Jul 07 2009

Senators Feinstein and Snowe Introduce Measure to Establish Federal Oversight for New Carbon Markets

- Measure is designed to prevent Enron-like fraud and manipulation in all carbon markets -

Washington, DC – U.S. Senators Dianne Feinstein (D-Calif.) and Olympia Snowe (R-Maine) have introduced legislation to establish federal oversight for markets that trade carbon allowances, which are permits to emit one metric ton of carbon dioxide into the atmosphere. The bill also establishes a framework to regulate carbon derivatives. 

Carbon markets will be an integral part of a cap-and-trade system to reduce greenhouse gas emissions – and the Feinstein-Snowe bill is designed to prevent Enron-like fraud, manipulation and excessive speculation in the new federal, state and regional carbon markets that will be established by such a system. Full oversight authority for all carbon market trading is granted to the Commodity Futures Trading Commission (CFTC).

“Some experts predict that the new carbon markets could generate upwards of $100 billion to $370 billion in economic activity each year. That’s why it is so critical that we provide consistent federal oversight now – at the outset – to guard against fraud and manipulation in every federal, state or regional carbon trading market,” Senator Feinstein said. “We can’t afford to unleash another Western Energy Crisis and jeopardize the environmental goals of the cap-and-trade system.”

Senator Snowe said: “As critical as expeditiously moving on meaningful climate change action, we must not allow carbon trading to become a new unregulated market without transparency and federal oversight.  This legislation that Senator Feinstein and I have developed will clearly and firmly place regulatory powers at the Commodity Futures Trading Commission to prevent the market failures that we have recently witnessed in our derivative markets.  While legitimate hedging and trading is an intrinsic element of cap-and-trade legislation, market manipulation must not be associated with reductions in greenhouse gas reductions and as a result this measure must be a fundamental component of any climate change bill.”

Major Differences

The Feinstein-Snowe bill (S.1399) differs from the carbon market oversight provisions in the House-passed climate change bill in several key ways:

  • First, oversight authority. The Feinstein-Snowe bill grants full oversight authority for all carbon market trading to the Commodity Futures Trading Commission (CFTC), because carbon allowances and carbon derivatives will both be based on cash for paper transactions and will effectively function as a single market. In physical commodity markets, on the other hand, the cash market is based on transactions of cash for a quantity of energy (like oil or natural gas), metal or an agricultural product, and the derivatives market is based on transactions of cash for paper, in which delivery is very infrequent.
  • The House bill divides the oversight authority between two federal regulatory agencies:
    • Oversight of cash-based allowances trading is given to the Federal Energy Regulatory Commission (FERC), and 
    • Oversight of carbon futures and derivatives trading is given to the CFTC. 
    • It also establishes a new federal working group of other relevant agencies charged with studying how best to regulate the derivatives market.
  • Second, clearing allowances. The Feinstein-Snowe bill requires CFTC to establish a clearinghouse capable of clearing of carbon allowance transactions under long established regulatory principles, because private entities may not step forward to establish a clearinghouse for allowances.
    • The House bill permits FERC to establish standards for clearing carbon allowance trades, but does not provide principles by which such standards should be established. It also does not give FERC authority to establish a clearinghouse for allowances, in the event that no private entity steps forward to clear the allowance trades.
  • Third, bilateral swaps. The Feinstein-Snowe bill requires that standardized bilateral swaps are classified as regulated derivatives, and cannot be exempt from regulation.  
    • The House bill would treat carbon swaps under the same regulatory regime as agricultural commodities swaps, for which there is currently an active unregulated over-the-counter market today.  To regulate carbon swaps, CFTC may need to assert affirmatively that over-the-counter swaps are “contracts for future delivery.” 
  • Fourth, professional standards. The Feinstein-Snowe bill establishes clear professional standards for carbon traders, brokers, and dealers. 
    • The House bill does not include a similar requirement.
  • Fifth, electronic monitoring.  The Feinstein-Snowe bill establishes a centralized, electronic database to track all trades and positions across multiple marketplaces, assuring that the regulator has a full view of the marketplace in real time.
    • The House bill does not establish a similar database.
  • Finally, administrative changes at the CFTC. The Feinstein-Snowe bill establishes a new department within CFTC focused exclusively on carbon markets, in recognition of their unique character in comparison to other commodities markets.
    • The House bill does not include such a provision.

Senator Feinstein said, “We believe that our legislation establishes a clear and cohesive system for regulating this unique new commodity trading marketplace. Our goal is to try to get this measure accepted during markup of the Senate climate change bill.”

Bill Summary

The Feinstein-Snowe legislation would establish a comprehensive and transparent framework to regulate the trading of carbon allowances and standardized carbon derivatives at the Commodity Futures Trading Commission (CFTC). 

  • Carbon market trading would be transparent, cleared and electronically monitored. 
  • Requires all trading of carbon allowances and standardized allowance derivatives to occur through “registered carbon trading facilities” and to be cleared by CFTC regulated clearinghouses.
  • Requires “registered carbon trading facilities” to:
    • Create a “central limit order book” so that every trade is recorded in real time with the Commission.
    • Publish trading data on at least a daily basis.
    • Maintain records.
  • Manipulation, fraud, and excessive speculation would be prohibited, and violations would be severely punished. 
  • Requires “registered carbon trading facilities” to:
    • Monitor for manipulation, using electronic tools.
    • Establish and enforce rules to assure fair trading.
    • Enforce aggregate position limits.
    • Utilize emergency authority to force traders to reduce positions.
  • Grants CFTC the authority to bring cases, open investigations, and use subpoena power to protect the marketplace. 
  • Establishes professional standards for all registered carbon market traders, dealers, and brokers.
    • Traders cannot be felons, may not have been stripped of a financial license, must submit to a background check, must complete at least 20 hours of pre-registration education on trading ethics, rules and laws, and must pass a test approved by CFTC.

Finally, the bill grants CFTC the authority to collect trading fees to cover its oversight costs.

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