Low Carbon Economy, 2011, 2, 62-70
doi:10.4236/lce.2011.22010 Published Online June 2011 (http://www.SciRP.org/journal/lce)
Contribution of Finance to the Low Carbon
Economy
Constancio Zamora Ramírez, José María González González
Department of Accounting and Finance, University of Seville, Seville, Spain.
Received February 1st, 2011; revised March 5th, 2011; accepted March 30th, 2011.
ABSTRACT
Given the advent and spread of carbon assets, as well as the rapid development of financial markets and transactions
related with them, this paper intends to achieve the objective of categorizing these phenomena and describing their
main characteristics, in such a way that it can be used as a reference by those professionals and scholars who are in-
terested in the fighting climate change through the world of fin ance. In this line, this paper will review and analyse the
main carbon assets on regulated and voluntary markets, Emission Reduction Purchase Agreements (ERPAs) and the
various structures they may acquire, the role of carbon funds, futures and options over carbon assets, as well as adap-
tation in financial markets, particularly in relation to climate derivatives and disaster bonds. The paper ends with a
proposal of a reference framework that gathers and categorizes different carbon assets, carbon markets and financial
operations traded on these markets.
Keywords: Carbon Markets, Carbon Assets, Carbon Finance
1. Introduction
At the international level, various measures are being
implemented to reduce greenhouse gases (GHGs). Th ese
measures are oriented towards a transition from our cur-
rent economic model to one known as the “low carbon
economy,” thereby separating it from the consumption of
fossil fuels [1]. The goal is to develop a system which is
capable of including the deterioration caused to the en-
vironment by GHG emissions throughout the production
process as a cost of that activity. The two mechanisms
available to achieve this are the creation of taxes on
emissions and the development of a market of tradable
emission rights, the latter of these two alternatives being
the choice made at the international level at the end [2].
Decreasing GHGs and establishing carbon asset mar-
kets has not taken place, in general, as a result solely of
the development of a regulatory framework. For instance,
the voluntary carbon asset market has arisen due to the
specific needs of companies and other organizations to
offset their emissions. The reasons which cause an or-
ganization that does not do business in a regulated sector
to offset its emissions are diverse and include [3]: the
development of the organization’s own social corporate
responsibility and sustainability policy, competitive dif-
ferentiation before their customers, an improvement in its
access to financial resources, and even having influence
on a regulatory framework which is foreseen to become
more burdensome in the future.
Moreover, the use which companies may make of
carbon assets that they obtain by offsetting their emis-
sions may range from the offsetting of internal emissions
while carrying out all or some of their activities, to the
offsetting of external emissions so as to offer
CO2-neutral products, which they believe may be more
greatly valued and better paid by customers.
Carbon assets are a mechanism for mitigation, because
they have come about as a result of an attempt to reduce
the level of GHGs in our atmosphere, with the lon g-term
objective of returning to the levels at which these gases
existed in the early twentieth century. Nevertheless, it
must be highlighted that the climate has already under-
gone changes which undoubtedly affect companies. In
this sense, business profits may be affected as a result of
the temperature variations which lead to greater or lesser
energy consumption. Companies may also suffer signifi-
cant losses of property and assets as a result of natural
disasters, which have become more violent in recent
times. These problems have also given rise to the crea-
tion of financial markets which are generally referred to
as adaptation in financial mark ets [4, 5].
Therefore, as can be concluded from the preceding

Contribution of Finance to the Low Carbon Economy63
paragraphs, becoming familiar with carbon markets en-
tails special difficulty: first of all, because of the diverse
origins of the carbon assets that one can encounter, and
secondly, because of the wide range of transactions that
can be performed in relation with these assets, which can
become quite complex and occur within the environment
of both regulated markets and Over-The-Counter (here-
inafter OTC). Along these lines, the purpose of this paper
is to propose a categorization and structure for carbon
markets, as well as for the financial transactions involv-
ing carbon assets which take place in those markets. It
may serve as a framework of reference for both scholars
and professionals in carrying out their research and pro-
fessional activities, respectively. In order to achieve this
objective, we have performed an analysis of the most
important markets and financial transactions related with
carbon emissions in business practice.
