Carbon trading – the practice where corporations buy and sell carbon credits – presents a unique opportunity for organisations to meet their citizenship obligations whilst increasing investment in green energy. Carbon trading was enshrined under the Kyoto Protocol of 1997 (the Protocol), an internationally binding agreement arising from the United Nations Framework Convention on Climate Change (UNFCCC). The Protocol employs the “polluter pays” principle by creating mechanisms for signatory industrialised countries to reduce their greenhouse emissions. As a signatory to the Protocol since 2005, Kenya is not required to curb its greenhouse emissions as the country’s level of pollution is below the Protocol’s established limits. This makes Kenya one of the leading renewable energy generating countries, and perfectly placed to benefit financially from selling carbon credits through the Protocol’s carbon trading mechanisms.

Kenya has heeded the global call to reduce greenhouse emissions and as part of Vision 2030, which aims to have one hundred percent (100%) renewable electricity generation by 2030, the country is preparing to launch East Africa’s first carbon trading exchange. The exchange will operate as a partnership between global firm Aircarbon Exchange (ACX), the Nairobi International Finance Centre (NIFC) and the Nairobi Securities Exchange (NSE). In launching this exchange, the country aims to leverage existing verification models and brokering networks to regulate and promote carbon trading activities.

Under the 2021 United Nations Climate Change Conference known as COP26 and Article 6 of the Paris Agreement of 2016, party states accepted targets for reducing greenhouse gas emissions in the form of emission quotas. Where these targets cannot be met, the UNFCCC has developed a framework known as the Emissions Trade Mechanism (ETM) where countries can trade their greenhouse emission allowances with those that have exceeded their permitted emission levels.

Carbon credit mechanisms in Kenya fall under two categories: the Clean Development Mechanism (CDM) and the Voluntary Carbon Market (VCM). CDM allows countries to meet their emission re- duction targets by investing in emission reduction projects in developing countries such as wind, solar and geothermal power projects. Under VCM, individuals, corporations and any other entity may volunteer to purchase carbon credits generated through carbon reduction projects.

Corporations can become actively involved in carbon trading through VCM. Foreign corporations which have been allocated a specified number of credits by their respective governments, based on the national quota, can offset their carbon greenhouse emissions by buying and selling carbon credits. Carbon trading provides a market-based solution to the global issue of how to reduce green- house emissions. It provides a financial incentive to states and corporations to limit their greenhouse emissions and come up with new and innovative ways to limit greenhouse gas production.

Operation of the VCM

The NIFC will create a platform for local and international corporations to trade carbon credits which will finance high impact environmental projects. The framework through which trading will take place is currently under development. However, what is clear is that the NIFC, in collaboration with ACX and NSE will create a carbon trading centre where organisations will trade certified carbon offset credits. These certified carbon offsets will be traded in the form of carbon certificates and carbon credits. Carbon certificates are permits which governments may allocate to corporations based on their greenhouse emissions quota as agreed at COP26. These permits may be given freely or auctioned to corporations setting an agreed limit of greenhouse emissions. Where a corporation curbs its greenhouse emissions significantly, it can then trade its excess permits on the carbon market. Corporations which have exceeded their greenhouse emission allowances may purchase additional allowances through buying additional carbon certificates.

Carbon credits on the other hand, can be earned from the UNFCCC and traded in the voluntary market by reducing, capturing and storing greenhouse emissions. Corporations like the Kenya Electric- ity Generating Company PLC (KenGen) have taken advantage of CDM which allows greenhouse emissions reducing projects to create tradable carbon credits through its renewable energy projects. For example, KenGen’s CDM, Olkaria II project, has been issued with 550,981 carbon reduction credits worth approximately USD 3.8 Million.

Tax Incentives

In Kenya, tax incentives have been introduced to boost the uptake of carbon trading. This is primarily through a preferential tax rate offered to corporations operating a carbon market exchange or emissions trading system. The Finance Act, 2022 sets the tax rate for NIFC certified corporations operating a carbon market exchange at fifteen percent (15%) for the first ten (10) years from the year of commencement of its operations. After the lapse of the initial ten (10) year period, these NIFC certified corporations will be subjected to the standard applicable resident corporate tax rate prevailing at the. The new tax rate for NIFC certified corporations came into effect on 1st July 2022 and is significantly lower than the prevailing corporate tax rate of thirty percent (30%).

