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FIA Sustainable Finance Report 2021

An update on key developments in global cleared derivatives markets

PUBLISHED SEPTEMBER 2021

Introduction

Climate change is urgent and real, and headlines in 2021 proved this point once more.  Continental Europe saw record-setting temperatures of more than 48°C (119°F) this August. Persistently high temperatures in Tokyo created health concerns for some outdoor Olympic events. And for the first time in history the US declared a water emergency for parts of the Colorado River thanks to persistent drought conditions.

Clearly much work remains ahead in reducing worldwide emissions and transitioning to a more sustainable global economy to alleviate the threat of climate change. However, FIA member firms and the global cleared derivatives industry at large have already made substantial progress in efforts to support lasting solutions to climate change -- and in 2021, our industry continued to make contributions in several areas. These include:

How derivatives markets are helping the world fight climate change

In September 2020,  FIA published a policy paper, "How derivatives markets are helping the world fight climate change." In the document, FIA highlighted three key areas of partnership and opportunity: 

Innovation: Innovations in derivatives markets, such as carbon trading platforms, help market participants discover prices for commodities that are vital to addressing climate change concerns. Exchanges, working in partnership with market participants, are quickly identifying new products that assist in sustainability efforts. 

Standardization: Industry-developed best practices and standards, such as sustainable sourcing for metals in physically delivered commodity contracts, highlight the importance of collaboration among market participants and leveraging industry expertise.  

Harmonization: In a fragmented global regulatory environment, it is crucial for the public and private sectors to work together to ensure laws and regulations avoid unnecessary conflicts and incentivize market-driven solutions.  

climate change

Emissions trading schemes: Building on established carbon markets in Europe, the UK launched its own market for trading carbon emission permits and Germany's pioneering national fuel Emissions Trading Scheme (nEHS) will kick off in October. And in Asia, China also debuted its national emissions-trading scheme to create the largest market for carbon in the world and New Zealand launched auctions of their renewed NZ ETS. Looking beyond compliance markets that aim to meet regulatory mandates, both CME Group's Nature-Based Global Emissions Offset (N-GEO) futures contract and the Singapore Exchange's Climate Impact X marketplace launched this year to support voluntary emissions offset markets.

New contracts and venues to manage climate risks: Derivatives exchanges continue to create innovative market-based solutions to help the global economy hedge climate-related risks. For instance, in July the London Metals Exchange began offering battery-grade lithium hydroxide futures to help support stability in related energy storage supply chains. Additionally, Nodal Exchange expanded its physically-delivered renewable fuels product suite by adding the Incubex-developed Oregon Clean Fuels Program (CFP) futures contract. And the European Energy Exchange launched a Zero Carbon Freight Index (ZCFI) to allow dry freight market participants to see for the first time how carbon emissions could affect shipping costs. It also expanded its long-term power futures offering to enable the hedging of renewable Power Purchase Agreements.

Growing liquidity in related markets: The market for ESG-related equity index futures continues to surge as investors around the world continue to find value in these products. Specifically, the ESG complex on five major derivatives exchanges including Eurex, Nasdaq Nordic, CME, ICE Futures US and the Taiwan Futures Exchange hit yet another record in Q3 as FIA data showed trading volume of 642 million contracts – more than double the 305 million in collective volume from Q3 of 2020. Volume in emissions trading markets, led by ICE Futures Europe, has also seen continued growth in volume with nearly 8.9 million contracts traded from January through July 2021, an 18% increase over the same period in 2020. Growing liquidity in these markets show the importance of derivatives exchanges as vital tools to help discover prices and manage risks related to climate change.

FIA and its members understand that these steps, while important, are only part of the global solution to climate change. Direct financial risks from extreme weather, as well as the transition risks associated with fundamental changes in how the world does business, require cooperation across industries and across governmental bodies in every jurisdiction. But this progress is an important sign of how cleared derivatives markets are evolving and will help inform next steps for sustainable finance initiatives around the world.

