Unlocking sustainable solutions: A glimpse into the Bursa Carbon Exchange

18 June 2024

The global effort to combat climate change has led to the emergence of innovative solutions, one of which is the voluntary carbon market. Voluntary carbon markets enable entities to trade carbon credits generated from projects that remove or reduce greenhouse gases (“GHG”) from the atmosphere to offset their carbon footprint.

The establishment of Malaysia’s voluntary carbon market exchange (“VCM”), Bursa Carbon Exchange (“BCX”), a subsidiary of the stock exchange Bursa Malaysia Bhd, represents a significant stride by Malaysia in promoting sustainability and addressing climate change.

Highlights

• BCX is the world’s first Shariah-compliant carbon exchange, offering three modes of carbon trading: auctions, continuous trading, and off-market transactions.
• BCX operates on a bare-trustee model, requiring both sellers and buyers to pre-fund their accounts before submitting trade orders.
• Only carbon projects issued by Verra (the organisation which administers the Verified Carbon Standard) from 2016 onwards are accepted on the BCX trading platform.
• BCX has defined different classes of market participants; however, only those falling within the classes of traders and suppliers are currently able to apply to be a market participant.
• On 25 June 2024, BCX will offer renewable energy certificates representing the environmental attributes of the generation of one megawatt-hour (MWh) of energy produced by renewable sources.

Background

In addition to being Malaysia’s VCM, BCX is the first Shariah-compliant carbon exchange in the world. The establishment of the VCM is a key initiative in enabling Malaysia to become a net zero GHG emission nation as early as 2050, which is also in line with commitments made further to the Paris Agreement. In addition to being the world’s first Shariah-compliant carbon exchange, BCX distinguishes itself with the following features: (i) non-interest-bearing accounts, (ii) a policy of no interest charged for late payments, and (iii) the inclusion of Shariah-compliant products in its listing.

Three modes of carbon trading

BCX operates as a global spot exchange, offering three modes of carbon trading:

• Auctions of carbon credits: BCX conducts auctions to facilitate price discovery for new products. Sellers set reserve prices and buyers submit sealed bids electronically through the BCX platform. The auction clearing price is determined when the total quantity of received bids does not exceed the total offered quantity. BCX’s inaugural auction in March 2023 witnessed active participation involving 15 buyers purchasing a total of 150,000 standardised contracts, leading to the price discovery of two new products offered by BCX: the Global Technology-Based Carbon Contract (GTC) and the Global Nature-Based Plus Carbon Contract (GNC+).
• Continuous trading for standardised contracts: BCX allows both sellers and buyers to submit bids and offer orders electronically on its trading platform. These orders are matched by BCX’s central order book using a price-time algorithm.
• Off-market transactions: BCX provides a unique avenue for buyers and sellers to use its trading platform for clearing and settlement of trades negotiated and matched outside of BCX’s central order book. This alternative allows for the mitigation of counterparty and delivery risks for both parties involved. Notably, these off-market deals are advantageous for those seeking to leverage BCX’s onboarding processes, encompassing know-your-client procedures, along with clearing and settlement services, for their direct carbon credit transactions.

These services provide flexibility for market participants to engage in climate mitigation activities while adhering to international standards.

Bare-trustee model

BCX operates on a bare-trustee model, requiring both sellers and buyers to pre-fund their accounts before submitting trade orders. This means that the seller must deposit carbon credits with BCX before any sell order can be entered, or the buyer must deposit sufficient cash with BCX before any buy order can be entered. BCX will hold the deposited cash and carbon credits in trust for BCX participants. This ensures instantaneous settlement upon a successful off-market transaction or matching through the trading platform, updating participants’ accounts immediately.

Contract specifications for carbon projects

BCX categorises carbon projects into standardised products based on contract specifications, including project type (nature-based or tech-based) and project geography (within or outside Malaysia). Currently, only carbon projects issued by Verra from 2016 onwards are accepted on the BCX trading platform. Verra develops and manages standards for sustainable development, climate action, and environmental conservation. It also administers the Verified Carbon Standard, a standard for certifying carbon credits to offset emissions.

BCX offers five types of carbon contracts:

• Global Technology-Based Carbon Contract (GTC)
• Global Nature-Based Carbon Contract (GNC)
• Global Nature-Based Plus Carbon Contract (GNC+)
• Malaysia Nature-Based Plus Carbon Contract (“MNC+”)
• Malaysia Technology-Based Carbon Contract (MTC)

Companies may choose to deal with the underlying carbon credits purchased by:

• keeping the underlying carbon credits in their BCX trading account for future use;
• selling the standardised contracts with the underlying carbon credits via BCX’s continuous trading platform; or
• transferring the underlying carbon credits to their own registry account with Verra or retiring the underlying carbon credits to offset their carbon footprint.

Rules of BCX and market participants

The Rules of BCX and the Operating Procedures of BCX (collectively, “Rules”) outline the processes and requirements that participants must adhere to, with stringent eligibility criteria to ensure the integrity of BCX. These requirements include, among other things, cash management and unit management requirements, as well as ongoing operational requirements to be fulfilled by the participants to maintain their status.

Under the Rules, there are different classes of market participants, as follows:

• Traders:  Buyers (participants that submit a buy order) or sellers (participants that submit a sell order);
• Suppliers: Participants that supply and seek admission of units for trading on BCX;
• Brokers: Participants that carry on the business of dealing in units; and
• Market makers: Participants that undertake the obligation of quoting sell or buy orders for contracts on BCX.

Both Malaysian and international corporations are eligible to be market participants. However, only those falling within the classes of traders and suppliers as set out in the Rules are currently able to apply to be a market participant. The other categories of participants are not open for applications at the time of writing.

Upcoming developments

Due to increasing domestic demand, BCX will offer renewable energy certificates (“RECs”) for the very first time by way of auction on 25 June 2024, and is targeting to offer continuous trading and off-market transactions of RECs in the third quarter of 2024. An REC is a type of Energy Attribute Certificate that represents the environmental attributes of the generation of one megawatt-hour (MWh) of energy produced by renewable sources. Distinguishing itself from carbon credits, RECs may only be used to reduce an organisation’s emissions from electricity consumption (and not GHGs in general). RECs are typically only consumed within the same geographical region where they are produced.

BCX will offer three types of RECs for trading, the Malaysia Hydropower REC Contract, the Malaysia Solar REC Contract, and the Malaysia Bioenergy REC Contract. To facilitate accessibility for market participants, BCX intends to introduce standard RECs contracts through auctions, initially involving only Malaysian RECs, with subsequent phases extending to global RECs. The International REC (I-REC) standard will be adopted when the RECs trading goes live.

The trading rules will mirror those of carbon credits, and the suppliers of RECs will be required to transfer their certificates to the BCX Unit Custodian Account, while buyers must transfer their funds to the BCX Cash Custodian Account, ensuring a secure and transparent marketplace for renewable energy attribute trading.

BCX will host its first auction of Malaysian carbon credits from the Kuamut Rainforest Conservation Project on 25 July 2024, signalling the offering of its first MNC+ generated via a domestic forestry project and the expansion of BCX’s product offerings to include local carbon credits in addition to global carbon credits.

Comment

BCX, as the world’s first Shariah-compliant carbon exchange, has played a pivotal role since its inception in facilitating carbon credit trading for corporations to offset their carbon footprints. Looking to the future, BCX’s commitment to sustainability remains evident with its plans to introduce RECs marking a significant stride towards a greener and more environmentally responsible future.

Further information

This alert has been prepared with the assistance of Senior Associate Nicole Leng, Associate Yung Jia Heng and Pupil Edwin Tan.