Analysis-Investors see pollution plan silver lining in EU carbon overhaul

By Simon Jessop and Kate Abnett

LONDON, July 21 (Reuters) - A European Union plan to tie free pollution permits to investments in decarbonisation could enhance corporate accountability, investors said, despite concerns that a broader overhaul of the Emissions Trading System (ETS) may weaken incentives to cut emissions.

Last Friday, the European Commission proposed an ETS revision, slowing the pace at which emissions must fall and easing the pressure on industries such as steel and cement by extending free permits until 2038.

However, from 2031, free allowances will only be available to companies that commit to investing in decarbonisation in Europe, a significant shift in a system that environmental campaigners have for years criticised for allowing industries to pollute and demanding nothing in return.

Emine Isciel, head of climate at Storebrand Asset Management, which manages around €125 billion ($143 billion), called the proposal "a powerful tool for investors".

"Free permits will now function as a strict compliance contract," she said, adding that investors would now be able to request specific information on a company's spending plans for decarbonisation, and the financial risk to its balance sheet if it were to lose its free CO2 permits.

Under the proposal, companies would receive 80% of free allowances if they submit plans to invest in decarbonisation in Europe, with the remainder released upon investment delivery. Failure to draft a credible plan or missing investment milestones may result in permit withdrawal.

Isciel said the requirement could replace reliance on "vague, voluntary ESG disclosures" with standardised, binding and audited decarbonisation plans, giving investors a clearer view of whether firms are genuinely investing in a low-carbon economy.

Nick Gaskell, senior sustainable investment manager at Aberdeen Investments, which manages around £384 billion ($516 billion), said the policy strikes a balance between maintaining carbon pricing incentives and addressing the investment needs of hard-to-abate sectors.

BILLIONS IN FREE PERMITS AT STAKE

Since 2013, the EU has given industries free CO2 permits worth around €255 billion to curb companies' carbon costs and help them compete with foreign firms. Under the new rules, companies will have to make decarbonisation investments at least equivalent to the financial value of the free CO2 permits they receive.

The EU plans are part of a broader attempt by Brussels to reinvigorate Europe's flagging industrial base and encourage firms to invest in Europe rather than the United States or China.

But in a sign of the bloc's struggle to reconcile competing demands from its member countries, the proposal appeared to introduce a new requirement for companies to have climate investment plans, months after the EU scrapped a similar requirement from its due diligence law in the name of reducing red tape.

CONCERNS OVER WEAKENED CONSTRAINTS

For investors, the success of the reforms may ultimately depend on whether the new accountability measures are strong enough to offset other parts of the EU proposal that weakened the ETS, to keep companies investing in the transition.

"We welcome the proposal to channel more ETS revenues into industrial decarbonisation and to link free allocations to credible transition investments," said Rikke Berg Jacobsen, head of ESG at pension fund AkademikerPension.

"The key question is whether these measures are strong enough to offset the weaker carbon constraint," Jacobsen said, referring to how, the proposed ETS revision would, overall, let industries emit more CO2.

EU countries and the European Parliament will negotiate the final changes to the ETS over the next year and could alter the Commission's proposal.

Peter Liese, who will lead the negotiations for the largest lawmaker group in the European Parliament, signalled he backed the plan to link free CO2 permits to investments in Europe.

"We want to give industry more time, but during this period, they must not sit back and do nothing," Liese said. "Investment within the EU is our goal, and this proposal achieves it far more effectively."

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(Additional reporting by Samuel Indyk, editing by Andrei Khalip)