In the upcoming sections, we will first analyze the
different carbon assets referred to as “primary”, which
arise directly from the contractual relations between
companies, or in the case of certain regulatory systems,
between companies and governments. We shall then
structure the different markets in which these assets may
be traded, then categorizing the various transactions that
can be carried o ut within th is structure. We co mplete this
analysis by examining adaptation in financial markets,
then concluding the report with a section containing our
final considerations, in which we provide a summary of
the different market types and the main financial transac-
tions involving carbon.
2. Primary Carbon Assets
A primary carbon asset can be defined as an agreement
(be it legal or voluntary) between two parties, in which
one party grants the other the right to offset an amount of
GHGs emitted into the atmosphere, within the frame-
work of that regulation or contract.
2.1. Regulated or Statutory Markets
First of all, we must distinguish those assets which come
into existence under the protection of required regulation
with which the company must comply. Such regulation
may be imposed by either local governments or by su-
pranational institutions such as the United Nations. In
this sense, the carbon asset does not come into existence
due to a voluntary contractual relationship.
The regulatory alternatives available are the creation
of taxes or the development of a market of transferable
emissions rights, though most legal systems have opted
for the latter by establishing a cap-and-trade type system
[6]. The way this system works is by setting certain
emissions reduction targets, and therefore an absolute
amount of emissions which are to be assigned amongst
the companies subject to that regulation, in such a way
that, when that level is surpassed, the organization will
be fined. However, the organization can avoid being
fined by accessing the flexibility alternatives created
through the systems, or more specifically: the market
itself, to which the company may turn to purchase emis-
sions rights which other companies are selling. They may
do this, for example, because they possess a surplus
amount above and beyond the emissions they produce. A
company may also increase its emissions by obtaining
credits earned as a result of reducing emissions through
projects carried out in other countries.
A market which comes about due to regulation to limit
emissions not only makes the system more flexible, but
also allows companies with higher marginal emissions
reduction costs to participate in the market and acquire
emissions rights from other companies which have lower
marginal costs. In this way, companies also have a fi-
nancing source added to the technological change pro-
vided by the resources obtained by selling surplus emis-
sions rights or credits obtained through projects in third
countries [2].
These assets, because they arise from regional, na-
tional or supranational regulation, are also referred to as
“statutory”. This system allows them to become fungible
more easily, or in other words they can be traded more
easily in an organized market.
At the international level, the regulation of the Kyoto
Protocol (1997) establish es the first period of co mpliance
from 2008 to 2012, at the end of which the signatory
countries must have reduced their emissions to a level
compared with the emissions produced in some year of
reference, which is generally 1990. The European Union,
in particular, has undertaken to reach this goal under a
system which has been called the “shared burden,” hav-
ing established the overall objective of an 8% reduction
as regards to the emissions produ c ed in 1996.
Once the cap is set, each country has to distribute
emissions rights amongst the companies with affected in-
stallations, through National Allocation Plans. Neverthe-
less, the possibility also exists that countries can in crease
their emissions by acquiring rights from third countries.
The companies which possess these rights can trade them
through the European Union Emissions Trading Scheme
(EU ETS) [7]. These assets, known as European Union
Allowances (EUAs), confer upon the company the right
to issue GHGs in amounts equivalent to 1 Tm of CO2
(CO2e)1. Therefore, a company may get rid of its EUA
surpluses for the emissions produced in a specific period,
or acquire these rights to offset some deficit that has been
1Not all GHGs have the same greenhouse effect. For instance, 1 Tm o
f
methane is equivalent to 25 Tm of CO2, 1 Tm of N2O is equivalent to
298 Tm of CO2, 1 Tm of HFC-23 is equivalent to 14,800 Tm de CO2, 1
Tm of SF6 is equ i va l e nt t o 2 2 ,800 Tm of CO2, etc. In general, emissions
rights and credits are specified i n CO2 equivalent units (CO2e).

Contribution of Finance to the Low Carbon Economy 64
produced.
