Environmental Engineering Reference
In-Depth Information
to the benefit of the long position holders who
engineered the squeeze.
Naturally, periods of low supply are most
proper for squeezes. With respect to emissions
markets, incidences of low supply would imme-
diately depend on the frequency and timing of
auctioning allowances into the market. Hence,
secondary emissions markets may be particu-
larly susceptible to squeezes when auctioning
of allowances occurs relatively infrequently and
discretionary. Similarly, restricted access to auc-
tions would also play in favour of those wanting
to engineer artificial supply shortages in the
markets' underlying.
In conclusion, the interplay between auction-
ing and secondary markets functioning in the
European energy markets plays a critical role. As
a consequence, it is recommendable for auctioning
to become an integral part of the overall market
design - with continuous and efficient price dis-
covery taking place in secondary markets, while
smooth and effective supply of the underlying
takes place through auctions.
From a market efficiency and liquidity consoli-
dation perspective it is intuitively advisable that
only instruments are auctioned which are traded
in liquid secondary markets. Otherwise, auction-
ing would provoke parallel markets in similar but
different instruments. Secondary market liquidity
would become fragmented. Eventually, efficiency
and integrity of the price discovery function would
suffer. Thus, the choice is limited to spot allow-
ances and listed futures contracts.
Whilst spot auctioning of emissions allowances
is straight forward and unobjectionable, auctioning
of futures requires some further considerations:
•
Auctioning futures would change the role
and economics for governments. In selling
futures governments would in fact become
a new large risk taker in the market who
by definition would not actively manage
its portfolio. In contrast to spot auction-
ing where proceeds would be available all
along, with futures auctions public budgets
would be attained upon maturity of the fu-
tures contract. Furthermore, by auctioning
futures there would also be the need for
governments, and their agents respective-
ly, to pledge and maintain margin collat-
eral with the clearinghouse to manage their
short positions.
Design Principles for Large-
Scale Auctioning in the EU ETS
If well designed, auctioning as the primary alloca-
tion method in the third trading phase in the EU
ETS has the potential to improve the efficiency
and integrity of secondary markets and, hence,
extend the EU's lead in a rapidly developing
global carbon market. However, for this to hold
a holistic design which integrates auctioning into
the secondary market architecture is of paramount
importance. Hereafter, we recommend and reason
some fundamental design principles to make
auctioning an integral part of the overall market
functioning.
33
•
Auctioning futures could also have con-
siderable adverse effects on the competi-
tive structure of secondary markets and
institutions. Let us assume that futures are
auctioned at only one particular venue and,
accordingly, cleared at a certain clearing-
house. Then the public auctioneer would
direct a significant share of the markets'
open interest to this clearinghouse. As a re-
sult, all secondary market trading activity
in futures would be directed to this particu-
lar clearinghouse and the associated trad-
ing venue. Hence, centralized futures auc-
tioning could negatively impair secondary
market competition.
Recommendation 1: Auctions should be for ho-
mogenous, fully fungible instruments only
