Michael Azlen - Turning Emissions into an Asset Class

The Rise of Carbon Markets: How Compliance Systems Are Redefining Climate Investing

A New Asset Class with Shrinking Supply

Imagine an asset class where supply decreases every single year—not due to scarcity, but by government design. It trades on exchanges, is liquid, and moves independently of stocks and bonds.
Welcome to the world of compliance carbon markets—where policy meets profitability, and sustainability becomes investable.

In this article, based on an episode of Resonanz Spotlight featuring Michael Azlen, Founder and CEO of Carbon Cap Management, we explore how carbon markets work, their role in driving real-world emission reductions, and how investors can benefit from this emerging asset class.

Understanding Carbon Markets: From Climate Policy to Investment Strategy

The Academic Journey Behind Carbon Cap

Michael Azlen’s journey into carbon markets began after selling his previous business. Initially a skeptic, he immersed himself in the science of climate change through the London School of Economics’ Climate Change Program, where he discovered the power of carbon pricing as the most effective tool for emission reduction.

What followed was years of academic research culminating in a peer-reviewed paper published in The Journal of Alternatives—establishing carbon as a liquid, investable asset class.
The proprietary data set created for this research now forms the backbone of Carbon Cap’s quantitative models and investment strategies.

Cap and Trade Explained: How It Works and Why It Matters

The Mechanism Behind Carbon Pricing

A cap and trade system has two goals:

1. To limit and reduce carbon emissions.
2. To achieve this reduction at the lowest possible cost.

Here’s how it works:

• Governments cap total emissions by issuing a fixed number of carbon allowances each year.
• Large emitters (such as steel or cement companies) must surrender permits equal to their emissions.
• The cap tightens annually, creating scarcity and driving prices higher.
• Companies then face a choice: pay for allowances or cut emissions—whichever is cheaper.

This market-driven incentive system turns the profit motive into a climate lever, promoting least-cost abatement across industries.

Real-World Impact

Since the European Union Emissions Trading System (EU ETS) launched in 2005, annual emissions have fallen by over 1.1 gigatons, with approximately 75% of that reduction coming directly from companies covered by the scheme.

The success of the EU ETS is inspiring countries from Japan to Brazil to develop their own carbon markets.

Compliance vs. Voluntary Carbon Markets: The Five Key Differences

While both aim to reduce emissions, compliance and voluntary carbon markets operate on very different principles.
Here are the five main distinctions Michael Azlen highlights:

For investors, the takeaway is clear: focus on compliance markets.
Voluntary credits have faced scandals and valuation issues, while compliance markets offer robust regulation, transparency, and liquidity.

The Investment Case: Returns, Diversification, and Risk

Historical Performance and Correlation

The S&P Global Carbon Index has delivered roughly 19% annualized returns over the past decade—outperforming the S&P 500—with low correlation to traditional assets.
This makes carbon an attractive portfolio diversifier with a distinct risk-return profile.

Market Liquidity and Geographic Reach

Carbon Cap currently operates across five major markets:

1. European Union (EU ETS) – the world’s largest and most liquid market.
2. California – with built-in price floors and ceilings.
3. United Kingdom – post-Brexit independent system.
4. Regional Greenhouse Gas Initiative (RGGI) – covering 10 U.S. states.
5. New Zealand – a pioneer in Asia-Pacific carbon trading.

New markets are emerging rapidly in Japan, South Korea, China, and Latin America, signaling exponential global growth.

Policy as the Main Price Driver

Carbon markets are inherently tied to policy and regulation.
Each significant price move—up or down—is typically triggered by government decisions or policy announcements.

To manage this policy risk, Carbon Cap diversifies across multiple markets with near-zero correlations and integrates real-time policy tracking into its models.

Forecasts suggest that to meet the Paris Agreement targets, the global carbon price must rise from $60 to around $120 per ton by 2030—a potential 12% annualized price increase.

Managing Volatility and Risk

Carbon is a high-volatility asset—roughly three times more volatile than the S&P 500.
Carbon Cap mitigates this through:

• Strict volatility limits (15%) and daily Value-at-Risk monitoring.
• Monthly risk meetings focused on liquidity and market exposure.
• Market entry frameworks assessing country, currency, and policy risks before investing.

This disciplined approach allows institutional investors to engage with confidence, even in a complex, evolving asset class.

Lessons from Early Challenges

The early years of the EU ETS revealed key lessons: allowing low-quality voluntary credits into the compliance system flooded the market and collapsed prices.
Regulators responded by banning voluntary offsets and tightening quality standards—paving the way for carbon removal credits, which are higher quality and higher priced, aligning environmental integrity with economic value.

Where Carbon Fits in a Portfolio

Most institutional investors classify carbon strategies within the absolute return or alternative diversification sleeve.
The World Carbon Fund, Carbon Cap’s flagship strategy, has delivered consistent performance over more than five years, combining long-short positioning with impact-linked performance fees, where 20% of fees are reinvested in climate mitigation.

This alignment of profit and impact is one of the most innovative aspects of the carbon investment model.

Key Takeaways for Investors

• Carbon pricing is the most effective tool for reducing emissions.
• Compliance markets offer scale, liquidity, and regulation.
• Voluntary offsets remain risky and opaque.
• Carbon exhibits low correlation and strong historical returns.
• Policy risk is both the challenge and the opportunity.
• Diversification across markets is crucial for stability and alpha.

Final Thoughts

As Michael Azlen puts it, “The carbon market harnesses the profit motive to achieve least-cost abatement.”
For investors, this means participating in a market that not only seeks returns but also accelerates the global energy transition.

Carbon markets may still be young, but their structure, growth trajectory, and policy tailwinds position them to become a core asset class of the future.