Potemkin Carbon Markets to Direct Investments

By Hazel Henderson, President, Ethical Markets Media (USA and Brazil)

The Kyoto Protocol and its global carbon emission-trading scheme
expires in 2012.  The World Bank in State
and Trends of the Carbon Market
found that the market declined in 2010
and is at a crossroads, due to loss of political momentum.  There are many new signs of a re-focusing the
20 year international effort to craft national policies and international
agreements to curb human (anthropogenic) caused changes to the Earth's climate.  As a longtime theorist and participant in
this hugely complex set of issues, I will try to connect most of the dots
necessary to explain why the Kyoto Protocol design led to the disappointing UN
conferences at Copenhagen (2009) and Cancun (2010).
Unlike the scorn UN diplomats and many NGOs heaped on
"fragmented" pacts and regional "side deals" that have
emerged, I applaud them, as does expert David Victor in Global Warming
(2011).  These smaller
"clubs" of powerful emitter nations are now creating pragmatic
agreements, such as those between China
and the USA to cooperate on
green technologies and Norway's
pact with Indonesia
to cooperate on managing and protecting forests.  Such bottom-up deals reflect local and
regional realities and may involve more logically, other pollutants such as
soot, ozone-producing VOCs and methane.  Curbing
these pollutants can actually lower total CO2 emissions faster and cheaper while protecting the
health of those directly exposed, such as providing solar cook
to rural women to avoid families inhaling smoke.

The Kyoto Protocol's targets for controlling CO2 emissions worldwide by
creating a global emissions trading structure was a visionary and ingenious
plan devised by brilliant economists and mathematical modelers, notably Dr.
Graciela Chichilnisky of Columbia University, inventor of catastrophe bonds. Kyoto promised financial markets a bonanza by creating a
new asset class for carbon and many CO2
derivatives, auctionable
emissions permits, free allowances, offsets and the alphabet soup of CDMs,
CERs, secondary CERs, RECs, along with trade on new exchanges: ETS, ECZ, RGGI,
as well as those in China, India, Brazil,
Australia and New Zealand.  Today, with evidence that CO2 emissions increased to
the highest ever in 2010 of 30.6 gigatons from the International
Energy Agency
(IEA), new approaches are vital.  Carbon markets are blamed for scandalous
profits on CDM offsets related to perverse incentives encouraging the burning
of HCFC-23, a greenhouse gas 11,700 times more polluting than CO2 garnered by JP Morgan
Chase, Citigroup, Goldman Sachs, Rabobank, Fortis, along with energy companies,
E.ON, Enel, Nuon, RWE and Electrabel.
European governments of Italy,
Holland and Britain, along with these
companies, bought these CDM "offset" which actually increased
polluting emissions.  Only whistle-blowing
by NGOs brought this to the attention of Jos Delbeke, director general of the
European Commission for Climate Action, who called for ending "usurious
profits" that are "repugnant" (IPS).  Meanwhile, a judge in California is forcing
the state to analyze alternative measures to its proposed "cap and
trade" plan which experts at a recent carbon expo agree will delay carbon
trading there (Reuters).  The upcoming conference in Durban, South Africa,
is expected to be a showdown over the Kyoto Protocol and between developing
countries and NGOs versus fossil fuel lobbies and carbon traders.

The deeper reasons why this theoretical Kyoto vision of a seamless global emissions
trading market, which could provide efficient reductions of actual CO2 emissions, has failed,
are explained by Prof. Victor.  Creating
new markets (and most markets are created by humans not by God's
"invisible hand") is in reality, a complex governmental task
involving new laws, monitoring compliance, fairness and regulating free riders.
Powerful incumbent fossil-fueled industries must be brought into compliance
while compensating blameless low or non-emitters, mostly in developing
countries.  The financial markets geared
up to compete for their share of trading the new carbon "asset class"
after the UN Framework Convention on Climate Change was set up in Kyoto in
1997.  Trading desks at most big banks on
Wall Street, in London
and a bevy of new firms appeared – as well as early voluntary trading platforms
like the Chicago Climate Exchange (CCX) now merged into ICE.

