Pricing the air – a conversation with Richard Sandor, "Father of Carbon Trading"

Dr. Sandor believes that the Chinese carbon market must be compatible with China's political, social, and cultural norms. He sees China as a leading light in the battle to deal with climate change.

Richard Sandor. Photo provided to Jiemian News

Richard Sandor. Photo provided to Jiemian News

Written by WANG Ziyuan

Edited by ZHENG Cuiying, Jessica LI


July 16 was the first anniversary of China's nationwide emissions trading scheme (CN ETS). The current scope of the CN ETS includes annual emissions of about 4.5 billion tons of carbon dioxide per year or around 40 percent of China’s total. It is the world's largest carbon market, three times bigger than the EU's.

Some of the major carbon trading markets worldwide are situated in the EU, the US, South Korea, New Zealand, and China. Dr. Richard L. Sandor (Ph.D.) is credited for founding the field of environmental finance, commoditizing greenhouse gas, and pioneering emissions trading. Recently, Jiemian News invited Dr. Sandor to share his insights on the future development of the CN ETS and his experience in establishing a carbon market.

Inspired by his lifelong friend and mentor, Nobel Prize-winning economist Ronald H. Coase, Dr. Sandor drew lessons from his innovative theory of social costs and was encouraged to pursue the building of institutions for emissions markets. He founded the Chicago Climate Exchange (CCX) in 2003, the world's first trading platform for greenhouse gas emissions. “If we can put a price on food, why can't we put a price on the environment, which is just as important?” He said during the interview with Jiemian News.

Dr. Sandor founded the Climate Exchange PLC (CLE) family of companies including the CCX, the European Climate Exchange (ECX), Europe's leading exchange operating in the European Union Emissions Trading Scheme (EU ETS) and the benchmark for world carbon prices, and the Tianjin Climate Exchange, which became one of the first carbon trading pilots in China.

“I have watched China as a student and a great fan. In the beginning, things go slowly. But all of a sudden, they exponentially explode. I'm extraordinarily optimistic about China’s national trading scheme.” Dr. Sandor noted that the Chinese carbon market should be designed and implemented in a way that is compatible with China's political, social, and cultural norms. “I've been committed for quite some time to the academic and business world in China, to make whatever small contributions I can that will make China a leading light in the battle to deal with climate change.”

Dr. Sandor said that environmental awareness and activity are very dependent on the level of economic wealth in the country. Globally, issues such as COVID-19, the energy crisis, and the Russian-Ukrainian war will slow down climate adaptation, but “Nothing is as powerful as an idea whose time has come," said Dr. Sandor, quoting Victor Hugo.

At the same time, he argues that a global network of cap-and-trade systems is not in line with the history of either political cooperation, economic cooperation, or international trade, and that, “Super macro solutions are intellectually interesting, but don't get to solve the problems.” 

Dr. Sandor was honored by the City of Chicago for his universal recognition as the “Father of Financial Futures”. In 2002 he was named by TIME Magazine a “Hero of the Planet”, and in 2007 as one of the magazine’s “Heroes of the Environment” for his work as the “Father of Carbon Trading.” He is also an honorary Professor at the University of Hong Kong and the School of Economics at Fudan University in Shanghai.

The following is the exclusive interview.

Jiemian News: Can we begin by having you share with our community your story behind Costa Rican CTOs, how they became recognized, and behind founding CCX, the world's first voluntary greenhouse gas trading market?

Dr. Sandor: China has been a preferred destination of mine for decades, and I've been committed for quite some time to the academic and business world in China to make whatever small contributions I can that will make China a leading light in the battle to deal with climate change. So, thank you for having me. 

My interest goes back well over three decades. In 1990, I was asked by an interest group that made lime, which would be a way to combat acid rain, if I would help advocate legislation for a cap-and-trade market. I had known something about inventing new markets. They asked, “You commoditized interest rates – can you then commoditize air?” I said I think so. The challenge is the same. We have to put a price on something scarce. And once you put a price on something, people will be careful with how they use that resource. If it is high, then it produces supply. If the price is low, it produces demand. And the idea was to create a right to admission.

