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Insight Conversation: Dr. Richard Sandor, American Financial Exchange

  • Featuring
  • Ivy Yin
  • Commodity
  • Electric Power Energy Transition
  • Topic
  • Energy Transition Environment and Sustainability

Global carbon markets are evolving rapidly as more countries recognize the need to put a price on carbon and market intermediaries develop trading infrastructure from auction platforms to financial products. Richard L. Sandor, chairman and CEO of the American Financial Exchange, was one of the earliest proponents of environmental products. He was named by TIME magazine in 2007 as one of its "Heroes of the Environment" for his work as the "Father of Carbon Trading."

Sandor, who was awarded the title of Chevalier dans la Legion d'Honneur (Knight of the Legion of Honor) in France in 2013, for his accomplishments in the field of environmental finance and carbon trading, has also been deeply involved in developing the framework of carbon exchanges in China, such as the incubation of Tianjin Climate Exchange, one of China's earliest pilot climate exchanges.

Sandor spoke with S&P Global Commodity Insights Energy Transition and Carbon Specialist Ivy Yuwei Yin about the evolution of carbon markets, the role of environmental finance in decarbonization and why capital markets are key to financing the net-zero goals of corporations and countries alike.

Insight Conversation: Richrad Sandor

How far is the world today from the goal of using emissions trading to fight climate change?

I think that we've made enormous progress. The first really active, wide-scale use of emissions trading as a tool to combat pollution was with the acid rain program in the US – The Clean Air Act of 1990. That should be viewed as the baseline. It is important to note that our company participated in the first trades. The Acid Rain program turned out to be the most successful environmental program in history, and even in the first part, it cost about $3 billion a year and generated $120 billion in reductions in medical costs right at the outset. And it resulted in people realizing that emissions trading can play a role in climate change.

Emissions trading was started in 1992 at the Earth Summit in Rio de Janeiro, Brazil, and with Kyoto Protocol signed in 1997 it became a policy that the UN adopted and put it in a broad framework. In the 25-year period from 1997 to now, it has made an incredible amount of progress, and it's something that I think most people do not realize.

It has made progress in spite of the fact that we've had four events that are supposed to occur every hundred years – September 11 in 2001, the Great Recession of 2007, the COVID pandemic in 2019 and now a war in Europe in 2022. Despite that we have had significant growth in environmental markets, Europe has achieved mass reductions in GHG emissions, there are 20 active environmental markets in the US and the open interest is almost the same size as gold. And finally, you've got a nascent market in (South) Korea and India and the biggest carbon market in the world, China, that recently celebrated its first anniversary. I feel very optimistic.

Where have we gone wrong and what are we doing right?

In my experience, I would say it takes a couple of generations to exercise massive economic change. Take for example, derivatives, which are financial futures that I started working on in 1969. They took a generation or two to have full adoption. We don't realize that the personal computer was not immediately adopted when it came out in 1975. Even for blockchain, the underpinnings began at Princeton in 1990. So that's already 32 years old. It'll probably hit its stride in 2030. Given the landmarks, I feel that, between now and 2030, we're going to see enormous changes and continued growth.

In the case of China, it is not "all of a sudden there's a market." Markets don't occur like spontaneous combustion. You have to look for structural changes, identification of property rights, build the exchanges, start trading, and then you have to develop a derivatives market. And for all those cases, you have to educate regulators, legislators, the press, accountants, lawyers, traders, and corporate executives. So, this is a generation process. Again, I'm very excited for the next seven to eight years, which I think will bring enormous changes.

I think it's a bad idea to go short on the inventive ability of the Asia-Pacific region to modify and to learn. I have enormous faith in humankind's ability to learn and grow.

Do you think carbon can really be traded as a commodity? Is it the right time?

It's not the market of the future. It's here right now. Carbon is standardized, widely traded, very big to European markets. And it's here in California. Widely accepted, widely used, and liquid.

The time wasn't right when the Wright brothers invented the airplane, or for Japanese or American automobile companies to do electric vehicles. The time is never right for change for those who are not flexible. The change must be embraced by the young, intellectual and entrepreneurial people who are trendsetters.

We set up a carbon exchange in Tianjin in 2007. Everybody said the time wasn't right. And they said the city wasn't right. I drove to Tianjin in 2006 from Beijing. It was a two-lane road, and it took me 3 hours. Right before the Olympics, it was 32 minutes by bullet train.

