Subprime Carbon?

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As policymakers debate Wall Street reform, there is little attention being paid to whether new regulations will be adequate to govern carbon trading and the carbon derivatives markets, which many experts believe could become larger than credit derivatives markets.

Most proposed climate bills rely on cap-and-trade systems to achieve greenhouse gas reductions, and the Obama administration also prefers this approach. But these bills do not seek to regulate carbon trading as a massive new derivatives market, which is, in fact, what it is.

This new report finds that existing financial regulations, as well as those in major cap-and-trade bills, are inadequate to govern carbon trading, creating a potentially huge regulatory gap.

It also outlines how lessons from the current financial crisis apply to carbon markets. In particular, it raises concerns about “subprime carbon,” risky carbon credits based on uncompleted offset projects (projects designed to sequester or reduce greenhouse gases).

Subprime carbon credits may ultimately fail to reduce greenhouse gases and, like subprime mortgages, could collapse in value, yet they are already being securitized and resold in secondary markets. The report recommends that lawmakers include carbon trading in current debates about financial reform, and warns against hastily creating carbon markets without proper oversight.