Financials Threaten To Undermine the Functioning of Emissions Markets

Abstract

The participation of financial actors is a key design issue in all emissions allowance markets. While financials perform several necessary market functions, excessive speculation may undermine market functioning. The potential for harm is gaining prominence as tighter emissions limits increasingly attract speculators and investors into allowance markets worldwide. However, adequate warning systems and tools to appraise the beneficial and detrimental facets of financial trading are wanting. We develop the first elements of a diagnostic toolbox to assess the scale and impacts of speculation and apply it to the EU emissions trading system. Our work is a first step towards informing current policy debates and invites further research to establish speculation-monitoring systems for allowance markets.