9203_9789814612432_tp.indd 18/9/14 9:50 am May 2, 2013 14:6 BC: 8831 - Probability and Statistical Theory This page intentionally left blank PST˙ws World Scientific 9203_9789814612432_tp.indd 18/9/14 9:50 am Published by World Scientific Publishing Co Pte Ltd Toh Tuck Link, Singapore 596224 USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE Library of Congress Cataloging-in-Publication Data Sandor, Richard L Sustainable investing and environmental markets : opportunities in a new asset class / Richard Sandor, Nathan Clark, Murali Kanakasabai, Rafael Marques pages cm ISBN 978-9814612432 (hardcover : alk paper) Investments Environmental aspects Investments Moral and ethical aspects Clean energy investment Sustainable development Economic aspects Environmentalism Economic aspects I Title HG4521.S3324 2014 332.6 dc23 2014014878 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Cover image: Buckminster Fuller and Chuck Bryne, Dymaxion Air-Ocean World Map (1981) This print belongs to Dr Richard L Sandor The use of an image of the Dymaxion Map is courtesy of the Buckminster Fuller Institute (BFI) The word Dymaxion, Spaceship Earth and the Fuller Projection Map are trademarks of the BFI All rights reserved Copyright © 2015 by World Scientific Publishing Co Pte Ltd All rights reserved This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the publisher For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA In this case permission to photocopy is not required from the publisher In-house Editors: Chye Shu Wen/Rajni Gamage Typeset by Stallion Press Email: enquiries@stallionpress.com Printed in Singapore ShuWen - Sustainabe Investing & Environmental.indd 24/7/2014 12:20:45 PM September 17, 2014 10:7 Sustainable Investing and - 9in x 6in pagev b1805-fm FOREWORD World Scientific is to be commended for publishing — and environmental market pioneer Richard Sandor and his three colleagues for writing — this masterly and path-finding overview of an asset class that is already important, rapidly gaining further scale and scope, and yet surprisingly and systematically underused My 1999 book Natural Capitalism, co-authored with Paul Hawken and L Hunter Lovins, asked the question: If capitalism is the productive use of and reinvestment of capital, what is capital?1 Industrial capitalism deals seriously with only two kinds of capital — financial capital and physical capital (i.e., money and goods) It ignores and even liquidates two even more valuable kinds of capital — natural capital and human capital (i.e., nature and people) Without people, there is no economy, and without nature, there are no people, so this omission is material But if you play with a full deck, productively using and investing in all four forms of capital, then you make more money, more good, have more fun, and gain stunning competitive advantage The authors of this book provide here a vital toolkit for people to start capturing these opportunities by valuing and investing in the salient missing parts Familiar environmental markets already monetize and trade in the abatement of negative environmental externalities — unpriced costs to health, wealth, and security imposed by one party on Paul Hawken, Amory B Lovins and L Hunter Lovins, Natural Capitalism: Creating the Next Industrial Revolution (Boston: Little Brown, 1999): free download (with a summary of the article from the Harvard Business Review) at www.natcap.org v September 17, 2014 vi 10:7 Sustainable Investing and - 9in x 6in pagevi b1805-fm Sustainable Investing and Environmental Markets another.2 Avoiding these costs can be valuable: Air pollution has already cost a half-billion northern Chinese people an estimated 2.5 billion person-years of life expectancy — five years per person.3 Less familiar and less mature than improving air quality, but even more promising, are ways to make markets in saved resources.4 Resource efficiency is typically profitable simply because (1) saving resources costs less than buying them; and (2) with new integrative design techniques, efficiency often produces expanding rather than diminishing returns.5 The savings can be dramatic: A detailed 2011 book showed how the United States, for example, could run a 2.6fold bigger 2050 economy with no oil, coal, or nuclear energy and one-third as much natural gas — $5 trillion cheaper in net present value than “business as usual” (with all