Monday, June 07, 2021

CFTC’s EEMAC explores how derivatives markets can facilitate the transition to a low-carbon economy

By Brad Rosen, J.D.

The CFTC’s Energy and Environmental Markets Advisory Committee (EEMAC) examined the potential role of carbon markets in the transition to a low-carbon economy at its recent agenda-packed committee meeting. EEMAC sponsor, Commissioner Dan Berkovitz, observed "reducing global carbon emissions to net-zero by 2050 is a significant global undertaking" in prepared remarks. He further noted that the International Energy Agency is calling for a "transformation of how we produce, transport and consume energy." The entire EEMAC meeting can be viewed here.

Supporting the transition to a carbon-neutral economy. Berkovitz noted three principal ways by which the CFTC, as a financial market regulator, can support the transition to a carbon-neutral economy. They are:
  • the CFTC is charged with ensuring the integrity of the markets it regulates, and this includes carbon derivatives markets. This requires an understanding of how the various carbon markets interact and how companies use them to meet compliance obligations, manage risks, and discover prices;
  • the CFTC should work with exchanges and market participants on the development of new products that will help companies meet these needs; and
  • the CFTC should ensure appropriate management and disclosure of climate-related risks.
Other commissioners weigh in. Acting Chairman Rostin Behnam took the opportunity in his remarks to pay homage to recently deceased former CFTC Commissioner Barton Chilton for his pioneering efforts to incorporate climate related market risk into the financial markets. Chilton, who passed away in 2019, chaired an EEMAC meeting in 2009 featuring a panel titled An Overview of Environmental Markets: CFTC & A Carbon-Constrained World. Behnam noted Chilton was well known for his signature flair to deliver statements and speeches lauding efforts by legislators, markets, and market participants to address climate related matters.

For his part, Commissioner Brian Quintenz observed that the derivative markets will play a critical role in connection with climate risks. Quintenz also noted that we currently are seeing a free rider problem in this space and noted cap and trade solutions have some merit. Commissioner Dawn Stump noted that the public doesn’t always recognize the enormous role the Commission already plays in these markets, and explained that the CFTC already oversees over 100 products that have a carbon related component. Stump is particularly sensitive to the impact climate change policies may play with respect to stranded assets, asset pricing changes, and credit risks.

Panel 1: Domestic and International Cap-and-Trade Carbon Markets. The day’s first panel examined cap-and-trade programs in the U.S., European Union, and United Kingdom, as well as lessons learned from these programs and ways in which they may evolve in the future. The panel included the following presentations:
  • Benjamin Grumbles, the Secretary of the Maryland Department of the Environment, on behalf of the Regional Greenhouse Gas Initiative (RGGI), which covers eastern states accounting for 21 percent of the nation’s economic output, noted that the consortium has seen greenhouse gas emissions slashed in half from 2006 through 2019.
  • Rajinder Sahota, Deputy Executive Officer of Climate Change and Research for the California Air Resources Board indicated that over 35 auctions have been held to-date with over $14 billion having been generated for California climate investments. Approximately 50 percent of these investments are benefiting disadvantaged communities.
  • Hans Bergman, the Head of Unit for ETS Policy Development and Auctioning within the European Commission’s Directorate General for Climate discussed matters associated with compliance, noting that by the end of March each year, each facility operator has to report emissions, verified by special independent verifiers. By end of April of each year, the facility operator has to surrender EU Emission Trading System allowances equivalent to reported emissions. In case of delay, Bergman noted fines are very high. As a result, the compliance rate is greater than 99 percent.
Panel 2: Exchange-Listed Carbon Derivatives. The second panel explored the current state of exchange-listed carbon derivative products. The presentations included the following:
  • Gordon Bennett of ICE indicated that ICE has the largest and most liquid environmental markets in the world and has seen open interest in its environmental complex in 2021 up 14 percent year-over-year at approximately 2.83 million lots.
  • Christian Schneider, Managing Director of Strategy for Nodal Exchange, took note of the bigger picture observing carbon markets globally account for 16 percent of global greenhouse gas emissions covered under the emissions trading scheme. He also observed that carbon pricing is an essential tool to achieve climate targets and that Nodal believes in the power of markets for a cost-efficient decarbonization of our economies.
  • Derek Sammann, Senior Managing Director and Global Head of Commodities at the CME, provided an overview of market based mechanism for carbon emissions. For a mandatory system, features include allowances for producing less emissions and emission reduction targets over a period of time. Allowances are emitted and allocated. An emission trading scheme (ETS) is a "Cap and Trade" mechanism.
Panel 3: Perspectives on Carbon Derivatives and the Underlying Markets. The day’s third panel featured a diverse group of stakeholders that provided their various perspectives on how the derivatives markets operate as risk management and price discovery tools, and how they expect these markets to change over time. The following panel presentations included:
  • Evan Ard, Executive Managing Director of Evolution Markets, focused on the OTC carbon markets and noted long-term shifts in liquidity in the power and natural gas basis markets. She also sees growth in global liquid natural gas markets, carbon markets and renewable energy certificate markets. In her view carbon pricing will play an increasingly important role.
  • Suzi Kerr, Chief Economist of the Environmental Defense Fund, discussed the economics of carbon pricing and considerations for developing equitable carbon pricing policies and particularly underscored environmental justice and equity concerns, and posed the question how will these issues affect policy choice. She also voiced her concerns for avoiding the risk of market manipulation and the need to protect small actors in these markets.
  • Erik Heinle, Assistant People’s Counsel for the Office of the People’s Counsel for the District of Columbia, shared a ratepayer perspective and noted that any carbon pricing regime needs to provide demonstrable cost and benefits to consumers. He emphasized that higher costs must come with clear benefits to sustainability. Moreover, there must be an equitable and just distribution of revenue from carbon pricing.
  • Annette Nazareth, Senior Counsel at Davis Polk, discussed the work of the Taskforce on Scaling Voluntary Carbon Markets and its recently issued Public Consultation Report. Nazareth acknowledged some of the grave difficulties we are facing with respect to the lack of standardization which is preventing progress being made as quickly as it is needed. She noted today’s markets remain highly fragmented and face ongoing NGO and press criticism regarding the quality of credits. The combination of real and perceived issues within the voluntary carbon market thereby creates difficulties in scaling them in line with the demands of the Paris accords.
According to Commissioner Berkovitz, the EEMAC may pick up on some of these matters when it meets again in the fall. Berkovitz added, he hopes that meeting will be of the in-person variety.