Transactions involving EUAs (as with other carbon
assets that we shall discuss below) may be performed
amongst parties that do or do not have installations af-
fected by emissions limitations, as well as through bro-
kers or platforms where they are traded and generate
market, the most notable of which are:
- European Climate Exchange (ECX).
- European Energy Exchange (EEX).
- Nordpool Powernext.
- Energy Exchange Austria (EXAA).
- Sendeco2.
In order to facilitate compliance with the Kyoto Pro-
tocol commitments, the Protocol foresees various mecha-
nisms to create flexibility, the first and foremost of which
is the potential for trading carbon assets. Similarly, a
company can increase the permitted emissions through
other mechanisms like the following, all of which allow
for the offsetting of 1 Tm of CO2e emitted into the at-
mosphere:
- The acquisition of Certified Emission Reduction Units
(CERs), issued for projects resulting from the Clean
Development Mechanism (CDM), which are mainly
characterized by achieving an emissions reduction in
a developing country (referred to as Non- Annex I
Countries, or in oth er words countries th at have taken
on no emission reduction commitments). CERs are
issued by the United Nations.
- Obtaining Emission Reduction Units (ERUs), which
are the credits granted for the so-called Joint Imple-
mentation (JI) projects for reducing emissions in a
country included in Annex B of the Protocol. The
project’s host country will have its emissions cap
lowered in order to issue these credits.
- Also foreseen in the Protocol and acknowledged by
the European Union is the possibility of offsetting
emissions through Removal Units (RMU) obtained
through carbon sink activities.
Among all these, CDM is the most common. The logic
underlying this mechanism is that developing countries
do not take on reduction commitments, because their
future development involves a significant increase in
their emissions. However, if a company in a developed
country decides to implement a project which co ntributes
to a decrease in emissions in a developing country, then
that developed country could have an increase in its
emissions allowance.
CERs are obtained after a strict verification process in
which not only the veracity of the emissions reduction is
checked; the additional nature of the project is also
measured, in terms of investment and technology. In
other words, the attempt is made to verify that the fi-
nancing obtained through the CERs makes the project
feasible and that the technology is actually transferred to
the country where the project is carried out.
2.2. Voluntary Markets
The assets analyzed up to this point come about within
the framework of regulation that requires compliance,
allowing emissions on the basis of an agreement which
establishes their amount and distributes that cap. How-
ever, there are assets which come about within what are
commonly referred to as voluntary carbon asset markets
[8].
The value of these assets is not determined by the
chance they offer the organization which possesses them
to emit an amount of CO2e into the atmosphere without
being fined, but rather by the added value which a spe-
cific project generates due to the reduction in emissions
which it entails. For instance, the holder of these assets
may use them to offset the emissions produced in its ac-
tivity and offer its customers a CO2-neutral product, in-
creasing its price as a result of this “added value”.
The carbon assets in voluntary markets are normally
created within the framework of a project that contributes
to reducing emissions. Similarly, because they possess
many particular features, the trading of these assets is
much more limited. An exception can be found in the
Chicago Climate Exchange (CCX), where companies
voluntarily commit to follow a system by which they
undertake to respect certain maximum emissions levels,
and these assets can be traded in the market.
In voluntary markets, carbon assets are usually re-
ferred to as Verified Emission Reduction units (VERs)2,
because they usually undergo some sort of verification
process, which verifies whether they are compliant with a
specific standard, such as the Voluntary Carbon Stan-
dard, the Voluntary Gold Standard, Gold Standard or
VER+. Likewise, there are registries that to guarantee
that the same amount of reduction produces one single
emission credit. These registries are normally developed
by the operators of the corresponding standard them-
selves.
However, voluntary markets entail significant added
risks. First of all, the value of the assets is more greatly
dependent upon factors such as the type of project which
generates them, their verification standards, the country
in which the project is carried out, etc. This makes them
less fungible and, as a result, the potential for trading
them is substantially lower. Secondly, they bear non-
compliance risks, such as selling the same credit on sev-
eral occasions, selling them in the initial phase of a pro-
ject which never ends up producing the carbon asset at a
later time.
