Via RFF Library Blog.
Brookings Institution / by Craig Pirrong
http://www.brookings.edu/papers/2009/09_cap_and_trade_market_oversight_pirrong.aspx[From introduction] The original concept of cap-and-trade envisioned that the total amount of carbon dioxide (CO2) emissions would be capped and rights to emit would be traded. But it is inevitable that there will be demand to trade instruments other than emissions rights themselves. Specifically, there will be a demand to trade derivatives on emissions rights…
the current regulatory environment is extraordinarily hostile to derivatives generally, and to carbon derivatives particularly. Indeed, several proposals have been introduced to constrain or eliminate various types of derivatives trading, including proposals to:
- Impose limits (e.g., speculative limits) on the uses of these products, or on the amount of trading certain kinds of entities can undertake;
- Restrict where and how derivatives are traded, with a decided preference for trading on organized exchanges;
- Constrain arrangements for the allocation of performance risk, with a decided preference for “clearing” derivatives transactions through central counterparties (“CCPs”);
- Ban certain derivatives altogether.
The American Clean Energy and Securities Act (ACESA), passed by the US House of Representatives in June, includes provisions mandating many of these restrictions.
All of these proposals are misguided, some extremely so. They are predicated on a widespread misunderstanding of what derivatives are, how they work, and the reasons that firms trade them…In this chapter I will support them by going back to basics, describing what derivatives are, why they are used, how they are traded, the abuses they are subject to, and the most efficient ways to constrain those abuses.
