Research report no. 3, 20 June 2005 Romain Frémont +33 (0)1 58 50 79 52 romain.frémont@caissedesdepots.fr

CO2 emissions exchanges and the functioning of trading systems

The various CO2 emissions exchanges in Europe

EXAA

ECX EEX

Nord Pool

Powernext

Climex

Sendeco2

CO2 emissions trading first began at the end of the 1990s, as awareness of the challenges posed by climate change grew. Prior to 2005, these transactions occurred over the counter, with no organised market system. The launch of the European emissions trading scheme has changed everything. The market’s scale has grown exponentially, with a total volume of more than 2 billion metric tonnes in emissions allowances allocated to industry. The launch of several emissions trading exchanges is therefore designed to provide liquidity and organise the market. This report looks at the six proposed exchanges as at mid-2005 and the conditions for their success.

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I. The overall challenges for exchanges

With the entry into force of European Directive 87/2003, the first international

CO2 emissions allowances trading scheme was launched on 1 January 2005 in the EU-25. This scheme enables various participants to trade emissions allowances based on their needs, which should minimise the overall cost of the effort to fight climate change. Beginning in 2008, it will be integrated into the larger system established by the Kyoto protocol.

The launch of this market has been gradual, in particular as a result of the

longer-than-expected period needed to allocate the allowances to installations and record them in the national registries. The nominal amount of these transactions has nevertheless increased substantially as a result of increases in both trading volume and market prices. The depth of the market offers a source of potential revenues for intermediaries (brokers) and exchanges.

EU carbon market growth

0

50

100

150

200

250

Jan. 2005 Feb. 2005 March 2005 April 2005 May 2005

Mill

ion

Euro

s

0

2

4

6

8

10

12

14

16

18

20

Pric

e (€

/ to

nne)

Market value (in M€) Price (€ / tonne)

Source : Point carbon daily

2

A. Exchanges and registries

In terms of market organisation, at least two conditions must be met for a CO2

emissions trading scheme to work properly. First, the emissions and respective allowance amounts must be tracked reliably and securely. This role is played by the registries. Second, the market requires sufficient liquidity to promote trading among participants and provide them with accurate pricing information. That role is played by the exchanges.

The national registries ensure that allowance ownership transfers are properly

recorded. In effect, these registries constitute the general ledger for the emissions trading system. For an allowance ownership transfer to be valid, it must be recorded in one of the 25 national registries. These transfers occur in real time, and the ownership transfer may not be confirmed ex ante. In other words, a registry does not contain forward transactions; only spot trades may be registered. The registry accounts are based on CO2 equivalent amounts. They contain no reference to price or the allowance value, in accordance with the terms of the Kyoto protocol. By ensuring the traceability of emissions allowances in volume terms, they ensure the environmental integrity of the trading system.

The market’s liquidity is ensured by several factors, the first of which is the number of allowances issued and traded. It is ensured by the financial intermediaries such as brokers, and can be facilitated through exchanges. These centralised electronic exchanges match up allowance buy and sell orders. Their main function is to contribute to the market’s liquidity, and they must offer their clients several advantages:

lower trading costs (no costs to finding a counterparty, negotiating prices, etc.);

reducing default risk;

guarantee of anonymity for participants;

rapid execution of transactions;

transparency of average transaction price.

Exchanges and registries are therefore closely linked, as the former need the

latter to ensure the smooth execution of their transactions. This link between registries and exchanges may be further solidified through a privileged relationship, or even a partnership agreement, with a specific national registry. That is the case for three of the six projects launched simultaneously on the European market (EEX with the German registry, EXAA with the Austrian registry and Powernext with the French registry).

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B. B. Different market models depending on the project

No fewer than six exchanges are looking to start trading CO2 emissions allowances in Europe: the Norwegian exchange Nord Pool, Germany’s EEX, the Amsterdam-based ECX (a subsidiary of the Chicago Climate Exchange), the French exchange Powernext, Austria’s EXAA and the Dutch exchange Climex. These exchanges all have certain points in common:

They are all run by the energy market operators of their respective countries (four electric utilities, green certificates in the case of Climex, and the IPE for ECX). The energy utilities’ entry into this new market is logical, since power companies account for nearly 60% of European CO2 emissions;

All those discussed in this report are offering trading contracts on EU

allowances. The Dutch exchange operated by Climex would like to expand its model by integrating CO2 credits issued through the Clean Development Mechanism created under the Kyoto Protocol (CERs). Nevertheless, it is unlikely that CERs will be transferred to a European registry before 2007, given the architectural limitations of the international system;

All these exchanges are electronic and based on an order matching system whose effectiveness has been proven in the energy market;

They have decided to specialise in one type of product and do not offer a complete range of products and services.

