Bill on climate change offers hope to Wall St.

As Washington begins to clamp down on the runaway financial markets that threw the world economy into crisis, lawmakers are handing a new opportunity to Wall Street on an unlikely issue: climate change.

At the heart of the 900-plus-page climate change bill that the White House and House Democrats have rallied around is a massive new dose of confidence in markets. Some critics say the bill may create a “carbon bubble” that could leave unsuspecting investors holding worthless assets and ultimately undermine efforts to reduce greenhouse gas emissions.

{mosads}The so-called “cap-and-trade” program seeks to curb emissions such as carbon dioxide by allowing utilities and other emitters to buy and sell emissions credits as needed. It’s the trading of those pollution allowances and the creation of financial instruments, or derivatives, to hedge risk in the market that has bankers and traders interested.

The Commodity Futures Trading Commission (CFTC), a federal agency that regulates commodities and futures markets, estimates that the carbon market eventually could become one of the largest commodity markets in the United States. 



It is little wonder, then, that big manufacturing isn’t alone in the lobbying mix. Some of the financial world’s biggest players are keeping close tabs on climate change legislation, which is being debated this week by the House Energy and Commerce Committee.



Among the financial firms lobbying on the issue this year are: Zurich Financial, Chicago Mercantile Exchange Corp., JPMorgan Chase & Co., the Reinsurance Association of America, Swiss Re, Deutsche Bank, UBS America and the International Swaps and Derivatives Association.



Estimates of the potential market size vary widely. New Carbon Finance, a private consulting firm, puts the market for derivatives, futures contracts and anything related to emissions allowances at $860 billion by 2020. The CFTC said the carbon market could reach $2 trillion five years after it starts.

“It wouldn’t be as large as some of the financial markets — Treasury bills — but it would be larger than any physical commodity market,” said CFTC Commissioner Bart Chilton, head of the agency’s energy and environmental markets advisory committee.

Kevin Book of the firm ClearView Energy Partners agreed that the carbon market would become the largest commodity market in the world, creating revenue streams for financial firms through the purchase and sale of allowances, transaction fees and market research services.

Peter Fusaro, chairman of Global Change Associates, said the market will likely start slowly, but once the regulatory apparatus is in place, will grow significantly. The worldwide market is around $120 billion at the moment, but would get a huge boost if the United States jumps aboard.

“We’re a very small market now, but hopefully with legislation we’ll be a very large market,” Fusaro said. “That will benefit Wall Street firms.”

Wall Street’s interest in the bill makes some in the environmental community nervous that speculators will create a carbon bubble that creates havoc in the market and undermines its ultimate effectiveness in cutting emissions.

Michelle Chan, green investment program manager for Friends of the Earth, an environmental advocacy group, said lawmakers need to do more to ensure adequate oversight of this huge new market because it presents unique challenges that may not be covered under the broader financial services regulatory reform effort Congress and the administration are simultaneously pursuing.

“The most important step policymakers could take to preserve the financial and environmental integrity of carbon markets would be to design the market itself to be fundamentally smaller, simpler and more stable,” Chan said.

“General derivatives regulations are designed to curb the most excessive behaviors in fairly liberalized and volatile markets; we can structure carbon markets differently,” Chan said.

One potential problem area concerns the trading of offsets to help industries meet their emissions targets. For example, a utility or a bank could invest in the development of a forest plantation in South America, which would count as an emissions offset because trees suck carbon dioxide out of the air, and then trade that credit on the market.

The bill requires an oversight body to verify that offsets provide real emissions savings. Lawmakers are working to add government regulations to the bill to avoid creating unregulated derivative markets such as the ones that exacerbated the financial crisis. But Chan said the legislation doesn’t do enough to assure investors that the offsets they buy will hold value.

“The problem is you can enter into formal contracts that are sold and resold before the greenhouse gas reductions have been verified,” Chan said.

“You could have unscrupulous carbon-offset dealers,” she said. Bad offsets could become “sub-prime carbon,” akin to the junk bonds of the 1980s or the sub-prime mortgages that helped caused the current financial crisis, Friends of the Earth warned in a recent report.

Environmental groups aren’t the only ones raising concerns about market oversight. In a staff memo this week, Senate Republicans on the Environment and Public Works Committee latched onto the Wall Street-climate change connection.

“Are some companies on Wall Street supporting cap-and-trade because they want to save the planet? Or are they supportive because cap-and-trade enables them to profit from trading billions of dollars worth [sic] of allowances in a new carbon market?” the memo says.

But market advocates say over-regulation presents its own problems. Book of ClearView Energy Partners said that while a wide open market can lead to excesses, it also provides more opportunities for polluters to hedge investments, which ultimately may keep energy costs from skyrocketing.

“If you say, ‘Let’s regulate the hell out of it,’ that won’t be helpful. To get the economic value of a market, you have to let it behave like a market,” Book said.

Energy and Commerce Chairman Henry Waxman (D-Calif.) and Energy and Environment subcommittee head Edward Markey (D-Mass.) made changes to an earlier version of their climate bill heading into the markup this week to address some of the concerns that Friends of the Earth and others have raised.

For example, the revised measure establishes a working group that will recommend to President Obama which federal agency should be responsible for overseeing the carbon market and whether specific rules are needed to address its unique attributes.

It also sets limits on the number of contracts a single investor can hold and sets a hefty $25 million fine for violating anti-fraud and anti-manipulation rules.

The history of finance tells us that despite efforts to modernize the rules that govern Wall Street, there will be future speculative bubbles that burst, Chan said. Congress may need to do more to ensure that the next one to blow isn’t the one it creates with the climate bill.