Abstract: In this paper, the author discusses the role of carbon emissions futures in complementing the carbon market and promoting green transition, i.e., providing effective pricing and risk management tools, optimizing resource allocation, and expanding the scope and the size of the carbon market. Moreover, she notes that an effective carbon emissions futures market builds on the following requirements: sound market system, good market participation, strict regulatory mechanism as well as highly motivated and capable market entities.
At the UN General Assembly last September, Chinese President Xi Jinping announced that China would peak its carbon emission by 2030 and achieve carbon neutrality by 2060. The 30/60 goal is the inherent requirement for China to realize sustainable high-quality development and the right choice to help build a community with a shared future for humanity.
To achieve this goal, it is critical to establish a national carbon market with effective prices, sound operation, and active linkages between spot and futures markets. The Guangzhou Futures Exchange, as a national trading platform for futures, will put efforts into establishing a market for carbon emissions futures, play its due role in product pricing, risk management and resource allocation, guide the optimization of industrial and energy structures, so as to help achieve the goal of carbon peak and neutrality.
I. Carbon emissions futures can help cut emissions through price discovery, providing risk management tools, optimizing resource allocation and expanding the scope and the size of the carbon market.
The carbon emissions futures market is a complement to the carbon market and can play a unique role in the transition towards green development.
First, it can provide effective pricing. As a complement to the spot market, the futures market will help deepen marketization of the carbon trading system through methods like transaction matching and central counterparty clearing; it will also mitigate information asymmetry and improve the acceptability of the carbon market by providing continuous, open, transparent, efficient and authoritative future prices.
Second, it can provide risk management tools. The futures market can provide businesses who need to control emissions with risk management tools to cope with the volatility of carbon price, reduce their operating pressure arising from price changes, and motivate businesses to cut obsolete capacity and push forward the green transition. Meanwhile, as the carbon price is closely related to energy, climate, and economic restructuring, companies in other sectors also face carbon risk exposure. These companies can utilize carbon futures to manage risks by locking in carbon costs well in advance while adopting energy-saving technologies or making arrangement for allowance transactions.
Third, it can enable the market to play a decisive role in resource allocation and allow the government to better play its part. On the one hand, introducing the futures market can bring benefits for companies who apply energy-saving technologies and voluntarily develop emissions-reduction projects, which could replace part of the fiscal subsidiaries, provide market-based incentives, pool public and private capital into renewable energy, green manufacturing and other low-carbon industries to facilitate low-carbon transition. On the other hand, government agencies can use future prices formed on the market to optimize low-carbon policies and enhance the soundness of macro regulation.
Fourth, it can expand the scope and size of the carbon market. Carbon emission futures allow investors to hold futures contracts instead of the physical goods who can roll over the contracts to achieve long-term investment in the carbon market. This helps meet the demand of social capital for carbon asset allocation and transactions without intervening in businesses’ use of emissions rights, while also providing room for other financial products like carbon securities, carbon funds and carbon options to develop.
II. A sound legal framework, extensive market participation and strict regulation are the prerequisites for launching the carbon emissions futures market.
Carbon emissions rights already have some of the basic attributes of futures such as highly standardized form and future demand arising from the time lag between allowance distribution and contract delivery. However, successful launch of carbon emissions futures also requires systemic thinking and planning, and auxiliary systems and mechanisms need to be put in place to create positive synergy.
First, a comprehensive carbon trading system should be established including mechanisms such as caps on emissions, allowance distribution monitoring and inspection of carbon emissions, contract delivery and information disclosure, which will lay a solid foundation for futures trading. For example, the emission cap and its annual change will affect businesses’ hedging plan; the difference between the amount of allowances held by businesses and their actual emissions will influence the settlement amount of futures; methods of allowance registration and contract payment will determine how the futures contracts will be delivered; and the delivery dates will impact the choice of the delivery month.
Second, we should expand the demand for the carbon market and have more players participate so as to give better play to the futures market. The emissions trading system should include more energy-intensive sectors, heavy emitters and businesses with emission reduction obligations, increase market liquidity, and enable better exchange of information and more effective pricing. Meanwhile, the types of products available for spot and futures trading should be diversified to satisfy businesses’ real needs and help them cut emissions with low costs or gain profits.
Third, a sound regulatory framework on carbon trading should be established to ensure the stable and healthy development of the futures market. As the regulator of futures trading, the China Securities Regulatory Commission (CSRC) has considerable experience in building futures markets, laying the foundation for the robust development of the carbon futures market. A regulatory framework made up of the CSRC and its local offices, futures exchanges, the China Futures Market Monitoring Center (CFMMC) and the China Futures Association (CFA) will work together to regulate the whole life cycle of carbon futures trading with the exchanges acting as the frontline regulator. In addition to regulatory risk management mechanisms like the margin requirement, price limit, position limit and large trader reporting, China has some unique systems like “penetrating” regulation, “one account, one trading code”, forced position reduction, forced position closing which will also help ensure the stable operation of the carbon futures market.
China is set to launch it national carbon market soon. Whether the above-mentioned requirements are met should be further examined. At present, the Guangzhou Futures Exchange, guided by the CSRC, is steadily pushing forward study on carbon emissions futures. Going forward, the Exchange will continue to monitor the operation of the spot market and development of related systems, communicate with businesses and conduct in-depth research to design futures contracts that meet the needs of the spot market. The futures market will be launched when conditions permit.
III. Actively develop market entities, and improve market players’ knowledge, understanding and ability to utilize financial instruments.
The core value of the market lies in “transactions” among market participants. Therefore, we should not only build an effective market, but also work to develop market entities.
First, we should improve the policy environment for businesses to participate in the carbon futures market. At present, the power sector can trade in the market. Although allowances for this sector have reached a considerable scale, businesses still lack motivation, transactions are not active and the pricing inefficient. To solve this problem, all relevant departments should work together and fully understand the unique role of carbon futures in price setting and risk management, remove institutional obstacles that hinder business participation, encourage and guide related sectors and enterprises to participate in the market, enhance their motivation so that the market can better play its role in carbon resource allocation.
Second, the Guangzhou Futures Exchange should leverage its expertise in fostering market development and encourage market entities to participate in capacity building. The Guangzhou Futures Exchange should step up its training efforts, guide businesses to apply their experience in other futures markets to the carbon futures market, encourage them to enhance study on carbon trading and related financial instruments, and increase their awareness and ability to utilize such instruments. Such training will help market players better understand carbon trading and learn to participate in the market.
Third, we should guide businesses to establish a comprehensive risk management system to help them participate in the carbon futures market. Such a system needs to meet their own operating needs, cover the entire transaction process, specify the principles, systems and processes of futures trading by clarifying the compliance responsibility, upholding the principles of hedging, effectively controlling risks, standardizing operations, strengthening supervision and inspection, and setting up a reporting system.
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