From Rio to Montreal: The Convergence of Environmental and Financial Markets

Dr. Richard L. Sandor, Chairman and CEO, Chicago Climate Exchange - www.theccx.com

The start of the European Emissions Trading Scheme (EU-ETS) has given a boost to the global market for trading emissions. Launched in January this year, the EU-ETS allocated emission allowances to be distributed amongst major emitters among its 25 Member States in a cap and trade system. In a short span of seven months, total value of trades in the mandatory EU-ETS has crossed 1.6 billion euros for the first half of 2005. Many analysts feel that this is merely the start of what could be the biggest financial market in the world. Meanwhile, market developments in North America's only emissions trading system, the Chicago Climate Exchange (CCX) are continuing to make steady progress. The market for Certified Emission Reduction credits, although still evolving, has the potential to be a big force. In short, all the components for a global emissions trading market are now in place.

The pace at which the transformation has occurred has been remarkable. Fifteen years ago climate change was a concern to a limited number of scientists and environmentalists. An even smaller number of individuals were thinking about a market-based solution to climate change. Today, global emissions markets are at the forefront of a subtle transition that is opening new possibilities: the convergence of the financial and environmental markets. Environmental issues, including greenhouse gas mitigation, are fast moving out of the confines of corporate EH&S departments and are becoming a topic of corporate Business and Financial Strategy. We are now witnessing a major development in the form of futures markets in property rights. Financial markets are being used to help address environmental concerns. These are truly exciting times.

As the world convenes for the First Meeting of the Parties in Montreal, it is perhaps instructive to share with you our own history in establishing what is now a significant development in environmental trading - the Chicago Climate Exchange (CCX) and its sister organization, the European Climate Exchange (ECX). During the Earth Summit at Rio in 1992, we presented a paper on a framework for a global emissions trading system at a "side show". The venue was a tent on one of the beautiful beaches in Rio. The idea was received with scepticism. It was simply too early for many of us. Following Rio, we worked tirelessly advocating a carbon market. We attended Kyoto and witnessed the last minute negotiations that led to the inclusion of flexible mechanisms into the Kyoto Protocol. During the 1990s we structured several transactions, including securitizing the carbon stored in a rainforest in Costa Rica or using a forward contract to assist in the regeneration of forests lost to fires on the lands of the Salish and Kootenai Tribe of Montana. We also shared with the public our suggestions for a "simplified" Clean Development Mechanism at the COP meeting Buenos Aires in 1998.

In the late 1990s we were approached by a leading Chicago-based foundation called the Joyce Foundation. The foundation was interested in funding a study on the feasibility of a regional trading system that could serve as a global model. Joyce funded the initial CCX design and implementation. This was the seed of CCX we see today. Trading and CCX were presented to the world at the 6th Conference of the Parties at The Hague in 2000. Through a consensus building process, we got some of the leading companies in the world to agree to an emission reduction commitment that was legally binding through a private contract.

Today CCX is active in the European ETS through ECX, a fully owned subsidiary of CCX. ECX offered the first quoted and cleared product for European carbon, with financially guaranteed contracts by LCH.Clearnet. ECX began trading futures on the International Petroleum Exchange in April 2005, believing its product was a natural for the energy market. The first day it traded 108,000 tonnes. Ten weeks later that figure hit a million in a day. Within four months it established itself as the leading exchange-traded product in the field, with a volume of more than 24 million metric tons CO2. With average daily volumes above 270,000 metric tons of CO2, and accounting for more than half of the market share among active exchanges, ECX futures have become the premier products for trading carbon in Europe. Some of the IPE Members active in ECX futures include most of the leading European and US Banks and some of the world's most prestigious industrials concerns.

In the United States, CCX administers the only fully integrated multisectoral, rule-based greenhouse gas emission registry, reduction and trading system that also employs independent verification, and includes all six greenhouse gases. CCX is the world's first and U.S.'s only system for GHG emissions trading, and the only legally binding framework in operation in North America. Since trading began in December 2003, total volumes have exceeded 2.8 million metric tons. Baseline emissions of CCX members (250 million metric tons) currently account for roughly 8% of U.S. major stationary source emissions. A unique feature of the CCX program is its recognition of the wide range of avenues available for mitigating GHG including on-site emission reductions, allowance trading, and use of a limited range of verified and tradable offset projects. These offsets include agricultural soil carbon sequestration, forest carbon sequestration, and landfill methane combustion. In addition, the program helps build north-south linkages by allowing participation from projects in Brazil and Mexico. Membership in CCX exceeds 100 diverse members from such corporate names as Ford, Motorola, American Electric Power, International Paper, Stora Enso to universities such as Tufts and University of Minnesota, to cities such as Portland, to farmers in Iowa and Nebraska.

The mandatory market in Europe has also spawned a voluntary market for organizations that fall outside the Kyoto Protocol requirements, where ECX has benefitted from the existence of CCX in North America. Drawing on CCX's experience in securing voluntary emissions reductions, albeit legally binding, ECX Associate Membership Ltd has engaged with many of the major UK and European businesses in advising them on, and implementing, emissions reduction programmes. In UK, from 1st April 2005, all publicly listed companies must, by law, issue an Operating and Financial Review (OFR) that addresses environmental matters that may affect their long-term value to stakeholders.

From Rio to Buenos Aires, passing through Kyoto and The Hague, we finally arrive in the beautiful city of Montreal. The contours of a truly global marketplace for emissions are beginning to emerge. CCX's role has been to get started, while building institutions for the future and informing the public debate. We are proud of progress to date and believe all Montreal attendees should be congratulated and thanked for their years of hard work and dedication.

For more information: rmarques@theccx.com