"FIA's board and our member firms have been focused on climate change for several years, and our work so far in 2021 is proof of our continued commitment to this important topic," said FIA President and CEO Walt Lukken. "Building on the momentum from our September 2020 policy paper, 'How derivatives markets are helping the world fight climate change,' we have redoubled our efforts to engage both private and public sector officials to support market-driven solutions to climate change. Much work remains ahead of us, but I am encouraged by the commitment we've seen and filled with hope for the future of our markets and the future of our planet."

The following report will provide updates on climate-related policy, information on sustainability related contracts and other private sector developments, and a look ahead to potential future work areas that will impact the global cleared derivatives industry.

Climate Policy Update

Climate Policy Update

From Washington to London to Brussels to Beijing, climate change is a top priority for policymakers. However, there is clear divergence around the specific actions and timelines between jurisdictions in their approach to sustainability issues.

FIA's staff and its member firms are financial experts, not climate scientists. But we firmly believe that market-based innovations in global cleared derivatives markets are vital to addressing climate change concerns by offering vectors for more sustainable investment financing and capital allocation, supporting price discovery and helping end-users mitigate both their current and future risks.  We also believe open, transparent, and competitive derivatives markets can assist the public sector by offering a global perspective to ensure laws and regulations avoid unnecessary conflicts or create additional unintended risks.

In 2021, FIA has continued its efforts to support the global response to climate change with these principles in mind. Here are the key issues in various jurisdictions where we are engaging on climate issues on behalf of our members.

EU

Europe

The European Emissions Trading System thrived in 2020, with the EU ETS representing about 90% of global value in what had grown to become a $277 billion euro market. And with the EU’s benchmark carbon price surpassing 60 euro for the first time ever in August, it's safe to say 2021 will be another record year for this leading carbon market.

The EU is engaged on far more than just emissions trading policy, too. European regulators have been active in many areas that touch on sustainable finance, including the new EU Taxonomy classification system that will require market participants to report on the sustainability of certain economic activities starting in 2022. The EU also proposed a Carbon Border Adjustment Mechanism in July. The proposal would levy a tariff on imported goods including steel, aluminum and other raw materials with the aim of ensuring European climate policies contribute to a global emissions decline instead of simply pushing carbon-intensive production outside of the region.

However, these complex pieces of legislation are still in early phases and there is no clear indication yet where the final policies may land, or the impact for derivatives market participants.

UK

The UK

The UK launched its own carbon market on 19 May on ICE Futures Europe. The new UK Emissions Trading Scheme became legally effective after the UK pulled out of the EU and severed its links with the EU Emission Trading Scheme, the world's oldest and most successful carbon market.

In April, FIA sent letters to both EU and UK representatives advocating for a firm link between the schemes "as soon as practicable" to support liquidity, price discovery and the ability to attract abatement from across a larger area.

FIA also continues to closely monitor the evolving regulatory landscape in the UK post-Brexit, and warns against potential divergence in rule sets in both the EU and elsewhere that will only make it more complex for market participants and ultimately undermine efforts to fight climate change. For instance, a sweeping Wholesale Markets Review announced by HM Treasury touches on key areas of sustainable finance regulation, and FIA is currently working with members and key stakeholders on a response to Treasury.

US

US

With President Biden assuming the White House in January, the US has begun to telegraph a greater willingness to engage with climate-related policies and carbon reduction targets. However, comprehensive climate policy and related regulatory efforts in US financial markets are still very much in the early stages.

In February, the US Commodity Futures Trading Commission's Market Risk Advisory Committee briefly touched on climate-related market risks to build upon a September 2020 report on the topic. In March, CFTC Acting Chairman Rostin Behnam announced the Climate Risk Unit “to support the agency’s mission by focusing on the role of derivatives in understanding, pricing, and addressing climate-related risk and transitioning to a low-carbon economy.” In April, US Treasury Secretary Janet Yellen appointed the department’s first-ever Climate Counselor to coordinate financial sector action on the topic, and then in July called for a regulatory review of potential climate risks to the nation's financial system. And currently, the US Securities and Exchange Commission is focused on supplementing its disclosure regime with information on climate risks for public companies. 

These broader efforts to explore climate-related issues have not yet led to discussions or potential actions that would directly affect derivatives market participants. However, FIA's Government Relations team in Washington, DC, continues to regularly discuss the evolving landscape with key policymakers and stakeholders, and offered to be a resource to President Biden and his administration about the role and opportunities in our markets.

