Collateralized Debt Obligations in Voluntary Carbon Markets

Collateralized Debt Obligations in Voluntary Carbon Markets

This executive summary—and the full white paper—is written by Jonathan Rincon Lopez, Kaden Gulamani, and Oli Yuan. It presents key findings from our research on using Collateralized Debt Obligations (CDOs) to enhance the effectiveness and scalability of voluntary carbon markets. To read the full paper, visit: https://www.economyzero.org/publications/white-papers.

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As the global climate crisis intensifies, with average temperatures breaching the 1.5 °C threshold for a full year as of early 2024, there is an urgent need for accelerated and large-scale decarbonization. Yet, current greenhouse gas emissions remain high, and approximately 25% of emissions are considered “unabatable” under current technologies and carbon pricing schemes. The voluntary carbon market (VCM) offers a flexible mechanism for mobilizing finance toward emission reductions,  particularly in hard-to-abate sectors and developing countries, where decarbonization financing is more expensive. However, a lack of standardization, fragmented verification systems, and limited  investor protections continue to hamper its credibility and scalability.

The white paper proposes the innovative use of Collateralized Debt Obligations (CDOs) to transform the VCM into a more efficient, trustworthy, and financially attractive ecosystem. By pooling debt from multiple carbon credit-generating projects in emerging markets and developing countries (EMDCs), and combining it with verified carbon offsets, Carbon Credit CDOs could de-risk climate investment while meeting the carbon offset needs of institutional buyers. This structure not only attracts a broader investor base but also enables project developers to lower borrowing costs, aligning environmental and financial incentives.

The global finance gap for climate action in EMDCs is stark. These regions currently receive just 14% of total climate finance—roughly $180 billion annually—far below the estimated $2.4 trillion needed by 2030. Public sector resources alone will not close this gap, particularly amid rising sovereign debt levels in the Global North. Carbon Credit CDOs offer a market-based instrument to  mobilize private capital at scale, channelling funds into high-impact, verified decarbonization projects across the Global South.

To function effectively, however, Carbon Credit CDOs require credible institutions and standardized governance frameworks. This report advocates for a coalition of major financial institutions to lead CDO issuances, while relying on a single, independent verification agency for measurement, reporting, and verification (MRV). Shifting the verifier’s incentive structure—so they are indirectly accountable to investors rather than project developers—could significantly improve transparency and trust. Regulatory alignment, particularly with agencies like the U.S. SEC, and the integration of ESG metrics into risk assessments are also critical for legitimacy and adoption.

Despite the risks—including project-level defaults, low liquidity, and regulatory friction—the white paper outlines robust mitigation strategies: diversified project portfolios, tranche-based credit allocation, proactive regulator engagement, and early formation of a secondary trading market. If executed with care, Carbon Credit CDOs could not only restore confidence in the VCM but also unlock the trillions needed to meet global net-zero targets—democratizing access to climate finance and enabling deeper, faster emissions cuts worldwide.