The economic theory behind Kyoto's
global emissions trading followed the same expansion of global financial
markets after the deregulations of the 1980s led by Britain's
Margaret Thatcher and US
President Ronald Reagan.  This market
ideology was underpinned by the Arrow-Debreu model assuming these expansions
were part of the desirable goal of "market completion."  This goal is now questioned by the bubble in
financial markets which burst in 2007-2008 and the rise of theories of the
global commons which acknowledge vital global public goods beyond the reach of
markets (Transforming Finance).  Such planetary resources as air, oceans and biodiversity
are essential to human survival and indivisible common property along with the
electromagnetic spectrum.  Tax payers' publicly
funded infrastructure of communications networks, satellites and the internet are
all crucial platforms underlying global finance.

The financial debacles of 2007-2008 called the huge
expansion of global financial trading into question as shadow banking,
securitization, high-frequency trading and derivatives grew as a percentage of
GDP in Britain and the USA.  Processes of securitization and financial
innovation created ever more exotic instruments still proliferating along with
volatility.  After the May 6, 2010,
"flash crash" on Wall Street, it became clear that increased
high-frequency trading provided only "faux liquidity" which
disappeared when needed.  Not
surprisingly, CO2 emissions
trading came into question as well.  Even
conservatives and Republicans in the US taunted "if you like credit
default swaps, you're going to love carbon derivatives!"  CDM offsets were too often revealed as
fraudulent "hot air" credits.
Powerful electric utilities gamed the ETS and wangled so many free
emissions allowances from compliant politicians, they actually crashed the
price of CO2 on that
exchange.  Rolling
Matt Taibbi targeted carbon derivatives trading as Goldman
Sachs' next big attempt to create a new bonanza after the housing mortgage securitization
game exploded.

never produced that envisioned global emissions trading regime despite all the
expectations and hype.  Instead, diverse
national, regional, local and corporate interests devised their own mixes of
trading, direct regulating and taxing of emissions, as analyzed by David Victor
in Global Warming Gridlock.
However, he misses most of the reasons emissions trading fails that stem
from inside the box of finance itself and all the problems and failures
revealed by the 2007-2008 crises – still unresolved by Dodd-Frank, Basel III,
G-20, the European Commission and British regulators.  Pragmatic use of the other market mechanism:
carbon taxes, was promoted by The Economist and others including the May
2011 report of Australia's Climate Commission, The Critical Decade.  Citing effects of climate change already
impacting Australia
with extreme weather, the Commission supports Prime Minister Julia Gillard's
plan to tax carbon emissions by big polluters after the failure of cap and
trade schemes.

The international diplomatic efforts from Kyoto
to Copenhagen to Cancun
and the agreements on binding caps, targets and time tables have produced the
perverse results mentioned earlier.  Their
rigidity caused national governments, which could not control domestic sources
politically, to simply renege on their commitments, as Victor documents.  He also explains why the climate issue is
less an environmental issue than one of the energy sector – and more amenable
to WTO-like negotiations on trade – an imaginative new approach.  Many engineering and technology approaches
have been hampered by incumbent fossil-fueled industries and sectors.  It's time to acknowledge as president Jeffrey
Leonard of the Global
Environment Fund
does in Washington Monthly, the 90% of historic
subsidies to fossil and nuclear energy that dwarf those to solar, geothermal,
wind and energy efficiencies.  Feed-in tariffs
and renewable energy portfolio standards which address CO2 emissions directly were needed to help offset the
blockages to growing and scaling the many technologies based on capturing the
sun's free daily flow of photons: abundant, renewable solar, wind, ocean as
well as geothermal sources.  The success
of such policies in Britain
has created energy-efficiency companies that complete globally (NY
) in this industry, now providing rapid paybacks ("Efficiency:
Bedrock of Green Transition