2If no verification process is completed, they are referred to as Emis-
sion Reduction units (ERs).
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Contribution of Finance to the Low Carbon Economy65
It can be highlighted that carbon markets have become
the main instrument in the fight against climate change,
as opposed to other instruments such as taxes on GEI
emissions. Furthermore, regulated cap-and-trade ma r k e t s ,
such as that of the European Union, are the most popular
due to the minimization of marginal costs in emission
reduction and the additional financing contributed to-
wards technological change aimed at a low-carbon eco-
nomy. Specifically, in the European market, apart from
EUAs, CERs have become the main mechanism foreseen
by the Kyoto Protocol to grant flexibility to the emissions
trade. In order to facilitate operations on carbon markets,
over the last few years there has been a rapid develop-
ment in carbon asset negotiation platforms. Finally, de-
spite the existence of voluntary carbon markets, where
the development of standards to verify carbon assets is
highly relevant for the reduction of consequent risks, of
significance is the fact that the level of negotiation of
these risks is slight in comparison with regulated markets
[9].
3. Emissions Reduction Purchase
Agreements (ERPAs) and the Financing of
Projects Which Produce Carbon Assets
Several of the aforementioned carbon assets come about
through projects which lead to a decrease in emissions,
with added financing obtained by transferring these as-
sets. This financing is usually obtained through specific
agreements known as ERPAs. These contracts basically
consist of the commitment assumed by a carbon asset
investor to acqu ire thos e produced th roughou t a period of
time specific in the contract, in exchange for a specific
amount.
ERPAs do not have a pre-determined financial struc-
ture. However, they normally invo lve the acquisition, for
a specific term, of the carbon assets created through a
specific project, generally one of clean development
(CERs), establishing the number of assets to be delivered
per year and the price to be paid for them.
Therefore, ERPAs may take on very different financial
structures, because it is the parties (project promoter and
financier) who define what they consist of, an d therefore
they depend upon their investment and financing needs.
In some cases, third parties may even become involved
[5].
As for CERs, the price which is paid for them is a
fixed amount, though indexing or optional clauses may
be established which limit or activate the variability in
their price. In this sense, we offer a list of the most
commonly used structures below, though this list is not
necessarily complete, because one may find other new
structures or combinations of structures, since the market
is undergoi n g con st a nt development:
- Fixed price, when the CERs (or whichever other car-
bon assets) are to be acquired at a price per unit es-
tablished in the ERPA.
- Indexed price, when the price at which the assets are
acquired will vary depending upon the changes in
variables or prices, such as:
 The value of those assets on secondary markets.
 The price of a specific raw material, such as petro-
leum, coal, natural gas, etc.
 Interest rates, inflation rates, etc.
- Floor and/or cap clauses. Price indexing may lead to
the introduction of other clauses which control varia-
tion:
 Floor: this means a minimum payment for the car-
bon assets, regardless of whether the reference
variable involves a lesser amount. However, the
price to be paid would potentially go on an increas-
ing path.
 Cap: unlike the preceding, the variation in price
would have a maximum in its amount.
 Collars: consists of a combination of the two pre-
ceding elements, or in other words, the price to be
paid will have a minimum but will never surpass an
established maximum, with the advantage that, for
the assets’ buyer, this structure is less expensive,
since the buyer needs not assume the considerations
for setting a minimum amount in the contract.
At the same time, a project’s financing may be related
with carbon assets that are generated in the future, in
which case certain structures like the following may ap-
pear:
- Monetization: this involves obtaining a volume of
funds in advance, before the project produces the
CERs or other carbon assets. Through monetization,
the financial entity, or market operator where appro-
priate pays for the assets in advance, instead of
awaiting their delivery to reimburse them, thereby
becoming their future possessor. Nevertheless, the
amount received must be covered, either in a corpo-
rate manner or by any other asset. In the event that
sufficient CERs are not generated to cover the amount
received, the promoter will be forced to complete the
coverage of that amount.
