The future is in the futures markets: an interview with Richard Sandor

richard sandor

Richard Sandor has a relatively painless solution to climate change. It relies on the financial markets, not onerous regulation. It even has a track record. He talked to us recently as part of his campaign to change the world through financial markets.

Sandor, now 73, was the chief economist of the Chicago Board of Trade for more than two decades, beginning in the 1970s. At the board, he developed such pioneering products as interest rates futures and catastrophe contracts. He later became chair of the CBOT’s Clean Air Committee, which created the spot and futures market for sulfur dioxide (SO2) emission allowances. This was a regulatory experiment created by the U.S. Environmental Protection Agency under the Clean Air Act of 1990 to see if the financial markets could be used to reduce pollutants that caused acid rain, under a system that has become known as “cap-and-trade.”

It worked, and it worked well. One lesson, Sandor says, is that you want to be short pollutants. A 2012 report by researchers at the Harvard Environmental Economics Program, “The SO2 Allowance Trading System and the Clean Air Act Amendments of 1990: Reflections on Twenty Years of Policy Innovation,” noted that not only were the effects on the pH of rainwater recognized quickly, but there also were unintended but larger benefits on human health from the reduction of airborne particles. Estimates of the health-care savings “appear to be on the order of $50 billion per year by 2012,” the report says. The EPA had estimated the cost of the program would be $6.1 billion; in 1998, the Electric Power Research Institute, an industry organization, estimated the cost was closer to $1.7 billion.

The original cap-and-trade program started with the assumption that the utilities emitting SO2 should bear the costs of the damage to the ecology. However, the cost of reducing SO2 was unknown, so the companies would want a way to manage that risk. The system that Sandor and his team set up gave each of the utility companies a number of allowances for SO2 emission. At the end of each time period, the companies would have to turn over allowances equal to the amount of SO2 actually released or pay a fine. Companies that reduced their SO2 through the installation of smokestack scrubbers, a switch to low-sulfur coal or closing offending power plants could save their allowances for future use or sell their allowances to companies that did not reduce their emissions.

Sandor, inspired by the success of SO2 allowance trading, left the board to start the Chicago Climate Exchange, which was sold to the IntercontinentalExchange  in 2010. After that sale, he established Environmental Financial Products. The company’s goal is to create exchange-traded products that will improve the environment.

Environmental Financial Products has had success helping governments around the world establish markets in pollutants and such natural resources as water. The notable failure is the United States government, in part because the very issue of climate change has become freighted with political meaning. Sandor says that politicians should stop discussing climate change as a yes-or-no question and instead estimate the probability of climate change and the severity of damages, should it occur. “It should be looked at the same way we look at insurance,” he says.

It is unlikely that your house will catch fire, but you buy insurance because the premium is so much less than the cost of replacement if that fire were to take place. Likewise, he says, even if there is only a 15 percent chance of destructive effects from climate change, insurance would have value.

Sandor blames the loss of institutional memory in Washington as much as politics. “With the SO2 program, two-thirds of the people who voted for it and witnessed its incredible effects are no longer in the Senate. Staff members are in their 20s and 30s and were not even born” when it took effect, he says, with the result that no one knows what happened.

Yet, Sandor’s work is accepted elsewhere. “We may never get anything out of Washington, D.C., but we are a federal republic,” he says. “We will lag at the federal level and lead at the local level.” Several northeastern states have established the Regional Greenhouse Gas Initiative to trade carbon emissions from utility companies. California has a cap-and-trade program for carbon, too. Outside of the United States, carbon and pollutant markets operate in parts of Canada and China. Water is traded in Australia.

The private sector is interested too; insurance companies have found that weather futures are a way to hedge the effects of climate change. “We’re already seeing that it’s working,” Sandor says. “This already exists, it’s just not known to the man on the street.” He says that corporate risk managers like the idea of environmental trading because they understand futures markets, even if politicians don’t.

Sandor sees the potential for market solutions for everything from murder rates in Chicago to endangered species. Will panda futures someday trade like pork bellies once did? “You can affect the supply-and-demand balance of almost anything,” he says. “We forget how powerful a tool the market is.”

  • Ah Richard here we are again with the Paris COP21 cabal working diligently to introduce version 2.0 of the Carbon Market Game. We saw what version 1.0 did a few years back, hundreds of billions in yearly trades spun into derivatives tens ways from sundown moving a trading volume ten times larger than the product underpinning it. A few token banksters were jailed and 5 years on we now see version 2.0 of the game about to be unveiled in Paris. All this when there is a well proven disruptive technology in hand that can solve the lions share of the driving CO2 crisis at a cost of mere millions of dollars each year. But hey who ever said that saving the world was the first order on the agenda, everyone knows it is all about the money. Here’s the historical version 1.0 commentary and the disruptive tech solution which as Steve jobs used to say, IT JUST WORKS.


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