CFTC chair calls for comprehensive regulation of emissions markets

Nick Snow
OGJ Washington Editor

WASHINGTON, DC, Nov. 4 -- Comprehensive regulation of financial derivatives will also need to be a critical component of a well-functioning domestic emissions trading market, US Commodity Futures Trading Commission Chairman Gary G. Gensler said on Nov. 3.

“As Congress moves forward with potential cap-and-trade legislation, I believe it should fully regulate the expanded carbon trading markets—including the futures market, the OTC market, and the cash market—without exception,” Gensler said in an address to the International Emissions Trading Association’s 2009 fall trading symposium.

“Ensuring transparency, protecting the price discovery function, and addressing financial risk are every bit as critical for emissions markets as for other markets,” Gensler said, adding, “It is crucial to ensure that carbon markets function smoothly, efficiently, and transparently. Effective regulation of carbon allowance trading will require cooperation on the parts of several regulators.”

Gensler said six regulatory components will need to be considered, including standard setting and allocation, compliance with emissions caps and offset requirements, record-keeping and registry maintenance, trade execution system oversight, clearing of trades oversight, and protection against fraud, manipulation, and other abuses.

The first three components, which Gensler said represent the “cap” portion of cap-and-trade, fall within other regulatory agencies’ expertise. CFTC is best equipped to handle the remaining components since it already fills this role in existing emissions trading programs, he indicated.

Lists examples
For example, the US Environmental Protection Agency issues sulfur dioxide and nitrogen oxide allowances under the federal acid rain, NOx budget trading, and clean air market programs, he said. On a smaller scale, 10 states from Maine to Maryland form the Regional Greenhouse Gas Initiative and issue GHG allowances, Gensler added.

“In each case, other entities issue allowances, ensure compliance, and maintain the registry. The constant, however, is that the CFTC regulates the emissions futures trading markets,” he explained. “In other words, the CFTC has a great deal of experience regulating the ‘trade’ part of cap-and-trade.” It already oversees contracts based on sulfur dioxide, NOx, and carbon dioxide allowances and offsets listed on the New York Mercantile Exchange and Chicago Climate Futures Exchange, Gensler said.

“In most respects, emissions contract markets operate similarly to other commodity markets the CFTC regulates,” he said, adding, “While each contract—such as SO2, wheat, treasury bills, or natural gas—presents its own unique challenges, the regulatory scheme is essentially the same.”

He said CFTC has thorough processes to ensure that exchanges have procedures in place to protect market participants and ensure fair and orderly trading, that products are designed to minimize potential manipulation, and that exchanges comply with the law and regulations.

Additional oversight
Its compliance staff monitors operations to ensure that exchanges are enforcing their rules and customers are protected from abusive practices. Its surveillance staff watches for signs of manipulation or congestion and determines how to best address market threats. “We have the authority to set and enforce position limits, and our enforcement staff is actively prosecuting cases,” Gensler said.

If Congress passes cap-and-trade legislation, CFTC would work with other regulators to implement appropriate additional safeguards, he noted. “There may be specific facets of carbon markets that require particular protections, and I look forward to working with Congress, market participants, and the public to offer the commission’s expertise in considering those,” he said.

“As a foundation, the markets should benefit from the protections that we currently have against fraud, manipulation, and other abuses as directed by the Commodity Exchange Act coupled with any new protections Congress is considering for the OTC derivatives markets,” said Gensler.

“We also must ensure that all transactions in both the carbon futures and cash markets are promptly reported and that a central registry is updated at least on a daily basis,” he said, adding, “With immediate registry of trades, it will be easier for regulators to identify manipulation in the markets.”

Gensler said he considers it important for companies to be able to make long-term capital commitments and hedge their carbon emissions allowances’ long-term price risk. “That is why it is critical to get the regulatory oversight right of both the futures markets and the over-the-counter markets that may develop out of a cap-and-trade program,” he maintained.

Contact Nick Snow at nicks@pennwell.com.

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