Institutional Investment in the EU ETS

Tyndall Centre for Climate Change Working Paper 156

41 Pages Posted: 26 Mar 2013

See all articles by Ivan Diaz-Rainey

Ivan Diaz-Rainey

CEFGroup & Department of Accountancy and Finance, University of Otago

Andrea Finegan

University of East Anglia (UEA)

Gbenga Ibikunle

University of Edinburgh; European Capital Markets Cooperative Research Centre

Daniel J. Tulloch

University of Oxford - Smith School of Enterprise and the Environment

Date Written: December 27, 2012

Abstract

This general review paper explores the role of institutional investment in EU ETS. We do so by addressing seven questions sequentially, namely: (1) How does the EU ETS work? (2) What drives the value of carbon? (3) What potential diversification benefits arise from investing in carbon? (4) How does investing in carbon sit with investors’ fiduciary responsibilities? (5) How can institutional investors gain exposure to carbon? (6) What unconventional risks does investing in carbon entail? (7) What will happen to the carbon markets post-2012, once the Kyoto protocol expires? From this discussion, it is evident that carbon markets generally and EU ETS specifically are, from an institutional investing perspective, a paradox. Recent years have seen increased market sophistication (trading efficiency) and it is evident that there are potential diversification benefits from investment in carbon and that investing in carbon can be consistent with fiduciary duties. Despite this, there is little institutional involvement in EU ETS due to the unconventional risks that come with investing in carbon allowances, derivates, and funds. In terms of these unconventional risks, the VAT carousel fraud and the theft of allowances in 2011 are relatively minor issues when placed against the absence of a clear post-Kyoto agreement. We conclude that if robust growth in climate change-related investing is to continue beyond 2012, more needs to be achieved in order to adequately address the climate investment gap. Legislation incorporating a fiduciary obligation for institutional investors to take into account the social costs of investment as well as private returns would begin to pave the way.

Keywords: carbon finance, institutional investment, EU ETS, environmental policy

JEL Classification: Q28

Suggested Citation

Diaz-Rainey, Ivan and Finegan, Andrea and Ibikunle, Gbenga and Tulloch, Daniel James, Institutional Investment in the EU ETS (December 27, 2012). Tyndall Centre for Climate Change Working Paper 156 , Available at SSRN: https://ssrn.com/abstract=2238831

Ivan Diaz-Rainey (Contact Author)

CEFGroup & Department of Accountancy and Finance, University of Otago ( email )

Dunedin
New Zealand

Andrea Finegan

University of East Anglia (UEA) ( email )

Norwich Research Park
Norwich, Norfolk NR4 7TJ
United Kingdom

Gbenga Ibikunle

University of Edinburgh ( email )

Old College
South Bridge
Edinburgh, Scotland EH8 9JY
United Kingdom

European Capital Markets Cooperative Research Centre ( email )

Viale Pidaro 42
Pescara, 65121
Italy

Daniel James Tulloch

University of Oxford - Smith School of Enterprise and the Environment ( email )

United Kingdom
1865614934 (Phone)

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