In spite of these common attributes, several major differences between the exchanges exist, in particular:

They have different target markets, as some are focusing on large industry, whereas others (e.g. Climex) are basing their strategy on smaller customers;

They have contrasting market models, as a major distinction can be made

between exchanges offering derivatives (forwards and futures) and those offering spot contracts;

Some require their clients to transfer a portion of their allowances through a specific registry (Powernext, EEX, EXAA), even though they ensure delivery of the allowances throughout Europe;

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Some registries require an ownership transfer from the allowance seller to

the exchange (EEX), which has non-negligible accounting and tax implications;

the proposed listing methods contrast between fixing1 (EEX, EXAA) on the one hand and continuous trading on the other (Powernext, ECX).

Table 1: the various market models

Climex ECX EEX EXAA Nord Pool Powernext

Contract offered at the

start-up Spot Futures Spot Spot Forward Spot

OTC clearing Yes Yes Yes No Yes No

Trading model Continuous Continuous Fixing Fixing Continuous Continuous

Hours N/A 8 - 17:00 10 - 10:05 15 -15:30 10-15:30 10-14:30

Trading days Working

days Working

days Working

days 2nd & 4th Tuesday

Working days Working days

Nominal amount 1t 1,000t 1t 1t 1,000t 1,000t

Agreement with national registry

No No Yes Yes No Yes

Clearing APX LCH Clearnet

EEX AG EXAA Nord Pool ASA CDC

Delivery Day +1 Day +3 Day +2 Day +1 Day +3 Trading day

Start date N/A 22 April 05 9 March 05 June 05 11 February 05 24 June 05

1 See the glossary at the end of this report for definitions of the terms used.

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C. Start-up and activity of the exchanges

The start-up of the exchanges is closely linked to that of the registries, which

in turn often depend on the finalisation of the National Allocation Plans. Thus it comes as no surprise that the Scandinavian exchange Nord Pool was the first to begin operations at 11 February 2005, since the registries for Denmark, Sweden and Finland were also the first to become operational.

The Dutch registry was also among the first four to become operational, which no doubt facilitated the start-up of the ECX exchange in Amsterdam. The first futures contracts on CO2 emissions allowances were launched on 22 April 2005 by EXC and IPE. Start-up of exchanges in 2005 11 February 9 March 22 April 15-30 June 2nd half

Nord Pool EEX ECX PWX & EXAA Climex

The third exchange able to commence operations was the EEX. On 9 March,

the German exchange launched its spot contract and listing system of morning fixing. At the start, EEX acted so as to keep its activities independent of the registry by having its members enter into agreements to sell their emissions allowances in the future once they have been allocated in the German registry. The three other exchanges have pushed back their start-up dates for various reasons.

EXAA’s launch is tied to that of the Austrian registry, which encountered

difficulties obtaining final accreditation from the European Commission. The exchange could begin operations in the second half of June, according to the most recent information available.

Similarly, Powernext tied its start-up to the online launch of the French registry,

which occurred on 16 May. Therefore the launch of Powernext Carbon did not come until the latter half of June.

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Climex had initially planned to begin operations in March, but had to push back the date because of implementation delays. Climex would like to achieve critical mass in terms of participants in order to avoid an EEX-type scenario. The Dutch exchange is also waiting for a sufficient number of allowances to be allocated in the various registries of the target countries (United Kingdom, the Netherlands, Belgium, France, Germany and Spain).

The growth in trading volume on the exchanges occurred very gradually in the first half of 2005. Several factors contributed to this slow start, including difficulties in setting up the registries, the lack of available liquidity and a wait-and-see attitude by participants in this new market. For now, the exchanges offering derivatives have recorded the largest trading volume.

