21 October 2011

MiFID II: carbon trading included, many problems unaddresed

The European Commission is proposing that trading on the carbon market should be governed by the revised Markets in Financial Instruments Directive (MiFID II), a set of new laws governing financial speculation.

The move comes amidst continued volatility in the $142 billion per year carbon market, most of which is traded in the EU, and follows a series of fraud cases in recent years.

The proposal to classify carbon as a financial instrument would bring the whole market - including “spot” and "derivatives" trades - under a single regulatory framework. These proposals were subject to significant corporate lobbying, as revealed in a report from Carbon Trade Watch and Corporate Europe observatory released last week.

A compilation of the new measures on emissions trading included in MiFID can be found here. I've also compiled a similar document in relation to the Market Abuse Directive.

Treating carbon as a financial instrument is a welcome recognition of the problems in this market, but it is no panacea. Emissions trading has not driven investments in cleaner energy and there is no sign of it meeting environmental goals, as the latest carbon price slump shows.

The inclusion of carbon in MiFID II leaves key exemptions in place, however. For example, MiFID does not cover trading on “own account” and so fails to capture speculation engaged in by energy companies, which are the largest players on the carbon market.

This issue is covered in more depth in
Letting the market play: corporate lobbying and the financial regulation of EU carbon trading

16 October 2011

Corporate lobbying and the financial regulation of EU carbon trading

The European Union is changing its rules on how carbon is traded in response to a series of fraud cases and the financial crisis.

My new report analyses these changes, and looks at how corporate lobbies are trying to influence this process.

It shows that the European Commission initially took a light-touch approach to regulating carbon markets, putting increases in the volume of trade ahead of security concerns. In so doing, it failed to anticipate the specific opportunities for gaming and fraud posed by creating a large market in an intangible commodity. A series of carbon fraud cases, and the role played by “derivatives” in triggering the financial crisis, has made this position untenable and ushered in a new wave of regulation. This brings together measures designed to address fraud and gaming, with others designed to limit the destabilising effects of speculation. These may clean up the market’s image, but they do not address the core problems with carbon trading.

The measures proposed to tackle fraud focus on tightening registry security – in essence, regulating more strictly who can trade in carbon so that it is no longer possible to simply register as a trader from a home computer, steal funds, then disappear without trace. This much is sensible, although the fact that it took a series of fraud cases to bring about these obvious protections casts Commission decision-makers, and the lobbyists who pressured them to avoid regulation, in a poor light.

More controversially, the Commission’s package of security measures manages to include changes that hide serial numbers. The City of London Corporation, not known for its radical pro-regulatory stance, reports surprise at this decision, stating that “It is not understood how this will aid security as it prevents the market from identifying the provenance of the allowances.” Indeed, it is hard to find explanations that do not point towards a cover-up. In making it impossible to anyone except law enforcement agencies to trace individual allowances, the Commission has reduced transparency across the whole scheme, making it harder for civil society to reveal evidence of fraud and gaming, or the perverse effects of the system, and making it impossible to trace the volume of permits re-issued as a result of theft. These reissued permits would, in turn, further inflate the already generous emissions limits that the scheme establishes.

Significant fraud and gaming risks remain, despite these changes. Holes in registry security mean that there is still a risk that carbon trading could be used for money laundering. This is a particular problem across different legal jurisdictions. While the EU is trying to close the door to registry fraud within its borders, it is at the same time attempting to link it’s carbon market to other emerging markets (eg. Australia), as well as allowing offsets to be traded within its scheme – increasing the potential for carbon fraud globally.

Fraud risks, in this narrow sense of deliberate deception for unlawful gain, are potentially less significant than those posed by “gaming” - deliberate deception that is legally sanctioned. As we have shown elsewhere, the lobby pressure to freely allocated large surpluses of emissions permits has resulted in windfall profits for industry and the power sector. The offset markets are notorious for the same practice. CDM credits are issued in relation to “additionality” claims that are impossible to prove. A recently leaked US cable gave dramatic evidence of the scale of this problem, reporting from a meeting in Delhi that “all interlocutors conceded that all Indian projects fail to meet the additionality in investment criteria and none should qualify for carbon credits.” These interlocutors included the Chair of the national CDM authority, as well as some of the country’s largest project verifiers and developers. In a nutshell, carbon trading schemes are awash with paper “reductions” that do not correspond to actual reductions of greenhouse gas emissions in the real world, and this is a systematic problem. Gaming results in windfall profits and undermines efforts to address climate change.

On the side of financial speculation, the key regulatory proposal is to classify carbon as a “financial instrument.” This would bring it under the scope of the Market in Financial Instruments Directive, a key component of EU market legislation that is currently under review. The International Emissions Trading Association (IETA) and other financial sector lobbyists have vigorously opposed this change, fearing that it could limit some avenues for financial speculation on carbon. A leaked draft of the proposed Directive suggests that the Commission may not side with the lobbyists, although some key exemptions remain in place. Most notably, leaving it to national authorities to set “position limits” would be ineffective: the majority of trades pass through the UK, which is opposed to this concept and would not implement it in any meaningful way. The restriction to trading on “own account” fails to capture speculation engaged in by energy companies, which are the largest players on the carbon market.

More fundamentally, though, restrictions on speculation shed critical light on the flawed purpose of the carbon market in the first place: it introduces speculation by design, undermining the stated objective of long-termer clean investment decisions. To really address these issues requires bolder steps to de-financinalise climate policy and move away from the carbon market model.

03 October 2011

The CDM's missing billions

According to World Bank figures, the global carbon market was “worth” $142 billion in 2010. Most of this number relates to financial speculation on permits in the EU Emissions Trading System. The value of the money that goes to CDM projects continues to decrease. The Bank officially claims it was $1.5 billion in 2010, its lowest level since the Kyoto Protocol entered into force in 2005. However, the real figure for 2010 may be closer to $300 million.

The difference between the official and "actual" figure was explained by the Mobilizing Climate Finance report, leaked to The Guardian. It notes that

The value of transactions in the primary CDM market – the largest offset market by far – totalled around $27 billion in 2002-10, which is estimated to have been associated with around $125 billion in low-emission investment. Since the bulk of transactions are forward purchase agreements with payment on delivery, actual financial flows through the CDM have actually been lower, about $5.4 billion through 2010.
The World Bank's official figures can be recalculated with these "actual financial flows" as follows:


WB Official

WB actual



















Figures are in $ billions