary reality of air pollution creates externality and free riding among government officials who desire to meet the environmental performance targets with minimum efforts or least disruption to local economic growth. Since the vendors have to base their employees and representative offices where the air quality monitoring stations are located, local government officials can still have access to people who actually run the air quality monitoring stations within their jurisdictions.

It is understandable that the emitters and the local governments are motivated to form a shadow clientele relationship with those third parties and manipulate data to their advantage, because climate finance and the government responsibility system offer economic gains and career prospects, respectively.

Such collusion was discovered in 2021. Between October and December 2021, the Ministry of Ecology and Environment sent a working group to each of the 31 provincial-level regions for supervising the MRV work to ensure data quality for the national carbon market, which found that four of the largest consultation firms had colluded with their clients. They faked coal samples, falsified or faked testing reports, and included unchecked information in their conclusions. The ministry published the cases on its website on March 14, 2022, providing evidence for holding the agents accountable for environmental information provision.

Therefore, the integrity of data is a prerequisite for climate finance to work. Although seemingly a technology-based engineering task, it is evident that the MRV of both carbon emissions and air quality data are impacted by institutional design of contracting and professionalism of the environmental services industry.

Preventive and/or remedial measures stipulated in policies, guidelines and written contracts for addressing possible wrongdoings of the agents can help reveal the quality of institutional design.

The Hong Kong Exchange and Clearing Limited is embracing ESG work in both its regulatory procedure and developing financial instruments for sustainable investment. Moreover, it is keen to develop a carbon market and has brought major players together to explore opportunities.

Enhancing the integrity of the MRV of air quality and carbon emissions data not only increases the credibility of the regulators but also protects green investors. Without high-quality environmental governance, it is impossible to create a level playing field, to incentivize real air pollution and carbon reduction on the ground, and achieve carbon neutrality, which is essential to achieve true sustainability.

The views don't necessarily reflect those of China Daily.