The Nordic Power Exchange (Nord Pool) leads the way in trading volume. With a one-month lead over its rivals, Nord Pool had traded more than 3.1 million tonnes of CO2 allowances by 31 May 2005, to which should be added another 0.5 million tonnes on the OTC market. As at 28 April, the Norwegian exchange had 43 members. The first trade involved EDF Trading and Statoil ASA.

The ECX had a successful opening, as more than 340,000 tonnes were traded in the first week, to 22 April, representing nearly one-third of its trading volume to date. By 31 May, more than 1 million tonnes had been traded on the ECX.

The spot market began slowly for the EEX. By 6 May, only 150,000 EUAs had been traded as spot contracts on the EEX. By 31 May, approximately 250,000 tonnes had been traded on the German exchange2. The EEX’s start-up difficulties can be attributed in part to the problems experienced by the German registry but also to its market model. This model is not simple, and it requires that participants transfer part or all of their allowances to a global account managed by EEX, which has tax implications for the participants.

Overall, more than 4.4 million tonnes have been traded on the various

exchanges operating. By 31 May, Nord Pool had accounted for 72% of the trades made on exchanges, compared with 22% for the ECX and 6% for the EEX.

2 The figures cited in this report were provided by the exchanges in their reports to Point Carbon (Carbon Market Daily and EEX / ECX / Nord Pool daily update)

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Traded volumes on trading platforms (between 31/01/2005 & 31/05/2005)

Today, the exchanges account for only a limited share of the total trading volume in emissions allowances. Since the beginning of the year, less than 10% of all transactions have gone through an exchange. The vast majority of the trading volume in this new carbon market has been handled by brokers specialising in this activity: TFS, Natsource, Evolutions Market, CO2e.com, and ICAP Energy Ltd. The brokers performed the first trades in this market, whether they be forward or spot contracts (e.g. trade involving EUAs between Shell and Energi E2 on 7 February).

D. D. Rates: remaining competitive The various exchanges have very different rate structures. Some are based on

membership fees and high annual fees, while others integrate the clearing fees into the trading commissions. All the exchanges, however, base their rates on trading volume, with lower rates for higher volumes. Another noteworthy point: in response to competition, Nord Pool reduced its rates on a permanent basis, while ECX lowered its rates on a temporary basis for 2005.

4,439 3,119

46,456

1,070 250

0 5 000

10 000 15 000 20 000 25 000 30 000 35 000 40 000 45 000 50 000

('000' tonnes) Volumes

Total volumes Traded Nord Pool ECX EEX Climex Powernext EXAA(EUAs all volumes on vintages) trading

platforms Source : Point carbon daily

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Table 2: applicable rates on the various exchanges

Climex ECX EEX EXAA Nord Pool Powernext

Membership fees €0

€0 for IPE members and €2,500 for others

€7,500 €1,100

€0 for existing members and €6,1833 for new members

€0

Annual fees €0 €0 €12,500 €1,200 / €3,600 / €9,600*

€4,000

€0 for members and between €1,000 and €3,500 for others*

Account fees €0 €0 €0 €100 €0 €4,000

Commission per tonne / lot

2% €0.04 / t €0.01*

€2 members and €2.5 / lot €0.04 / t

€0.12 / €0.06 / €0.03*

€0.005/t From 3 to 2 cents / t*

System access fee (per terminal) €0 $38 €7,800 N/A €371 N/A

Clearing membership fees €0 €2 and €1

(2005) / lot €0 €0 €618 €0

Annual clearing fees ** €0 €0 €0 €0

€371 for non-members

€0

Clearing fees €0*** €2 and €1 (2005) / lot €0.01 / t €0*** €0.01 / t €40 / trade

Cap €40,000 / year €60,000 / 3

years €20,000 / year

* Based on annual trading volume ** Does not include new account fees *** Clearing fees included in trading fees

The significant differences in the rate structures make comparisons between

exchanges difficult. Moreover, we are not including information on management fees for margin calls for participants or accounting processing costs on forward contracts. Nevertheless, the following graphs attempt to provide such a comparison based on the information summarised in table 3.

