Subprime Carbon? Re-thinking the World's Largest New Derivatives Market

As U.S. policymakers debate ways to effectively reform Wall Street, little attention is being paid to how and whether new financial regulations will be adequate to govern the carbon derivatives markets, which many experts believe may eventually be larger than the credit derivatives market. Similarly, most federal climate change bills do not provide for adequate carbon market regulations, creating a potentially huge regulatory gap. Existing climate legislation fails to recognize that financial markets have become vastly more complex and exotic since the early 1990s, when the U.S. introduced sulfur-dioxide trading. In addition, such legislation does not focus enough on regulating the secondary carbon markets, which will be dominated by speculators and will dwarf the primary trading markets. The speculative nature of the secondary markets has the potential to create a carbon bubble and spur the development of subprime carbon. “Subprime carbon” credits are futures contracts to deliver carbon that carry a relatively high risk of not being fulfilled, and could collapse in value.