- Collateralization: in these cases, the financing is actu-
ally obtained from a third party unrelated to the
ERPA, which will not become the future title-holder
of the CERs (or other carbon assets). However, the
financing received will be guaranteed precisely by the
funds which are obtained with in the framework of the
ERPA contract. In a certain way, therefore, one can
say that the ERPA is “monetized.” The guarantee to
return the financing received may be completed by
others grant ed by the p romoter.

Contribution of Finance to the Low Carbon Economy 66
- Leveraged carbon finance or the financing of projects:
the financing received is guaranteed exclusively by
the funds generated through the project, which is why
this is also referred to as financing “without re-
course.”
Last of all, we must point out the role played by in-
vestment funds in these types of projects. Social aware-
ness about climate change has also come to determine the
way in which certain funds invest. For instance, invest-
ment funds which are known as “green” exclude or
minimize their investments in projects and companies
which are especially pollu ting, establish ing ratings on the
sustainability of th e companies in which they inv est. One
can also distinguish those hedge funds which specialize
in acquiring future carbon credits at a very low price by
taking part in projects to reduce emissions, which may
obtain a significant bonus on th e sale of the cred its which
they generate.
However, those which have taken on the most impor-
tance in developing CDM projects are the so-called car-
bon funds [10]. These funds attract resources from both
the private and public sectors, investing them in projects
which generate carbon credits through the flexibility
mechanisms in the Kyoto Protocol, so that their partici-
pants can use them to offset their emissions and they can
live up to their commitments. Therefore, their investors
do not earn cash returns on them (though there is a po-
tential for this), but instead they receive CERs, for in-
stance as the return on their investment.
As stated in this section, ERPAs have become a rele-
vant instrument for carbon market operations and may
adopt different structures, particularly in relation to
CERs. Furthermore, different structures have been de-
veloped in order to relate a project’s financing to the
carbon assets it will generate in the future. Also, we can
highlight the significant role played by “green” invest-
ment funds and, particularly, carbon funds, to finance
investments based on a low-carbon economy.
4. Carbon Asset-Based Derivatives
Primary carbon assets may give rise to a wide range of
transactions which in many cases become other assets in
and of themselves. For this reason, one can also point to
the existence of secondary carbon assets, or in other
words, those which are created on the basis of an invest-
ment in other carbon assets [4].
In general, the price of primary carbon assets is deter-
mined by the trading values in organized markets. In the
case of EUAs, for example, prices of more than 30 Euros
have been reached, with floors under 0.50 Euros having
been reached, as well. As a result, the market risks for
companies are significant, and assets with more or less
complex derivative structures have been developed.
Nevertheless, these structures may also be contracted
amongst private parties (OTC), especially by banking
institutions which already have very sophisticated prod-
ucts. Likewise, most of the carbon asset financial mar-
kets offer derivatives on them. The following structure
may be considered the most common:
- Futures: this consists of setting a price at which a
specific carbon asset will be traded (EUAs, CERs,
etc.) at the end of a specific time period (3, 6, 9, 12
months, etc.). Contracting futures is inherent to or-
ganized markets such as the ECX, in which futures
are traded on both EUAs and on CERs. These con-
tracts are structured into lots of 1,000 Tm, with deliv-
eries in the months of March, June, September and
December of each year. The buyer and seller view-
points of the market are very different. Whereas the
buyer is looking out for increases, because they want
to secure the price of the carbon asset that they will
be acquiring at some future time, sellers look out for
decreases, intending to secure the price at which they
will sell the asset through the contract. These con-
tracts, for instance, make it possible to secure the
margin that will be obtained from the sale of the
CERs produced by a certain project. Another market
in our surrounding environment which markets this
product is the EEX.
- Options: in this case, the buyer of the option acquires
the right to purchase (these options are known as calls)
or sell (known as puts) the carbon assets at a fixed
price in the contract, in exchange for payment of a
premium to the seller or issuer of the option. The
ECX is a platform in which one can find products
with this structure, on both EUAs and CERs.