3 Some Nord Pool prices are quoted in Norwegian Krone (NOK). They were converted into euros at the rate of €0.12367per NOK as at 16/05/2005

9

10

Comparison of transaction costs on various exchangesScenario 2: second transaction of 100,000 tonnes for a member

480 €

1,000 €

1,500 €

3,040 €

6,000 €

5,000 €

0 €

1 000 €

2 000 €

3 000 €

4 000 €

5 000 €

6 000 €

7 000 €

EXAA EEX Powernext Nord Pool Climex ECX

Cos

t

Comparison of transaction costs on various exchangesScenario 1: first transaction of 75,000 tonnes for a non-member

750 €2,868 €

7, 290 €

12,669 €

31,550 €

9,200 €

0 €

5 000 €

10 000 €

15 000 €

20 000 €

25 000 €

30 000 €

35 000 €

EEX Nord Pool EXAA Powernext ECX Climex

Cos

t

Table 3: Assumptions for cost scenarios

Member of the exchange Not for the first transaction

Number of access points to system 1 Average annual emissions trading 600,000

Transaction 1 transaction of 75,000 allowances (75 lots of 1,000 tonnes) and a second of 100,000 allowances

Date of trade 16/05/2005

EUA price €16.75 Spot contract Climex / EEX / EXAA / Powernext Forward contract Nord Pool

Futures contract ECX Rate in NOK at 16/05/2005 €0.12367

The two graphs clearly indicate that for relatively limited annual trading

volumes and transactions, ECX and Climex are the least expensive. By comparison, EEX and Nord Pool offer less competitive rates at comparable volume, largely as a result of their very high entry fees. Once these entry costs have been paid, however, these exchanges are more competitive and the various exchanges offer pricing terms that are relatively close to one another for members with significant trading volume.

The outlook: consolidation likely?

Along with the quality of services provided, the underlying rate elements will be major competitive factors for the exchanges. Competition could indeed be fierce among the various market models being implemented.

The market nevertheless remains in a premature development stage, and its

depth should be kept in perspective for the initial period (2005 – 2007). If we use the assumption often cited by some analysts that only 10% of European allowances will be traded, or 200 million tonnes per year (out of a total of approximately 2 billion tonnes allocated per year), this represents barely a half day of transactions on the CAC 40 at a price of €15 per tonne!

In the future, however, the trading volume could become more substantial.

Some analysts believe that the market could reach more than €10 billion per year beginning in 2008.

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We realise that the market’s small size until 2007 will make it difficult for so many exchanges to coexist. That is even truer when one considers that the specific nature of the CO2 emissions allowances market will not result in the disappearance of specialised intermediaries such as brokers. The share of transactions executed on exchanges will exceed 10% in the future, but it will not reach 100%.

Unless liquidity grows rapidly in the CO2 market, consolidation will be

inevitable. We also predict that some exchanges will specialise in certain products, as is the case with financial markets, with some focusing on derivatives and others on spot transactions. In the absence of such consolidation, the risk is that the carbon market would become fragmented along product and regional lines, allowing several exchanges to remain viable but entailing higher costs for users and resulting in reduced efficiency in sending proper pricing signals to market participants.

II. Review of the exchanges

The second part of our report focuses on the more specific characteristics of each of six exchanges in the European CO2 market. The exchanges are presented in alphabetical order.

A. Climex: pan-European ambitions

Climex is the name of the exchange operated by the New Values group. It is based in Amsterdam, along with its rival ECX. The New Values group is 50%-owned by Netherlands-based Rabobank and 50% by APX (Amsterdam Power Exchange) through its Tennet subsidiary. In 2005, New Values announced a partnership agreement with the Spanish exchange Sendeco2 in order to create the first “pan-European exchange for CO2 allowances”. More recently, the two partners announced a partnership agreement with Asia Carbon International in order to provide the exchange with CERs.

Climex’s leading product is a spot contract for European allowances. Climex

will also likely offer forward contracts. The exchange hopes to be able to offer CERs to participants once it commences operations.

Trades are cleared through Amsterdam Power Exchange (APX), which plays

the role of counterparty for all the exchange’s trades. Before they are allowed to trade on the Climex exchange, participants must deposit collateral in the form of allowances in a registry account under the name APX and maintain cash balances on an interest-bearing account maintained by APX. These collateral amounts serve as limits for trading and for each order placed on the exchange, with the limit verified electronically for order authorisation. Once the order has been authorised and prepared, APX is responsible for the settlement and delivery of the transaction between the two counterparties. APX provides the settlement and delivery service within 24 hours.

