The role of carbon markets in preventing dangerous climate change - Environmental Audit Committee Contents

Memorandum submitted by JP Morgan Chase & Co


    — Global cap and trade with international offsets the most cost-effective way of tackling emissions.— Encouraging recent US developments. But transition to truly global carbon market may be lengthy, and priority needs to be given to the question of how different carbon markets can be better linked and harmonised, and how a fungible unit can be traded across markets.— Above all, to be effective, carbon market requires policy and regulatory frameworks that provides investors with long-term certainty. Prolonged uncertainty will un-necessarily increase cost of capital.

    — International offsets that utilise flexible mechanisms are necessary: the CDM is by no means perfect, but scaled-up and reformed CDM represents best way forward for an evolving carbon market. Such a mechanism could continue to help reduce emissions in cost-effective manner, bring developing countries further into mitigation, and might be most suitable candidate to generate fungible cross-market unit.

    — Voluntary carbon market plays valuable complementary role to compliance markets. DECC's decision to exclude VERs, at this stage, from its quality assurance scheme was a mistake.


  1.  J.P. Morgan is a major player in international carbon markets. Our Environmental Markets team, part of our overall Global Commodities business, has a strong origination, trading and sales platform around carbon emission reductions, covering the EU Emissions Trading Scheme, Clean Development Mechanism and emerging regional compliance/pre-compliance markets in the United States. The Environmental Markets team, run from London as the centre for emissions trading, has personnel based in New York, India, Africa and South America. In addition, J.P. Morgan has a strong presence in the voluntary carbon market, through its acquisition 12 months ago of ClimateCare, the pioneering carbon offsetter.

2.  The business works closely with advisers based in London and New York on policy and regulatory issues. We are active in the policy arena. We hold one of the Vice-Chair positions of the Carbon Markets and Investors Association (CMIA), and chair the CMIA's Regulatory Oversight Committee. We chair the Climate Change Group of the American Chamber of Commerce to the EU, based in Brussels. In July 2007, the Head of J.P. Morgan Global Commodities testified to the US Senate Committee on Environment and Public Works in a hearing on "Global Warming Policy".

  3.  J.P. Morgan is moreover a major investor in renewable energy, with over $2 billion of bank capital invested to fund wind and solar projects in the US. We have also helped raise another $3.4 billion from other institutions for investment.

  4.  In summary, we are fully engaged in the carbon and clean energy markets and view them as a priority for the bank and our clients. We believe that our global presence, especially in Europe and the US, makes us well-placed to comment on key issues relating to international carbon markets and their role in mitigating dangerous climate change.


  5.  J.P. Morgan takes a leadership role in the financial services industry, helping to reduce our greenhouse gas emissions in our value chain and internally. We will co-operate with others to help achieve significant reductions, working with our clients and closely engaging with policy-makers around the world. This approach towards climate change is framed by the following core principles:

    — based on the scientific evidence from the Intergovernmental Panel on Climate Change, climate change is linked largely to the emissions of greenhouse gases caused by human activity;

    — we therefore endorse the precautionary approach of early action to tackle dangerous climate change; and

    — in that context, we need a comprehensive public policy towards climate change that establishes certainty for investors and stimulates significant investments in greenhouse gas mitigation.

  6.  The Environmental Audit Committee has invited respondents to submit memoranda on a potentially wide range of issues in relation to carbon markets. J.P. Morgan's submission has been prompted by our business interests outlined above and our leadership role in the financial services sector, and we would therefore like to concentrate on three priority issues:

    — the development of a global carbon market;

    — the Clean Development Mechanism and international carbon offsets; and

    — the voluntary carbon market.


  7.  The purpose of emissions trading, as set out as one of the flexible mechanisms in the Kyoto Protocol, is to reduce carbon emissions at least economic cost. Against that background, J.P. Morgan views a global cap and trade system with offsets as the most cost-effective long-term policy framework for reducing emissions associated with climate change and establishing a price for those emissions. In contrast to a carbon tax, a mandatory cap provides certainty and transparency in respect of the environmental objective; and the trading element serves as a crucial cost-containment and capital allocation mechanism. It is a well-tested and understood mechanism, for example in relation to tackling sulphur and nitrous oxide emissions in the US, that is able to harness the power of markets to achieve the environmental objective cost-effectively. A cap and trade programme, with global coverage and long-term certainty, will help allocate the capital and manage the risks associated with the technology advances needed to make currently uneconomic project types viable, including carbon capture and storage, advanced photo-voltaic and other next generation technologies.

8.  We also recognise that such a global system will take some time to develop and that cap-and-trade cannot and should not be the sole policy response to dangerous climate change. There are a variety of additional policy mechanisms available to play a significant role in slowing, stopping and reversing growth in greenhouse gas emissions. In particular, national and regional initiatives to: implement energy efficiency standards and policies; incentives to develop and deploy low-carbon technologies; and regulation, where appropriate, to influence consumer behaviour. Technologies and processes developed through these mechanisms can find global markets, ease transition costs and reduce political challenges to global policy integration.