As a result of that work, I got called to Geneva in 1991. The United Nations was planning a conference in Rio called the Earth Summit. I was asked to deliver a paper on the potential for a worldwide carbon market. That was 30 years ago and there weren't too many people interested in the topic. But we went to a little side event in a tent on Copacabana Beach. I sat there and had a Caipirinha, and after I gave the paper, I said, I know how to do this. At that conference, the Under-Secretary-General of the United Nations was Maurice Strong. He had headquarters in Costa Rica. I went down to visit him and President Figueres, whose sister, Christiana Figueres was the convener of the Paris meetings and an active environmentalist. We soon got to know each other, and I said to them that I would be interested in helping in whatever way possible.

They had something called a CTO, which was the securitization of a tropical rainforest. It was quite seriously done to make sure of unambiguous property rights. Anybody who would buy carbon that was sequestered had to be sure that the park was going to be in existence, that there were various known quantities of carbon, and that there were provisions for replacing carbon if there were landfills or forest fires. We went through a complex list.

After satisfying ourselves, we made the first purchase of 1000 tons of carbon credits in that country, and it was meant to be a demonstration trade. Things are very different in the business world. If you have a hypothesis and talk about it, it remains a hypothesis. If you actually spend money, people look at it as a very different proposition. The fact that we had purchased the credits, and were prepared to resell them or hold them in our inventory as an investment, created a lot of opportunities. And the fact that the person who introduced us was the Under-Secretary-General of the United Nations put us in a very different category than any other buyer. So it was a result of the fact that, we were experienced in emissions trading, had delivered a paper to the United Nations, and we were serious.

At that point, it became our mission to establish a worldwide community that would be devoted to setting up emissions trading systems in countries around the world.

Jiemian News: When you first facilitated financial interest rates trading, you were ahead of legislation, which was both an opportunity and a great challenge. You had Congress redefine a commodity to be both tangible and intangible. What was the process of creating a new futures commodity like?

Dr. Sandor: The only reason you would try to be ahead of your time is that you want to be on time. You can't be on time unless you start early – that's a principle message for entrepreneurs. You have to be there as the events are unfolding. Once it is clearly in fashion, you're going to be too late. In the case of financial futures, we look at four quadrants in terms of setting up a market to make sure that the gains from trading are cost-effective. One of them is legislative, the second is regulatory, the third is the design of the exchange itself, and the fourth is the design of the contract for the commodity that you're trading.

In the case of financial futures, it required an act of Congress to redefine a commodity. It then required an application to the new regulatory authority to make sure that it was consistent with their objectives. After that, we had to have exchange rules and regulations that would govern the trade of the commodity. Once we sorted that out, we can then worry about how big the commodity was and what the standards were. In this case, it was Ginnie Mae, the Government National Mortgage Association (GNMA). It was mortgage-backed security, and later it was treasury bonds of a specific duration. There's a very important exercise to make sure that the process existed, and it would be easy and cost-effective for you as a financial institution to consume that asset. It is no different than what's the best place to get cabbage or a car, you need that infrastructure.

Jiemian News: Many incommensurable values are given a price from an economic policy point of view, including human life, but rightly so – you commented that nature will become an all-you-can-eat buffet without pricing. But did you face ethical backlash from the public when you proposed the idea of a carbon market and translated climate change consequences into monetary terms?

Dr. Sandor: I'm an economist who invents markets. When you disrupt any existing way of doing business, people oppose it because they have financial interests that depend on existing systems. Every single invention has a natural group of resistance who profit and know how to use existing distribution channels.  

The environment poses a unique problem because it is a source of life. But we argue that it isn't so unique. We see that the world is better served by markets in wheat, rice, and pork. If we can price food, why shouldn't we be able to price the environment which is equally important? What we've learned in the last couple of centuries is that a well-organized agribusiness community makes sure that the wheat that is grown in Kansas gets delivered to Shanghai effectively with a minimum of transaction costs. If we can do that, why can't we analogously develop a system that delivers clean air throughout the world?  

