Carbon markets: Are firms prepared for an influx of regulatory scrutiny?

Market conditions, driven by rising prices and volatility, have led to an uptick in speculative trading activity within the European Union Emissions Trading Scheme (EU ETS), raising concerns over possible market manipulation.

Earlier this year, the European Securities and Markets Authority (ESMA) released findings from its review into the EU carbon markets. The report suggested that no instances of market manipulation were found, but this was heavily caveated by data and market transparency limitations.

ESMA’s headline message was a reminder that “emission allowances are financial instruments and subject, together with any derivative therefore, to the full set of Market Abuse Regulation provisions”. A number of policy recommendations were made to increase market transparency and monitoring, including the introduction of position limits on carbon derivatives and centralised market monitoring of the carbon market at EU level, in line with existing monitoring for gas and power markets.

We have gauged the market’s reaction to ESMA’s findings and summarised recommendations for firms to consider below.

What is the market’s response?

Across the market, we have seen a general consensus with a number of ESMA’s findings. In particular, the difficulties encountered in identifying counterparties and the significant increase in High Frequency Trading (HFT) activity. Firms are increasingly telling us that they are having to rely on technology solutions to spread positions across the market and reduce exposure to HFT arbitrage. While arbitrage in its own right does not constitute market abuse, there is a growing scepticism across the market with regards to ESMA’s conclusion that the markets are not subject to potential market abuse.

Another theme that emerged was the lack of monitoring of carbon markets to date. While carbon markets have been subject to less regulatory scrutiny, there has been a growing sentiment that this will soon change, which is now reflected by a number of ESMA’s recommendations. Despite this expectation, we’ve seen a wide range in sophistication levels of market abuse systems and controls across the market and, as regulation grows increasingly stringent, it is clear that many firms may have more to do to mitigate their regulatory risk and ensure they are not advertently or inadvertently committing market abuse.

What does this mean for firms?

The report found no explicit market abuse, but the inference was clear - firms need to be alert. Regulatory supervision of carbon markets will continue to increase, and firms should be prepared to have their surveillance and monitoring activities subjected to the same degree of scrutiny as their wider trading activities. Collectively, firms across the sector will need to make significant steps towards achieving the level of transparency and surveillance expected by the regulator, primarily in ensuring that technology solutions and the associated processes and controls are in place including automated trade and communication surveillance to adequately supervise their trading activities.

To find out more about how we can help you in this space, please contact a member of the team below.

Contact us

Tom Bullock

Tom Bullock

Director, ESG Specialist, PwC United Kingdom

Tel: +44 (0)7701 297359

David Parker

David Parker

Manager, PwC United Kingdom

Tel: +44 (0)7808 798791

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