Banks: Gearing Up for Carbon Trading

A federal plan to cap greenhouse gas emissions and sell the rights to emit them probably won't kick in for a few years. But while U.S. policymakers continue to squabble over the details of the "cap-and-trade" proposal, big banks are gearing up for what they see as a new profit center. "U.S. carbon trading is coming," says Louis Redshaw, head of environmental markets at Barclays' (BCS) investment bank. "You have to be in it to win it."

The industry is calling on its experience in Europe, where regulators set limits on emissions in 2005 and the carbon market now tops $79 billion. With no such rules in the U.S., carbon trading is limited to a number of regional exchanges in which participation is often voluntary. Last year trading stateside amounted to less than $400 million.

But that's about to change. As part of a broader effort to tackle global warming, the Obama Administration wants to impose caps on carbon; a bill is now working its way through Congress. Those restrictions—which even the most vocal opponents see as inevitable—would create a national market for buying and selling carbon credits, permits to emit greenhouse gases. Analysts figure rules will be in place by 2013, and carbon trading could top $1 trillion a year by 2020, according to research firm New Carbon Finance. At that size, carbon would rival oil as one of the largest commodity markets.

The biggest banks in the U.S. and Europe are quietly preparing for the potential payoff in trading. France's SociÉtÉ GÉnÉrale (SCGLY) has set up a U.S. group devoted to carbon. Morgan Stanley, which already is active on the U.S. regional exchanges, says it will expand its unit once policymakers finalize the rules.


The carbon credits themselves could be a source of profit for financial firms. That's why Morgan Stanley (MS), JPMorgan Chase (JPM), and Goldman Sachs (GS) are buying stakes in so-called offsetting companies. These independent businesses invest in eco-friendly projects, such as reforestation programs in Oregon, that reduce greenhouse gases and produce carbon credits as a result. The credits can be sold to companies looking to mitigate—or offset—their carbon footprint. Prices on the credits could soar once the U.S. imposes emission caps and the carbon market takes off. Says Seb Walhain, the global head of energy and commodities at Holland's Fortis Bank Nederland: "Carbon soon will become part of the regular business for banks."

Some investment banks are doling out advice to companies preparing for restrictions in the U.S. Citigroup (C), for example, is working with utilities and oil refiners, which want to know whether carbon caps will hurt their bottom lines. "Our job is to manage customers' risk," says Garth Edward, Citigroup's director of environmental products. Banks collect an estimated $2 million to $3 million per client for such advisory services, according to financial consultancy TowerGroup.

The financial exchanges, meanwhile, are developing derivatives that will help companies reduce the financial impact of carbon limits. CME Group, the world's largest commodity exchange, plans to launch a product in coming months, following the Chicago Climate Exchange. BlueNext, a venture backed by NYSE Euronext (NYX), is meeting with potential customers to gauge their interest in derivatives. Says BlueNext Deputy Chief Executive Jean-Pierre Hort: "We will be ready for U.S. trading."

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