The difference is that, in the case of environmental goods, there's a question of who owns the environment. We know how a farmer or the government owns an acre of land. Likewise, we have to create a property right – and that is the right to emit. Once we limit the right, we thereby limit the amount of pollution, whether it's carbon or sulfur. My mentor and dear friend, Ronald Coase, is quite well known and revered in China. In one of his great articles on the theory of social costs, in 1960, he argued that in addition to taxes or subsidies, trading an allowance of emissions under a cap would be as efficient, if not more efficient, than taxes or subsidies. This is because the stakeholders will voluntarily maximize their economic benefits when trading. He subsequently won the Nobel Prize in Economics, and his theory has been used to auction airwaves, oil leases, and things of this nature.  

Ronald and I were friends for 50 years. He encouraged me to pursue the building of institutions for emissions markets. Now, there are a lot of questions that arise. Who gets these rights? How are they assigned to people? If there are people who are given special advantages, does that hurt the system? There are questions about the affected wealth distribution. But all of these are easily answered if one looks at the framework of emissions trading as a tool for combating climate change. It is only a matter of education.

As a teacher, I love students. I don't view that as a formidable goal. I always find that if you walk into a classroom, there are no legacy misconceptions. It is very easy to teach somebody in their 20s a new concept because almost everything is new. A very important part of starting a new market is to educate academics, educate students, educate journalists, educate regulators, educated attorneys, educate accountants, and educate users. It is essentially a broad educational effort in the same way it would be for an iPhone or an electric car, or almost any other disruptive technology. It's all about a very methodical plan to clear out legislative hurdles, and regulatory hurdles, design exchanges, design the contracts, and then have a series of constituencies, all of which need to be taught about to effectively introduce this new financial innovation.

Jiemian News: In July 2021, China’s nationwide carbon trading officially kicked off at the Shanghai Environment & Energy Exchange (SEEE) and is now approaching its first anniversary. What advice do you have to mature its platform in the next 20 years to facilitate active trading and drive a low-carbon transition, and what potential significance does this market have on a global scale?

Dr. Sandor: We first brought to China the idea of a carbon market as a policy tool to deal with climate change at a UN meeting about two decades ago. Our desire was for China to develop a market with Chinese expertise and Chinese culture in mind, and judge by the standards that China had for itself. It was not to take a tool from the western economies.

The dream was to have it designed, implemented, and ultimately solve the problem in a way that was consistent with the political, social, and cultural norms that were present in China. When we gave the first talk on this at the United Nations in 2005, we were thinking about setting up the first Climate Exchange. We've come a long way in those 17 or 18 years. We have seven pilots that were established in Shanghai, Hubei, Beijing, and Tianjin, we had a national market established by the Shanghai Environment and Energy Exchange, and we have been part of developing bond futures.

This, in my opinion, tends to be laying all of the groundwork. While it appears slow, if we take a look at financial innovations, power steering was invented in 1935, and it didn't do anything until 1955. It was only widely adopted after another twenty years. It took about thirty years between the Wright Brothers and commercial air travel. So far, I believe that China has laid the groundwork. The first year was to set up, and I would expect some exponential growth in the next two or three years.

In the case of the acid rain program, the act was passed in 1990, and my company did the first trade two years later. But the Act didn't get effective until 1995! I'm extraordinarily optimistic about China’s national trading scheme. Regulating around 4.5 billion tons of annual carbon dioxide output from the power industry makes it the biggest carbon market in the world. I watched China as a student and a great fan. In the beginning, things go slowly. But all of a sudden, they exponentially explode.

It is now an intensity program, but I believe it will eventually transition to an absolute cap as opposed to carbon intensity. I have been giving lectures throughout China, and I am privileged to hold the Honorary Professorship at the University of Hong Kong and the School of Economics at Fudan University. Young people are very enthusiastic, and academics are aware. We've also dealt with the regulators, the Chinese EPA, and the various development commissions. Now that the groundwork is set, I expect a bit of a pause.