Transition to uses
of lower-carbon natural gas and co-generation are necessary in the short run.  The effects of Japan's
Fukushima plants make unlikely future reliance
on nuclear energy with Japan
now shifting to wind, solar, efficiency and I expect also its abundant
geothermal resources.  Germany has also shifted from
nuclear to expanding its green economy.  Carbon
sequestration of CO2 from burning coal is unproven, hugely costly
and reduces the energy efficiency of power plants.  China's research on in situ methods
of mining coal may prove viable (Atlantic
Monthly, 2010
).  Most conventional
analyses miss the carbon sequestration possible from well-managed lands and
forests, as demonstrated by Dr. Allan Savory's holistic management approaches
to land-restoration in many countries (savoryinstitute.com).  Conventional centralized models still overlook
the many efficiencies in distributed, smaller scale solar PV, thermal CSP, wind,
shallow geothermal, and low-head hydro now gaining market share from central
electric utilities.  Such Small is
approaches reflect E. F. Schumacher's deep analyses of issues of
scale and how decentralization yields many more jobs while saving capital and
revitalizing communities.

Thus, I agree with political
scientist Victor's characterization of current emissions trading as
"Potemkin markets" and that carbon taxes are the best market
mechanism – allowing governments to set prices rather than quantities of
pollution emitted.  He also  acknowledges realistically that direct
regulations will always have a place and that these will grow – along with the
growth of regulation-driven industries in recycling, remanufacturing and reuse,
as well as companies like Waste Management.  The recycling industry in the USA employs
more people today than the auto industry (E Magazine).  I recall speaking on a panel with Waste
Management's president who began by acknowledging that his was a
regulation-driven company in a regulation-driven industry.

Old arguments about
markets versus regulation (vilified as "command and control") are now
countered by the truth that all economies are mixed (mixtures of markets and
regulations) determined by their value-systems I termed "cultural
DNA" (Politics of the Solar Age, Building a Win-Win World).  These realities emerge quickly with on-the-ground
field trips rather than in GDP and macro-economic aggregations as well as more in-depth
understanding of energy markets and technology options.  All these real world details were researched
by the US Congress Office of Technology Assessment (OTA), multi-disciplinary
studies of technological choices and second-order consequences, from 1974 until
1996 when Republicans, led by then Speaker Newt Gingrich, shut OTA down.  The OTA's many ground-breaking studies of all
these issues are now archived at the Government Printing Office, the Library of
Congress, Princeton University, University
of Maryland and at the
Henderson-Schumacher Library at Ethical Markets Media in St. Augustine, FL.

served on the
Technology Assessment Advisory Council of the OTA from its inception in 1974
until 1980 and helped develop the systems approach to technology assessment –
now emulated in many government and academic settings worldwide.  From this research experience, I learned that
the most systemic approaches to climate change would be to tax all pollutants
(not just carbon or its CO2) by shifting taxes from incomes and
payrolls in revenue-neutral ways ("Introduce Green Tax"
Christian Science Monitor).  Such new approaches are now offered by US
Senators Maria Cantwell (D-WA) and Susan Collins (R-ME).  So far, powerful incumbent fossil fuel and
nuclear lobbies have prevented this logical approach – far superior to capping
and trading emissions schemes which they promoted then captured.  The Waxman-Markey bill in the US Congress in
2008 failed due to this gaming by incumbents, leading to giveaways of emissions
permits that were supposed to be auctioned, distrust of the big polluters and
Wall Street and the impossibility of meeting Kyoto targets and timetables.

