he creation of a market for carbon will result in the creation of a price for carbon. is, in turn, will impose carbon price risks on myriad rms and give rise to the demand to hedge these risks. Derivatives have proven amazingly power- ful tools to manage numerous risks, including commodity price risks like carbon. us, it is inevitable that the creation of a carbon market, through ACESA or some other mechanism, will create a demand for carbon derivatives. T
In the minds of many in Congress, this is some- thing to be feared, rather than embraced. ere is very deep suspicion in Congress of derivatives, and this suspicion is embodied in ACESA’s deriv- atives regulation provisions. e bill subjects car- bon derivatives to the most rigorous regulatory regime, requiring all carbon derivatives to be ex- change traded. ACESA also imposes draconian restrictions on other derivatives.
ese provisions reect the widespread belief that
derivatives were a major cause of the nancial cri- sis of 2008-2009 and the energy price spike of 2008.
is brings to mind Mark Twain’s quip that “It ain’t
what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t true.” Congres- sional animus—and hence, the derivatives provi- sions in ACESA—are based on a fundamental mis- understanding of derivatives in general, and their role in the ongoing nancial crisis in particular.
As a result of this misunderstanding, ACESA imposes restrictions that will greatly reduce the benets that market users will obtain from deriv- atives. ese restrictions will impair, and likely impair substantially, the ability of market par- ticipants exposed to carbon price risk to man- age that risk. Moreover, these restrictions will do little to combat real potential abuses of these products, such as market power manipulations. Furthermore, although many of the restrictions (e.g., clearing mandates) are justied as a means to reduce systemic risk, they can also contribute to systemic risk, and even ignoring that possibil- ity, impose unnecessary costs on market partici- pants.
Congress would play a more constructive role if it were to focus on legitimate market abuses, such as manipulation, and revitalize the ex post deter- rence that is the most ecient way to combat it. A series of misguided court and commission de- cisions have undermined ex post deterrence; in large part, blame for these misguided decisions rests with Congress and its failure to dene what constitutes an illegal manipulation with sucient precision to permit courts and regulatory agen- cies to deter it eciently. In trying to dra statutes so broad as to encompass every conceivable form of manipulative conduct, it has instead produced laws so vague and ambiguous that they argu- ably fail to reach any manipulative conduct with
C A p - A N d -T R A d E :
E f f I C I E N T LY R E G U L AT I N G T h E C A R b o N d E R I VAT I V E S M A R k E T