The Corresponding Adjustment Is a Sovereign Covenant

Every country in the Paris Agreement has a Nationally Determined Contribution: a pledge to cut its emissions to a stated level, measured against a national account and denominated in tonnes of CO2 equivalent (tCO2e). When a country authorizes a carbon credit for any use other than toward its own NDC, it applies a corresponding adjustment. It adds that tCO2e back into its own account, as though the reduction never happened. The country gave up the right to count that reduction as its own, so a third party can use it.

In finance, a promise of that kind has a name: a covenant. A covenant is a binding undertaking written into an instrument, a commitment to do or refrain from doing something, that a counterparty relies on and prices. The corresponding adjustment is exactly that: an undertaking by a sovereign, recorded and reported internationally, not to count adjusted tCO2e toward its own NDC.

That undertaking prevents what the industry calls double counting. Without it, the host country counts the tCO2e against its own net emissions and the buyer counts the same tCO2e toward theirs. Two owners for one tCO2e means no asset, because the first thing an owner must establish is that nobody else owns the same thing. The wrapper puts an investor’s interest under settled law; the covenant makes sure what sits inside belongs to them alone.

The promise is observable. Under Article 6, the host country authorizes the units, applies the adjustment when they are first transferred or used, and reports both in its annual information and its biennial transparency report, where an international expert review team checks the arithmetic.

And sovereign promises are priced every day by markets. Bond yields, credit default swap spreads, and currency markets all answer one question continuously: how likely is this government to do what it said. Political risk insurance, investment treaties, and export credit agencies cover the case where it does not. None of that machinery asks what the promise is about. A covenant to correspondingly adjust a credit is underwritten the same way as a covenant not to expropriate any other asset.

The covenant brings carbon inside a paradigm that already works, with a century of documentation, pricing, and remedy behind it.

A correspondingly adjusted carbon credit is a pair of promises: a sovereign’s covenant not to count it towards its NDC, and a permanence obligation that prevents its reversal. Those promises are the value of the unit and the basis of its environmental benefit, because a credit counted twice is no benefit, and a credit reversed a decade later forfeits its value. Together they are what an investor owns, what an underwriter prices, and what the instrument wraps.

Next up: The Sovereign Authorization.

Part of No New Parts, a sixteen-part series by Andrew Gilmour.