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Shanghai carbon exchange aids first custody contract to build trade

[BEIJING] The Shanghai Environment and Energy Exchange announced its first "custody contract" on Thursday, allowing a brokerage to borrow permits from a local company and trade them, in a bid to inject liquidity in a depressed market.

China's government will launch a nationwide carbon trading market next year and is working on plans to harmonise the seven existing pilot markets, but it remains unclear how many of the existing local exchanges will survive the transition.

They are now scrambling to stay in business by offering a range of other financial tools, including buy-back contracts, loans using permits as collateral, permit-credit swaps and forward contracts negotiated over the counter.

Under the custody contract, Wujing Thermal Power Plant, a subsidiary of the State Power Investment Corporation, one of China's biggest power firms, transferred 2 million permits to Carbon Trading Capital. The Shanghai exchange carried out the transfer and did a risk evaluation of both parties ahead of the contract signing.

Wujing will receive an agreed share of any carbon-trading profits and will see the full amount of permits returned to it in May in order to comply with its emission targets.

Capital is a brokerage firm registered with all seven of the country's regional exchanges. The permits are nearly 4 per cent of Wujing Thermal's annual amount. "Shanghai regulators gave the approval to intermediaries with capital and credibility to provide financial services to industries with little trading experience," said Kou Weiwei, China director at Carbon Trading.

According to the rules, borrowers have to pay a 30 per cent margin as a risk deposit. Mr Kou said the deal is risk-free since Shanghai is supporting the banking of older local permits that the Chinese government will convert for use in the national market in 2017.

Liquidity in the Shanghai exchange has declined after local factories closed and dumped their permits on the market, causing a glut. No permits have traded since early September when the permit price fell close to a near-historical low of 13.4 yuan. "We think the decline mirrored fundamentals and it is good the government stepped back," said Mr Kou, but she said the market was still unable to send sound price signals because fluctuations could be triggered by a small number of companies.

REUTERS