EU markets regulator the European Securities and Markets Authority (ESMA) announced today the release of its “Final Report, Emission allowances and associated derivatives,” reviewing and addressing the functioning of the EU carbon market. The report, created at the request of the European Commission, provides an in-depth analysis of the trading of emission allowances (EUA) and emission allowance derivatives, and includes recommendations from the regulator to improve market transparency and monitoring.

The European Emission Trading System (ETS) forms one of the EU’s key policy tools addressing climate change, putting a price on carbon emissions. The system works on a cap and trade basis, setting a cap limiting the amount of greenhouse gas (GHG) that can be emitted by companies each year, and a fixed number of carbon emissions allowances are issued annually, with companies required to hold enough allowances to cover their emissions and ensure they fall under the cap, and able to trade allowances with one another as needed.

ESMA’s new report provides its analysis of the trading of these emissions allowances.  Some of the regulator’s key findings include market characteristics indicating that long positions in carbon derivatives as mainly held by non-financial entities for hedging purposes, while most short positions are held by banks and investment firms providing liquidity and carbon financing, and positions by investment funds remain limited. The market is also characterized by a significant level of high-frequency and algorithmic trading.

While ESMA’s report did not find any current major deficiencies in the functioning of the EU carbon market, the regulator included several recommendations aimed at improving transparency and oversight. Recommendations included extending position management controls to trading venues trading derivatives on emission allowances, adapting position reporting, publishing weekly position reports on open positions in futures on emission allowances, and providing ESMA with access to primary market transactions, among others.

The report also examines two possible courses of action for the Commission’s consideration, but without providing a final view on the issues. These include introducing position limits on carbon derivatives in order to prevent market abuse and support orderly pricing and settlement, and the setting up centralised market monitoring of the EU carbon market to help address the challenges posed by the fragmented nature of data on the EU carbon market.

Click here to access the ESMA report.