Tuesday, June 21, 2022

Derivatives markets resilient amid geopolitical strains, climate change, CFTC’s Romero says

By Suzanne Cosgrove

Commodity markets have faced significant challenges in recent years, first from the pandemic and its related supply chain issues, and now from the geopolitical events that surround Russia’s invasion of Ukraine, said CFTC Commissioner Christy Goldsmith Romero.

Speaking Wednesday in an address to the Chicago Bar Association’s Futures and Derivatives Law Seminar, Romero added that the derivatives markets “are providing the risk management and price discovery that our market participants need” to weather the period. “These markets are global,” she said, and the CFTC is in close communication with international regulators.

Climate challenges. Romero also noted the CFTC is following current drought conditions, which have been particularly hard-hitting in the U.S. Southwest. Wildfires, flooding, droughts and other disasters have increased in number and severity, causing devastating losses, she said. The USDA reported 20 climate disasters in 2021 that each caused $1 billion in losses. “These, in addition to climate disasters that caused significant losses under $1 billion, could impact derivatives markets.”

Climate-related financial risk presents a unique set of risk management challenges because their historical patterns may not predict future events, Romero said. In addition, climate events may put strain on individual states or particular regions of the country, which could cause sub-systemic shocks. Goals set by the Paris Accord and commitments to net zero by a number of companies have accelerated the discussions about how derivatives markets can help mitigate that risk, she said.

Net zero calls for limiting global warming to no more than 1.5 degrees C as determined by the Paris Agreement in 2015, a goal that was reiterated at the 26th U.N. Climate Conference of the Parties in November 2021.

Many companies are challenged to meet net zero targets solely through the reduction of their carbon emissions, Romero said. “There has been a huge surge in demand for voluntary carbon markets and other products that would complement a reduction in emissions to help companies meet their targets,” she added.

Sustainability products. While there are more than 200 listed sustainability products on CFTC-regulated exchanges, the size of listed environmental derivatives markets is small when compared with over-the-counter carbon products, Romero said., which was estimated at a total of more than $1 billion last year.

“The opportunity to scale up the number of high-quality carbon products that are listed on exchanges could be a game changer in helping drive up supply to meet the surge in demand,” Romero told the group. Voluntary carbon markets face challenges in establishing pricing, and the CFTC can facilitate the exchanges’ introduction of new environmental products, she added.

The CFTC is currently gathering information and data in a push to understand climate risk in detail, how to assess that risk, and the steps market participants are taking to reduce risk, she said. To that end, CFTC published a Request for Information earlier this month in an effort get public feedback on climate-related market risk.

The information gathering process also included a public roundtable on voluntary carbon markets held by the Commission on June 2. Roundtable participants who came from the demand side of the voluntary carbon markets-–those seeking to invest in credits--voiced concerns about price transparency, as well as integrity-related issues like double-counting of credits and a need for independent verification, Romero said.

On the supply side, the agricultural community understands that climate risk is real, and it has been largely engaged in sustainability efforts for years, Romero said. But the roundtable also highlighted the community’s increased costs for fuel and fertilizer following Russia’s invasion of Ukraine. The agricultural community may not have the current resources to make certain sustainable investments that could become carbon credits, she said.

Also at the roundtable, “[w]e heard several participants say that the CFTC could help with standardization and taxonomy, as well as curbing greenwashing,” Romeo said. “One purpose of the Commodity Exchange Act is to promote responsible innovation,” she said. “To me that applies as equally in the ESG space as it does to technology.”