A federal interagency working group, led by the CFTC and including representatives from the Department of Agriculture, Treasury, SEC, EPA, FERC, FTC, and DOE (EIA), has released a report on oversight of existing and prospective carbon markets, as required under section 750 of the Dodd-Frank Act. The group was charged with providing “recommendations . . . to ensure an efficient, secure, and transparent carbon market, including the oversight of spot markets and derivative markets.” Accordingly, the report recommends that the following objectives guide the oversight of existing and prospective carbon markets:

Objective 1. Facilitate and protect price discovery in the carbon markets.

  Carbon market design and oversight should strive to ensure that carbon markets – including those for allowances, offsets and derivatives – reflect both supply and demand conditions, considering the present marginal cost of achieving emission reductions and market participants’ expectations of future marginal costs of reductions.

Objective 2. Ensure appropriate levels of carbon market transparency.

Regulatory oversight must ensure that proper levels of transparency exist in carbon markets. Both pre-trade and post-trade market transparency measures should exist in order to provide timely and accurate information to carbon market participants. Transparency can generally increase the efficiency of markets by providing for more informed decision making by market participants. To encourage market participation, transparency provisions should preserve the confidentiality of traders and their positions consistent with commodities and securities laws and provide appropriate exceptions for large or “block” trades. Regulatory oversight provisions also should ensure appropriate provision of fundamental market data relating to aggregate emissions of regulated entities and the supply of allowances and offset credits in the markets.

Objective 3. Allow for appropriate, broad market participation.

Regulatory oversight should ensure that rules regarding market participation allow entities with emission compliance obligations to efficiently meet their obligations and allow offset credit providers to bring those credits to market. More broadly, the rules and trading systems should be designed to encourage market liquidity, facilitate price discovery and allow those directly and indirectly impacted by the regulation of carbon emissions to efficiently hedge associated risks. Open market participation promotes the development of market liquidity and price discovery, which are essential to the efficient functioning of primary, secondary and derivative markets and could facilitate the ability of entities to hedge commercial risks associated with regulation of carbon emissions.

Objective 4. Prevent manipulation, fraud and other market abuses.

Carbon markets should be free of manipulation, fraud and other market abuses. Measures should be in place to prevent price distortions, market fraud and other manipulative activities and to provide for sufficient transparency for regulators to monitor activity in the market.

The group made the following additional recommendations regarding oversight of the derivatives market and the primary (sale of allowances and offsets) and secondary (resale) markets:

Derivatives Market–Rely on the existing regulatory oversight program, as enhanced by the Dodd-Frank Act, for both existing and prospective carbon allowance and offset derivatives markets. The current legal framework for oversight of derivative markets, as enhanced by provisions in the Dodd-Frank Act that will become effective in July 2011, will provide for robust and effective oversight of carbon derivatives markets and closely linked derivative markets, such as those based on energy commodities.

Primary and Secondary Markets–Ensure that appropriate oversight mechanisms are in place for primary and secondary allowance and offset markets, reflecting the above objectives and the interdependence of primary, secondary and derivative carbon markets and any unique characteristics or circumstances of such markets.