participants from making mutually benecial ar- rangements that reect their heterogeneous pref- erences and information. Moreover, mandated clearing will, in my view, actually exacerbate sys- temic risks because it ignores the incentive and information considerations that make bilateral management of performance risk more ecient under quite common circumstances. Since AC- ESA subjects carbon markets to the most restric- tive part of the entire regulatory scheme, it will constrain these markets most. In eect, ACESA will make it extremely costly to trade anything but the simplest, most plain vanilla derivatives that are suited for exchange trading.
is is harmful because vanilla derivatives are un-
suitable for managing many of the risks that those with carbon exposure face, as the earlier example of the power plant’s hedging needs illustrates. Most exchange-traded derivatives that will attract any liquidity will have relatively short maturi- ties—in months, at most.17 Moreover, the most liquid contracts will be “linear” instruments, like futures. at is, their payos will be linear func- tions of the price of carbon. Even those contracts with non-linear payos, like vanilla put and call options, will have (a) short maturities, and (b) a very limited set of possible payos.
But since as noted earlier many rms exposed to carbon price risk will face very long dated
exposures, and optimal risk management strat- egies would require the use of derivatives with non-linear derivatives (Froot, Scharfstein, and Stein, 1993). Raising the cost of managing these risks by forcing market participants to go through a cumbersome waiver process would force rms either to bear the higher cost, or live with the risk, which imposes costs of its own on investors. Moreover, raising the costs of managing risks is likely to raise the cost of nancing new capacity. Given the potential importance, and great uncer- tainty of carbon price risk over the life of a power plant or chemical renery, those nancing such facilities may prefer, and indeed require, that the borrower manage such risks. Raising the costs of managing these risks will impede investment.
In brief, by creating appreciable regulatory obsta- cles to the creation of the kinds of contracts that are best adapted to the needs of some users, AC- ESA will impede ecient management of carbon price risk. is will impose costs. Some invest- ments will be foregone. Moreover, risks that could be borne at a lower cost if shied via derivatives, will instead be borne by those who incur high costs, including costs of nancial distress. What’s more, no visible benet osets these costs. For in- stance, these contracts are not useful for carrying out a manipulation, so impeding their use will not advance the legitimate regulatory goal of dimin- ishing manipulation.
Even in those commodities in which exchanges list contracts with maturities going out years, trading activity is focused in the nearby con- tracts. For instance, on August 10, 2009 crude oil contracts were listed with maturities extending to December 2017, but well over 95 percent of trading volume was for contracts expiring in the next three months.
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