The UN Climate
Summit in Copenhagen
was thus set up by over-expectations for the train wreck that occurred.  Projecting this, Ethical Markets had begun
tracking private investments in green companies and technologies since 2007 in
its Green
Transition Scoreboard
®.  Our first
total of $1.6 trillion already committed and in the pipeline, helped push the
pragmatic side agreements, also favored by many NGOs and the Climate Bonds Initiative, the Climate Prosperity Alliance, CERES, IIGCC
and other investor groups.  They included
agreements between the US
and China
on sharing low-carbon, green technologies and the government commitments of
multi-billion dollar funds for low-carbon investments, mitigation and
adaptation.  Government-pledged funds
have not yet materialized – largely because obsolete economic models see them
only as "costs" since they omit multiple "externalities."  The Stern
showed that these failed economic models had created the world's
largest market failure.  Direct
investment by conventionally trained portfolio managers were still inhibited by
these false models ("efficient markets," "rational actors")
which omitted externalities.  Thus, the risks
were misunderstood in their overreliance on Value at Risk models – failing to
see the real costs overhanging the balance sheets of polluting companies.  As quantitative easing in Britain and the USA
printed money for big banks which failed to "trickle down" to
revitalize Main Streets, it became clear that such future funds should be
directed at investing in greener, future economies (Planck

Governments were
also misled by these incorrect economic models still underlying portfolio
analysis and GDP national accounts (GDP:
Grossly Distorted Picture
).  All fail
to account for the costs avoided by direct investments in growing greener
economies.  While initial capital costs
are higher for all new technologies, in the case of solar, wind, ocean,
geothermal and other renewable energy, the fuel is free.  Beyond climate stabilization, green
development promotes health and avoids huge costs of remediation, mitigation
and other "defensive" strategies to both companies and governments.  Further evidence of how omitting
"externalities" can lead to systemic inefficiencies is the May 2011 UNEP
report Metals
Recycling Rates
, documenting the waste, unnecessary over-extraction
across most of the world's mining and manufacturing – and the overlooked
opportunities in re-manufacturing, re-use, recycling and product redesign.  At last, the Inter-American
Development Bank
(IDB) is learning from cities, notably pioneer Curitiba, Brazil,
and other cities in Argentina,
Bolivia, Columbia
and Peru
that the 4 million informal workers who recycle materials can be properly
compensated as a vital part of the global recycling industry.  Job creation and qualitative, healthier
growth was also highlighted in the OECD report on Global
Green Growth

Ethical Markets' Green
Transition Scoreboard
® has become a focal point for private retail and
institutional investors to analyze the growth of green sectors and deepen their
due diligence using updated asset valuation models (Updating
Fossilized Asset-Allocation Classes
It provides a guide to the winning technologies that are part of the
evolutionary succession from the 300 years of fossil-fueled Industrial Age to
the cleaner, greener, information-rich Solar Age.  We have
that pension funds and other institutional investors shift at
least 10% of their portfolios away from risky hedge funds and commodity ETFs to
investments in growing green companies.  The
report for fourteen global institutional investors representing AUM of over $2
trillion called for a similar switch of 40% of their assets as beneficial for
both hedging climate risks and in opportunities to share in the green
transition.  John Doerr of US
venture capital firm Kleiner Perkins estimated
this to be nothing less than the $45 trillion reindustrialization of the world's
economies.  The CERES investor
coalition's letter to its members and other shareowners stresses its Roadmap to
Sustainability.  Mayor Michael Bloomberg,
along with 40 other mayors of the world's largest cities (which consumes 2/3rds
of the world's energy and emit over 70% of greenhouse gases), meeting in Sao
Paulo , will join the Rio+20 Summit in Rio De Janeiro in 2012 in promoting the
shift to a green economy and sustainable jobs (C40
for Rio+20

