Developing an Efficient Carbon Emissions Allowance Market

Author(s): S. Viswanathan

Published: March 2010

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Carbon trading works only if markets for carbon provide enough liquidity and ―pricing accuracy, i.e., markets provide prices that are useful for hedgers and other users of carbon markets. Further the creation of a de novo market for carbon assumes that the incentives to create such markets exist and that these markets will occur in the form that regulators desire. We argue that while regulators should receive all relevant information on trades (a trade repository), some discretion is necessary in the structure of markets. We suggest that regulators follow a ―hybrid approach to regulation, where regulators require some markets to be exchange-traded centralized limit order books, require trades between large financial intermediaries to be centrally settled but allow for some contracts to be over-the-counter with the right to move markets to a different reporting or settlement structure as they develop. Such an approach requires the regulator to have genuine discretion in decision making. Some recent examples involving the CFTC and ICE are discussed.