It is a recurring theme in this commentary that the success of a trading market depends on having robust and reliable post-trade processes. It is hard to imagine a clearer illustration of this principle than the crisis currently affecting the European carbon market.
Following a series of attempted and successful frauds on carbon registries across Europe (see list below), the European Commission announced yesterday that all carbon registries across Europe would be closed for at least a week, until 26 January, thus blocking all transfers of emission units. With settlement impossible, the two main spot markets have suspended trading (see the circular from ICE).
Thus, the spot market in carbon is stopped for a week because of security deficiencies at a small number of registries. We wrote in our report last July, “Any perception of irregularity in the operation of the market is widely reported and could bolster the arguments of those who believe that the use of market mechanisms to address climate change has no merit.” Sadly, this risk is increasing with the passage of time.
Ironically, the thieves have used one of the most successful features of the European carbon infrastructure – the ease with which units can be transferred cross-border – to make their getaway. Units stolen in one country can be almost instantaneously transferred to another and another country and finally sold to a bona fide buyer. Tracing the units takes time. Recovering them is even harder. Many countries have laws governing the recovery of stolen property, but these may come up against the question whether emission units are treated as “property” for the purpose of the law.
It seems to us at least four actions are needed to rebuild confidence in the market.
1. Urgently address the security weaknesses in some registries. The European Commission already has this in hand during the suspension.
2. Registries whose security is below acceptable standards should be isolated, so that if any units are stolen they do not get into wider circulation.
3. The legal and regulatory basis of the carbon market needs to be addressed. It is unlikely that financial regulators, accustomed to reviewing securities market infrastructure, for example, would have approved the security systems that have allowed frauds to take place. The European Commission have, indeed, published a Communication to initiate a review of oversight of the market, but this aspect should be given high priority.
4. To re-build confidence for the future, the Commission should publish the designs for the Union Registry that is due to replace national registries next year, so that it can be subject to public scrutiny.
Summary of known frauds in carbon registries
250,000 units stolen from various accounts in the German registry in a phishing attack.
1.6 million units stolen from account of Holcim in Romanian registry as a result of infiltration by the Nimkey Trojan virus
German, Dutch and Belgian registries closed for investigation
Austrian Registry closed because of hacking attack
Suspected theft of about 7 million units from Czech registry, including 475,000 units stolen from Blackstone Global Ventures
All European registries closed