Asia

Asia

The challenges in China are unique, as the fast-growing nation looks to balance economic expansion with the need to reduce emissions. Beijing's latest Five-Year Plan also prioritized sustainability efforts, charting a course towards realizing previously stated goals of having nationwide emissions peak by 2030 and achieving carbon neutrality by 2060.

In a major milestone in the nation's evolution towards a low-carbon economy, China opened its first nationwide carbon market in July and reportedly supported the trading of 4.1 million tonnes of CO2 in its very first session. And as its local financial markets continue to thrive and open up to the rest of the world, China has also embarked on its first ever draft Futures Law which will encompass trading and settlement principles consistent with international markets -- and assuredly impact how China's markets will evolve to support a sustainable global financial system.

Elsewhere in Asia, the Australian Prudential Regulation Authority is consulting on draft guidance to banks, insurers and others about the financial risks of climate change. Additionally, the Bank of Japan said it would help directly finance projects addressing climate change, including issuing no-interest loans to commercial banks supporting projects judged to be environmentally friendly.

Notable FIA work over the last year

Growing Use of Environmental Futures

Growing Use of Environmental Futures

Several derivatives exchanges are rolling out new contracts intended to support trends toward sustainability in various sectors of the economy. These include not only emission allowance contracts that play a key role in reducing carbon in the atmosphere, but also futures and options on carbon offsets, clean fuels, bioenergy, and recycled materials.

In some cases, such as steel scrap futures, futures contracts have been available for many years before the current wave of interest in sustainability. But the range of contracts has grown rapidly recently as more exchanges and market participants have focused on this corner of derivatives markets.

This sector of the global futures and options markets, often referred to as environmental futures, covers several broad types of contracts. There is no industry-standard definition of what should be included, but FIA estimates that there are currently eight categories that include more than 100 contracts.

Within some of these categories there are many different futures and options. Within others only a few. The level of trading activity tends to be relatively low, compared to the major contracts that serve as the primary benchmarks for the underlying commodities. In most cases these contracts serve markets that are quite small, at least for now, and there are a limited number of end-users in position to use these contracts to hedge their risks. The overall level of trading activity is growing rapidly, however, and several exchanges are moving quickly to expand their offerings in this area.

The table below shows some examples of these contracts.

Green Contracts

Examples of futures and options that are aligned with the global transition to a more sustainable economy

Category

Type of Commodity

Exchanges Active in This Market

Biofuel

Ethanol, Biodiesel

B3, CME, ICE

Emission Allowance

EUA, UKEA, CCA, RGGI

EEX, ICE, Nasdaq, Nodal

Emission Offset

GEO, CER

CME, ICE

Low Emission Fuel

Low Sulphur Gas Oil, Low Sulphur Marine Fuel

CME, ICE

Renewable Energy

Fuel Credits, Electricity Certificates

Nasdaq, Nodal

Recycling

Aluminium Scrap, Steel Scrap, Paper

LME, Norexeco

Resource Conservation

Water Rights

CME

Sustainable Production

Palm Oil

Bursa Malaysia

For further information about the green futures and options listed on derivatives exchanges, contact FIA's data services at data@fia.org

Industry Resources and Case Studies

Industry Resources and Case Studies

As with public policy developments, many climate-related actions undertaken by the derivatives industry itself involve behind-the-scenes work that may not be apparent to the casual observer. However, FIA continues to promote the continued work in the global cleared derivatives industry to support the transition to a more sustainable global economy.

Here are some important case studies and educational resources:

Customer demand for sustainable rubber drives change at supply chains and exchanges

SGX

As environmental concerns become more important to consumers, leading manufacturers are responding by changing their procurement practices -- and their supply chains -- as a result. One example is the car industry, where German automaker BMW recently partnered with tire maker Pirelli to use sustainable rubber for its tires.

As changes in the physical market take place, commodity exchanges are poised to follow. Recent actions at Singapore Exchange provide a clear example of this evolution. The exchange bought a stake in a recently established digital trading platform called HeveaConnect that specializes in supporting the production and procurement of sustainable rubber. SGX also is providing the platform with pricing inputs from its rubber futures market and is working with the platform's backers to promote its adoption.

