When a German utility company, Stromio, recently called for Limits on EU Carbon Market Speculators, our curiosity was officially piqued... for a few reasons. Being a B-Corporation we strive to do the right things; acting in an environmentally friendly way being one of them. As a RegTech we also spend a lot of time looking at regulations (surprise surprise!), and more specifically, regulation in the derivative markets in the form of Position Limits. When we heard the news, we really couldn’t not comment.
For those who are new to carbon emissions trading (I imagine that might be most people), they are a relatively new instrument in a growing market. Carbon emissions controls date back to the Kyoto Protocol of 1997 on climate change where countries were set targets to reduce greenhouse gas emissions. This cascaded from the country level to the company level and firms were then given allowances of how many metric tons of CO2 they can emit. In earnest though, the first real trading scheme at scale for carbon was put into place by the EU Emissions Trading System in 2005.
Under the scheme, factories, power stations and other installations are set a maximum cap on the total amount of carbon emissions they can produce. Carbon emissions contracts are auctioned off and can subsequently be traded in a few ways; privately between operators, via Europe’s climate exchanges, or OTC. In the real world, these contracts are purchased by companies when they exceed their emissions targets and they need to purchase emissions allowances in order to balance the excess.
But... these companies are not the only players in these markets! Stromio’s grievance stems from the speculative activity of hedge funds in this space which has led to record price increases in emissions allowances with prices more than doubling over the past year. Hedge funds have taken a keen interest in the market ahead of expectations for stricter EU climate policies whereby CO2-producing firms would either have to reduce their carbon footprint or buy more carbon emissions. You don’t have to be an economist (or a hedge fund manager for that matter) to understand the demand dynamics afoot there. There’s also little stopping speculators from building substantial positions in these markets given emissions allowance derivatives are not subject to ESMA’s position limits regime under current EU law. Stromio says this is wrong and needs to be examined by the powers that be.
To be entirely honest, the situation summons a healthy dose of conflict for us as a B-Corp RegTech company.
Wearing our B-Corp hat, if the cost of emissions allowances increases, this makes it more expensive for firms churning out CO2 to mitigate their emissions output which in turn (we hope) means companies will be even more incentivized to reduce emissions. As a B-Corp, we think that’s good.
However, putting on our RegTech cap, Stromio’s claims are not baseless. Most position limit regimes across the globe were originally put into place to ensure accurate price discovery, limit excessive volatility, and restrict the ability for market participants to stockpile market-moving amounts of a given derivative contract. Given the huge rally in prices in such a short space of time, Stromio’s point is well made.
Ultimately, we think it makes sense for position limits to be applied in situations such as these...but we’d also like the cost of carbon emissions to stay elevated for the sake of the planet. In short, we’re asking to have our cake and to eat it.