Welcome to Money Talk. I'm Kim Parlee. The transition to a lower carbon economy is well on its way. It's having some interesting impacts on all sorts of different economies. One way to incentivize polluters to lower their greenhouse gas emissions is to put a cost on it, put a price on carbon, and now there is an ETF that tracks the price of carbon credits. With more on this is Michael Craig, head of asset allocation at TD Asset Management and Hussein Allidina, head of commodities at TD Asset Management. They are co portfolio managers of the TD Global Carbon Credit Index, ETF Ticker TCBN, which was launched today on the TSX. That was a lot. That was a lot I had to get out. It's great to have you both here. Thank you for having us. Let's start I want to get into the details of the of the ETF and how it works. But just before we get there, I mean, I haven't spoken to you in a bit in terms of just the markets. In 30 seconds or less. I mean, what are you seeing right now as we kind of get through the summer and start getting into the fall? Well, the market's got kind of a bag of rocks last Friday from Jackson Hole. Powell told the world and I think central banks will follow, that rates are going higher and going to stay there for a while and that has spooked the equity markets. Equity markets are down about 5 to 6% since then. So we're going to have a tight, elevated period of higher rates. Markets aren't going to like it. Consumers aren't going to like that. And I think we're going to have a very volatile full market uptick in equities as people come back from the carnage and reassess where we stand. Not fun. All right. But one of the interesting things about we're going to talk about, too, I think, is maybe the offset something like this might have with the market over the next little while, too. But let's let's talk a bit about the again, the TD Global Carbon Credit Index ETF. The two of you were actually at the TMX this morning opening the markets, there you are. You guys looked pretty happy about this, pretty exciting that it happened. Hussein, can I start with you? Just maybe, can you explain what carbon credits are and and how the carbon credit market works? Yeah, for sure. So there's a couple of different ways that we can price carbon in Canada as an example. We have a carbon tax. That is not what we're talking about in this ETF. Other markets like Europe, like California, like the northeast of the US, the REGI market, they have a cap and trade system and broadly speaking, the way it works is that industry that is covered by this regulation has to buy credits to offset their emissions. One credit, broadly speaking, is a ton of carbon every year in Europe. If you're a covered entity, you have to submit a carbon credit which you are either allocated or you buy in the open market to offset the emissions of the prior year. In Europe in particular, you know you're refiner I'm a refiner, we're both issued an allocation. You happen to be a cleaner operator than I am, and as a result, you have excess credits so you can go into the market and sell. I being the dirtier operator, need to go into the market and buy those credits. If I don't have those credits, I'm fined on a daily basis a pretty exorbitant amount. And effectively that structure affords, allows there to be a price on carbon which is set by the market, not by a regulatory body or the government. The market dictates where the carbon price is. Ultimately, the carbon price needs to go to a level to discourage you and I from emitting. Yeah. And you mentioned refiners as an example. And so I'm assuming that's one kind of company, but what are the kinds of companies, the industries that are doing the most on that? So who needs the dealers the most? Yeah, so It's a very good question. So first, if we look at globally, how much of emissions are priced, ten years ago, about 5% of the world's emissions were subject to some form of either carbon price or cap and trade. Today that number is just shy of 25%. And as we move forward, anticipate that number grows as more countries economies put a carbon price in place, specifically the industries that are covered. If we look at Europe, where our ETF today is focused, about 36% of Europe's emissions are covered by this cap and trade program. And within the economy, it's the more polluting sectors that are being targeted. So we think about industrial materials, pulp and paper refining power generation aviation and that sort of coverage universe will grow through time and you'll add more covered industries into it. I want to come back to this, but before we do it, just what what is this ETF designed to do? So early days, we'll track the price of carbon in Europe. Europe's the deepest market right now, the most liquid. And in terms of investors, it offers us the most liquidity and the least amount of frictions to to establish position. Over time with, you know, you mentioned the Northeast, California, U.K., etc., other markets will evolve and we would expect that to be brought into this ETF. But for now, in terms of liquidity, that's the market we'll follow. These are early days, but we see this as a very, very prudent system to reduce carbon over the long term. We wanted to make sure that we had an investment vehicle to be able to to use that within our within our accounts. It's an interesting time to be launching this as well. As you mentioned, it's early days. And, you know, you mentioned what's going to drive the pricing of these carbon credits is demand and supply. But maybe tell us a bit more about that. Yeah. Because anyways, please go ahead. So in Europe again, we're going back to my refinery example. We are allocated credits. Now, the free allocation that we get is decreasing through time, by design, by regulation. So right now it decreases by roughly total emissions are mandated to decrease by about two and change percent every year. There is some discussion to lift that, but ultimately the allocation of credits decreases unless our demand for those credits, i.e. our emissions decrease the market's in deficit. And ultimately that is why we're constructive on carbon prices, because by mandate, the amount of allocation that moves into the system is decreasing. And I guess, you know, so much of this is going to be driven as well by just if we get back to growth again. I mean, I'm thinking years out from now as opposed to right now, that's going to be, you know, with growth comes emissions, which comes the need for the credits too. But carbon prices, I understand, are more firm in in Europe, but they've been volatile in we've seen volatility in lots of other asset classes. You expect that? I mean, do you expect to see some more volatility in this type of thing, or? So carbon prices are volatile relative