externalities valued at zero).6 This tripling of end-use energy-efficiency and shifting of energy supplies from one-tenth to three-fourths renewable would strengthen national security, require no new inventions or Acts of Congress, and could be led by business for profit Yet, that study’s astonishing financial returns (e.g., tripling or quadrupling U.S buildings’ energy productivity with a 33% internal rate of return (IRR) and doubling that of industry with a 21% IRR) Hank Patton has devised a transactional framework for intergenerational commerce so that people not yet born can invest today in providing the goods and services — and avoiding the “bads” and nuisances — that will advance their interests and our own; see hank@worldste ward.org Yuyu Chen, Avraham Ebenstein, Michael Greenstone and Hongbin Li, “Evidence on the Impact of Sustained Exposure to Air Pollution on Life Expectancy from China’s Huai River Policy.” Proceedings of the National Academy of Sciences (8 July 2013); available online at www.pnas.org/content/early/2013/07/03/1300018110 Amory B Lovins, “Making Markets in Saved Resources.” In Festschrift for E.U von Weizsăacker, RMI Publication #E89-2725 (June 1989); available online at www.rmi.org/ Knowledge-Center/Library/2013-19 MakingMarketsinResourceEfficiency Amory B Lovins, “Integrative Design: A Disruptive Source of Expanding Returns to Investments in Energy Efficiency.” RMI Publication #X10-09 (2010); available online at www rmi.org/rmi/Library/2010-09 IntegrativeDesign; Amory B Lovins, Michael Bendewald, Michael Kinsley, Lionel Bony, Hutch Hutchinson, Alok Pradhan, Imran Sheikh and Zoe Acher, “Factor Ten Engineering Design Principles.” RMI Publication #X10-10 (2010); available online at www.rmi.org/rmi/Library/2010-10 10xEPrinciples Amory B Lovins and Rocky Mountain Institute, Reinventing Fire: Bold Business Solutions for the New Energy Era (White River Junction, VT: Chelsea Green, 2011); available online at www.rmi.org/reinventingfire September 17, 2014 10:7 Sustainable Investing and - 9in x 6in pagevii Foreword b1805-fm vii reflect only private internal costs and benefits Those results leave out all avoided environmental, security, and other negative externalities (including the avoidance of 82–86% fossil carbon emissions) They also omit major positive externalities, such as side benefits that have been well documented to transform real estate by adding value often worth one, sometimes two, orders of magnitude more than the energy savings themselves.7 The markets already being made in saved resources — so that all ways to provide or save resources can compete fairly — are impressive and valuable But they barely scratch the surface of the asset- and wealth-creating opportunities For example, Chapter 13 of Natural Capitalism outlines some of the roughly 20 new ways my team devised in the 1980s for making markets in saved energy, water, and materials.8 Many of these methods are gradually entering use For example, electric grids in about three-fifths of the United States now let “negawatts” (saved electricity) and demand response (changing the timing of electrical demand) compete in formerly supply-side-only auctions In the giant PJM power pool, 94% of the winning bids in a recent auction came from the demand side, because negawatts cost less than megawatts In transport, some jurisdictions are starting to make markets in “negatrips” and “negamiles,” encouraging competition between different ways of getting around or of not needing to Such markets can even reward real estate developers “Smart-growth” or “newurbanist” models create or restore compact, walkable, mixed-use cities and towns that help people be already where they want to be so they need not go somewhere else Since such layouts are more desirable and valuable, they generally boost developers’ profits In water, efficient use is starting to bid against increased supply, and the same is true for some other resources Scott Muldavin, “Value Beyond Energy Cost Savings.” (2010); available online at www.greenbuildingfc.com This discussion is also provided in Chapter 5.3 of the predecessor to Hawken et al., Natural Capitalism, op cit — namely, Amory B Lovins, Ernst U von Weizsăacker and L Hunter Lovins, Factor Four: Doubling Wealth, Halving Resource Use (London: Earthscan, 1987), pp 164–176 September 17, 2014 viii 10:7 Sustainable Investing and - 9in x 6in pageviii