We agree that this
green transition is necessary, viable and inevitable – as those "Potemkin
markets" for trading carbon have failed to even slow the total carbon
emissions ("Worst-ever
Carbon Emissions
," IEA).  Private
investments now at over $2
are still leading the way and encouraging pension funds, as well
as governments and international financial institutions to set up guarantees
and green bonds.  The leadership of UNEP-FI in helping create the UN Global Compact and the UN Principles
of Responsible Investment (UN PRI, with 800
firms and assets under management of over $25 trillion) has been unappreciated
and hardly mentioned in mainstream media.
UN PRI has now helped launch reforms in business school curricula,
similar to the RI
in Australia.  These curricula
reforms will address the blockage of obsolete portfolio management and
asset-allocation models ("Changing
the Game of Finance
," SRI in the Rockies) by
offering re-training courses for portfolio managers in ESG "triple bottom
line" accounting and integrated valuation models of EIRIS and the Global Reporting Initiative (GRI).  In truth,
there are few "black swans" or "perfect storms" since these
labels are simply excuses, concealing narrow, inadequate models and the
pernicious practice in economics and too many business models of
"externalizing" social and environmental costs (World
).  Responsible,
ethical investors developed the new accounting protocols in the GRI.  Accountants and micro-economists developed
the new models at the company level, while the LSE's Paul Woolley Center for
the Study of Capital
Market Dysfunctionality
promotes a set of
Principles for Institutional Investors to address the glaring conflicts of
interest in the financial system between agents and their principals so
familiar in corporate law (Future
of Finance review

Today, at last,
governments are facing up to the task of similar reforms to national accounts:
GNP/GDP stemming from the Beyond GDP conference in the European Parliament in
2007 (www.beyond-gdp.eu) and the Ethical
Markets-Globescan surveys
showing large majorities in 12 countries, of the
public's understanding of the need to include indicators of health, education,
poverty gaps and the environment in GDP and all national indicators.  The OECD's new Better Life Index moves in the
right direction – and its next revision will include indicators of poverty gaps
(GINI coefficients) as cross-cutting measures of inequality and gender.  Relying on GDP's averaging of incomes will
give way to more granular views of other forms of wealth beyond money: healthy,
educated workforces; efficient infrastructure, and productive ecosystems, all
set at zero in GDP.  Luckily, we can now
overcome the persistent objections of macroeconomists ever since 170 nations
agreed to reform their GDP in Rio's Earth
Summit in the 1992 Agenda 21, Article 40.
With the development of the internet and the web, we no longer need
macroeconomic models of national accounts in GDP used since World War II.  These obsolete methods of measuring war
production were never intended to measure national well-being, as warned by
their developer Simon Kuznets.  Now the
website "dashboards"
displaying all indicators of well being, quality of life in many disciplines
and metrics beyond money-coefficients are growing at the OECD, the EC with
Jochen Jesinghaus' MDG Dashboard, in Sweden with Hans Rosling's dynamic
displays, Brazil's many new "observatories," and in the USA the
pioneering Calvert Henderson Quality of Life Indicators since 2000, still
regularly updated at www.calvert-henderson.com.

An indispensible
roadmap beyond the Kyoto
protocols and the "Potemkin markets" inadvertently created is David
Victor's Global Warming Gridlock.
While explaining the wrong approaches of the past, Victor also sees that
the world "requires a massive re-engineering of energy systems."  He even calls for geo-engineering, which we
see as risky and unnecessary.  Kyoto's obsession with
carbon and CO2 was required by financial traders to create a single
new "asset class."  This was pushed
by the market fundamentalists, including economists as well as entrepreneurial
economic guilds in the US
and Britain, along with big
banks and the financing sectors, and elite US environmental groups, led by the
Environmental Defense Fund.  We now need
to go straight to the green transition and continue growing the infrastructures
of the global green economy: smart grids; public transport; compact,
pedestrian-friendly cities and sustainable forests, land management and organic
agriculture.   Progress is bringing better batteries, LED
lighting and direct conversion of solar energy based on photosynthesis.  We can re-frame "low-carbon"
industries properly as "low entropy" since sustainability and
eventual climate stabilization is about reducing throughput of energy and
materials in economies to the minimum – across the board – beyond the dismal Jevon's