Likewi se, an EUA-CER swap is al so possible, like th e
one offered by Sendeco 2, in which two parties exchange
one set of assets for another. This transaction is justified
by the difference existing between the two assets, given
that CERs are traded at a somewhat lower price than
EUAs, but their value for the purposes of offsetting
emissions is practically the same. This strategy wo uld be
advisable for a company, for instance, that possesses
EUAs, but whose emissions may be offset in the same
way with CERs, while receiving compensation in cash by
way of the swap.
The Repo-Swaps structur e, with bo th EUAs an d CERs,
normally occurs in response to an OTC transaction be-
tween a GHG issuer and a financial institution. The is-
suer may be the possessor of a series of rights which it
does not foresee it will use until a certain time period
elapses, and therefore it assigns them to a bank. As for
the bank, it will deliver to the issuer of the GHG the dif-
ference between the cash price and the trading price at
the time of maturity.
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Contribution of Finance to the Low Carbon Economy67
Transactions have been executed on carbon markets
under basic financial structures, primary and derivative,
as well as other more specific carbon asset structures.
The performance of regulated markets after 2012, the
final date foreseen in the Kyoto Protocol, together with
that of voluntary and regional markets, will entail greater
complexity in these contractual structures, requiring the
international unification of their legal implications.
5. Adaptation in Financial Markets
Up to now, we have been discussing primary assets, de-
rivatives and transactions of a fin ancial nature which can
be used by companies to mitigate climate change. How-
ever, an emissions level has already been reached which
will not be reduced in the short term, and it is assumed
that this change will have effects on temperatures, pre-
cipitation, storms and other weather phenomena that may
affect businesses both adversely and advantageously. In
this respect, financial mechanisms have already been
created, as well, to be able to convey or exchange these
risks. This conveyance of risks may be extended to in-
clude catastrophes, such as a hurricane, or other phe-
nomena, regardless of whether their origin lies in climate
change, and regardless of whether they are of a meteoro-
logical nature, as may be the case with earthquakes or the
eruption of a volcano.
Therefore, while the markets described above are ori-
ented towards reducing GHG, therefore having been
given the name of “mitigating” the markets we will be
describing in this section are referred to as “adaptation”
because they make it possible to lessen the adverse ef-
fects which the climate and other natural phenomena
have on companies. Basically, two types of financial
alternatives can be distinguished for managing these risks
[4,5]: climate derivatives and disaster bonds.
5.1. Climate Derivatives
Climate derivatives come about because a certain
weather phenomenon may affect different companies in
different ways. For example, high temperatures may
benefit energy companies due to the increase in demand
by companies and private individuals when they turn on
their air conditioning devices. Similarly, coastal hotel
businesses would benefit. On the other hand, high tem-
peratures may harm, for instance, companies with agri-
cultural interests, tho se that own office buildings or even
shopping malls, because their electricity costs skyrocket.
Other industries sensitive to weather and climate are
construction, entertainment, clothing and drinks. The
most sensitive sector of all is that of energy, for obvious
reasons. In general, a company’s profits will be sensitive
to these phenomena if its sales or some of its cost com-
ponents vary i n response thereto.
Companies have managed to develop mechanisms to
manage these risks. The most common and traditional is
insurance, but insurance only covers risks like frost, hail
and wind, of an extreme nature, and damage must be
caused to the company’s property. It would be quite dif-
ficult to cover, for example, a decrease in sales during a
snow season that sees low levels of precipitation . Climate
derivatives can cover such risks, though. For instance, in
the event that one single climate risk affects two compa-
nies in different ways, these companies can swap the risk
through a futu re, to provide one example3. In that way, if
the temperature rises above a certain level, the buyer of
the future may receive a payment from the counterpart
selling the future.
The underlying factors, in addition to references to
temperature, may include other variables, such as snow-
fall, hurricanes, frost or wind. In such contracts, a period
must be established for observing the variable, as well as
the weather station of reference whose measurements
will determine the payments made pursuant to the con-
tract.
The most common structures are futures and options.
