ESMA finds 'no major deficiencies' in EU carbon market

Financial watchdog the European Securities and Markets Authority has issued its final report on the EU Emissions Trading System, finding no major problems in the functioning of the market after some participants had warned of excessive speculation.

The group, however, did make recommendations to enhance market monitoring, including extending position management controls on carbon allowance derivatives contracts.

"The report's analysis did not find any current major deficiencies in the functioning of the EU carbon market based on the data available," ESMA said in a statement March 28. "However, ESMA's analysis of the market has led it to put forward a number of policy recommendations to improve market transparency and monitoring."

ESMA's report presented an in-depth analysis of the trading of emissions allowances and related derivative contracts based on data gathered from various sources, including the European Market Infrastructure Regulation, the Markets in Financial Instruments Regulation, and the Markets in Financial Instruments Directive.

The group found that non-financial entities mainly held long positions in carbon derivatives for hedging purposes. These entities were CO2-emitting companies that under law are required to surrender allowances to cover their emissions each year.

Short positions are mainly held by banks and investment firms, providing liquidity and carbon financing, the ESMA said.

"Positions by investment funds remain limited, with positions principally held by third-country funds; and the share of high-frequency and algorithmic trading is significant in the carbon market, even if the relevant firms are only holding very small or no actual positions," it said.

Ukraine conflict hits prices

The ESMA said it was aware that the war in Ukraine has had a major effect on the carbon market, with prices of EU Allowances declining 30% between Feb. 23 and March 4, which was the cut-off date for its analysis.

"ESMA notes that the carbon price by March 22 had recovered but appreciates that the situation remains volatile," it said.

EU Allowance contracts for December 2022 delivery fell to Eur58.19/mtCO2e ($63.72/mt) at the close March 7, from an all-time high of Eur96.33/mt Feb. 7, according to S&P Global Commodity Insights data.

The prices crashed following Russia's military invasion of Ukraine that began Feb. 24. The prices have since rebounded to Eur78.61/mtCO2e at the close March 25, S&P Global data showed, and were trading as high as Eur81.99/mt intraday March 28 on the Intercontinental Exchange Endex.

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ESMA recommends greater transparency

The ESMA put forward several policy recommendations on market transparency and monitoring from a securities regulators' perspective, despite finding no evidence of major deficiencies in the EU carbon market.

The recommendations include extending management controls on EU Allowance derivatives, amending EU Allowance position reporting, tracking the chain of transactions in Market in Financial Instruments Regulation reports, and providing the ESMA with access to primary market transactions.

"The measures proposed would provide more information to market participants, regulators and the public and are intended to contribute to the continued smooth functioning of the market, which plays an important role for the EU's transition to a low-carbon economy," the ESMA said.

The group identified two possible courses of actions that the European Commission could consider regarding the introduction of position limits on carbon derivatives and a centralized monitoring of the carbon market at EU level, in line with the ACER-style monitoring of the gas and power markets, it said, referring to the EU Agency for the Cooperation of Energy Regulators.

The report provides a "factual and comprehensive basis" for the EC, the Council of the EU, and the European Parliament to determine whether additional measures to regulate the carbon market are necessary, the ESMA said, adding that it stands ready to provide required data or advice in support of that process.

Lawmaker urges market reforms

EU lawmaker and rapporteur on the EU ETS reforms Peter Liese said the ESMA's report shows that radical reforms of the market are not required, but that some actions are needed.

"It is important to let the market work and also to enable companies, especially SMEs [small and medium-sized enterprises], to get help from financial actors to manage their obligations," he said in a statement March 28.

The report highlights the need for "concrete action", Liese said, urging the EC to propose changes, including a more effective price regulation mechanism -- a measure he has already called for.

Liese, environment spokesperson for the center-right European People's Party in the EU Parliament, has proposed stronger rules under Article 29a that seeks to avoid excessive and sustained carbon price spikes by allowing the regulator to bring forward carbon auction supplies.

"Although the ETS price represents only a small fraction of the currently extremely high energy prices, these high prices and the dependency on Russian energy imports urge us to find efficient and impactful solutions to keep the prices under control and enable companies to survive even if they have to use coal temporarily," Liese said.

Liese called for a delay in the payments that companies need to make under the EU ETS to provide more time for purchasing allowances beyond the April 30 annual deadline.