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EU ETS reform and the role of financials on the market

As the legislative process to reform the EU’s Emissions Trading System is moving forward, the debate on whether to increase the market transparency and potentially limit the access to the market for the financial institutions is also heating up. Despite the different opinions among the experts, there are options that might address the issue of excessive speculation and at the same time keep the market open for the players that ensure its liquidity.

ETS price volatility

The debate about the role of financials is fuelled by the price volatility in the EU ETS market. In 2021 the prices of the allowances (EUA) on the primary market increased from 33.51 euros/t in January to 74.57 euros in December. The prices remained volatile also in the first quarter of 2022: on 23 February, the EUA prices reached 92.80 euros only to fall to 57.91 euros on 7 March, which means the EUA prices changed by around 37 per cent within just two weeks.

The industry and utilities are impacted both by high prices as well as their unpredictable swings. It is worth to remember that the European Commission assumed that in order to reduce the emissions by 55 per cent, in 2030 EUA prices will eventually reach 60 euros. Such rapid price swings undermine the emitters’ efforts to properly plan their long-term green investments and drain their financial resources. These rapid changes fuelled the discussion of whether allowing the financial institutions to participate in ETS without many restrictions was the right decision. The debate also revolves around ETS design that makes it vulnerable to speculative activities. While financial players remain important for the liquidity of the market and help to facilitate trade, some of their activities, combined with ETS flaws might lead to excessive speculation and price swings.

The ongoing debate

There are different opinions by experts and stakeholders on the reasons behind the price volatility. Nevertheless, due to insufficient market data on the participants, their trading and positions there is no definitive answer on the scope of the speculation. Many emitters argue that the financial actors help to ensure market liquidity and price discovery. The European Securities and Markets Authority (ESMA) concluded that there is no evidence that the speculative activities had a significant impact on the prices, but at the same time supported better market oversight and transparency (also admitting that it is “complex to obtain a clear picture of who trades and from where”). ESMA also supports considering further measures like position limits on the open position in EUA derivatives.

Some of the proposals go further than that. MEPs from ITRE and TRAN committees opt for excluding financials that do not act on behalf of emitters (so those speculating would be excluded) and the discussion about the role of financials gains momentum in EPP. This was also reflected by the ENVI committee voting in mid-May: the MEPs supported keeping the market open only for the regulated entities with “past, current, or predictable future EU ETS compliance obligations” (the exceptions are possible though if EC deems it could negatively impact the market). Some independent experts argue that while financials should remain on the market, their influence should be limited, leaning towards ESMA recommendations or the price corridor to prevent EUA price swings.

Finding common ground

The definitive answers on the actual scope of speculative activities in the ETS market will not be available anytime soon: it requires improvements in reporting, market transparency and careful analysis of the available data. This whole process as well as agreeing on concrete measures will take years. The way out of this situation is to focus on the possible reforms, that could address the market volatility, whether it is caused by the speculations or not. Therefore, the discussion should focus on the market flaws and possible fixes.

The market design issues were explored in-depth in a recent study by Compass Lexecon. One of the examples shows, how the market lacks an effective tool to address the issue of excessive speculation. The financial actors, who bank the allowances for speculative purposes accumulate them on their accounts, waiting for the price to increase in the future. Such allowances are not available for the emitters – the entities for which the ETS market was established and which need them to cover their emissions. Despite that fact, these allowances are still calculated as part of TNAC (Total Number of Allowances in Circulation). In such cases, the Market Stability Reserve (MSR), a mechanism which is designed to react to market oversupply/shortage by absorbing or releasing allowances, doesn’t react to the shortage. This is because MSR uses a trigger mechanism based on TNAC, which includes also those allowances, which are held by financial institutions on their accounts, not the EUA prices. In some cases, MSR can even absorb some allowances from the market, if – according to the TNAC calculation – there are too many allowances on the market (regardless of the fact that there’s a scarcity of EUA since they are banked by the financial institutions).

The most obvious step to address the issue is not only to improve reporting and transparency but to ensure that the MSR trigger mechanism is based also on the price thresholds, so it can react to de facto market scarcity. Another measure could be exploring the idea put forward for the discussion by ESMA – introducing the position limits. Similarly to MSR reform, it wouldn’t exclude the financial institutions from the market completely, but limit the scope of the speculative activities.

Therefore, the recent proposal to release a certain amount of allowances from the MSR to finance post-pandemic recovery is a step in a good direction both from a market and financial perspective. However, the idea to release allowances from MSR should be complemented by more accurate allocation key, which should be dedicated to mitigating the results of the current war crisis, not the post-pandemic recovery. Moreover, allowances released from MSR should not be accounted o the TNAC, otherwise corresponding number of allowances will be deuced for auctioning volumes in the next years.


The ongoing debate and the controversies around the ETS creates an opportunity to reform EU’s carbon market, protect emitters from the rapid price swings and – at the same time – keep the financials on the market. The reform proposals should focus on making the system more resilient, even if the scope of excessive speculation is yet to be examined. These reforms should be implemented along the other changes in ETS, so the issue of big reform doesn’t resurface each year. It will also protect emitters from the volatile prices (whether caused by excessive speculation or not) as well as the credibility of the EU’s crucial climate tool.

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