And while there are no overtly "sustainable" rubber futures as of yet, SGX has a rubber committee comprised of representatives from key producers and tire makers that provides a forum for inputs and suggestions on market developments including sustainability – which ultimately help shape contract specifications for its SICOM rubber products.

Read more about the customer-driven movement towards sustainable rubber.

Water futures show importance of markets in price discovery

CME Group

On December, CME Group launched futures on the Nasdaq Veles California Water Index (NQH2O) for public trading. The benchmark powering this innovative, cash-settled water futures contract uses rights leases and sales transactions across the five largest and most actively traded regions of California to provide a volume-weighted average price of freshwater in the region.

Fundamentally, the NQH20 futures help discover water prices and manage risks for end-users. That allows for greater transparency and ultimately efficiently align supply and demand of this important resource at a time when climate change makes water issues particularly troublesome for many in California.  As businesses and communities around the world face increasing water risks, similar market-based solutions to risk-management can be an important part of the solution.

Read more about CME water futures.

Supporting hedging of renewable energy risk

eex

The global shift to renewable power is spurring the creation of new infrastructure – and not just wind farms, solar plants, battery storage and transmission lines. Financial tools are also playing a role by helping buyers and sellers of renewable energy manage their price risk.

One example is a recently announced alliance between the European Energy Exchange, Europe’s leading wholesale power market, and Pexapark, a software and advisory company based in Zurich that specializes in working with the renewables industry.

Pexapark's clients include European power companies such as RWE and Vattenfall as well as renewable players such as Vestas, the Danish wind turbine manufacturer. It provides them with analytical tools for calculating the risks involved in building renewable energy projects and selling the output on the open market.

Read more about the EEX partnership.

LME sets new ESG baseline for metals

LME

The year 2021 marks the first reporting period for the LME’s responsible sourcing requirements, demanding that all physically settled contracts on the exchange are made up of metals that maintain robust supply chain due diligence systems. The aim of these systems is to ensure human rights are respected all along the global mineral supply chain network.

Beyond the human rights aspect, the baseline set by the LME also requires ISO 14001 and 45001 certifications, ensuring all sites producing metal to be delivered into LME-approved storage facilities have environmental and occupational health & safety management systems in place. The industry is up for this challenge, with some producers going beyond the minimum requirements through more extensive certifications and targets.

The LME set these requirements as a reaction to the new demands of the market. As the first metal exchange to add ESG components to brand listing requirements, the LME is providing clarity to both ends of the supply chain on the complex topic of sustainability.

Read more about LME’s sustainability strategy.

Liquidity challenges in recycled paper highlights need for patience alongside innovation

Norexeco

With sustainability being the word of the decade, a futures contract on recycled paper might seem like a bright idea. And it may well be – eventually. But a recently launched effort to start such a market is having trouble getting off the ground, showing the challenges ahead in the movement toward more sustainable commodities.

Norexeco, a commodities exchange based in Norway that focuses on pulp and paper markets, launched a cash-settled futures contract tied to old corrugated cardboard containers in late 2020. However, issues including the structure of the recycling industry as well as price reporting have created challenges in building liquidity behind a contract that otherwise seems very in-line with current sustainability efforts.

But while liquidity takes time to build, it is not an impossible to build interest in contracts like recycled cardboard futures. The London Metal Exchange is a great example, launching steel scrap futures in late 2015 and slowly gathering momentum over the last several years as more steel producers and consumers joined the marketplace to hedge their risks.

Read more about recycled paper futures.

Other noteworthy sustainability resources:

Next

What's Next

FIA and its members are committed to working with the public and private sectors to help respond to the real and urgent threat of climate change. This includes continued collaboration through existing channels such as formal comments filed with global regulators or through programming at FIA-sponsored industry conferences as climate related issues increasingly become a part of our organization's day-to-day work.

Here are several particularly noteworthy FIA workstreams related to sustainability.

FIA participation in major sustainable finance initiatives

In 2021, FIA joined three major trade groups to represent market participants in the derivatives industry in the broader conversation about climate change and sustainable finance.