The Kuznets Curve shows us that environmental awareness and activity are very dependent on the level of economic wealth in the country. As you might imagine, the first things people are concerned about are food and housing. Once they have that, they then begin to turn their attention to clean air and other things. Clearly, COVID-19, high energy prices, the war between Russia and Ukraine – all of these will slow the adaptation. But I don't think they'll stop it.

As the great French writer, Victor Hugo said, “Nothing is as powerful as an idea whose time has come”. This is critical for people like you whose whole lives and the quality of your life will be dependent on clean air and clean water. While you might have setbacks, you will not be stopped, and China will not be stopped from solving this very important problem. They are only small blocks in the road that will be overcome, and one has to be very careful not to be sidetracked by slow or stops in a long-term trend. I hope all of your listeners recognize that this is a lifelong commitment to making the quality of life in China better for its citizens.

Jiemian News: There now seems to be a trend in starting carbon markets in other countries, such as Japan. Many are looking forward to linking carbon markets, but some scholars warn that a global network of cap-and-trade systems will deliver greater complexity and fewer emissions cuts. Where do you stand on this?

Dr. Sandor: There's too much attention paid to designing a comprehensive, worldwide, linked set of markets. If we look at the history of trading, for example, cotton in the 19th century, we had centers in Mumbai, Egypt, Liverpool, London, and England, we had winter tours in Switzerland, we had different grades, and ultimately, arbitrage came in. Nobody set up a worldwide system, it evolved.

People want to solve a comprehensive problem, but that's not the way the history of markets developed, nor is it the way the history of institutions. Look at the European Union, which started as a Coal and Steel Community (ECSC) among France, West Germany, Italy, Belgium, the Netherlands, and Luxembourg, and then gradually spread to 10, 20, and now close to 30 countries. It evolved. It is not realistic to assume that there will be one master plan which will fit the world, with China, Japan, and the US all fitting in. I think that is not in line with the history of either political cooperation, economic cooperation, or international trade, and it distracts us from getting the problem solved. Super macro solutions are intellectually interesting but don't get to solve the problems.

Jiemian News: Do you see a future in tokenizing carbon credits and blockchain-based carbon registries?

Dr. Sandor: We're in a whole new era. In California, we can start with a tomato, and have remote sensing to monitor whether it's grown sustainably. We can track it on a railroad and put it on the blockchain to see everywhere it's been. By the time it gets to the consumer, we have a complete map out of it.

The efficiencies of blockchain for registries, for tracking, are enormous today. Again, since it reduces friction, it narrows the gap between wholesale and retail prices, and consumers and producers are better off. Remember, this is the desire to get the goods and services from the producer to the consumer. The blockchain, monitoring devices, and protocols that exist in the blockchain can be useful in solving this existential crisis. We are at the cusp of a very important revolution with the Internet of Things. That's where I think young people should spend their time on.

Whatever small success I have had, it all comes down to focus, focus, focus. In a city like Shanghai or Hong Kong, coastal flooding could kill millions of people. Let's just solve the problem and make sure that you have a multigeneration of children and grandchildren that are free of climate problems. Then we can worry about other issues.

Jiemian News: Can a similar market solution be extended to, for instance, biodiversity protection or water conservation? 

Dr. Sandor: I think the next major problem is water. China's got 21 percent of the world's population and only 7 percent of the water in the world. The availability of clean water has become critical, and this challenge is almost as big as climate change. One could also argue that they are very related. Comprehensive water plans and water management are areas that are very important for China and the world.  

The preservation of forests is not only related to carbon sequestration, but also biodiversity and pharmaceutical rights within the forests. We can also think of markets based on monsoons and seasonal rains. The number of applications is enormous, and the incentives that we have to put in place, which create the storage and continuous availability of clean water, are all solvable once you get legislation, regulation, the building of institutions, and education. That's why I am always excited to speak to the Chinese academic community and young people. It is your world, and it will not be pleasant if there's no water, and if the air is fouled. China has the ability to change that. It has taken hundreds of millions of people out of poverty, and there's no reason why it can’t be a leader in dealing with issues of planetary importance like water and the air. If we just encourage education and enable the youth of the world to focus on solving problems as opposed to debating them, the future is so optimistic.