No matter what some skeptics may think, markets can help industrial and emerging nations to face the challenges brought about by the Kyoto Protocol signed in 1997, intended to reduce emissions of greenhouse gases and other pollutants. In fact, some even argue that market-based initiatives, such as the Montréal Climate Exchange (MCeX), may be more effective in promoting the greening of the economy than schemes solely based on taxation. Albeit taxes can certainly place a financial burden on firms emitting greenhouse gases, they are not as helpful as markets, such as MCeX, at inducing them to change. Polluters, certainly, can be motivated to avoid additional taxation by shifting to less-pollutant technologies. But taxes on greenhouse gas emitters leave virtually untouched the more environmentally performing firms. Cap and trade schemes on the contrary, have the ability to induce innovative firms to cash out on their capacity to reduce those emissions, boosting their bottom-line in exchange of further reductions. By providing a price for emissions, exchanges also help the more polluting companies to make appropriate technological and investment choices regarding abatement of greenhouse gases, and facilitate in general more flexible managerial approaches to deal with greenhouse emission constraints. In the end, thus, actors interacting in a market place and seeking profits can help societies to reduce greenhouse gas emissions, while preserving the health of the nation’s economic fabric. To be effective, though, greenhouse emission permit exchanges (also known as climate exchanges) need governmental intervention to function. Without governmental intervention to limit emissions –creating scarcity– climate exchanges face limited possibility to flourish and make a full contribution in decreasing greenhouse gas emissions as well as other polluters contemplated in the Kyoto Protocol.

Léon Bitton, Research and Development Vice-President of the Montreal Stock Exchange, has been instrumental in the creation of the Montreal Climate Exchange, which began operations in May, 2008. He recently spoke about the operation of MCeX. The conference took place on March 3rd, 2010, and it was sponsored by CIRANO, an interuniversity research center based in Montreal, and the Montreal chapter of the Professional Risk Managers’ International Association (PRMIA). Mr. Bitton’s lecture discussed the launching and functioning of the Montreal Climate Exchange and the impact of governmental policy trends on its development. In Mr. Bitton’s view, without appropriate governmental intervention the climate exchange is unlikely to ever take-off. This governmental intervention covers various aspects. First, government has to define what the unit for the credit to be traded is (i.e. the equivalent ton of emissions); secondly, it has to set a sufficiently constraining limit for emissions and a fine for companies not respecting the limit. The fine should be high enough to make attractive for firms to buy credits, if they cannot comply with the upper limits set. Thirdly, appropriate regulations to monitor emissions should be established. The monitoring could be accomplished by the private sector itself, with mechanisms that are akin to those employed by auditing firms monitoring accounting reports and practices of clients paying for certification. In fact, says Mr. Bitton, some auditing firms have anticipated the need for environmental auditing and are already serving their clients who want to exhibit external verification of their (voluntary) emission reductions. Finally, government should establish rules on the acceptable green projects (both domestic and international) that can sell credits for reduced emissions.

Once the appropriate measures have been enacted by government, climate exchanges can greatly contribute to attain a balance between societal objectives concerning the economy and the environment. First, exchanges favor a more flexible approach for companies’ adjustment. Firms with over the cap emission levels may keep their production levels by buying credits from other firms. Climate exchanges would give them a higher range of options to cope with the new environmental constraints. Secondly, exchanges provide price signals able to induce innovative firms to reduce emissions below the targets in order to profit for the selling of credits. Exchanges can also favor price risk management by means of contracts of futures and options, and provide vital liquidity for all players active on it.

The Montréal Climate Exchange (MCeX) and Canada’s federal government environmental policy

The exchange, one of the several created in recent years throughout the world, is the result of a joint venture between the Montréal Exchange (TMX) and Climate Exchange PLC, a leader in the field of environmental finance which operates, among others, the Chicago Climate Exchange and the Chicago Climate Futures Exchange. TMX provides to the partnership its negotiation platform, a compensation chamber and a solid body of regulations.