b1805-fm Sustainable Investing and Environmental Markets These markets can spur “solutions economy business models,” which typically lease the desired service rather than sell a product whose use produces the service Solutions-economy business models align providers’ interests with customers’ interests — that is, rewarding both for doing more and better with less for longer.9 Underlying environmental markets are the vital principles of financial economics — sound but often dangerously overlooked For example, the lower financial risk of the small, fast, modular investments now taking over the electricity market is one of the reasons these projects are often worth an order of magnitude more than is normally assumed.10 Some traditional suppliers of capital continue to chase big, slow, lumpy projects For example, huge investments are still being made on the basis of apparently low spot prices for fracked natural gas that reflect neither the attendant risks and uncertainties nor the value of the gas’s price volatility (The volatility is discoverable from the straddle in the options market and is likely to rise if the apparent cheapness of wellhead gas causes expanded exports of liquefied natural gas, petrochemical producers’ pivots to cheaper gas, and downstream bottlenecking.) Counting price volatility alone approximately doubles the price of gas that is relevant for fair comparison with its constant-price carbon-free physical hedges — energy-efficiency and renewables — that are increasingly outpacing and outcompeting it Financial analysts have a duty to warn investors who ignore volatility — which is akin to constructing a bond portfolio of all junk bonds and no U.S Treasury bonds by considering yield but not risk Analysts could also advise investors to short the portfolios of those who persist in such foolishness In addition to such tactical openings, the strategic horizon for applying financial economics and making environmental markets See Natural Capitalism, op cit., Chapter B Lovins, E Kyle Datta, Thomas Feiler, Karl R Rabago, Joel N Swisher, Andre Lehmann and Ken Wicker, Small Is Profitable: The Hidden Economic Benefits of Making Electrical Resources the Right Size (Snowmass, CO: Rocky Mountain Institute, 2002); for more information, visit www.smallisprofitable.org 10 Amory September 17, 2014 10:7 Sustainable Investing and - 9in x 6in pageix Foreword b1805-fm ix stretches boundlessly Herman Daly, ecological economist and professor at the School of Public Policy of University of Maryland, neatly summarizes how the first Industrial Revolution made people about 100 times more productive because the relative scarcity of people limited the exploitation of seemingly boundless nature Today, we have the opposite pattern: abundant people but scarce nature So, it is no longer people that we must strive to use far more productively, but nature The four interlinked principles of natural capitalism — (1) radical resource productivity; (2) producing in the same way nature does (closed loops, no waste, no toxicity); (3) rewarding these shifts through solutions-economy business models; and (4) investing some of the resulting profits back into the kinds of capital in shortest supply (natural and human capital) — can, together, create an extraordinarily less risky, more durable, and more rewarding economy for all — forever In today’s dirty, depleted, and dangerous world, environmental markets are the key both to short-term tactical opportunities and to longer-term transformational ones I applaud Richard Sandor, Nathan Clark, Murali Kanakasabai, and Rafael Marques for crisply describing where to find the key and how to insert and turn it — and for giving us a glimpse of the treasures behind that golden door Amory B Lovins Cofounder and Chief Scientist, Rocky Mountain Institute Old Snowmass, Colorado October 2014 September 17, 2014 366 10:7Sustainable Investing and - 9in x 6inb1805-Conclusion page366 Sustainable Investing and Environmental Markets water quantity and quality Pricing should create incentives to develop infrastructure, generate conservation (the equivalent of energy-efficiency in carbon markets), and foster innovation In related developments, investors should be watching for opportunities in transporting water efficiently and economically and in setting standards for water use in the hydraulic fracturing (fracking) process Such