Though most climate policy wonks are now focused on US federal legislation or the summit in Copenhagen, the Western Climate Initiative is soldiering on—and doing good work too. The WCI’s Markets Committee recently released a white paper on carbon market oversight that is worth a read.
While the paper doesn’t draw many conclusions about WCI’s final design, it does provide a very helpful summary of the principal regulatory options in both the U.S. and Canada. It also includes a nice overview of regulation under the EU’s cap-and-trade system, as well as a discussion of the regulatory options under consideration for the big cap-and-trade bills in Congress. In other words, it’s a good primer for understanding the lay of the land of carbon market regulation.
The more I study the issue, the more I’m drawn to a regulatory framework that restricts secondary and derivatives trading to registered exchanges— at least at the outset of the program. One good vehicle would be the US Commodity Futures Trading Commission (CFTC) which has an excellent track record of carefully managing commodities trading in the US. (Together with the Chicago Climate Futures Exchange, the CFTC handles the trading program for RGGI.) In simple terms:
Exchanges are associated with a higher degree of oversight and transparency. They are centralized marketplaces that offer standardized contracts that are fungible with one another and generally require “clearance.” Federal law in the United States and provincial law in Canada generally require exchanges to set rules implementing governance principles on market manipulation, publication of trading information, fair and equitable trading, emergency authority, and more.
In “clearing,” a central organization becomes the buyer to the seller and the seller to the buyer—that is, it becomes the counterparty to both sides. The clearing organization, therefore, assumes the obligation to complete the transaction even if one party is unable to perform its part. Most clearing organizations associated with exchanges perform clearing only for members, who set the clearing organization’s rules and collectively shoulder the risk of default of any one party.
There seems to be growing interest in using an exchange for carbon markets. I’ll dig into this more on this later in the series. For now, WCI is accepting public comments on the white paper until December 18.