Global Carbon Trading Activity Spurs Revenue Opportunities for Broker Dealers

Needham, MA - 11 March 2008

As sell-side margins on trading desks compress, broker-dealers need to look for new, high margin products. New research from TowerGroup finds that carbon will be one of those products.

In providing a framework to reduce the global level of carbon emissions and combat global warming, the Kyoto Protocol opened the door to a new way for trading desks to make money. Carbon emissions trading, led by such cap-and-trade systems as the European Union Emissions Trading Scheme (EU ETS), are relatively new. But the battle against global warming is just beginning. TowerGroup believes it is essential for broker-dealers to recognize that this market offers opportunities not just to trade carbon credits, but also to structure complex risk-mitigation strategies for carbon compliance.

“The carbon trading movement is compelling because it satisfies the desire to reduce greenhouse gases while also affording revenue-generating opportunities,” said Stephen Bruel, an analyst in the Securities & Capital Markets research service at TowerGroup. “However, success will be determined by a broker-dealer’s ability to structure a solution that mitigates the cost of complying with regulation for reducing carbon emissions. The true winners will be those who take in to account a client’s future emissions, comply with regulation across a variety of borders, and understand the available offset vehicles.”

The carbon trading market is an artificial market constructed by governments and bureaucracies and in theory can be eliminated by those same forces at anytime. However, TowerGroup believes that government support will ensure its longevity.

Currently, between 70 and 80 percent of all carbon emissions transactions are conducted over the counter (OTC). But as products become standardized and exchanges expand their offerings, TowerGroup expects trading to become more exchange-based. As more countries adopt cap-and-trade systems, market expansion will result in a push towards product “harmonization” to facilitate cross-border transactions, an overall shift in the products used to offset emissions, and more exchange activity.

“Although carbon emission trading is currently focused in Europe and is still years from full maturity, TowerGroup believes that no broker-dealer can ignore the potential of this market,” added Bruel. “Despite the current absence of such major players as the United States and Australia, we believe it is possible for the beginnings of a global system to be implemented over the next five to seven years. Broker-dealers should not delay the building of a carbon trading desk.”

The new research, titled “Carbon Credit Market: Rising as Fast as the Sea Level?,” explores the impact of carbon trading on broker-dealers and defines the steps that they must take to gain a foothold in this increasingly important commodity

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