  9.  In this respect, J.P. Morgan endorses the broad policy approach being pursued by the UK Government and European Union towards tackling dangerous climate change, where an emissions trading scheme—and we acknowledge the pioneering role played by the UK here—lies at the heart. The EU has continued to develop its own emissions trading scheme, and we welcome the certainty it has provided through the decision, no matter what happens internationally, reached in December 2008 to proceed with and expand the European carbon market after 2012. More recently, other developed nations have started to go down the cap and trade path: Australia, New Zealand and Japan. But the most notable developments are now taking place in the United States.

  10.  In the US, the Obama Administration has set a goal of reducing GHG emissions 80% below 1990 levels by 2050 through a cap and trade programme and pledged significant re-engagement in the UNFCC-driven international process. Leadership in both houses of Congress—bolstered by strengthened majorities from the recent elections—are actively working to develop legislation for the implementation of a federal cap and trade scheme. In parallel, the US is likely to implement complimentary energy policies to increase the development and deployment of low-carbon and non-emitting generation resources. In short, it appears that the US has reached an inflection point where the question is no longer whether or not federal action will be undertaken to control GHG emissions; and has shifted to the debate about policy mechanisms, targets and timelines.

  11.  In this context, the next two years are a critical period for the development of US policy. The essential corollary is the extent to which the ultimate US programme creates conditions that foster the long-term development of an integrated global carbon market. In the short-term this is a question of flexible mechanisms and international project-based offsets that connect the US to the broader international market. In the longer-term, the key issue is the extent to which initial US policy contributes to a framework of common but differentiated international responsibilities that provides a robust and durable carbon price signal.

  12.  These national and regional developments are very important. But they will not be enough in themselves. At present we have what might be described as a patchwork international carbon market, where there is potential for either increasing linkages but also the threat of prolonged fragmentation. If the carbon market is to play its envisaged effective role in reducing emissions, this question of linkage is fundamental to progress. We should therefore like to reinforce the point that participants require policy frameworks on linking markets that will give investors clarity and predictability for the long-term, in particular:

    — a comprehensive international agreement on climate change incorporating commitments from developed and developing countries;

    — detailed proposals about how to overcome the complex regulatory and financial barriers to linking different carbon markets; and

    — specifically in relation to linking, proposals on how participants can trade—especially during this transitional period—in carbon allowances from one system to another, ie through a legally recognised and fungible unit.

  13.  The case for a global carbon market, with a universal price for carbon, is clear. Such a market would provide the common purpose and economy of scale—underpinning the pathways to the medium and long-term emissions reductions goals which should be the centrepiece of an international climate change agreement—to enable the efficient deployment of capital to facilitate the transformation to a low-carbon economy. But the transition to the global market may be lengthy and problematic. We suggest that a focus on this transitional phase, with the emphasis on linking and harmonisation, will be just as important as the arrangements that eventually support a single market.

  14.  During the transitional period, the development of a federal US cap and trade scheme will obviously be key. It will therefore be vital for policy-makers in the UK and Europe to stay close to the US administration and Congress as they consider their own scheme. In that regard, J.P. Morgan welcomes the recent proposal from the European Commission to institute a joint EU-US working group on carbon markets: it will be important for existing financial sector participants in the market to provide their input and expertise, and we would welcome the opportunity to contribute.

  15.  There is one other issue we should address, relevant to the performance of the EU ETS right now and the broader issue of linking. There has been extensive commentary in the media recently about the fall in the ETS carbon price. J.P.Morgan takes the view, as do other market participants, that this is very much related to the bigger picture and these almost unprecedented economic circumstances. We are clear that policy-makers should avoid any precipitate responses that might be damaging in the longer-term. Notably, there have been suggestions that price controls, in the form of floors (or ceilings), should be introduced. We oppose any such suggestion. First, price controls would take us down the road of a carbon tax, with regulators setting the price as opposed to the more economically and commercially efficient means of letting the market decide. Second, price controls introduced in one market would make the task of market linking considerably more difficult, as it would be hard to imagine other programmes allowing in credits that are artificially low due to price controls.

  16.  In response to the problems the ETS is experiencing—and the risk of excessive price volatility that might undermine the credibility of carbon markets more generally—we return to our fundamental point about policy uncertainty. A tenet of this market is that it is driven by policy; and, so long as the over-arching international policy and regulatory frameworks are not in place, the uncertainty will continue, thus making investors understandably reluctant to commit capital because they cannot have a clear view about the future price of carbon. This uncertainty and consequent risk raises the cost of capital un-necessarily. So, although we acknowledge what European legislators have done to provide post-2012 predictability for investors, the overall international picture—pending a comprehensive agreement incorporating major developed and developing countries—remains unclear for business. Ad hoc interventions in the ETS would if anything increase policy risk for investors: an international policy framework for the long-term, based on medium and long-term emissions caps, are what the market needs to evolve to achieve its mitigation role.


