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.
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 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:
| Year | WB Official | |
|---|---|---|
| 2010 | 1.5 | 0.3 |
| 2009 | 2.7 | 0.54 |
| 2008 | 6.5 | 1.3 |
| 2007 | 7.4 | 1.48 |
| 2006 | 5.8 | 1.16 |
| 2005 | 2.6 | 0.52 |
Figures are in $ billions
05 September 2011
Wikileaks and EU climate targets
A cable detailing a 2008 spat between the EU and US on climate change targets sheds light on the EU’s lack of ambition.
In a frank exchange on March 7, U.S. and European principals reviewed work on climate change under the Major Economies and UNFCCC Processes. U.S. principals secured EU Environment Commissioner Dimas' admission that current EU proposals will permit some EU Member States to record absolute increases in emissions by 2020.
Dimas conceded that “some EU Member States will be permitted under the EU's proposals to record an absolute increase in emissions by 2020.”
Jim Connaughton, Chairman of the White House Council on Environmental Quality at the time, further questioned the EU’s achievements in relation to its Kyoto targets:
for Europe, 1990 as a reference year incorporates the early 1990s economic collapse of eastern Europe, which no policymaker would recommend be repeated; the UK's decision to move away from coal to natural gas, long before climate change was a policy issue; and the EU's use of diesel fuel, at the expense of air quality and human health.
Wikileaks and the CDM: no "additionality" in India
Several of the recently released wikileaks cables discuss the CDM in passing. A cable on the CDM in India is particularly enlightening, however. It reports on a seminar with the US Consulate General Office (Congenoff) and analysts from the Government Accountability Office (which later released a skeptical study on offsets).
At a seminar on CDM in Mumbai, R K Sethi, Member Secretary of the National CDM Authority and the present Chairman of the CDM Executive Board, publicly admitted that the National CDM Authority takes the "project developer at his word" for clearing the "additionality" barriers. Mathsy Kutty of Det Norske Veritas (DNV), a CDM Executive Board-accredited validation and verification organization for CDM projects, told ConGenoff that the designated authorities of host countries approve projects in a cursory manner and do not check to see whether the project meets all the requirements laid down by the CDM Executive Board. CDM projects in India do not have to be validated or verified to get host country approval while both processes are mandatory to get the project registered with the UNFCCC, she continued. For this reason, she pointed out, Indian projects account for 44 percent of the total projects rejected by the CDM Executive Board.
Most Indian CDM projects are initiated without foreign backing, and
For this reason, Santonu Kashyap of Asia Carbon maintains that Indian projects can never fulfill the additionality requirement as no developer will risk investing in a project unless he is certain of a revenue stream independent of the CDM incentive. In a separate discussion with GAO analysts and ConGenoff, Jamshed Irani, Director of Tata Sons and the Chairman of the Tata group's Steering Committee on Sustainability, agreed that no Indian company is brave enough to rely entirely on a CDM-driven revenue stream.
Although all of the CDM project developers spoken to claim that their projects have sustainability benefits, the cable concludes that
Amidst complaints about the "arbitrary" decisions of the CDM Executive Board, all interlocutors conceded that all Indian projects fail to meet the additionality in investment criteria and none should qualify for carbon credits.
16 August 2011
Technology Transfer in the CDM: some basic considerations
“Technology transfer” is often described as one of the key “co-benefits” of the Clean Development Mechanism, but it is a concept that requires further elaboration.
The UNFCCC's CDM Registration & Issuance Unit tried to measure the extent of CDM “technology transfer” at one point by looking at how many projects involved technology imports. It used companies' own reporting of "the use of equipment or knowledge not previously available in the host country for the CDM project." Industrial gas projects (such as those involving HFCs) came out well in this study.
Taking technology imports as a measure is fairly useless measure of the potential benefits, however. Further analysis of the HFC cases have shown that a fairly simple, pre-existing piece of technology was transferred in a massively inefficient manner, as this February 2007 article by Michael Wara demonstrated.
The extent to which HFC projects have contributed to a series of other perverse incentives has since been established in far more detail, with even the European Commission now accepting that they suffer a total lack of environmental integrity.
More fundamentally, though, a better definition of "technology transfer" is needed - and a clearer understanding of the context in which it works, is helpful. Three key points may be raised here.
First, the CDM can serve to disincentivise and delay the passing of environmental regulations.
Third, the CDM promotes a development model that eclipses local technologies. As Larry Lohmann argues,
The UNFCCC's CDM Registration & Issuance Unit tried to measure the extent of CDM “technology transfer” at one point by looking at how many projects involved technology imports. It used companies' own reporting of "the use of equipment or knowledge not previously available in the host country for the CDM project." Industrial gas projects (such as those involving HFCs) came out well in this study.
Taking technology imports as a measure is fairly useless measure of the potential benefits, however. Further analysis of the HFC cases have shown that a fairly simple, pre-existing piece of technology was transferred in a massively inefficient manner, as this February 2007 article by Michael Wara demonstrated.
The extent to which HFC projects have contributed to a series of other perverse incentives has since been established in far more detail, with even the European Commission now accepting that they suffer a total lack of environmental integrity.
More fundamentally, though, a better definition of "technology transfer" is needed - and a clearer understanding of the context in which it works, is helpful. Three key points may be raised here.
First, the CDM can serve to disincentivise and delay the passing of environmental regulations.
As the CDM program became active, policymakers realized that the additionality requirement provided incentives to retard the process of creating developing countries’ policy in order to preserve credit eligibility.Second, technology transfers through imports by private actors can crowd out domestic industry - as the work of Ha-Joon Chang (eg. the books "Bad Samaritans" and "Kicking away the Ladder") eloquently demonstrates.
