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Incentives and transparency needed for carbon market, says CFTC chairman

Working with corporates and market participants, the CFTC hopes to create futures and derivative markets that will incentivise carbon offset and climate change mitigation, said Rostin Behnam, acting Chairman of the CFTC, while speaking at the Institute of International Finance’s (IIF) US Climate Finance Summit.

“What the CFTC can do and how we can utilise our skills, data and expertise in commodity markets, clearing, market structures, settlement, post trade processes and data collection is to create incentives or to help markets develop around carbon and carbon offsets,” he said.

“There is a large group of economic stakeholders and participants who agree that a price on carbon will help support the transition.”

A report published in September by the CFTC’s Market Risk Advisory Committee (MRAC) put forth 53 recommendations to manage climate risk, with the first among them the implementation of carbon pricing. The report received unanimous support from all MRAC committee members.

“As long as carbon remains a negative externality. More specifically, a danger to our environment, human health and other things. If we're not pricing this in, we're not going to move away from carbon emissions as quickly as we need to,” said Behnam.

Green incentives

With one of Joe Biden’s first orders as president putting the US back into the Paris Climate Agreement, there is renewed vigor to expand carbon markets.

“It's all about incentives, it's all about creating incentives for financial markets,” Behnam said.

“In order to meet Paris goals and other targets, given the advancements and the challenges we're facing in the climate space. We're going to need to go quicker and that's why a price on carbon will create incentives for financial markets and allow participants to allocate capital in different directions such that the transition will be smoother and quicker.”

For climate financing, the private sector has not waited on the government, with the CME Group set to launch futures contracts in voluntary global emissions offsets on March 1.

What regulators like the CFTC can do is keep the market transparent and creditable, said Behnam.

“What we need to do as a regulator is to create a functional, transparent and credible market. I think that's going to be one of the biggest challenges for the carbon offset market.

“There's a role for the public sector to at least help support the development and create a credible transparent market so that we can support the huge and growing demand to be net zero or even net negative by corporates.”

Derivatives play a key role

Financial instruments like derivatives will be key in getting corporates accustomed to ESG and sustainable finance products.

“Derivatives, allow asset owners and investors, institutional or otherwise, to get exposure to an ESG product through a futures contract,” said Behnam.

He added that the other aspect derivatives can help in is highlighting the risk management angle of climate financing – something some future’s contracts are already doing.

“[We’re] starting to see products to develop around sea level change around temperature change around water availability and water sourcing. These are the types of innovation and products I know derivatives market participants have been doing for many years and I think we're going to see the growth of this space as a risk management tool.”

As more financial institutions plan for climate change, the CFTC chairman, warned that planning for climate risks will not be as easy as traditional financial risk.

“It's not apples to apples with climate change, we certainly have to use the data and the history that we have to predict what might happen with climate change, but there's going to be a lot of uncertainties and there's going to be a lot of nonlinear sort of events that we could not have predicted.”