The acceleration to cleaner sources of energy accelerated in 2020 with many companies pledging to reduce their carbon emissions. In fact, according to the UN, 120 countries, 23 regions, 454 cities, 1,397 businesses, 74 investors, and 569 universities across the globe have pledged to become carbon neutral by 2050. Many of these entities may look to market-based mechanisms as a tool to execute their individual strategies.
Emissions trading schemes, or market-based mechanisms (MBM) more broadly, are designed to provide an efficient mechanism for countries, firms, and even individuals to reduce their carbon footprint. The theory is simple - increased optionality and competition should help carbon find an equilibrium price while effectively reducing emissions.
However, the uniqueness and regional nature of emissions trading and carbon offset projects have prevented harmonization between programs and ultimately the development of a standardized price. It is a difficult task to mitigate climate risk without a universal benchmark.
Current Options for Emissions Trading
In compliance markets, an emissions cap is set for certain types of industries, generally with obligated parities selected based on pre-determined emissions output thresholds. Firms that reduce below a mandated cap can sell excess carbon credits to firms who are still emitting above their assigned cap. Some programs also allow firms to use offset credits from emission reduction projects to satisfy a portion of their obligation.
While offset credits play a role in compliance markets, they also have the flexibility to allow firms to reduce carbon emissions outside of a regulated framework. Voluntary offset projects and associated credits allow firms to take near term action to meet carbon reduction goals while they work to transition to low-carbon business practices.
The airline industry is a prime example of the private sector leveraging voluntary offset projects to reduce emissions. Prior to the steep decline in airline travel due to COVID-19, emissions from the airline industry were higher than all but five countries in the world. The International Civil Aviation Organization (ICAO), a UN specialized agency, adopted the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) as a market-based mechanism to meet an ambitious goal of carbon neutral growth from international aviation beyond 2020.
A Market-based Solution
The Taskforce on Scaling Voluntary Carbon Markets, a private sector-led voluntary carbon market initiative where CME Group is a member, has stated that “a large, transparent, verifiable and robust voluntary carbon market will be critical to reaching net zero and net negative goals,” and that the current voluntary market also needs to scale by at least 15 times in order to achieve these goals. Among their key recommendations around properly scaling the market is a call for a physically delivered futures market.
CME Group and Xpansiv markets CBL, a leader in spot energy and environmental markets, have jointly developed the Global Emissions Offset futures (GEO) contract.
The GEO futures contract sets its foundation in the selection criteria and review process developed for CORSIA. ICAO and TAB spent years developing a stringent screening process to determine which offset registries and project types are eligible. The result is a set of criteria that firms across industries and geographies s use as a guide to assess the robustness of emissions offset projects and associated credits.
Long Term Effort
Even as the world grapples with disruptions from the COVID-19 pandemic, companies, shareholders, and consumers have strengthened their call for a reduction in carbon emissions as part of a larger Environmental Social Governance (ESG) movement.
The shift to a low-carbon economy requires a long-term effort, but near-term reduction strategies that leverage emissions offset projects may also help be part of the solution today. The GEO contract will provide a regulated and standardized platform for companies to manage their emissions risk, while also helping to establish a much-needed global emissions offset pricing benchmark.
OpenMarkets is an online magazine and blog focused on global markets and economic trends. It combines feature articles, news briefs and videos with contributions from leaders in business, finance, economics and politics in an interactive forum designed to foster conversation around the issues and ideas shaping our industry.
All examples are hypothetical interpretations of situations and are used for explanation purposes only. The views expressed in OpenMarkets articles reflect solely those of their respective authors and not necessarily those of CME Group or its affiliated institutions. OpenMarkets and the information herein should not be considered investment advice or the results of actual market experience.
Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss. Swaps trading should only be undertaken by investors who are Eligible Contract Participants (ECPs) within the meaning of Section 1a(18) of the Commodity Exchange Act. Futures and swaps each are leveraged investments and, because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade.
BrokerTec Americas LLC (“BAL”) is a registered broker-dealer with the U.S. Securities and Exchange Commission, is a member of the Financial Industry Regulatory Authority, Inc. (www.FINRA.org), and is a member of the Securities Investor Protection Corporation (www.SIPC.org). BAL does not provide services to private or retail customers.
In the United Kingdom, BrokerTec Europe Limited is authorised and regulated by the Financial Conduct Authority.
CME Amsterdam B.V. is regulated in the Netherlands by the Dutch Authority for the Financial Markets (AFM) (www.AFM.nl).
CME Investment Firm B.V. is also incorporated in the Netherlands and regulated by the Dutch Authority for the Financial Markets (AFM), as well as the Central Bank of the Netherlands (DNB).
TriOptima AB is regulated by the Swedish Financial Supervisory Authority for the reception and transmission of orders in relation to one or more financial instruments. TriOptima AB is registered with the US National Futures Association as an introducing broker. TriOptima holds a permit under Section 49A of the Israeli Securities Law, however TriOptima’s operations are not subject to the supervision of the Israel Securities Authority. This permit does not constitute an opinion regarding the quality of the services rendered by the permit holder or the risks that such services entail. TriOptima’s services are designed exclusively for Qualified Investors in accordance with Israeli law. TriOptima AB materials are directed to Equivalent Counterparties and Professional Clients only and are not intended for Non-Professional Clients (as defined in the Swedish Securities Market Law (lag (2007:528) om värdepappersmarknaden)) or equivalent in a relevant jurisdiction.