-David Drieseen and David Popp
Third, the CDM promotes a development model that eclipses local technologies. As Larry Lohmann argues,
'technology transfer' continues to carry the connotation, as it always has, of moving Northern technology into a ‘technology-deprived’ area in the South. In practice, this typically plays out in the degradation, skewing or destruction of one set of technologies in favour of another.Although Chang and Lohmann appear to be making similar points, the latter engages in a more fundamental critique of the benefits of "development" regimes.
18 July 2011
World Bank Partnership for Market Readiness begins push for new carbon markets
The World Bank is busily encouraging “middle income” countries to create new carbon trading schemes. It hopes that this will lead to a “scaling up” of carbon markets and has created a new Fund, the “Partnership for Market Readiness” (PMR), to meet this aim.
Without much fanfare, the Fund's first meeting took place on 30-31 May in Barcelona, just ahead of Carbon Expo, a huge carbon trading jamboree co-organised by the World Bank and the International Emissions Trading Association (IETA). Representatives of over 30 countries joined the meeting, according to the Bank.
The Partnership approved initial grants of $350,000 to Chile, China, Columbia, Costa Rica, Indonesia, Mexico, Thailand and Turkey. Each of the eight countries will now develop a “Market Readiness Proposal” to detail their plans. Two further countries, Morocco and Ukraine, have been confirmed as participants.
The Bank hopes that the PMR will stimulate two main activities: the creation of new cap and trade-style carbon markets, and engagement in “NAMA crediting.” The latter suggestion pre-empts ongoing debates within the United Nations Framework Convention on Climate Change (UNFCCC), which has yet to agree to this controversial means of “scaling up” carbon finance beyond carbon offset projects.
A range of economic activities might be covered, with the current (non-exhaustive) list including: power generation, iron and steel, transport, construction/buildings/housing, cement, energy efficiency, waste management, and NAMAs for “low-carbon cities”. In Mexico, the PMR will work to set up a carbon offset registry, while in China it is promoting the creation of regional emissions trading pilot schemes.
Funding pledges so far come from: Australia, the European Commission, Germany, Japan, Norway, The Netherlands, Spain, Switzerland, the United Kingdom and United States. These amount to a little under $70 million of the $100 million expected total.
The latest pledges include $7 million from the International Climate Fund (ICF), the UK government's means of channelling climate money through the World Bank. This follows the usual UK-government practice of re-announcing the same money several times: the money can be double-counted as part of the UK's Official Development Assistance (ODA) funding, and this same money also forms the UK's contribution to “fast-start financing.”
For “fast” read “slow” - while the rhetoric suggests that money will be directed towards the immediate needs of people already facing the impacts of climate change, the use of such funds to develop new market-mechanisms is a boost for schemes that are notable for delaying action to address climate change.
The vast majority of the money from the PMR will be directed towards establishing systems for “monitoring, reporting and verification” (MRV) – in other words, technical support for the creation of a system of tradeable carbon credits. However, this remains a small proportion of the total needed to pilot market mechanisms, meaning that the scheme's “beneficiaries” are likely to spend far more on the schemes than the money that the Bank puts in.
More information
Carbon Trade Watch, Partnership for Market Readiness: a critical introduction, January 2011
Without much fanfare, the Fund's first meeting took place on 30-31 May in Barcelona, just ahead of Carbon Expo, a huge carbon trading jamboree co-organised by the World Bank and the International Emissions Trading Association (IETA). Representatives of over 30 countries joined the meeting, according to the Bank.
The Partnership approved initial grants of $350,000 to Chile, China, Columbia, Costa Rica, Indonesia, Mexico, Thailand and Turkey. Each of the eight countries will now develop a “Market Readiness Proposal” to detail their plans. Two further countries, Morocco and Ukraine, have been confirmed as participants.
The Bank hopes that the PMR will stimulate two main activities: the creation of new cap and trade-style carbon markets, and engagement in “NAMA crediting.” The latter suggestion pre-empts ongoing debates within the United Nations Framework Convention on Climate Change (UNFCCC), which has yet to agree to this controversial means of “scaling up” carbon finance beyond carbon offset projects.
A range of economic activities might be covered, with the current (non-exhaustive) list including: power generation, iron and steel, transport, construction/buildings/housing, cement, energy efficiency, waste management, and NAMAs for “low-carbon cities”. In Mexico, the PMR will work to set up a carbon offset registry, while in China it is promoting the creation of regional emissions trading pilot schemes.
Funding pledges so far come from: Australia, the European Commission, Germany, Japan, Norway, The Netherlands, Spain, Switzerland, the United Kingdom and United States. These amount to a little under $70 million of the $100 million expected total.
The latest pledges include $7 million from the International Climate Fund (ICF), the UK government's means of channelling climate money through the World Bank. This follows the usual UK-government practice of re-announcing the same money several times: the money can be double-counted as part of the UK's Official Development Assistance (ODA) funding, and this same money also forms the UK's contribution to “fast-start financing.”
For “fast” read “slow” - while the rhetoric suggests that money will be directed towards the immediate needs of people already facing the impacts of climate change, the use of such funds to develop new market-mechanisms is a boost for schemes that are notable for delaying action to address climate change.
The vast majority of the money from the PMR will be directed towards establishing systems for “monitoring, reporting and verification” (MRV) – in other words, technical support for the creation of a system of tradeable carbon credits. However, this remains a small proportion of the total needed to pilot market mechanisms, meaning that the scheme's “beneficiaries” are likely to spend far more on the schemes than the money that the Bank puts in.
More information
Carbon Trade Watch, Partnership for Market Readiness: a critical introduction, January 2011
Subscribe to:
Posts (Atom)