Up to now, actors in the exchange participate on a voluntary basis. The Canadian federal government approved a Regulatory Framework for Industrial Greenhouse Gas Emissions in 2008, intended to set reductions in emissions intensity from 2006 levels for major polluting electricity generation produced by combustion, oil and gas, pulp and paper, iron and steel, cement, and fertilizers, among other sectors. The Framework intended to lay the foundations for setting mandatory caps for emissions from 2010 onwards. However, no mandatory limits have been effectively set since the Framework was released. Moreover, Canadian government officials have recently declared that Canada will align its greenhouse control policy with that of the U.S. Given the animosity of important sectors in the American political arena against U.S. endorsement of the Kyoto Protocol, prospects of adoption of a cap and trade federal Canadian policy on greenhouse gas emissions are becoming rather slim. At any rate, players in the Montréal Climate Exchange seem to believe so. In August 2008, the price of a credit allowing the emission of carbon ton of exhausts (to be delivered by 2011) was about 13, 25 $. The same ton was traded at 2 $ the day of Mr. Bitton’s lecture. Recent declarations to the media of a prominent U.S. senator, expressing doubts about the likelihood of adoption of any “cap and trade” policy in the U.S. are not likely to help the implementation of such a policy on Canadian territory.

The Western Climate Initiative (WCI)

The reluctance of Canadian and U.S. federal governments to set “cap and trade” policies has indeed slowed the emergence of climate exchanges. However, their reluctance has not prevented provincial and state-level governments in North America from launching their own initiatives to tackle the issue. For instance, the Western Climate Initiative (WCI), started by states and provinces along the western rim of North America (comprising in Canada the provinces of British Columbia, Manitoba, Quebec and Ontario), intends to favor initiatives dealing with climate change, independent of their national governments.

The stated purpose of the WCI is to identify, evaluate and implement ways to collectively reduce greenhouse gas emissions in the region. The initiative requires partners to set an overall regional goal to reduce emissions, develop a market-based, multi-sector mechanism to help achieve that goal, and participate in a cross-border greenhouse gas registry. The WCI plans to lay the foundation for an international cap and trade program involving the United States and Canada. On September, 2008, the WCI released an outline for the implementation of its cap and trade proposal. The first phase of this plan would be implemented on January 1, 2012, followed three years later by a broader cap on carbon emissions in 2015. The North American approach of the WCI favors a balanced market with buyers and sellers of emision credits. One of the criticisms addressed to a would-be strictly pan-Canadian climate exchange has been precisely that Canada would have more companies seeking to buy credits than sellers. Arguably, the operation of a such a seller-dominated market would push up the price of the carbon to levels that can eventually harm the economy. If implemented as planned, WCI (throughout its four provincial partners in Canada) would cover slighly more than three fourths of the Canadian economy. However, political leaders of the provinces contributing significantly to greenhouse emissions, have expressed strong reservations and thus, those provinces are unlikely to join the WCI in the years to come. It is particularly the case of Alberta, which in 2008 was responsible of 42% of the combined emisions of all Canadian provinces and territories. The Framework adopted by the federal government contemplates a mechanism that can entice Alberta and other reluctant provinces to join in. In the initial years of the framework, companies of targeted sectors may be able to meet a significant part of their regulatory obligations by contributing to a specialized fund. The latter will be used to support the development and dissemination of new technologies that can reduce greenhouse gas emissions. Contribution to the fund will be done at an established rate and up to the established limit. This mechanism woud increase the chances of a political agreement on cap and trade for carbon emisions. However, an established rate will create an upper bound for the price, limiting the market capacity to price carbon emisisions beyond this level. The interplay among political actors will determine the final outcome of regulations. Markets are ready to provide solutions and mechanims to deal with the pressing issue of greenhouse gases. In the meantime, the Canadian federal government seems to favor a-wait-and-see attitude. Time will tell for how long it can keep on that track.