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Climex contract characteristics

Product EU Allowances (1 EUA = 1t CO2)

Listing €0.01 / t CO2

Nominal amount of contract 1 tonne Type of contract Spot / bilateral forward derivative Listing method Continuous Clearing APX

Climex would first like to focus its activity on the Dutch, German and UK

markets. The exchange hopes to attract participants holding small allowance amounts through a simple and less expensive trading system than that traditionally offered by electronic exchanges. The exchange will nevertheless need to attract the large allowance holders in order to provide market liquidity.

B. ECX: specialisation in futures contracts The European Climate Exchange (ECX) is a wholly owned subsidiary of the

Chicago Climate Exchange (CCX) and the International Petroleum Exchange (IPE), based in London but controlled by the US-based Intercontinental Exchange (ICE). The exchange is located in Amsterdam.

The proposed contract, the ECX Carbon Financial Instrument (ECX CFI), is a

futures-type derivative listed on the IPE. The exchange also offers clearing services for OTC transactions.

LCH Clearnet, the clearing house for the London Stock Exchange and

Euronext, operates the settlement/delivery system. In order to participate, each clearing house member must deposit a minimum amount of allowances on an account held by LCH Clearnet in a European registry. The transfer of allowances from the seller’s account to that of the buyer therefore goes through a pivot account held by LCH Clearnet. The final settlement takes place three days following the contract’s final liquidation date.

To ensure settlement/delivery, margin calls (initial margin call and daily adjusted margin call) are calculated daily for the various contracts depending on the gains and losses recorded each day by the market participant (marked-to-market contracts). Penalties are also assessed against participants who fail to deliver.

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ECX contract characteristics

Product EU Allowances (1 EUA = 1t CO2) Listing €0.01 / t CO2Nominal amount of contract 1,000 tonnes of CO2Price scale €0.05 Type of contract Futures derivative Maturities Quarterly (from December 2005 to March 2008) maturing in

March, June, September and December of each year. Contracts that mature annually also exist, with maturities expiring at the end of each year between 2008 and 2012.

Maturity dates Last Monday of the month Settlement price Weighted average calculated at the end of each trading

day Listing method Continuous (8:00 – 17:00 GMT) Clearing LCH Clearnet

In its market study, the US operator notes that spot transaction volumes will not be sufficient to ensure the necessary liquidity for industrial companies to hedge against the risk of non-compliance. From that standpoint, the range of forward contracts provides them with greater visibility for their investment decisions and compliance.

C. EEX: backed by the leading EU market for CO2 The European Energy Exchange (EEX) is the operator for the German power

exchange. Germany represents the second largest energy and EUA market in Europe behind Russia. The European Energy Exchange is based in Leipzig, Germany. It was created through the 2002 merger of two companies, LPX Leipzig Power Exchange based in Leipzig and the European Energy Exchange based in Frankfurt.

Compared to its competitors, EEX has developed a rather original market

model based on spot contracts traded on the basis of a fixing price. During the fixing process, buy and sell limit and market orders for EUAs are matched daily. Daily trades in EUAs begin with a pre-trading session from 7:30 to 10:00. The buy and sell orders are entered into the EEX system, but no transaction is recorded. OTC transactions may also be recorded and the order book checked at all times.

The main trading period consists of an auction between 10:00 and 10:05 each

morning. All orders recorded in the order books are matched (call phase followed by a freeze phase). If several orders match up, an indicative price for the trading session will be posted, otherwise the bid and ask price limits will be posted. Once this session is completed, all participants are informed of the results of their transaction, with prices at the time of matching and volumes retained.

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Recording of orders OTC

cancellation

07:30 – 10:00

EEX trading sessions

Source: EEX spot market concept

Processing of surplus orders

and administrative

processing

Recording Archiving

Fixing Order matching

Price listing

Evening 10:05 – 17:00

Batch processing

Post - trading

10:00 – 10:05

Pre-trading Trading

For unmatched orders, a new session enables traders to execute surplus

orders in part or in full and to adjust the price listed during the auction. The trading session ends at 17:00, during which period the orders will have been processed.

The clearing of these trades is performed by EEX AG, which acts as a central

counterparty for all trades. Participants go through clearing members, which are for the most part banks. The participants deposit guarantees (cash or securities) with their clearing member, who in turn deposits this collateral with the clearing house.

