Combining Project Finance with Trading ERU’s? Eric Boonman Head of Environmental Markets 11 January 2019 Designator | author

Kyoto protocol The Kyoto protocol is the fundamental international agreement governing the global carbon market. The European Union has established the EU ETS in response to its member states’ Kyoto obligations and to help its industry to prepare for the challenges and opportunities presented by global response to climate change.

Global supply and demand outlook Japan BAU short ~1,500Mt ? (100) 1,000 Canada BAU short ~1,500Mt ? EU non ETS >50% emissions (700) 1,000 CER & ERU 2,000M +/- 1,000M PHASE III ??? ~1,400 OTHERS US states, Australia, NZ, voluntary, … ? Any price forecast is futile under such circumstances. But, it is reasonable to assume that CER/ERU supply will be insufficient to cover all needs. Hence emissions need to be reduced. Phase II total ~1,400Mt short

Fortis: new products for the emerging carbon markets Accepting returns in carbon Including carbon value in financing and due diligence CDM / JI project financing Carbon Financial Services Trading on demand or to order Index based procurement/divestment CER / ERU purchasing and sales Delivery date swaps (quasi repo’s) Trading Services Managing customers carbon accounts Custody of other Kyoto Compliance Units Fund custody and administration Administration and Trust Co-sponsorship of the European Carbon Fund to ensure reliable deliveries of Kyoto Compliance Units for customers Investing in and developing funds Eliminate counter party risk and guarantee trades Cross commodity correlation model Clearing CDP Climate Leadership 2006 – Top 50 Global Co-sponsor and guaranteed placement CP for European Carbon Fund Initiated index based position management contracts for customers Trading on behalf of 300 customers Cross selling successfully with trust, custody, escrow & settlement

Fortis: a pioneering role in Carbon Banking 2004 Fortis realizes first-ever trade of European Union Emission Allowances (EUA's) using an ISDA-based contract: Carbon Deal of the Year ( Euromoney) Fortis becomes a co-sponsor of the European Carbon Fund, investing 15 million Euros to help emerging countries combat climate change. December 2004: the Fortis carbon trust and custody services is launched 2005 Started offering carbon clearing services October 2005 : won best diversified financial and made Climate Change Leadership Index December 2005: concluded first index based carbon compliance contracts with clients 2006 January: European Carbon Fund awarded Most Promising investment Opportunity February: Structured and executed first ever CER call option deal April: Concluded first complete second phase strip transaction from 2008-2012 Jun: Executed first combined trading/trust/escrow/settlement carbon transaction July: reached the 100th customer milestone with a record 4 new customers in 1 day August: transacted and received ownership of issued CERs for the first time October: executed first to second phase roll 2007 Launch of the Fortis Carbon Neutrality Program March: start of global 24hr carbon banking services from Amsterdam, Hong Kong and Houston June: Be selected as the FSP for the UNDP MDG Carbon Facility for its initial pipeline of 15MT March: Best Trader 2008 reward according to Pointcarbon Fortis, has quickly established itself as the reference for the market, serving more than 300 clients’ needs on a daily basis

CDM project cycle JI two options: Track 1 via host country An emission reduction project needs to go through a lengthy procedure before being registered at the United Nations CDM Executive Board and eventually receiving CERs. Normally, 6-10 months is needed to get a project through the process. An independent consultancy is normally hired to provide an in-depth analysis of the project’s emission reduction potential, methodology, feasibility and social impact. The expected emission reduction is detailed in the PDD (project design document). The standard contract of forward CER purchase transaction is named ERPA (Emission Reduction Purchasing Agreement). After the validation by a Designated Operational Entity and the approval by a Designated National Authority, the project is submitted to the United Nations’ CDM Executive Board for registration. If the project gets officially registered at the UN CDM EB, it is recognized as a CDM project. Following that, verification & certification occurs every 1-3 years. Upon verification, a corresponding number of CERs will be issued by the UN CDM EB. This quantity will vary compared to the planned quantity in the PDD. CDM project identification + service agreement PIN Project Design Document International buyer search Validation starts ERPA Letter of Approval Validation ends Registration Monitoring JI two options: Track 1 via host country Track 2 comparable to cdm Verification + Certification Issuance CER Distribution

Nature of carbon finance for a typical JI project Capital Markets (Financial Institutions, Private Equity, Hedge Funds...) Equity and/or Debt Ownership + Dividend and/or Principle + Interest Power Purchase Agreement ERUs Global Carbon Market Cash Cash By-product: ERUs Main product: Electricity

CDM and JI project’s risk assessment Fortis Bank Environmental Markets has undertaken significant research in the field of CDM and JI project risk assessment. A thorough understanding and assessment of the JI project’s delivery risk will enable us to maximize our investment return by constructing a diverse CER and ERU portfolio in terms of technology, stage, size and geography. Fortis Environmental Markets’ desk has developed a highly objective and auto-improving Delivery Risk Model to screen most CDM and JI projects. This model combines a serie of quantitative and qualitative metrics to help us gauge a potential CDM and JI project’s expected performance.

Custody Agreement The Custody agreement transfers economical and legal ownership Custodian receives power of attorney from seller and buyer and will become focal point The pdd CERs or ERUs are inputted into delivery risk model Outcome will be taken as collateral within financing package Mitigating counter party risk To build up investor confidence a similar role for ji projects is recommended

Conclusion To date, many of the world’s premier institutional investors have invested in CDM and JI projects. This strong interest is mainly due to CDM and JI projects’ unique return profile and superior diversification benefits due to its total lack of correlation with traditional securities market. The window of opportunity for purchasing CDM credits from low hanging fruit type projects has passed but in JI there is still low hanging fruit The next wave of carbon reduction projects will need to account for the value of carbon abatement in their discounted cash flow models, and in part rely on the carbon credits for repayment, especially for CDM projects. Due to the volatile nature of the international carbon market, significant risk discounting on the future value of carbon credits needs to take place, but there is enough confidence in the carbon market to be able to use carbon credits as collateral. However, given the nature of carbon project proponents, a custody agreement governing the legal and economic ownership and title of forward carbon streams can strongly mitigate counterparty risks, leaving primarily technological risks.

Thank you eric.boonman@nl.fortis.com +31 653258817 11 January 2019 Designator | author