standardization is the first step in facilitating the limitation of pollution caused by fracking (2) Environmental markets will continue to grow The environmental marketplace is vibrant with activity around the world Contrary to the notion that the world will have a unified environmental market, we are witnessing a “plurilateral” system that includes regional, state, and national markets.6 In the United States, California is leading the way California has been an agent of change for more than a century — in film, high tech, social media, and the environment California is already forging alliances with other carbon markets that are developing nationally and internationally And, given the latest serious droughts affecting the state and its economy, California may start to lead in water markets as well Policymakers and investors should follow the trends in California closely In the United States, environmental solutions tend to begin at the state level and then percolate to the federal level While the developed world shies away from market solutions to environmental problems, emerging economies not China, with seven separate cap-and-trade markets, is leading the way An eighth program in the city of Qingdao has been announced as of the writing of this book Others may follow, as the expectation is that these pilots will serve as the blueprint for a national mandate in the coming years Plurilateral refers to the development of a framework for GHG emissions trading involving a medium-sized set of countries (e.g., 5–20).The concept of a plurilateral regime was coined by Richard L Sandor in the mid-1990s Although it was first published in 1999, it was not fully defined until 2001 in the following publication: Richard Sandor, “The Case for Plurilateral Environmental Markets.” Environmental Finance (September 2001) September 17, 2014 10:7Sustainable Investing and - 9in x 6inb1805-Conclusion page367 You Can Put a Price on Nature 367 They could also provide the motivation to foster regional markets in SO2 , NOx , and other particulate matter pollution in major Chinese metropolitan areas China’s policies started by focusing on promoting energy-efficiency (as defined in Chapter 5), and the programs are morphing into capand-trade markets India also has an energy-efficiency trading program Cap-and-trade markets are under consideration in Brazil, South Korea, Mexico, Vietnam, and Kazakhstan A recent survey of 66 countries shows that 61 have passed climate and clean energy laws, and the trend is starting to influence other countries to the same.7 Even at the national level, in the United States we might be witnessing the reemergence of “cap-and-trade” as a policy tool As new greenhouse gas legislation is being debated, a report by the Clean Air Task Force advocates for trading as the most cost-effective approach to reducing greenhouse gas emissions from the utility sector.8 In assessing the future of cap-and-trade, investors may be better served by closely watching Sacramento, California, and Beijing than by watching Washington, DC or Brussels Emerging markets that begin developing environmental policies by setting energy-efficiency goals are on the right track, and investors should look at countries that adopt such goals as indicators that cap-and-trade markets are likely to develop The expected growth in market-based programs can also be measured by the number of lesser known programs in sustainable fisheries management and water For example, the existence of 21 separate water quality programs in the United States Michal Nachmany, Sam Fankhauser, Terry Townshend, Murray Collins, Tucker Landesman, Adam Matthews, Carolina Pavese, Katharina Riefig, Philip Schleifer and Joana Setzer, “The GLOBE Climate Legislation Study: A Review of Climate Change Legislation in 66 Countries Fourth Edition.” (London: GLOBE International and the Grantham Research Institute, London School of Economics, 2014) Clean Air Task Force, “Power Switch: An Effective, Affordable Approach to Reducing Carbon Pollution from Existing Fossil-Fueled Power Plants.” (February 2014); available online at http://catf.us/resources/publications/files/Power Switch.pdf September 17, 2014 368 10:7Sustainable Investing and - 9in x 6inb1805-Conclusion page368 Sustainable Investing and Environmental Markets shows a fertile ground for further institutional development These practical demonstrations are