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Khanchit Khirisutchalual

While Europe’s carbon market is generally functioning well, regulators say reforms are needed to enhance transparency.

A European Securities and Markets Authority (ESMA) review of the European Union carbon market didn’t uncover any major deficiencies in the market’s current operations.

However, the regulators proposed a series of policy recommendations to improve market transparency, including changes to position reporting requirements, extending controls to trading venues that trade in derivatives on emission allowances, and increasing transparency in over-the-counter (OTC) derivatives.

“The measures proposed would provide more information to market participants, regulators and the public and are intended to contribute to the continued smooth functioning of the market, which plays an important role for the EU’s transition to a low-carbon economy,” ESMA said in a release.

ESMA’s report suggested that European policymakers consider establishing position limits on carbon derivatives and introducing centralized carbon market monitoring.

It detailed arguments both for and against these ideas to provide insight into whether additional measures are required to regulate the carbon market.

Apart from the policy recommendations, the report also detailed the regulators’ findings about the market’s current conditions.

The regulators found that long positions in carbon derivatives are primarily being used for hedging by non-financial companies, and that short positions are mainly held by banks and investment firms that are providing liquidity and carbon financing.

They also found that investment funds have limited positions in the market, and that a significant share of carbon market trading involves high-frequency and algorithmic trading, even though these traders “are only holding very small or no actual positions.”

The ESMA noted that the war in Ukraine has had a “major impact on the carbon market,” with prices declining by 30% since the start of the invasion.