With all the concern about carbon trading, it’s worth pointing out that there are some common sense solutions to the risk of carbon market manipulation. Foremost among these solutions is restricting trading to regulated exchanges (such as the Commodity Futures Trading Commission, which handled agricultural futures) and banning unregulated, or lightly-regulated, “over-the-counter” trading.
In a later post, I’ll wade into all this in more detail. For now, I’ll just point to a pair of short but clear fact sheets that make a good intro.
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1. Ensuring the Integrity of the Carbon Market from Environmental Defense Fund.
Trades must be through exchanges.
The centerpiece of effective carbon market regulation is to require that all trading, including trading of derivatives, be done through a regulated exchange.
This ensures —
1. Transparency: Exchange trading maximizes market transparency, because all parties in the market (as well as federal regulators) have access to pricing information in real time, and can see what other traders are doing.
2. Simplicity: Exchange-traded products can be easily standardized which makes them easy to understand and easy to price. With no “exotic” or unusual products, trading costs can be lower and limit the level of risk in the system.
3. Discipline: The exchange clearing house imposes financial discipline by requiring that transactions be valued by a neutral party each day. This avoids the problems now being faced by banks holding securities and derivatives that are worth much less than the value listed on their balance sheets.
2. DOs and DON’Ts for Creating Carbon Price Safeguards from Natural Resources Defense Council.
BAN “DARK TRADING.” “Over-the-counter” trading allows traders to buy and sell a commodity out of view of regulators and other market participants, increasing price volatility and credit risk in the energy and financial markets. Congress should ban “dark trading” by requiring trading to take place on registered exchanges, or with transparent reporting.
ïƒ˜ When trading takes place on regulated, open exchanges, everyone knows the real prices and regulators can more do their job more effectively. Exchange trading is also safer—participants put up collateral to ensure they’ll perform; the exchange guarantees against one side’s default; and credit risks are effectively eliminated.
ïƒ˜ The House bill proposes that “dark trading” be banned for the energy markets as well as for the carbon markets. Feinstein-Snowe pushes carbon markets towards exchange trading, but provides limited exemptions for emitters hedging their carbon risk.
Okay, more on this later.