How will carbon market mechanisms function under EPA regulation? During today's OnPoint, Henry Derwent, president of the International Emissions Trading Association and the former climate change director in the United Kingdom, discusses the future of carbon markets in the United States and internationally. Derwent comments on recent security breaches in Europe's market and explains how markets can improve transparency and accountability.

Transcript

Monica Trauzzi: Welcome to the show. I'm Monica Trauzzi. Joining me today is Henry Derwent, president of the International Emissions Trading Association and the former climate change director for the United Kingdom. Henry, it's great to have you here again.

Henry Derwent: Thanks for calling me onto the show.

Monica Trauzzi: Henry, we've seen the price of carbon fall recently, in particular following the Copenhagen climate meeting. Are investors hesitant to put money into carbon trading at this point because it's so dependent on political will and what's happening politically?

Henry Derwent: I think investors are worried about what's going to happen after 2013 in markets, particularly outside the European Union. The European Union is obviously the biggest carbon market in the world, and the European Union's market is secured through to 2020 and beyond that on the basis of a pretty aggressive reduction of emissions expected in Europe, could be more aggressive, but the market is basically there. But the value of emissions reductions elsewhere in the world obviously depends on whether there's going to be more demand from new schemes in the United States, in Australia, and those things are uncertain, so people are just sort of waiting to see what happens.

Monica Trauzzi: So let's talk a bit about what's happening in the U.S., because we sort of have two different routes that could take place, either the regulatory route through EPA or climate legislation. How would the market mechanisms differ if we saw a regulation through EPA rather than legislation?

Henry Derwent: Do you know, I don't think we really know the answer to that, because we've been focusing, I think all the specialists in the emissions trading, legislation and policy have been focusing on what must be the first best thing to do, which is to put together a national cap-and-trade scheme. And there's a sort of piecemeal situation already out there where a number of states are developing their own rather different approaches to cap and trade and emissions reduction, and it seems time for Washington to do its traditional thing of trying to make sure that there is some sort of harmonization and clear regulatory environment across the whole of the United States. So the prospect that the EPA might have to act on the instructions it's already been given, in the absence of a new legislation at national level, is still a pretty new one. And it does look as though the EPA has some ability to deal with cap and trade in this context. It obviously has a track record of doing so in other emissions contexts, but exactly how that could work, I think we need to be much clearer about exactly what the legislation would allow, what would be the best way forward to see whether this certainly second-best solution is actually capable of producing anything.

Monica Trauzzi: As you said, a lot of people agree that this is the second-best solution. Congress is still working towards legislation. It's looking unlikely that it might pass this year. However, the bills, as they stand now, would they help create sort of liquid carbon markets? Are they setting things up correctly?

Henry Derwent: I think they are good steps on the road. I mean, I think that in a sense, it's quite good that none of them has coalesced into the obvious thing that the United States is going to do, because I think there's plenty of debate yet to be had about some of the design features, some of the most important issues -- allocation, for example, under Kerry-Boxer. Nobody really knows exactly how that was supposed to work. So there are features which are great, there are features which lead people with experience abroad and people with particular worries about costs to say, oh, maybe that's an area that should be looked at again. I think that there's a long way to go yet, and although you say that it looks more and more unlikely that there will be legislation this year, I think it's a little bit early to be really concluding that. After all, we have three of the most powerful senators supported by the president trying to put together something, clearly in the last stages of creating something new, and I think we need to see what happens to that.

Monica Trauzzi: Yvo de Boer has announced he will be leaving his post at the U.N. One analyst was quoted as saying that the announcement marked a sad day for the carbon market. What impact will his departure have on the push for an international agreement and where we might see carbon markets going?

Henry Derwent: Yeah, I'm not so sure that it makes that much difference to the carbon market. This was a post which was already always going to have, as I understand it, a change at around this time. I think it's probably better to get the issue of a change out of the way now rather than wait until closer towards the Cancun meeting, which we're expecting certainly in Mexico towards the end of this year. And I think the most important thing will be the identity and the political weight of the successor that will be appointed, and I think that actually is probably what the market is looking for at the moment. You didn't see much in the way of sort of price reaction to Yvo's resignation. Most people were expecting that there would be a change at about this time.

Monica Trauzzi: Recently, Europe's emission trading system was in the news because it was a victim of a cyber attack. Does this case sort of serve as an example of a broader issue relating to security of the market and also potential cheating that we might see in the markets?

Henry Derwent: It's always difficult to defend an institution which has suffered a run of bad luck, but I think there is an element of bad luck here. For example, the value-added tax fraud which we saw in Europe a little while ago is not something that one would have wanted to see, but it's essentially about the means used in European countries to collect value-added tax on transactions, rather than something wrong with the market which has produced those transactions. So the same problem that happened to mobile phones, for example -- anything of significant value where there's a lot of transfers from one place to another with value-added tax charged at one place and not charged in another place. The recent problems that you're referring to are essentially about the vulnerability of registries and registry system to phishing attacks which tempt the unwary to release details, which can then be used by fraudsters to create a title or an appearance of title to instruments of value. That can happen really anywhere where there are valuable transactions taking place through electronic means, if you don't have an up-to-the-minute, effective financial control system which prevents details being stolen. And I'm afraid the European registries, and remember, this is at the moment something which is not harmonized, though the new phase beginning in 2013 is going to be covered by a harmonized system. This just reveals, I think, that the Internet security and electronic security controls operating those registries were just not up to scratch. It's hard to blame the carbon market for that.

Monica Trauzzi: But because we're not dealing with something tangible in these markets, are we ever going to see the transparency and accountability that we might expect from other markets?

Henry Derwent: I think so, after all, money is not very tangible in many ways. A lot of the derivative markets which operate as a means of covering risk in commodities markets where, at the end of the day, there are sort of solid things which are being traded, but the way those are used in modern financial transactions involves essentially contracts passing from one set of hands to another very fast through electronic means. And I don't think that anything particularly new, and I don't think that when you look at the market in carbon reductions it's radically different or presents different problems of control to the markets that we see at the moment.

Monica Trauzzi: OK, we're going to end it right there.

Henry Derwent: OK.

Monica Trauzzi: Thank you for coming on the show again.

Henry Derwent: Not at all, thank you.

Monica Trauzzi: And thanks for watching. We'll see you back here tomorrow.

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