Carbon Credit Watch

Coming soon to a carbon market near you: regulation and corruption

Brady Yauch
Probe International
April 27, 2010

When regulators created Europe’s carbon market, it appears that regulating it wasn’t at the top of their agenda. But now, after several scandals have helped to bring the carbon market to a standstill and highlight its susceptibility to fraud, one of the carbon market’s biggest players—Barclays Capital—says it’s time for better regulation [PDF].

According to Reuters, Trevor Sikorski, head of carbon research at BarCap says, “ more robust regulation of registry accounts and regulation of the spot market would erode access to market to all but the most sophisticated of these participants (fraudsters).”

Sikorski advocates classifying all carbon permits as a financial instrument—a suggestion that is one among a number of options currently being considered by the European Commission.

Classifying carbon as an asset, says Reuters, would make the practice of layering carbon transactions through other, non-regulated, but legitimate businesses, harder.

“This is our preferred option because it brings the spot market into a more comprehensive regulatory framework without having to reinvent a new set of regulations,” Sikorski said.

To date, opening an account at a national emissions registry in order to trade spot carbon has been frighteningly easy —in some cases requiring just two telephone numbers and a company registration number. Sikorski believes a due diligence check on people who want to open an account is one way to bring further regulation to the market.

Barclays’ interest in better regulation in the carbon market is well justified. According to the bank, it has already traded more than one billion tonnes of carbon credits—worth more than $40-billion. Currently, it is the largest liquidity provider in the carbon market [PDF] .

The bank’s call for better regulation in the carbon market comes after a string of embarrassing scandals.

In March, Europe’s carbon market was brought to its knees, after “used” or “spent” carbon credits from Hungary were resold and eventually found their way back onto the market, casting doubt on the authenticity of all credits.

Last December, Europol estimated that, up to 90% of the carbon market volume was caused by value-added tax fraud—resulting in losses of approximately 5-billion euros in tax revenues for several EU countries.

Then, in February, regulators unearthed a phishing scam, which involved online fraudsters targeting the carbon market in order to steal emissions and sell them illegally.

But Probe International economist Patricia Adams, says that while BarCap’s suggestions for tighter regulation might make it harder for fraud artists and thieves to scam carbon markets, it won’t address the biggest problem of all—that it is impossible to ensure that each and every carbon credit traded has truly reduced CO2.

Ultimately, CO2 is a commodity with no inherent value, says Adams, who monitors international finance. Most transactions involving carbon permits involve parties that have no interest in the CO2 — the value lies in the permit. If no CO2 is actually offset, neither buyer nor seller would suffer a loss. The only incentive anyone has in dealing with this intangible commodity is in avoiding fines or suffering bad PR.

But given the sheer number of credits out there, and the impossibility of confirming that every windmill contracted for in faraway lands was indeed built, that every meter measuring the flow of gas piped underground was recording CO2 and not air, and that every seedling committed to be planted was planted (and was sold as a credit only once), in practice, there will be no way to ensure the authenticity of carbon credits.

“No matter how large the army of regulators to check up on the carbon credit providers,” says Probe’s Adams, “it will never be large enough to ensure integrity in the market.”

Even if enough regulators could be appointed, she adds “the regulators themselves would become too numerous to regulate.” In the final analysis, she adds, “carbon markets are political constructs controlled by politically empowered regulators who will be gatekeepers to a multi-trillion dollar market. This then becomes the tried and true recipe for good old fashioned and widespread corruption.”

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