So 'the time isn't right' reflects a total misunderstanding of Chinese culture. These policies are well-thought out. When they decide to move, it's with great speed and great intensity. So right now, the building blocks are all there at once. China has seven pilot markets. They started a national market – it's still carbon intensity-based. I might be slow at first, but that's like saying the first airplane should look like a 747. The important thing is that the financial innovations are no different than industrial innovations. They take 20 or 30 years.

How do you view the role of speculative capital or volatility in climate or carbon markets?

No different than anything else. The same arguments came up in 1975. They said, how do you know that anybody trades grain or wheat could ever trade interest rates? And if they do, how could they control the market? They were wrong about nobody trading it. And then they were wrong about too little market making. And then they were wrong about too much market making. So, everything that I've heard about every other market that I've developed in every country around the world – first, it goes through a stage that you'll never get any market makers or speculators, and then you get the argument you're going to get too many.

New products like tokenized carbon and blockchain integrated carbon products have appeared, and raised eyebrows in the industry. What's your view on these developments?

It's very important to recognize that in any transformational change, there are going to be many failures and some successes. Everybody in the market needs choices, and the bad ones will not succeed. I think a free market for ideas and a free market for new products are very important. Nobody knows who the winners are going to be. But you should learn something from those that fail.

What is the role of legislation and regulation in carbon markets and how it evolves?

Like the cotton market in the 19th century – you had the markets in Mumbai, Switzerland, Liverpool, New Orleans. You had different grades and types. Arbitrage occurred. I think what we will have in the world is a plurilateral trading regime, and there will be separate markets with separate standards, much like the cotton market. And they ultimately will be tied together by arbitrage.

China should have a market designed by Chinese for Chinese needs. A market in North America should be developed in California by Californian people for the will of Californians. The Europeans should have a market with separate country goals, have a net goal and allow each country some flexibilities.

Markets that are designed with the needs of local social and economic goals should emerge around the world. A grand plan for one worldwide market is neither realistic nor practical. These markets will be integrated ultimately after they are developed to meet the needs of their local constituents.

You often speak about the Environmental Kuznets Curve, according to which economic growth initially damages the environment but after the standard of living improves, people seek to repair the damage. Does carbon pricing reflect this?

Yes, eventually. The Kuznets curve explains why it comes and goes. As wealth goes down, environmental objectives take a lower place because of the economic well-being. And when you get over the crisis, it surges. And when you get another crisis, it falls. But it is in the meantime a continuous uptrend with ups and downs.

I believe that unambiguously for carbon trading, if you look at volumes and adoption, it is a long-term secular trend. I believe it will happen in the three largest economies in the world, and it is happening – in Europe, the US and China.

What is your view of the carbon border adjustment mechanism and global carbon taxes?

I think that lots of these things are very important, but not really critical for the objectives. Napoleon called in some generals when they didn't achieve their military goals, and he said to them, when I told you that take Vienna, I meant take Vienna. I didn't mean anything else. The goal is to reduce carbon. It's not to punish polluters. It's not their border adjustments. The big picture is to reduce carbon. People get confused.

It's a great difficulty as a practitioner because they want to attach 20 minor ideas onto a major idea. Like Voltaire said, they let the perfect be the enemy of the good. This is the danger that lots of people don't realize – the goal is very simple: to reduce CO2 emissions. Everything else is secondary to that goal.

When I was in meetings in Washington, I said, here's a mechanism. It's efficient. It's going to save the environment. And somebody said, well, but you're letting the utilities or the oil companies make some money, and I don't want these bad people to have any successes. I said, well, we're here to save the world. It's not an ethics class.

Do you think the carbon market is the best instrument to cut emissions, versus subsidies or taxes?

It is simply the most cost-effective way of doing it. And it doesn't have to be exclusive. If you want to stop climate change, you put a cap on emissions. You may want to put subsidies. You may want to have a tax.

You may want to do 30 other things, but the goal is to cap and reduce emissions. Ultimately you need an absolute cap.

The important thing is to be flexible with public policy and the implementation to achieve these social and environmental goals, and to build institutional capabilities. A carbon intensity cap forces you to build the foundation for creating a homogeneous commodity and effectively monitoring and verifying the emissions.