  17.  In paragraph 7, we said that we viewed cap and trade with offsets as the most effective long-term framework for addressing dangerous climate change. We should therefore like to cover the role of offsets, and specifically the CDM. Policy-makers, notably in Europe and the UN, have consistently advocated the part that emissions trading schemes can play in bringing forward action on emissions in developing countries, and how such schemes could drive flows amounting to tens of billions of dollars each year to support the transition to low-carbon development paths. This is why the future scope and structure of the CDM, and the possibility that it will be scaled up, is high on the agenda for the Copenhagen conference in December.

18.  The CDM has been much maligned in recent months, with critics questioning whether its projects are truly "additional". We acknowledge that the CDM has its failings: it lacks transparency; it is too bureaucratic and its administrative procedures are overly burdensome; it doesn't provide sufficient coverage of least developed countries; it would benefit from a full-time board. These failings understandably fuel sceptics' misgivings about the CDM's effectiveness in mitigating climate change.

  19.  But we shouldn't let these defects blind us to the CDM's successes. Since it was established, it has been responsible for more than 750 previously uneconomic clean energy projects that have been implemented in the developing world, covering project-types such as wind, hydropower, biomass energy and landfill gas. According to a conservative risk-adjusted estimate from the UN Environment Programme, the CDM is likely to generate at least 1.5 billion tonnes of emissions reductions in carbon dioxide equivalent up to 2012. More than that, there is the role the CDM fulfils in promoting awareness of climate change with governments, regulatory authorities and businesses in developing countries. A scaled-up CDM could register even more of an impact in this sense.

  20.  The other aspect relating to CDM and offsets in their broader sense concerns the core objective of emissions trading: to cut emissions at least economic cost. While we appreciate that developed countries should abate carbon substantially in their own backyard, and that it would be wrong simply to "buy" their way out of their reductions commitments through cheaper investments in low-carbon projects in developing countries, policy-makers will also acknowledge that climate change mitigation has to be balanced with what is realistically affordable, and that it will ultimately be impossible to defeat dangerous climate change without business and popular support. The flexible cost-containment role that offsets in the shape of mechanisms such as the CDM play are therefore essential, especially during the critical transitional phase we have highlighted earlier.

  21.  So J.P. Morgan advocates an ongoing pivotal role for the CDM and offsets, viewed both from a climate change and business competitiveness perspective. We believe that the focus in the forthcoming international negotiations should be on how to improve and scale up the CDM so that it can provide necessary emissions reductions in developing countries that are measurable, verifiable and additional. The approach that the international community takes on this important issue will also be germane to the design of US cap and trade, where the argument for international offsets still needs to be won. The other—so far unrealised—function that a reformed, improved CDM might provide is to be the fungible commodity that can be traded between different cap and trade schemes during the transitional period. Hence the need for recognition of and support for the mechanism, at least in principle, across the policy-making spectrum.

  22.  One other issue we would briefly raise is forestry. According to the IPCC, deforestation accounts for nearly 18% annual GHG emissions. Allowing tropical forest preservation to count as an offset would significantly expand the scope for emissions reductions. We know that this would call for major work on legal frameworks and technical issues such as permanence. However, the creation of incentives relating to avoided deforestation (REDD credits) must be a priority for the international negotiations.


  23.  The role of the voluntary market in tackling climate change is often overlooked. We would like to use this opportunity to underline the benefits the voluntary sector can bring:

    — it is a market with full price elasticity and, as such, can be used to reinforce compliance markets;

    — it also provides an outlet for innovative project-types that at present do not qualify for the CDM (often more for political than for sound environmental reasons);

    — voluntary projects also help to build capacity, especially in developing countries where CDM projects tend not to proliferate at present, such as in Africa; and

    — the voluntary market brings many citizens into contact with low-carbon projects and helps to spread awareness of climate change.

  24.  For these reasons, J.P. Morgan was disappointed—as were other voluntary market companies—by the decision taken by the UK Department of Energy and Climate Change to exclude Verified Emissions Reductions (VERs) from the Quality Assurance Scheme for Carbon Offsetting that it recently launched. We are concerned that this decision sends the wrong message about the voluntary market and ignores the steps the industry has taken to improve quality and behaviour in the sector over the last two years. Government officials have told us that "the door is open" to ongoing dialogue on this issue; we will take them at their word and hope they will be prepared to re-consider their decision soon.

3 March 2009

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