The margins of each participant are calculated daily by EEX based on the

transactions performed and certain parameters (such as credit rating) in order to cover maximum daily losses estimated under various scenarios. Similarly, member banks ask their clients to deposit the same risk coverage amounts. EEX requires that its members have at least €20 million in shareholders’ equity. In addition, each member must deposit €1 million in a special fund used in case of a problem. In the market model, EUAs shall be delivered two days after the transaction has been concluded.

On EEX’s spot market, EUAs traded are safekept in an overall account held by

EEX within the German registry (custody account). The account positions of each member (of the “sub-account mirror” type) are also tracked by EEX. In practice, EEX’s proposed market model results in an ownership transfer of the allowances from the holder to EEX.

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Only netted positions are included in transactions, which for a participant means only the surplus or deficit linked to his positions during the trading session. The same applies to cash transfers that correspond to movements of allowances. The transfers take effect two days following the conclusion of the transaction.

EEX contract characteristics

Product EU Allowances (1 EUA = 1t CO2)

Listing €0.01 / t CO2

Nominal amount of contract 1 tonne of CO2

Price scale €0.01

Type of contract Spot

Listing model Fixing (10:00 – 10:05)

Clearing EEX AG

EEX counts on the liquidity cushion offered by German allowances on the

European market (approximately 25% of the total). In that respect, EEX has a major advantage. EEX hopes above all to attract companies and banks that are already participants in its power exchange.

D. EXAA: the Austrian niche

Energy Exchange Austria (EXAA) is the Austrian power exchange based in Graz. Founded in 2001, EXAA began its market operations by launching a spot market for electricity in 2002. At end-2004, EXAA had more than 30 members from all parts of Europe.

Only one type of security is traded on the EXAA exchange without any specific

vintage in the initial period. The market model is based on a fixing price (twice per month) at a specific time when the buy and sell orders are matched. Individual orders are first recorded in a closed order book to prevent participants from seeing their respective orders. Before matching the orders, the exchange verifies that the securities deposited in the bank account and in the registry indeed cover the orders recorded in the order book and, if necessary, asks the traders to settle up their collateral amounts. The participants are informed of the prices immediately after the end of the sessions. This price is used for clearing (MCP = Market Clearing Price) and the allocation of allowances. In the event where no transaction could be recorded because buy and sell orders did not match up, the best bid and ask prices are reported on the system and trading is opened during a second fixing session.

16

EXXA guarantees trades between counterparties. The collateral for buyers is

deposited in cash in an Austrian bank (Oesterreichische Kontrollbank) prior to the opening of the trading session. The minimum amount required is €10,000. Securities deposited by participants for electricity trades may be used. The allowances must be deposited in an account opened by EXAA on the Austrian registry. The participant no longer has access to transferred allowances during the trading session.

EXAA contract characteristics Product EU Allowances (1 EUA = 1t CO2)

Listing €0.01 / t CO2

Nominal amount of contract 1 tonne of CO2

Price scale €0.01 Type of contract Spot Listing model Fixing (10:00 – 10:05) every second and fourth Tuesday of

the month. Recording of pre-trading orders: 1 day before trading (11:00-16:00) and the day of the trading session (8:00 – 11:00 and 11:30 – 14:30) Trading dates: every second and fourth Tuesday of the month Fixing hours: 15:00 – 15:30 Post-trading hours: 15:30 – 15:45

Clearing EXAA

EXAA’s market analysis revealed that there was no demand for continuous

trading of allowances. The purpose of a fixing every two weeks is to maximise liquidity through short trading sessions, rather than diluting the trading and volumes through continuous trading.

E. Nord Pool: the advantage of a head start The Nordic Power Exchange (Nord Pool) is the Norwegian operator of the

power trading exchange for the Nordic countries, in particular Norway, Finland, Sweden and the eastern portion of Denmark (Zealand). Nord Pool spot belongs to the Nord Pool group and is 20%-owned by Nord Pool ASA and the Nordic Transmission System Operators (Statnett SF, Svenska Kraftnät, Fingrid Oyj each hold 20%). Eltra and Elkraft each own 10%.

