February 23, 2009

Lawmakers Brace for Battle over Carbon Market Oversight Plans

Nicholas Institute for Environmental Policy Solutions

February 23, 2009

*SECTION:* Vol. 3 No. 8

Copyright 2009, Carbon Control News

Looming debates on federal climate change legislation as well as growing concern over the fate of the financial sector are prompting renewed focus by lawmakers, industry groups and other experts on how to regulate emissions trading markets and other carbon-related financial products created under a mandatory greenhouse gas (GHG) control regime, setting up likely substantive and jurisdictional battles on the issue, sources say.

Efforts to grapple with the issue include a "working paper" from Duke University suggesting additional issues lawmakers may want to consider in climate legislation in the wake of the current financial crisis, as well as newly unveiled or anticipated legislative proposals that include language related to carbon market oversight.

In addition, sources say there is an ongoing dialogue within the International Emissions Trading Association (IETA) -- which includes diverse interests that would buy, sell or trade emissions allowances under a carbon regime -- seeking a consensus among its membership on carbon market oversight issues.

The carbon market regulation issue is related to, but separate from, the question of how extensively lawmakers or regulators should rely on emissions trading and offsets to lower costs of a mandatory climate change program and how generous such programs should be to emitters. The question involves both policy decisions and expected political jockeying for jurisdiction among multiple congressional committees with a possible claim to regulating the new carbon market.

A new working paper from Duke University's Nicholas Institute for Environmental Policy Solutions states that the creation of a U.S. carbon market offers an opportunity to design a program that builds upon best practices for market regulation as well as "lessons learned from recent market failures." The paper notes that four federal agencies with a say in market or emissions policy are "viable candidates" for regulating the new carbon markets -- the Commodity Futures Trading Commission (CFTC) the Securities and Exchange Commission, the Federal Energy Regulatory Commission (FERC) and EPA. The working paper is available at CarbonControlNews.com.

The paper comes at a time when congressional and other sources say they expect a near-term debate on financial market regulation, while it remains unclear whether it will include carbon market-specific provisions.

One Capitol Hill source views a number of emerging proposals on the issue in part as "placeholders" for the debate over climate change legislation, but also says they could play a role in ensuring that regulatory issues do not fall through the cracks in the meantime. The source says it is possible some of the issues will surface in debates prior to action on a climate measure.

In addition, the source says the Obama administration may play an important role in helping to set the agenda on the issue -- amid a division of jurisdiction among Senate committees on banking, agriculture, environment and energy, and between a comparable number of panels in the House. Without that direction from the White House, there is the potential for "cats going in all sorts of different directions," the source says.

Pending legislative proposals this Congress with links to the carbon issue already include the Derivatives Markets Transparency and Accountability Act of 2009, passed by the House Agriculture Committee Feb. 12, which subjects to CFTC regulation carbon allowances as well as "any credit authorized under law toward the reduction in greenhouse gas emissions or an increase in carbon sequestration." The law also mandates efforts to encourage crediting for agricultural carbon sequestration activities.

Sen. Carl Levin (D-MI) on Feb. 13 floated an anti-speculation bill for energy and agriculture markets that classifies as an energy commodity which is subject to CFTC regulation "any commodity" that results from management of air emissions including GHGs, a proposal that includes language on the issue similar to a proposal from Levin during the previous Congress. Other Senate efforts prior to this Congress -- besides the comprehensive climate bill from Sens. Joseph Lieberman (I-CT), John Warner (R-VA) and Barbara Boxer (D-CA) debated in June 2008 -- include a stand-alone proposal on carbon market oversight in late 2007 from Sens. Dianne Feinstein (D-CA) and Olympia Snowe (D-ME) that would have given EPA a central role in managing the carbon markets.

The Duke paper also references previous House legislative proposals on the issue, including climate change legislation floated in 2008 by Rep. Edward Markey (D-MA) and a subsequent "discussion draft" by then-House Energy & Commerce Committee Chairman John Dingell (D-MI) and Rep. Rick Boucher (D-VA). The Dingell-Boucher draft largely incorporated the Markey language giving FERC, over which the committee has jurisdiction, a central role in handling the issue.

However, in addition to noting the previous proposals, the paper includes a discussion of "additional options" for increasing transparency and oversight, including the option of creating a single electronic market for both emissions allowances and financial "derivative" products based on carbon allowances. Other suggestions include: limiting trading of "carbon derivative" products such as futures, options and swaps to "registered carbon derivative exchanges" (RCDE) approved by the regulator; the imposition of a limit on the number of contracts or options that participants could hold at one time in order to prevent excessive speculation; and minimum margin requirements for carbon exchanges designed to limit "counterparty risk" -- which is essentially the risk that a party to a financial deal faces if the other party fails to meet its commitment. Sources say the failure by financial institutions to shield against such counterparty risks is a major cause of the current financial crisis.

Another section of the report referencing the financial upheaval in late 2008 notes that there is widespread acknowledgment that more government oversight to ensure the underlying value and integrity of financial instruments known as credit default swaps -- a type of financial derivative -- "might have prevented the financial collapse that occurred when default rates surged and counterparties were left with near limitless and largely hidden liabilities that they could not cover." Accordingly, the paper suggests that "regulating allowance derivatives from the outset could help avoid the recent problems associated" with those swaps.

Several sources contacted about the Duke report were unfamiliar with it, though one source said there are some indications it could provide backing for upcoming legislative proposals on climate change including an upcoming bill expected from newly installed House Energy & Commerce Committee Chairman Henry Waxman (D-CA). Many observers presume that as the new chairman of the committee, Waxman will embrace the Dingell-Markey strategy of suggesting a major FERC role. Committee staff did not return calls seeking comment on the report.

Meanwhile, a source with IETA says the report appears to grapple with many of the issues the group is discussing internally in an effort to develop a consensus among its members on options for carbon market oversight. The groups membership includes banks, utilities, industry, carbon traders and carbon exchanges.

The source did not offer a timetable for reaching agreement but said that the group is hoping to strike a balance that establishes "the right amount of oversight" and allows for both needed regulation and a robust market for emissions credits. The source says "the issue has evolved quite a bit" since the coalition offered views on the Feinstein measure in early 2008, well before the Senate debate on comprehensive climate legislation. -- Doug Obey