Broker dealers seeking new, high margin products will increasingly look to carbon emissions trading but will need to invest in technology if they are to take advantage of this growing market, according to research from analyst house TowerGroup.
In providing a framework to reduce the global level of carbon emissions and combat global warming, the Kyoto Protocol opened the door to carbon emissions trading, led by such cap-and-trade systems as the European Union Emissions Trading Scheme (EU ETS).
Although these schemes are relatively new and "artificial markets", the battle against global warming is just beginning, says TowerGroup, and government support will ensure the longevity of carbon trading.
Furthermore, as sell-side margins on trading desks compress, broker-dealers will look to cash in on the market.
However TowerGroup says technology will be key if brokers are to capitalise on increasing product complexity and trading velocity in the markets. Investment banks need to ensure their technology platforms can accommodate the unique needs of carbon products.
The rise in global carbon trading will also result in the need for regulatory harmonisation and a shift from over-the-counter (OTC) - which currently accounts for between 70% and 80% of transactions - to exchange-based trading.
Most carbon trading is currently carried out in Europe - specifically the EU ET which was the first cap-and-trade market. The EU ETS has seen a tripling of dollar value of trading in 2005 and 2006. TowerGroup says it will be difficult to match this rate of growth but says "this market will remain healthy".
The overall carbon market will also expand into new geographies, such as the US and Australia. There will be a move to harmonise regional schemes and eventually a global market, although TowerGroup predicts this will take time because of the difficulty involved in bringing politicians, financial players and regulators in line.
"Although carbon emission trading is currently focused in Europe and is still years from full maturity, TowerGroup believes that no broker-dealer can ignore the potential of this market," says Stephen Bruel, analyst, securities and capital markets research service, TowerGroup. "Broker-dealers should not delay the building of a carbon trading desk."
Earlier this year transatlantic exchange operator Nyse Euronext teamed with French state bank Caisse des Dépôts to launch a European carbon emissions market called Bluenext which operates a spot market in CO2 emission allowances.
Meanwhile the New Zealand Exchange (NZX) is gearing up to launch TZ1, a new carbon market, in June 2008. NZX has appointed Mark Franklin as CEO of TZ1 as it seeks to corner the Asia Pacific carbon market.
In another sign of the growth of the market, OMX revealed last year that it is forming a European energy derivatives unit after a $412 million acquisition of Nord Pool ASA's clearing and consulting operations and international derivatives products.
OMX says its ambition is to build a leading European market for CO2 products, based at first on Nord Pool's current products, including CO2 products (EUAs, CERs) and the international power contracts.
Finextra is also getting involved in all things green. Imtiaz Ahmad, head of emissions trading at Morgan Stanley will be speaking at Finexpo - Green City
on Thursday 10 April. The London conference will bring together senior business leaders, traders, technologists and green professionals within the financial services industry to stake out the issues and share insights, knowledge and best practice in preparing for a carbon-constrained future.