Good green derivatives

A peek beneath the hood of the EU carbon market

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Estimated reading time ~ 9 mins

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“Good derivatives, those that are regulated and transparent, should be encouraged and will flourish for generations if properly nurtured.”

- Richard L. Sandor, recognised by TIME Magazine as the "Father of Carbon Trading"

In October 2021, European energy prices had only begun to build up a head of steam. The worst was yet to come of course. Nevertheless, the European Commission (EC) thought it necessary to task the European Securities and Markets Authority (ESMA) with examining trading behaviour in the EU carbon market, and in particular, whether the market needed to be reformed to help respond to rising energy prices.

ESMA’s interim report was published in November 2021 and highlighted how EU ETS participant activity had not “significantly changed since 2018 and is broadly in line with the expected functioning of the market.” The agency’s final report, published in March 2022, was similarly sanguine, concluding that they had “not unearthed any major abnormality or fundamental issue in the functioning of the EU carbon market from a financial supervisory perspective.”¹

Concern that nefarious speculators were partly responsible for the surge in EU carbon prices reached a peak in February 2022. One day after the EUA price breached €98 for the first time, an article in Bloomberg suggested that Peter Liese (the lead lawmaker steering EU ETS reform at the time) was now looking into how speculation could be curbed (see In the trigger zone: What proposed changes to Article 29a mean for EU carbon prices).

Much has changed in the intervening 30 months since ESMA’s final report was released. The worst of the energy crisis has passed with European energy prices returning to near pre-crisis levels - the recent rebound an exception to that trend. However, as I outlined in Know your onions: Concern over the role of speculators in Europe's energy markets is overplayed, there is still a case for greater transparency over the role played by different market participants in the EU carbon market:

“ESMAs analysis was always going to be backward looking. Arguably the composition of the players in the market and the strategies that they employ has changed considerably since then. There could be a case for re-opening a new investigation into speculative activity in the EU carbon market, one that focuses more on the broader energy complex given the issues identified in the European gas market.

All financial markets can be thought of as levers of government policy, but arguably none more so than the carbon market. The over-riding issue for the EU should be increasing the level of transparency in the market. It’s only through greater levels of monitoring and disclosure that all market participants - whether financial or non-financial - can trust the markets signal.”

Fortunately, we do now have a more up-to-date view of what’s happening beneath the hood of the EU ETS. Earlier this month ESMA published its first annual report on EU carbon markets, providing some insight into how the functioning of the EU ETS has evolved, with a particular focus on 2023.