In futures, the parties swap the amounts in one direction
or the other depending upon whether the climate index
rises above or falls below the strike. With options, these
are usually referred to as calls or puts. In the case of calls,
the buyer, after payment of a premium, receives an
amount for each point in which the index of the cli-
mate-related underlying factor rises above a certain ref-
erence level (strike). On the contrary, in puts, the buyer
of the option receives an amount based on whether the
index of the climate-related underlying factor falls below
the strike.
The beginning of the climate derivatives market was
OTC, though it has been on the rise, with the develop-
ment of organized markets, the epitome of which is cur-
rently the Chicago Mercantile Exchange (CME). Even
greater growth is expected for these markets in the future,
given the sensitivity which economic activity in general
is undergoin g wi t h respect to changes in climate.
3In the specific case of temperature, the technical reference is not de-
grees centigrade, but rather HDDs (Heating Degree Days) and CDDs
(Cooling Degree Days). HDD is the number of days in which the tem-
p
erature falls below a pre-established level. This measurewas created
to determine efficiency in the energy use of a building. As for CDD, it
refers to the days in which th e temperature rises above a pre- e st a bl is h ed
level. These two indices may have values even greater than 1 point pe
r
day, because each degree-day in which the temperature distances itsel
f
from the reference, the indicator goes up by one point. Therefore, in the
case of HDD, if the reference level is 18˚C and the average temperature
of one day is 16˚C, the index would go up by 2 points that day (greater
heating use is needed). As for CDD, it is used to determine energy use
in the event of excessive heat, or in other words, by the need to use air
conditioning. The reference temperature is normally 18˚C /65˚F, below
which a building requires heating. In many cases, these indices are
calculated cumulatively for time periods, normally by months or sea-
sons.

Contribution of Finance to the Low Carbon Economy 68
5.2. Disaster Bonds
The fundamental characteristic of these bonds is that
certain payments thereof (normally the principal) do not
take place if a certain event of a catastrophic nature de-
fined in the bond issue takes place. Normally, the issuers
of these bonds belong to the insurance industry, with
interests in areas which would have to face the payment
of claims resulting from huge losses, if a hurricane,
earthquake, etc. were to take place.
The appeal of these bonds is that they reward the in-
vestor with much higher interest rates than the market
commands in similar risk issues (normally the three-
month LIBOR rate plus a differential, fluctuating be-
tween 3% and 20%).
Thus, adaptation in financial markets have comple-
mented mitigating markets by covering the impact ex-
pected from climate change due to the emission levels
already reached. Within adaptation, of interest are both
climate derivatives, which allow companies to establish
futures and options to offset the risks derived from the
impact of climate change on their economic activity, and
disaster bonds, linked to catastrophic events. In the future,
these financial structures are expected to develop further
as the effects of climate change gradually worsen and
become more apparent.
6. Final Considerations
This paper has reviewed and analysed the main carbon
assets that are traded both on regulated and voluntary
carbon markets, as well as the financial structures and
transactions carried out therein. Given the diversity and
complexity inherent to this field, also involved in the
fight against climate change, Table 1 is hereby intro-
duced as a reference for the categorization of the various
assets, markets and financial operations referred to.
Regulated carbon markets have become a basic instru-
Table 1. Carbon markets, carbon assets and financial transactions.
According to
action on climate
change System Market in which
the transaction is
performed Type of operations - structuresExamples of markets and transac-
tions
Cash transactions ECX, EEX, SENDECO2
Futures ECX, EEX
Organized markets Options ECX
Cash transactions
Sale/purchase of EUAs or CERs directly
between private parties and later
registration.
Acquisition of a shareholding in a
carbon fund.
Term forwards ERPAs
Options
Certain clauses in ERPAs.
Contracts between private parties (e.g.,
an investor and a financial institution)
involving puts (or calls) on emission
rights.
Regulated
(In this study, the
Kyoto Protocol and
the EU ETS) OTC
Others
Monetization of ERPAs
Collateralization of ERPAs
Leverage Carbon Finance
EUA-CER Swaps
Repo-Swap Transactions
Cash transactions
Futures Voluntary Organized markets
Options CCX
Mitigation
OTC
Transactions in voluntary
markets are usually with OTC,
though they are o p en t o a n y
structure.
