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Following concerns raised by Spain, a regulator's review of the
EU's main carbon trading mechanism has cleared financial market
players of blame for meteoric carbon price rises but still wants to
rein them in.
The EU's financial regulator, the European Securities and
Markets Authority (ESMA) found that new laws had not led to
manipulative trading of emission allowances (EUA) in the EU
Emissions Trading System (ETS) in a 28 March
report. The EU ETS is seen as the EU's key lever for reaching
net-zero under a
proposed Fit for 55 package of policies.
In its report, ESMA noted that "The various segments of the EU
carbon market appear to broadly function as expected" and there
were currently no "major deficiencies" in how it operates.
Non-compliance buyers, such as banks and investment firms, have
been legally allowed to use EUAs as investments since 2018. Related
investing rose in the second half of 2021,
according to Budapest-headquartered broker Vertis Environmental
Finance.
Spain argued that this activity was increasing appetite for EUAs
required by power generators and hiking electricity costs paid by
consumers in a 30 September paper sent to the European
Commission (EC).
But ESMA found "relevant firms are only holding very small or no
actual positions." As such, it advised considering new rules
governing the firms to ensure "fair and orderly" markets, but it
warned a shorter leash for firms could not keep EUA price swings in
check.
Carbon market scrutiny recommended
ESMA suggested better monitoring, transparency and, potentially,
new regulations for financial market players.
For example, it suggested amending the EU Auction Regulation to
ensure that ESMA is updated on transactions in the primary EUA
market.
Other measures could potentially come in the form of position
management controls and position reporting for EUA derivatives.
Transparency measures might include reporting on futures, on top of
current combined reports that include futures. This could take the
form of, for example weekly reports on open positions in futures
and counterparty classifications, among other things.
It said a closer watch on financial markets was needed to keep
enough EUAs in circulation. "[T]he emergence of new participants
(and instruments) with buy-and-hold strategies warrants future
monitoring to the extent that they may lead to a reduction in the
supply of physical emission allowances available for trading, even
though the available evidence suggests that their impact is only
limited so far," said ESMA in the report.
EUA account holders could also be better identified in the EU
Registry that keeps track of the ownership of allowances.
ESMA regretted that a lack of data on "who trades what from
where" had proved a challenge when trying to investigate the carbon
trading claims.
It advised that the EU's co-legislative bodies take the report
and consider whether more carbon market rules are necessary.
ESMA offers to monitor EU ETS
ESMA weighed up the pros and cons of EU-level monitoring of
carbon markets, now undertaken by the authorities in individual EU
member states, to prevent future "abuse."
It presented six arguments in favor and four against a central
watchdog, but said more research was required.
A centralized watchdog could detect market manipulation, apply
limits on holdings of derivative open positions, and could also
facilitate cross-market monitoring, for example of not only EUAs
but also wholesale gas or power markets, it said.
ESMA's preferred structure was joint EUA market surveillance by
three countries — the Netherlands, Norway and Germany — in
order to "swiftly" enhance the market monitoring of the bloc-wide
carbon market.
The alternative to this could be a modeled on how the EU's
Agency for the Cooperation of Energy Regulators (ACER) regulates EU
wholesale energy markets, where ESMA acts in the place of ACER.
Ukraine war lowers carbon price
At the start of March, war in Ukraine and worries of Russian gas
shortfalls caused compliance buyers to sell-off of EUAs, seeking to
raise liquidity amid energy price concerns. A parallel drop in
demand for EUAs caused prices to fall 35%,
according to the research arm of Dutch digital banking group
ING.
The war in Ukraine has had a "major impact on the carbon
market," found ESMA, although it observed the carbon price has
since recovered.
The regulator noted that EU ETS market participants' belief that
fossil fuel would be needed less in the EU — whether due to gas
supply disruptions, Russian gas import bans or assumptions of
economic downturn — may have caused the temporary collapse in
the carbon price.
Despite this volatility in early March, financial market players
see the report as further confirmation of the resilience of the
current EU ETS regulations. "Remember, since the selloff that
stoked fears of policy reversal we have had: [EU ETS price control
policy] Market Stability Reserve reaffirmed, Fit-for-55 reaffirmed
and the 'no major deficiency' report from ESMA communications," tweeted
Managing Director, Head of Climate Investments and Strategy at ETF
provider KraneShares on 29 March.
Posted 31 March 2022 by Cristina Brooks, Senior Journalist, Climate and Sustainability
This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.