providing valuable lessons in administration, monitoring, and verification They can also help show that the initial perception that these are unsurmountable challenges is a myth (3) The costs of catastrophic events will rise Eight of the top ten most expensive weather events have occurred since 2003, and those that affected the United States cost the U.S economy billions of dollars in losses We expect this trend to continue and intensify, with further increases in insured and uninsured losses Hurricane Sandy did not touch down in New York City but it caused severe impact in an area of the United States which is a major financial, transportation, and residential hub Another event of similar or greater magnitude could have tremendous financial and physical impact This trend has huge implications for the financial industry as a whole Management of such catastrophes can change the nature of the private insurance industry as well as government emergency assistance and self-insurance Does the insurance industry or government have sufficient capital to cover the extent of future catastrophic losses? In addition, the impact of major earthquakes on nuclear power generation is all too clear The Fukushima nuclear disaster triggered shutdowns in nuclear power plants around the world What is the effect of such shutdowns on building new nuclear capacity, particularly in India and China, where power demand is growing fastest? On a related point, there is also a nascent role for professionals interested in the use of catastrophe-based and other alternative risk-management products in areas of the world that are also affected by natural disasters but lack developed capital markets, such as Central America and Southeast Asia Again, the possibilities for innovation are vast As demonstrated throughout this book, markets in emissions and user rights have solved environmental problems and created September 17, 2014 10:7Sustainable Investing and - 9in x 6inb1805-Conclusion page369 You Can Put a Price on Nature 369 enormous investment opportunities They achieved these ends by commoditizing the externality and then pricing it The same concept has been applied to weather-driven events and catastrophes Financial innovation and markets have a significant role to play in other situations and fields where there are good and bad externalities, such as medicine, education, and biodiversity The convergence of the environment and finance is here to stay, and the market mechanisms described in this book are only the beginning The new asset class of environmental goods is just in its infancy and holds enormous promise May 2, 2013 14:6 BC: 8831 - Probability and Statistical Theory This page intentionally left blank PST˙ws September 17, 2014 10:7 Sustainable Investing and - 9in x 6in b1805-index INDEX annual reconciliation, 41 asset class, v, xiii, 1–4, 7, 21, 35, 45, 50, 53, 54, 59, 62, 87, 88, 90, 138, 163, 165, 192, 193, 195, 231, 262, 265, 283, 311, 325, 339, 343, 344, 354, 359, 369 Australia, 6, 11, 12, 63, 94, 96, 102, 110, 119, 139, 152–155, 157, 160, 191, 239, 242, 248–255, 261, 271, 292, 317, 360, 365 Australian water markets, 12, 248, 249, 251, 255 Assembly Bill (AB 32), 5, 111, 113, 179 abatement costs, 19, 242 acid rain, xi–xiii, 3, 4, 28, 35–38, 55, 56, 60, 61, 80, 85, 102, 104, 230, 241, 359, 360 Acid Rain Program, 2, 3, 21, 24–26, 35–39, 42, 43, 45, 47, 48, 57, 58, 65, 67–70, 77, 78, 83, 101, 102, 105, 113–115, 132, 138, 361–363 Afforestation/Reforestation (A/R), 173, 174, 177, 178, 186 agriculture, 59, 64, 74, 86, 92, 112, 154, 155, 171, 174, 175, 178–180, 192, 196, 236, 237, 240, 253, 254, 258, 264, 270, 280, 332, 339 air, vi, xi–xiii, 9, 16, 17, 25, 28–30, 32–35, 37–39, 48, 49, 54, 55, 91, 113, 115, 137, 139, 167, 211, 222, 234, 235, 265, 267, 281, 292, 338, 341, 353–356, 359, 360, 367 Alberta, 106, 109, 129–137, 159, 248 allowance allocation, 40, 70, 73, 75, 84 allowance registry, 41, 124 allowance trading, 29, 41, 58, 70, 96, 106, 115, 147 allowances, xii, 3–5, 11, 12, 20, 21, 25, 28, 31, 32, 36, 37, 40–48, 50–54, 57, 62, 65, 68–71, 75–79, 83, 84, 87–89, 93, 95, 99, 102, 110, 111, 113–119, 121, 123–129, 132, 136, 137, 153, 158, 161, 173, 176, 178, 187, 245, 352, 359, 360 alternative risk-management products, 368 Bermuda, 312, 319, 321, 322, 324, 340 Bermuda Stock Exchange (BSX), 322 bid–ask spread, 75 Brazil, 102, 139, 152, 156, 158, 160, 172, 179, 