Gbenga Ibikunle

The CO2 Trading Market in Europe: A Financial Perspective

The trading of carbon dioxide (CO2) emission allowances, or permits, has been established in recent years as one of the primary mechanisms for tackling global warming and climate change. The European Union (EU) has taken an important initiative in this direction by establishing in 2003 the first ever mandatory cap-and-trade system for CO2 permits: the EU Emissions Trading Scheme (EU ETS). The purpose of this paper is to initially provide a brief introduction to the EU ETS and subsequently assess its operation during the years 2005-2010 from a financial market perspective. The in-sights gained through this analysis are particularly important not only for policy makers and market stakeholders but also for the growing community of the so-called ‘carbon’ investors.

Price Discovery and Trading after Hours: New Evidence from the World’s Largest Carbon Exchange

We investigate the impact of after-hours trading on magnitude and timing of price discovery over the close-to-close period on the world’s largest carbon trading platform, the European Climate Exchange (ECX). Low volume trading in carbon financial instruments can lead to relatively high levels of price discovery but the generated pricing has low efficiency levels. This is associated with high levels of informed trades and low levels of liquidity trades. Our results show higher trading volume per minute and greater price efficiency for after-hours when compared with regular trading hours. As a result of a higher proportion of informed trades, adverse selection costs for trades during the after-hours are significantly larger than those for trades during the regular trading-day.

Price Impact of Block Trades: The Curious Case of Downstairs Trading in the EU Emissions Futures Market

Using high-frequency data from the European Climate Exchange (ECX), we examine the determinants of price impact of €21 billion worth of block trades during 2008–2011 in the European carbon market. We find that wider bid-ask spreads and volatility are characterised by a smaller price impact. Larger levels of price impact are more likely to occur during the middle of the trading day, specifically the four-hour period between 11 a.m. and 3 p.m., than during the first or final hours. Purchase block trades induce a relatively smaller price impact on price run-up, while sell block trades exhibit a larger price impact on price run-up. We conclude that block trades on the ECX induce less price impact than in equity or conventional futures markets, and that a significant proportion of the effects contradict findings on block trades in those markets; thus, we provide the first evidence of the curious bent to block trading in the European Union emissions trading scheme.

Order Flow, Liquidity and Price Leadership: The Curious Case of High-Tech Entrant Markets

We investigate the role of price leadership and informed trading in the competition for order flow between high-tech entrant trading venues and established national trading venues. An analysis of BATS Chi-X Europe (Chi-X), a high-tech entrant, and London Stock Exchange (LSE), an established national exchange, suggests that Chi-X’s price leadership in the London market is critical to its acquisition of market share at LSE’s expense. Intraday variations in price leadership, driven by informed trading, liquidity constraints and institutional trading arrangements are, however, inconsistent with the theoretical liquidity-efficiency link. Asymmetric effects of dark and algorithmic trading across the platforms are also reported.

The information content of high frequency trading volume

We propose a state-space modeling approach for decomposing trading volume into its liquidity-driven and information-driven components. Using a set of high-frequency S&P 500 stock data, we show that informed trading is linked with a reduction in volatility, illiquidity, and toxicity/adverse selection. We observe that our estimated informed trading component of volume is a statistically significant predictor of one-second stock returns; however, it is not a significant predictor of one-minute stock returns. This disparity is explained by high-frequency trading activity, which eliminates pricing inefficiencies at low latencies.

Emissions Trading in Europe: Background and Policy

This chapter provides a background to emissions trading in Europe. The literature on cap and trade is reviewed from both theoretical and empirical perspectives. The operational structure of the EU-ETS is explored along with the critical issues relevant to its phases.

Price Discovery and Trading After Hours on the ECX

This chapter investigates the impact of after-hours trading (AHT) on the magnitude and timing of price discovery on the world’s largest carbon trading platform, the ECX. Low volume trading in carbon financial instruments (CFI) can lead to disproportionately high levels of price discovery; however, the generated pricing has low-efficiency levels. This is associated with high levels of informed trades coupled with low levels of liquidity trades. Results obtained show evidence of higher trading volume per minute and higher price efficiency for after-hours when compared with regular trading hours (RTH). As a result of a higher proportion of informed trades, adverse selection costs for trades during the after-hours are significantly larger than those for trades during the regular trading day.

The Liquidity Effects of Trading Carbon Financial Instruments

This chapter explores the liquidity effects of the introduction of a new regime of rules for the Kyoto commitment period (2008–2012) in the EU-ETS. Results obtained show evidence of a sustained increase in the liquidity of traded carbon financial instruments as a result of the new trading rules. However, we also find evidence of reductions in liquidity following regulatory changes after the commencement of the Kyoto commitment phase.

Liquidity and Market Efficiency in Carbon Markets

This chapter examines the relationship between liquidity and market efficiency in carbon markets, by using analysing trading data from the world’s largest carbon exchange, the ECX. Results obtained show that there is a strong relationship between liquidity and market efficiency such that when spreads narrow, return predictability diminishes. This relationship is more pronounced for the highest trading carbon financial instruments and during periods of low liquidity. Since the start of trading in Phase II of the EU-ETS prices have continuously moved nearer to unity with efficient, random walk benchmarks, and this improves from year to year. Overall, findings suggest that trading quality in the EU-ETS has improved markedly and matured over the sample period (2008–2011).

The Price Impact of Block Emissions Permit Trades

This chapter examines the determinants of the price impact of €21 billion worth of block trades completed in the European carbon market between 2008 and 2011. Findings obtained show that wide bid-ask spreads and volatility are characterised by small price impacts. Large levels of price impact are more likely to occur during the middle of the trading day, specifically the four-hour period between 11 am and 3 pm than during other hours of the trading day. Purchase block trades induce relatively smaller price impact on a price run-up than sell block trades. Block futures trades in carbon markets generally induce lesser price impacts than in equity or conventional futures markets and a significant proportion of the effects contradict findings on block trades in those markets.