Nord Pool’s market model is based on the continuous listing of spot contracts, whose clearing is ensured by Nord Pool ASA. Nord Pool also offers forward derivative contracts.

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Nord Pool Clearing ASA is the counterparty for all transactions and will

guarantee the financial settlement and delivery of allowances to participants. Cash securities will be deposited in a specified bank account. Members may also use the bank account used for transactions in the power market. Sellers may deposit as allowances collateral a certain number of EUAs in accounts opened by Nord Pool in a registry.

Delivery versus payment occurs three days following the transaction date. The

seller deposits a certain number of EUAs, equivalent to the amounts traded, at the end of the trading day. Nord Pool is then responsible for transferring the allowances to the buyer’s account in the specified registry. Nord Pool will open an account in various registries depending on the members.

Nord Pool contract characteristics

Product EU Allowances (1 EUA = 1t CO2)

Listing €0.01 / t CO2

Nominal amount of contract 1,000 tonnes of CO2

Price scale €0.05 Type of contract Spot and forward derivative + OTC Maturities (forward) Semi-annually (from December 2005 to March 2008)

maturing in March and December of each year. Maturity dates Last Monday of the month

Settlement price Weighted average calculated at the end of the trading day Listing method Continuous (10:00 – 15:30)

Clearing Nord Pool Clearing ASA

To manage the risks, Nord Pool has set some rules for an initial margin call

based on the financial situation and trading volume. A daily margin call is also calculated based on a statistical model that takes account of intra-day price changes (to cover significant price increases and decreases depending on the positions). Nord Pool also performs netting of cash and allowance positions among members at the time of delivery versus payment.

Nord Pool is counting on its current members to provide momentum for the

European allowances market on its exchange. With a presence in several countries covered by the Directive, Nord Pool is well positioned to capture a significant share of the trading among Nordic countries.

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F. Powernext: real-time settlement Powernext operates the power exchange in France. Based in Paris, this

company is 34%-owned by Euronext and various European power companies active in its market. Powernext currently has around 50 members.

The Powernext market model is based on a real-time settlement/delivery system, which sets it apart from its competitors. To make this project possible, Euronext and Powernext partnered with Caisse des Dépôts, which will ensure payment versus delivery on the allowances. The project’s originality lies in the fact that the model does not depend on a traditional clearing house. There are no margin calls, and deliveries are made in real time. Caisse des Dépôts acts as a manager for the delivery versus payment mechanism and as the central custodian, but not as a clearing house.

To participate in the Powernext exchange, each client must first open an account with the French national registry and a bank account with Caisse des Dépôts. The delivery of the allowances is guaranteed throughout Europe. The participants must transfer an amount of allowances and cash one day prior to the trading day.

The trading sessions will take place daily between 10:00 and 14:00. Thanks to a real-time electronic system, the participants will be informed as to the results of their allowance transactions nearly immediately, based on the response time of the CITL. Payment will occur the afternoon following the trading session or the following day, depending on the amounts.

During the trading session, the positions (stock of allowances and cash amounts) of the participants will be monitored prior to the execution of the transaction in order to ensure delivery versus payment.

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Powernext contract characteristics

Product EU Allowances (1 EUA = 1t CO2)

Listing €0.01 / t CO2

Nominal amount of contract 1,000 tonnes of CO2

Price scale €0.01 Type of contract Spot Maturities (forward) Semi-annually (from December 2005 to March 2008)

maturing in March and December of each year.

Maturity date Last Monday of the month Settlement price Weighted average calculated at the end of the trading day Listing method Continuous (10:00 – 14:00) Clearing Caisse des Dépôts

Powernext’s strategy is based on a product range that is simple and quick. Powernext is touting the simplicity of an integrated system from trading to delivery, open to any participant, without the burdens and delays inherent in a traditional clearing house.

