January 18, 2011

Interagency Working Group Releases Carbon Oversight Study

Washington, DC – A Federal interagency working group led by the Commodity Futures Trading Commission (CFTC) today released a report on the oversight of existing and prospective carbon markets, fulfilling a requirement established in Section 750 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Act requires the group to “conduct a study on the oversight of existing and prospective carbon markets to ensure efficient, secure, and transparent carbon markets, including oversight of spot markets and derivative markets.” The Act requires the group to submit its report to Congress with recommendations for the oversight of existing and prospective carbon markets.

The interagency group is composed of the following members: the Chairman of the Commodity Futures Trading Commission (CFTC), who serves as the group’s Chairman, the Secretary of Agriculture, the Secretary of the Treasury, the Chairman of the Securities and Exchange Commission, the Administrator of the Environmental Protection Agency, the Chairman of the Federal Energy Regulatory Commission, the Chairman of the Federal Trade Commission and the Administrator of the Energy Information Administration.

“This report fulfills Congress’s mandate to conduct a study on carbon market oversight,” CFTC Chairman Gary Gensler said. “I thank all of the members of the interagency working group and their staffs for providing thoughtful analysis on carbon markets and contributing to the recommendations included in this report.”

The Dodd-Frank Act directs the interagency group to consult with representatives of exchanges, clearinghouses, self-regulatory bodies, major carbon market participants, consumers and the general public in completing the study. To this end, the CFTC solicited public comments through both informal consultations and a formal comment process focusing on key questions raised by Section 750. Twenty-three written submissions were received, which are available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=911.

In its report, the interagency group recommended that the following objectives guide the oversight of existing and prospective carbon markets.

Objective 1. Facilitate and protect price discovery in the carbon markets.

Carbon market design and oversight should strive to ensure that carbon markets – including those for allowances, offsets and derivatives – reflect both supply and demand conditions, considering the present marginal cost of achieving emission reductions and market participants’ expectations of future marginal costs of reductions.

Objective 2. Ensure appropriate levels of carbon market transparency.

Regulatory oversight must ensure that proper levels of transparency exist in carbon markets. Both pre-trade and post-trade market transparency measures should exist in order to provide timely and accurate information to carbon market participants. Transparency can generally increase the efficiency of markets by providing for more informed decision making by market participants. To encourage market participation, transparency provisions should preserve the confidentiality of traders and their positions consistent with commodities and securities laws and provide appropriate exceptions for large or "block" trades. Regulatory oversight provisions also should ensure appropriate provision of fundamental market data relating to aggregate emissions of regulated entities and the supply of allowances and offset credits in the markets.

Objective 3. Allow for appropriate, broad market participation.

Regulatory oversight should ensure that rules regarding market participation allow entities with emission compliance obligations to efficiently meet their obligations and allow offset credit providers to bring those credits to market. More broadly, the rules and trading systems should be designed to encourage market liquidity, facilitate price discovery and allow those directly and indirectly impacted by the regulation of carbon emissions to efficiently hedge associated risks. Open market participation promotes the development of market liquidity and price discovery, which are essential to the efficient functioning of primary, secondary and derivative markets and could facilitate the ability of entities to hedge commercial risks associated with regulation of carbon emissions.

Objective 4. Prevent manipulation, fraud and other market abuses.

Carbon markets should be free of manipulation, fraud and other market abuses. Measures should be in place to prevent price distortions, market fraud and other manipulative activities and to provide for sufficient transparency for regulators to monitor activity in the market.

The Dodd-Frank Act includes significant reforms of the derivatives markets that will apply to carbon derivative products, whether traded on an exchange or over-the-counter. However, primary and secondary carbon allowance and offset markets will not be subject to the same comprehensive oversight as derivative markets. Various characteristics of carbon markets suggest the need to consider whether additional regulation is necessary for primary and secondary carbon allowance and offset markets.

Based on its study, the interagency group made the following recommendations in its report regarding the oversight of existing and prospective carbon markets:

1. Rely on the existing regulatory oversight program, as enhanced by the Dodd-Frank Act, for both existing and prospective carbon allowance and offset derivatives markets. The current legal framework for oversight of derivative markets, as enhanced by provisions in the Dodd-Frank Act that will become effective in July 2011, will provide for robust and effective oversight of carbon derivatives markets and closely linked derivative markets, such as those based on energy commodities.

2. Ensure that appropriate oversight mechanisms are in place for primary and secondary allowance and offset markets, reflecting the above objectives and the interdependence of primary, secondary and derivative carbon markets and any unique characteristics or circumstances of such markets.

Appropriate oversight for the primary and secondary allowance and offset markets will depend upon market-specific factors, including how primary and secondary markets are structured and the breadth of the market (e.g., national or regional). Appropriate oversight may not be the same for all markets. As such, more detailed work may be necessary to consider the appropriate oversight regime for existing and prospective primary and secondary carbon markets, particularly if or when Congress considers Federal market-based options for reducing greenhouse gas (GHG) emissions. In designing prospective markets, policymakers also should recognize the ability to achieve the above-described market oversight objectives through both traditional market oversight provisions and in part by the design of the underlying GHG policy.

Last Updated: January 18, 2011