Good Derivatives

Several years ago, I was at a dinner in Hong Kong (arranged by Christine Loh, formerly CEO of Civic Exchange, but now Undersecretary for the Environment in the HK government) with Dr. Richard Sandor, the founder of the Chicago Climate Exchange (CCX). Long before he worked on environmental matters, Dr. Sandor was Chief Economist at the Chicago Board of Trade, and played a key role in establishing financial derivatives in the 1970s and 1980s. He’s now written a book entitled Good Derivatives: A Story of Financial and Environmental Innovation, and of course I was very interested in reading it – especially since I was working in Chicago during much of that time, and had helped establish an early emissions brokerage there in 1981 (in conjunction with the Illinois State Chamber of Commerce). Our brokerage only lasted about six months — until the funding ran out! — because hardly anyone even knew what we were talking about in those very, very early years of emissions trading. But that early experience as an emissions broker was formative and it ultimately led me to U. Penn to work on applying such market mechanisms to deal with the problem of acid rain.

Perhaps not surprisingly, Dr. Sandor was completely unaware of our early Chicago emissions brokerage efforts. His own efforts were considerably more successful – although truthfully much of that was due to his work in Europe (and the establishment of a sister European Climate Exchange) rather than any U.S. regulatory actions. In fact, most of the CCX activities have now been shut down, because of a lack of environmental regulatory support within the U.S.

I found the book itself quite interesting, primarily because it presented emissions trading from a completely different perspective than my own — i.e., from a financial viewpoint, rather than a technical/engineering one. Thus, for example, there was almost no discussion about marginal pollution control costs of FGD scrubbers or about ambient air quality standards, but lots and lots of info about market liquidity, open interest, and the structure of futures contracts. One reviewer on amazon.com commented about the author’s ‘deliberately self-centered’ approach, calling it a form of ‘radical realism’ and ‘vérité’ that attempts to show events through his own eyes rather than in a truly objective fashion. I’d tend to agree — but given his success, I’d also allow that Dr. Sandor has earned that right, and the book is interesting on its own terms. I’m closely watching what happens with one of the Chinese exchanges his company helped set up. The Tianjin Climate Exchange has been selected as one of the seven pilot schemes for emissions trading in China’s 12th Five Year Plan, and recently obtained $750,000 from the Asian Development Bank to help make that happen.