FIA joined the Taskforce on Scaling Voluntary Carbon Markets, a private sector-led initiative working to scale an effective, efficient and functioning voluntary carbon market to help meet the goals of the Paris Climate Agreement.  The goal of the Taskforce is to gather stakeholders across the carbon markets value-chain to put forth a fully functional voluntary carbon market that can scale up to effectively reduce emissions and fight climate.

The Global Sustainable Finance Council also welcomed FIA as a participating member this year. Sponsored by the International Capital Markets Association, the GSFC’s objective is to bring together key global and regional associations and other stakeholders to coordinate and promote sustainable finance efforts and act as a representative counterparty to the official sector on sustainable finance policy matters.

FIA also joined as a member of the US Climate Finance Working Group, a body of 11 financial services trade associations. The group published its Principles for a US Transition to a Sustainable Low-Carbon Economy in February and has continued to meet on key issues in anticipation of increased focus on climate issues by the Biden Administration.

For more information on FIA's participation in any of these groups, contact FIA's Director of Government Relations Kyle Glenn.

FIA Sustainable Finance Working Groups

As FIA's work increasingly is focused on sustainability related concerns, in 2019 we launched Sustainable Finance Working Groups in both the US and in the UK-Europe region that are open to all members. Regular policy updates are provided based on the local differentiation in regulatory priorities and oversight, and members are kept informed of emerging developments and progress on outstanding issues.

In the UK and Europe, things have been particularly busy as the EU continues progress on Taxonomy and the UK has embarked on a Wholesale Markets Review that touches on sustainability concerns. For those interested in regular updates on developments affecting the derivatives industry, contact FIA's Senior Director of Regulation John Graham to join FIA's distribution list or working group.

In the US, the Biden Administration continues to send strong signals that climate-related proposals are very much on the agenda for the near future. For updates on the state of play for climate-related polices in Washington, contact FIA's Director of Government Relations Kyle Glenn to join FIA's distribution list or working group.

COP26 and its impact on climate policies

The United Nations Climate Change Conference kicks off on 1 November, and already we have seen a number of preemptive moves in both the private and the public sector in anticipation of this important event.

Much of the attention is, naturally, on the commitments from major economies like the US, EU and China. However, the world is closely watching the developed nations that make up the G7 to also come forth with a financial plan to support vulnerable nations in their transition to a low-carbon future. Any such sustainable finance plans surely will have an impact on many parts of the global economy, including derivatives markets.

FIA is closely monitoring both the initial build-up to the COP26 conference, and plans to report out on key trends and developments.

Ongoing research, reporting and dialogue

In 2020, FIA published a policy paper in consultation with its members across the cleared derivatives industry on climate-related risks for financial markets and the global economy. The paper, "How derivatives markets are helping the world fight climate change," focused market-driven solutions and highlighted potential partnerships with the public sector to help build a more sustainable economy in the long term. 

As this more recent report shows, FIA has continued this work in earnest since then through dialogue with industry stakeholders and regulators as well as through original research and reporting on key sustainability trends. Our work has had particular focus within three key areas of partnership and opportunity: 

Innovation: Innovations in derivatives markets, such as carbon trading platforms, help market participants discover prices for commodities that are vital to addressing climate change concerns. Exchanges, working in partnership with market participants, are quickly identifying new products that assist in sustainability efforts. 

Standardization: Industry-developed best practices and standards, such as sustainable sourcing for metals in physically delivered commodity contracts, highlight the importance of collaboration among market participants and leveraging industry expertise.  

Harmonization: In a fragmented global regulatory environment, it is crucial for the public and private sectors to work together to ensure laws and regulations avoid unnecessary conflicts and incentivize market-driven solutions.  

For additional information, download the full September 2020 policy paper, "How derivatives markets are helping the world fight climate change." 

Contact FIA Staff 

To join FIA's EU/UK Climate Working Group: John Graham - Senior Director of Regulation or Christiane Leuthier - Vice President, Commodities

To join FIA's US Climate Working Group:  Kyle Glenn - Director of Government Relations or Michael Sorrell - Deputy General Counsel

For more on Asia sustainability trends: Tze Min Yeo - Vice President, Legal & Policy, Asia-Pacific

For additional industry data: Will Acworth - Senior Vice President of Publications, Data & Research