Even the UNFCCC and the IPCC have now changed course in the right
direction as we, Mercer,
Tomorrow's Company and others
advocate.  The UN's IPCC with the WMO have recommended
policy-makers shift toward addressing emissions of soot, VOCs and methane in
local hotspots – thus lowering CO2 emissions more swiftly and
cheaply, based on the local and regional agreements that are politically
practical.  Victor's main strategic
advice in Global Warming Gridlock on forming smaller "clubs"
of those willing and enthusiastic about addressing climate change is widely
visible: in US-China green technology accords, Britain's legally-binding
"Green Deal" and green bank, the World Bank, local trading systems,
private green bonds in the Climate Bonds Initiative and daily shifts in
institutional portfolios toward growing the green economies.  The UNEP's Green Economy Report, based on its
Green Economy Initiative which was launched in Geneva in 2009, has gathered
adopters and led to greater interest in Rio+20 to be held in Brazil in
2012.  NGOs continue to provide most of the  pressure with WWF, IUCN, Global Footprint, IISD and the Green Economy Coalition (of
which Ethical Markets is a member) leading the way.  The UNEP report on Recycling Rates of
mentioned earlier provides another landmark, describing another huge
market failure in properly pricing these metals and accounting for the full
costs of their extraction and use – still widely "externalized" from
company and government balance sheets.
Correction of these pricing errors will reduce virgin extraction rates
and lead to expansion of today's recycling, reuse and remanufacturing
industries – already employing millions of workers worldwide.  IISD has exposed the absurdities of massive
subsidies to fossil fuels even as governments try to cap their emissions and is
now correctly fostering more sensible procurement of green technologies.

A seminar in the USA's
prestigious Council on Foreign Relations asks "Are Economists
Necessary?"  My view has always gone
beyond economics, since all public and private decisions must be based in
multi-disciplinary systems models such as we pioneered at OTA and later at the Calvert Group.  Adam Smith was right about "the human
propensity to barter," but more and faster trading is not always better
Financial Trading
").  We are
aware of market failures and false prices, as well as special interests and tax
policy manipulation.  Economics can be
useful at the micro-level, but macro-economics has failed and is in
disrepute.  Economics' focus on money
transactions – only one form of wealth – misses all the others.  Internalizing all those externalities can
help get prices corrected as Trucost is proving.  But all the other forms of wealth need the
multiple metrics and disciplines TEEB
and those now used in all the indicators of well-being, social and
ecological assets and quality of life.

Beyond helping
develop the newer, more practical approaches needed for the eventual
controlling of further carbon-emitting lies the ultimate industrial design
revolution toward biomimicry: learning the efficiency principles in Nature's
billion year experimentation and innovative use of materials and design ("Leading
Edge Technologies Mimicking Nature"
from Paradigms in Progress 1991,
1995).  Britain's Tomorrow's Company has
launched its Tomorrow's
Natural Business
program to familiarize corporate managers with these
deeper principles of long-term success and sustainability.  Beyond costly methods promoted by coal
companies, we can use Nature's carbon sequestration through proper
land-management such as pioneered by Allan Savory and shift to forest-saving
and the working business models of biomimicry in human production as pioneered
by Janine Benyus, John Todd, Gunter Pauli, the Bioneers and others showcased at
www.ethicalmarkets.com and by the Buckminster Fuller Awards on which I have
served as a judge.  All these design
reforms and new metrics will reform and re-shape financial markets for the

Hazel Henderson,
D.Sc.Hon., FRSA, is author of Ethical Markets: Growing the Green Economy
(2007) and co-authored with Fritjof Capra Qualitative
.  She founded Ethical
Markets Media in 2004 and created its Green Transitions Scoreboard®.  She co-created with The Calvert Group, the
Calvert-Henderson Quality of Life Indicators, regularly updated at www.calvert-henderson.com.