to your tradit ional equities, fixed income assets. I think what is surprising about carbon, you know, if you'd asked me 12 months ago, Europe is moving into recession. Will carbon prices be higher or lower? My prior would be that carbon prices, because economic growth is lower, would be lower. Right. Ultimately, though, what you're seeing happen in Europe because of the shortage in natural gas, you're seeing, you know, dirtier fuels, frankly, coal as an example generation pick up. So the demand for carbon credits is increasing and prices have held relatively firm. Today we're trading north of about €80 a tonne at the high. We were just shy of €100 a tonne. They have sold off a little bit over the course of the last week, week and a half, as concerns about what Europe might do with the program have grown. And that's why you've seen a bit of weakness. But broadly speaking, carbon prices have outperformed, you know, equities, fixed income. Year to date, bonds, equities both down double digits, metal is down double digits. Carbon is up about two or 3% today. So it's actually there's been a lot of volatility, but in the year it's actually been okay. Yeah. And again, that's by design, right? No one wants to see carbon credits kind of race off to the moon like energy prices have been in the air but and certainly don't want them lower. So there is a degree there is incentive to have some stability, but it is a volatile asset class, but one that very much behaves on its own, kind of its own kind of candor. Not not it does not have a lot of relationship to bonds or equity. Which is nice, that counters cyclicality in this kind of market. We've only had about 15 seconds, though, but price forecast, do you dare do it? I mean, you said around €80 a tonne right now. Where where do you see it going? So we don't have an official price forecast. But if you look at what academics, the World Bank, the UN and others have said, if we have any hope of reaching our climate objectives, Paris 2030 prices need to be north of $100 US dollars a tonne. That is kind of the consensus on where we need to go. There's other groups that have forecasted materially higher prices. If you look at the supply and demand in Europe for carbon, you need to have materially weaker growth, i.e. materially lower carbon emissions in order to not be in deficit. So that pertains to higher prices in our view. We touched a little bit on this about just the construction, how the how the carbon credit market works. But I want to ask the question that people are, you know, care probably the most about when they're watching is why would I put a carbon ETF into my portfolio right now? And I will tell people, do your own research, do what's good for you, but from your perspective. So there's first two characteristics about this. A, it's volatile, more volatile in stocks and bonds, but B, it does tend to operate on its own axis. It does is very uncorrelated. So any time as a multiasset allocator, you can find an investment that you think is going to go higher and has a very low correlation to what you hold. It's interesting. So from a diversification perspective, it's quite intriguing. Secondly, more and more companies are going to be covered by this trading protocol and that's going to hit either revenues or or earnings. So either, you know, as a company, you have a new expense, either pass it on to your customers and you get lower, lower profits or you eat it and you lower margins. This is a way to hedge that in a portfolio such that at the price of carbon does goes higher. And you're, you know, maybe you go to oil companies and those prices are hit a bit, you offset that through the carbon ETF. So that's kind of it. There's a diversification and a hedging aspect. And ultimately, look, I grew up on the West Coast. I never heard the term atmospheric flood in the 30 years I live there. And in November they had three of them. Yeah, half of Pakistan right now is underwater. The world is changing climate. Climate change is real. And we need real kind of solutions for it. I think this kind of mechanism is one I think that aligns industry and consumers. Look, we've got to make some decisions. We have to innovate or consume less, and we have to do it now. And so that's what what I think is quite interesting about this solution. It is. And I'm curious, though, from a risk standpoint, when you when you look at this, you know, it's a you know, you can see the growth and just as very clear and the and the fact that it's negative correlated. But I think it's also highly regulated, which means it could be political. In an inflationary environment, this adds a cost. So what are the risks that people have to think about? Yeah. So I think when you think about carbon and the demand for credits, growth is obviously a big one. So if we have weak economic growth, we have less output, we have less carbon emissions and that's a risk. There is a tail risk that because the market is dependent on regulation. The reason that you have the EU ETS is because the European government came together and said, look, this is the amount of allocation we're going to afford and this is how it's going to evolve over time. You could see a pause or a suspension of the program on the heels of the elevated energy prices that you're seeing. But for context, Kim, I think it's important. European carbon price is $80 a tonne. Even if you get rid of it entirely, it does not fix the energy problem. Arguably makes the energy problem worse because you need to transition because of the issues Mike's talked about. But I think the biggest risk is we wake up tomorrow morning or next week and Europe says, look, we're putting a hold on the program. Last question, and you touched on this as well, too, but just from an asset allocation point, this is all about no correlation. This is the thing that's attractive for people to think about as they're, you know, building their portfolios to make sure they can withstand what's happening in the markets. 100%. Yeah, 100%. We did a lot of work on this. I would advise as much. But, you know, you get to a point where, you know, you get to a point where there's actually a fairly sizable allocation and you still actually get to a portfolio with better risk and return characteristics and so on. So the point is, as I actually put it, the math in the meat grinder, you actually get to a pretty interesting allocation without even knowing a thing about the asset class, just looking at its risk return characteristics. So, so I think it's been interesting day. It's not often you're involved in like launching of a brand new asset class which was this pretty much is and the wonderful thing is it is very much it does improve the portfolio dynamics that we would otherwise have.