Identifying and forecasting the effects of global warming is a scientific chore. But the challenge of combating the problem will be largely economic — which is why big financial firms are rushing into the fast-growing area.

The so-called Stern report, commissioned by the British government (see story, above), calls for financial solutions to environmental problems, such as imposing carbon taxes, promoting emissions trading systems and creating government policies that favour the development of low-emission products. The report estimates that the market for low-emission technologies could reach into the hundreds of billions of dollars — if governments take the actions it says are necessary.

With that kind of money on the line, it’s no surprise that financial firms are clamouring to get their share. Numerous “cleantech” companies are already seeking and finding financing.

The Cleantech Venture Network reports that North American venture-capital investing in cleantech reached a record US$933 million in the third quarter, up 11% from the prior quarter and 120% from the same quarter a year earlier. In the nine months ended Sept. 30, cleantech investments totalled US$2.3 billion, double the US$1.1 billion invested in the same period in 2005.

The emissions trading space, envisioned as a way to use markets to achieve efficient emission reductions, is also an attractive one for firms looking to exploit their trading talents in a new venue.

So far, emissions trading has been limited largely to Europe, where a mechanism known as the European Union’s Emissions Trading Scheme was introduced to help countries meet their obligations under the Kyoto protocol. The system has come under criticism, largely for how governments issued the credits, but it is also widely touted as a model for the future if the world is to make a concerted effort to reduce pollution and tackle global warming.

Trading schemes are also in the offing for various parts of North America. The Montreal Exchange and the Chicago Climate Ex-change, the latter a voluntary trading system for corporate and municipal polluters, have jointly established the Montreal Climate Exchange, with the intent of providing an emissions trading venue for Canada. It will probably need the government to impose greenhouse gas emission reductions to get off the ground.

In the U.S., emissions trading markets are being developed in California under a recently adopted environmental bill, and by a collection of states in the northeast known as the “regional greenhouse gas initiative.”

A recent report by Oslo-based research firm Point Carbon predicts a high likelihood that a federal emissions trading scheme will emerge in the U.S. by 2009, as public opinion drives state and local politicians to take action and corporations push for federal action. Companies vastly prefer a federal scheme, as they fear a patchwork of regional markets and a jumble of rules — an undesirable quagmire to which players in the Canadian capital markets can relate.

All the action means financial firms are seeing opportunities for trading profits and creating new financial products.

In mid-October, Morgan Stanley announced it will invest US$3 billion in carbon trading credits and other emission-reduction projects over the next five years. “We strongly support the use of market-based solutions to meet environmental policies and objectives,” says Simon Greenshields, managing director and global head of power, associated power fuels and carbon/emissions trading and structuring.

As November began, Switzerland-based banking giant UBS AG launched the world’s first emissions index based on the components of the EU ETS. It suggests that its index will serve as a basis for creating structured products and derivatives based on the emissions market.

UBS expects the emissions market to grow in the years ahead. Indeed, a new report from the World Bank finds that, in the first nine months of 2006, the carbon market grew to almost US$22 billion, up from less than US$11 billion in 2005. “All the data show that the carbon market is becoming a powerful financial force supporting clean development,” says Karan Capoor, co-author of the report.

Most of the boon is attributable to the EU ETS, which represents almost US$19 billion of the total carbon market. The remaining US$3 billion is accounted for by project-based transactions, most of which occur in Asia.

The prospect for growth in trading schemes appears strong; it is becoming accepted as a viable way to achieve emission reductions efficiently in open economies. Not only are the schemes expected to spread by country, but it has been suggested that existing markets should expand the range of pollutants they trade, that emission caps be extended to a broader selection of industries, including airlines, and that markets be used to help prevent things such as deforestation.

@page_break@“The GHG market has performed well. But what is more important, it is delivering, in terms of catalysing green investments at a more rapid pace than expected,” says Andrei Marcu, executive director of the International Emissions Trading Association. “It is a real change, in terms of the availability of finance to address environmental problems in developing countries.”

There is also plenty of potential in the developed world, where emissions are highest and reductions may be steepest. “Clean energy is clearly benefiting from the carbon market,” says Joëlle Chassard, manager of the World Bank’s carbon finance unit. “But its true potential for sustainable development can only be realized if there is a strong policy signal for its continuation into the longer term.”

Financial mechanisms are proving essential as governments move to tackle global warming, and many firms stand to profit from the growth of “going green.” IE