ERPAs on VERs
Cash Issue of disaster bonds
Futures Organized markets Options Climate derivatives contracted at CME
Adaptation Voluntary
Futures
OTC Options
Traded climate derivatives, suc h as
those between a company and an insurer
or bank.

Contribution of Finance to the Low Carbon Economy69
ment in the fight against climate change, and the cap-
and-trade markets are the most developed [2]. None-
theless, this expansion has been of a qualitative nature,
because fundamentally the types of carbon assets and
financial trading transactions have been increased [4].
The main difficulty lies in getting these markets to
achieve an acceptable depth and breadth. This fact would
truly indicate that the cost of climate change as an exter-
nality is being integrated into the eco nomy. Furthermore,
of interest is the creation and development of voluntary
carbon markets, although their trading volume is cur-
rently well below that of regulated markets. In this line,
the distribution and consolidation of standards for the
verification of carbon assets traded on voluntary markets
is the key to growth.
As well as the emission rights traded on carbon mar-
kets, CERs have become a very important mechanism to
endow the emissions trade with flexibility, as foreseen in
the Kyoto Protocol. In this regard, ERPAs on CERs have
become very important in carbon market operations, and
various structures have been developed. Along these
structures, also of interest is the distribution of futures
and options over emission rights and CERs as the main
secondary carbon assets.
Likewise, climate derivatives and disaster bonds are
becoming a useful instrument to enable organizations to
manage the economic and financial risks derived from
the effects of climate change, although these instruments
are expected to be more widely distributed as these ef-
fects gradually become broader and more apparent.
Given the diversity and complexity of carbon markets
and the financial transactions they invo lve, a key issue is
the development of regulations to endow the emissions
trade system with warranties, stability and security. In
this regard, a priority is progress towards a global
agreement to succeed the Kyoto Protocol, which will
only apply until the year 2012. To this effect, the next
Conference of the Parties scheduled for late 2011 in
Durban (South Africa) will be crucial. Furthermore, pol-
icy-makers should make an effort to develop those issues
of the regulatory framework that guarantee and encour-
age transparency in the financial transactions that in-
volved several types of carbon assets.
This paper is mainly restricted by its focus on carbon
assets and markets based on the Kyoto Protocol, such as
the EU ETS. In this regard, we should acknowledge the
significant progress being made in other national and
regional markets, in different countries, such as the US,
Japan or New Zealand. The reason why the main refer-
ence used herein is the EU ETS is mainly because it was
the first international emissions trade market to be cre-
ated, having become since then a worldwide reference in
the global performance of carbon markets. Furthermore,
right now, the EU ETS is by far the most relevant market
by carbon asset trading volume [9].
Finally, this paper may be potentially improved with
further research on the following issues:
- The behaviour of carbon markets that are being estab-
lished in leading Eastern powers, such as China, as
their economic growth becomes an important deter-
mining factor in world economic gr owth.
- The variables that explain the price of carbon assets,
particularly any interactions with other commodities
to which they are linked [1 1, 12].
- The end purpose of carbon markets is an effective
transition towards a more sustainable energy model.
In order to reach this objective, in policy-making it
will be necessary to have more complex tools to se-
lect techniques, processes or more adequate price
structures, instead of other more traditional analytical
models, such as discounted cash flow method [13].
- As regards legal considerations, research should help
develop an international standardization process to
record carbon assets in financial statements. From an
accounting perspective, there is a great deal of debate
about the way these assets should be considered [14,
15]. More specifically, there are questions about
whether they should be treated as intangible assets,
inventory, or financial instruments. As for the value
which they are assigned, there is also debate over
whether these elements must appear at their cost or at
their fair value, and depending on which is the case,
how any changes in valu e should be dealt with [16].
- Another significant legal issue is the taxation of car-
bon asset transactions [2]. Including the profits on
these transactions in the accounting results of the fi-
nancial year may lead to differen t taxations. Similarly,
none of indirect taxes created by these transactions
have been harmonized yet. Further research on these
issues would provide greater transparency and uni-
formity to the tax effects of different carbon asset
transactions.
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