As he puts it in his column:

In picking on carbon, I take no position on its merits as a way of controlling emissions. Rather, the purpose is illustrative. If I were a risk manager, what danger signs would I look for as the market develops? Let us take three yardsticks of risk: simplicity, liquidity and leverage. The more a market has of the first two and the less of the third, the safer it should be. Derivatives based on subprime mortgages ticked all the danger boxes. So far at least, carbon does not.

His assessment is that, for the moment, the financial instruments in the carbon market are relatively straightforward, relatively liquid, and there currently is not much scope for arbitraging between markets. But he’s also honest enough to admit that when he first looked at credit derivatives in 2003, he concluded that they were fairly simple. As he notes, perhaps with hindsight, “as markets develop they become more complex and risky”. Even if the FoE is wrong at the moment on the risk part of the future carbon trading market (as opposed to their efficacy), they may still be right in the future.

In summary, these are the problems:

• It is  ineffective at driving emissions reductions.
• It fails to drive technological innovation.
• It leads to lock-in of high-carbon infrastructure.
• It allows for, and relies on, offsetting (rather than promoting carbon reductions).
• It creates a risk of subprime carbon.
• It provides a smokescreen for lack of action on climate finance by the developed world.

The reasons, they suggest, are because the policy has been captured by financial and industrial interests – not so much “the polluter pays” but “let’s pay the polluter”. Some of the financial instruments created on the back of the trading scheme match derivatives for complexity.

Friends of the Earth is not alone. The report quotes the UK’s Committee on Climate Change:

“We cannot therefore be confident that the EU ETS [emissions trading system] will deliver the required low-carbon investments for decarbonisation of the traded sector through the 2020s. Given this risk, the Committee recommends that a range of options such as regulation and taxes for intervention in carbon and electricity markets should be seriously considered.”

FoE argues that it would be more effective to use carbon taxes to create behaviour change; direct regulation and standard setting to reduce emissions from heavy polluters; and public investment in energy efficiency, renewable energy and transport, potentially funded by a financial transaction tax such as the Tobin tax.