Funding Renewable Energy Projects

Kenya’s thriving renewable energy sector stands to benefit greatly from an established carbon trading framework. Significantly, the growth and success of carbon trading in Kenya would have the added advantage of making renewable energy generation more profitable and therefore help Kenya move towards its goal of achieving the one hundred percent (100%) clean energy target by the year 2030. Renewable energy projects particularly for geothermal power, require significant equity funding. The reward of certified carbon credits can attract a wider array of equity investors looking to leverage on the same. It is notable that Kenya’s largest power generator KenGen, already has certified carbon credits in the excess of USD 3.8 Million available for sale.

International corporations that wish to earn carbon credits or simply obtain certificates that help meet their net-zero goals will also be afforded the opportunity to invest in renewable energy projects in Kenya with the aim of obtaining internationally certified carbon credits in return. Energy generation activities have been identified as some of the greatest contributors to greenhouse emissions, particularly the generation of electricity from non-renewable sources. The opportunity to earn carbon credits by investing in green technology which reduces greenhouse emissions will incentivise corporations to invest more in these technologies.

Carbon trading provides a market-based solution to the global issue of how to reduce greenhouse emissions. It provides a financial incentive to states and corporations to limit their greenhouse emissions and to come up with new and innovative ways to limit greenhouse gas production.

Impact Investment

It is important to note that carbon trading can also incentivise impact investment, particularly in renewable energy projects. Given how impact investment has evolved, it is not difficult to see how it can be used to finance projects and have tangible social and environmental benefits which are in a jurisdiction with an established carbon trading framework.

Impact investing firms can put money into projects within local communities that create employment, address community needs for clean water, sanitation and energy, as well as generate internationally certified carbon credits. These impact investors can leverage on carbon credits as a primary or sole source of return. There have been successful projects in Kenya that have capitalised on blue carbon exchange. For example, through the Vanga Blue Forest project in Kwale County, thousands of native mangrove trees have been planted and this has aided in trapping tonnes of carbon. The carbon credits under this project have been sold in the international carbon markets.

Challenges

Despite the benefits to be drawn from the establishment of a carbon trading exchange in Kenya, it is not clear how effective emissions trading is in the fight against climate change. Moreover, there is significant complexity in running a successful carbon trading exchange. The principle of cap and trade where countries and corporations meet their greenhouse emissions targets by buying and selling carbon credits has arguably created more greenhouse emissions than it has curtailed. This is due to “free-riding”, where western countries and corporations, which are amongst the largest emitters, seek out greenhouse emissions credits from developing countries which produce less greenhouse emissions, therefore, not reducing developed countries’ greenhouse emissions but outsourcing the responsibility. Despite this criticism, the carbon trade is still easier to implement than expensive direct regulations and unpopular carbon taxes.

Critics of carbon trading have noted the complexity of running a carbon trading exchange which includes pricing of carbon credits, falsification of statistics and the difficulty involved in measuring how much a company is polluting in comparison to the amount it claims to have offset.

Looking Forward

Kenya can address some of the challenges by creating a statutory body tasked with monitoring and evaluating carbon projects to certify that the carbon credits claimed are accurate and verifiable. Globally, it is hoped that COP27, which took place in November 2022, will provide further impetus toward establishing a coherent and credible framework for carbon trading. Kenya’s carbon exchange can look to Singapore which recently set up a successful carbon exchange through Aircarbon Pte Ltd, which began trading in Singapore in 2021 by targeting corporations and accredited investors. The exchange currently has more than one hundred and twenty (120) active firms, with many more at various stages of joining. In addition to this, since its launch, the Singapore exchange has seen millions of carbon credits exchanged with trading volume expected to grow exponentially as listed firms across Singapore, Hong-Kong and Japan comply with new climate reporting requirements. This is an encouraging example of the success of a carbon trading exchange and offers a practical guide on how Kenya can embark on establishing a successful carbon trading exchange in East Africa.