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Appendix: Glossary

Order matching: an order is matched when counterparty is found and the sell order matches the buy order. Two compatible orders on opposite sides are combined. Settlement bank: credit institution acting on an exchange for its own account or that of a participant. Settlement banks are generally clearing members. Order book: centralisation by the exchange’s trading system of buy and sell orders for allowances. CCX: name of the Chicago emissions allowances exchange. The Chicago Climate Exchange (CCX) began operations in December 2003 and has more than 80 members, from industrial companies such as Ford and American Electric Power to universities, municipalities and agricultural sector institutions. Participants have pledged to reduce their greenhouse gas emissions by 4% relative to their 1998-2001 levels between now and 2006. More than 1 million tonnes of carbon have been traded on the CCX since the market opened. Clearing house: The clearing house is a financial organisation whose goal is to eliminate default risk in the markets. Concretely, the clearing house is the sole counterparty for all operators. It ensures the monitoring of positions. It requires that a guarantee deposit be placed in its accounts on the day a contract is concluded. In the event of a potential loss by a participant, it makes a margin call. Collateral or security: To guarantee the proper execution of transactions, sellers (who receive the payment) and buyers (who receive the allowances) must deposit collateral (cash or shares). The collateral deposited by the seller is called the margin. Trading fees: fees received by the operator of the exchange for the services provided by the exchange to access its trading system. EUA futures and forward contracts: these two types of contracts call for the delivery of an amount of allowances at a future date. Whereas futures are standardised, anonymous contracts with fixed maturity dates, forwards are bilateral agreements (not anonymous) that are negotiated (not standardised) and have specific maturity dates. Forward contracts generally result in the final delivery of the instruments exchanged, but futures typically do not result in delivery.

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Spot contract: these are cash contracts for which both counterparties agree to immediate delivery (with a possible lag of one to three days to allow for the settlement and delivery) of an amount of allowances at a fixed price. Fixing price: listing method that consists of matching at a point in time all buy and sell orders previously entered into an order book in order to fix the equilibrium price of the session. All matched orders will be executed on that day. Close out: this refers to the final processing of a transaction (close) with the delivery of a security or the receipt of its corresponding value. OTC (Over the Counter): an over-the-counter contract between two parties (no anonymity. The OTC market can be distinguished from the organised and centralised market. Settlement and delivery: settlement/delivery is the last step in the processing of a transaction on an exchange. It consists of the closing out of the buyer’s and seller’s reciprocal commitments and the bookkeeping entries ensuring the definitive nature of the transactions, in other words the delivery of the allowances to the buyer and the payment of the corresponding funds to the seller. Delivery versus payment: a system under which a central counterparty (clearing house) ensures the simultaneous and parallel transaction of a transfer (delivery) of allowances from the seller’s account to the buyer’s account (through a pivot account opened by the clearing house) and a transfer of cash from an account opened by the clearing house to the account of the seller.

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Research reports of the Caisse des Dépôts Climate Task Force

Research report N°1 : “Carbon investment funds: general assessment of the market” Ariane de Dominicis, January 2005 Research report N°3: “CO2 emissions exchanges and the functioning of trading systems” Romain Frémont, June 2005 Research report N°5: « domestic offset projects » Ariane de Dominicis, September 2005 Research report N°7: “Carbon investment funds: growing faster” Ariane de Dominicis, November 2005 Executive summary of the report: “Expanding the means to combat climate change through domestic offset projects” Emmanuel Arnaud, Ariane de Dominicis, Benoît Leguet, Alexia Leseur, Christian de Perthuis, November 2005 All publications and Climate taskforce’s quarterly newsletter available in English at: http://www.caissedesdepots.fr/GB/espace_presse/fiche3.3.php All publications available in French at: http://www.caissedesdepots.fr/FR/espace_presse/fiche3.3.php

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This research report was written on behalf of the Caisse des Dépôts Climate Task Force. The analyses and opinions expressed do not bind Caisse des Dépôts. The Climate Task Force of Caisse des Dépôts is a company-wide unit that conducts and coordinates research and development work in the field of fighting against climate change. Publication Director: Christian de Perthuis Climate Task Force contacts:

Emmanuel Arnaud: +33 (0)1 58 50 98 19 Ariane de Dominicis: +33 (0)1 58 50 98 20 Romain Frémont: +33 (0)1 58 50 79 52 Céline Lauverjat: +33 (0)1 58 50 73 96 Benoît Leguet: +33 (0)1 58 50 98 18 Lê anh Pham: +33 (0)1 58 50 41 86 Christian de Perthuis: +33 (0)1 58 50 22 62

Caisse des dépôts et consignations Département développement durable

56, rue de Lille 75356 – PARIS 07 SP

www.caissedesdepots.fr - Tel: +33 (0)1 58 50 00 00

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