235, 259, 365, 367 bubble, 30, 66 by-catch, 285, 291, 296–298, 307, 309 California, 8, 9, 33, 43, 56, 78, 94, 97, 102, 104, 109–114, 116–120, 129, 132–137, 159, 178, 179, 182, 187, 190, 191, 197–199, 202, 203, 207, 225, 313, 341, 363, 365–367 California Air Resources Board (CARB), 113–115, 136, 137 California’s Cap-and-Trade Program, 5, 78, 109, 113, 118, 186 371 page371 September 17, 2014 372 10:7 Sustainable Investing and - 9in x 6in b1805-index Sustainable Investing and Environmental Markets cap-and-trade, xii, 2–5, 14, 18–20, 29–32, 35, 38, 48, 53, 55, 61, 67, 78, 82, 96, 101, 103, 105, 107–109, 113, 118, 120, 134–137, 153, 156, 157, 160, 164, 179, 186, 192, 199, 226, 246, 247, 266, 292, 359, 363, 366, 367 carbon, carbon allowances, xiii, 3, 65, 85, 87, 93, 95, 111, 113, 121, 128, 173, 176, 352 carbon credits, 93, 159, 164, 165, 177, 180, 189–192, 204 carbon cycle, 166–168 carbon dioxide (CO2 ), 1, 4, 5, 9, 12, 36, 41, 47, 59, 60, 63–66, 68, 70, 72, 73, 76, 80, 82, 84, 87, 89, 98, 99, 111–113, 118, 120–125, 130, 132–135, 137, 140, 142, 144, 152–157, 163, 164, 166, 169, 170, 173, 176, 177, 182–185, 187, 188, 192, 195, 219, 245, 256, 268, 332, 360 carbon dioxide allowances, 4, 125, 359, 360 Carbon Disclosure Project (CDP), 8, 350 carbon intensity, 5, 81, 96, 105–109, 134, 141, 150, 157, 160 carbon sequestration, 114, 165, 166, 169, 175, 176 catastrophe, xiii, 11, 310, 312, 313, 316–320, 322–325, 327–329, 332–334, 337, 359, 368 catastrophe bonds (CAT bonds), 312, 317–319, 322, 323, 327, 329, 359 catastrophic events, 8, 230, 310, 311, 328, 340, 368 catastrophic insurance, 337 catch shares, 292–297, 300, 305, 308, 309 CERES, 8, 350 Certified Emission Reductions (CERs), 5, 10, 65, 75, 76, 85, 89, 93, 145, 154, 155, 158, 177 Charles Keeling, 62 Chicago Board of Trade (CBOT), 23–28, 42, 52, 53, 117, 337 Chicago Climate Exchange (CCX), 94, 117, 142, 174–176, 182 Chicago Climate Futures Exchange, 29, 94 Chicago Mercantile Exchange (CME), 4, 5, 8, 11, 88, 95, 111, 117, 127, 216, 337–339 China, xi, 5, 9, 55–57, 64, 66, 90, 94–97, 102, 105, 106, 119, 133, 138–142, 144, 147, 151, 157, 160, 210, 232, 233, 236, 244, 259, 320, 354, 356–358, 365–368 Clean Air Act in 1970, 28–30 Clean Air Act Amendments (CAAA), 39, 40, 47, 48 Clean Air Act Amendments (CAAA) of 1990, 25, 28, 35, 37 Clean Air Act of 2003, 48 Clean Air Interstate Rule (CAIR), 38, 44, 48, 49 clean development mechanism (CDM), 65, 72, 145, 149, 153, 177, 178, 182, 183 clean dozen, 359–361, 364 Clean Water Act (CWA), 268, 269 Climate, Community & Biodiversity Standards (CCBA), 179, 180 command-and-control, 15, 18, 20, 29, 32, 285, 363 commoditization, xiii, 4, 21, 356, 359 compliance market, 130, 179, 182, 190, 191, 199, 200, 202, 204, 205, 208 cooling degree day (CDD), 50, 79, 312, 338, 339 corporate social responsibility (CSR), 2, 123, 158, 185, 188, 189, 191, 344, 349 crop science, 258 Cross-State Air Pollution Rule (CSAPR), 48, 49 page372 September 17, 2014 10:7 Sustainable Investing and - 9in x 6in Index deforestation, 59, 117, 156, 158, 160, 161, 163–167, 169–173, 180, 193 degradation, xi, 10, 16, 60, 143, 158, 161, 165, 169–173, 193, 268 desalination, 235, 241–243, 259–261 discards, 291, 296–298, 309 earthquakes, 8, 311, 313–315, 320, 325, 327, 328, 330, 331, 345, 368 electronic registry, 68, 361 emission intensity, 67, 130, 133, 134, 157 emission-reduction units (ERUs), 5, 65, 75, 76 emissions trading, 4, 5, 9, 19, 21, 29, 31, 33, 58, 61, 62, 65, 66, 68, 73, 83, 84, 93, 96, 98, 104, 106, 111, 114, 119, 120, 129, 142, 152, 176, 178, 228, 359, 360, 362, 366 energy intensity, 107, 108, 134, 140, 141, 220 energy saving certificates (ESCerts), 7, 150, 157, 229 energy-efficiency, 3, 4, 6–8, 10, 60, 77, 80–82, 85, 91, 92, 105–110, 120, 123, 125, 128, 143, 146, 149, 150, 156, 157, 160, 194–196, 206, 219–227, 229, 230, 257, 358, 365–367 environment, xi, xiii, 2, 8, 13, 19, 20, 24, 28, 67, 110, 133, 137–140, 145, 157, 176, 180, 195, 196, 244, 245, 254, 268, 277, 283, 287, 321, 345, 351, 356, 357, 359, 366, 369 environmental assets, xiii, 1–4, 7, 19, 49, 95, 138, 156, 230, 245, 268, 352, 359 environmental finance, 1, 3, 5, 6, 40, 64, 94, 104, 156, 343, 352 environmental markets, v, viii, xi, 2, 8, 13–15, 20, 21, 23, 101, 102, 104, 133, 143, 159–161, 165, 190, 192, 193, 194, 206, 229, 256, 268, 277, 364, 366 Environmental Protection Agency (EPA), 2, 25, 26, 28–31, 38, b1805-index 373 40–43, 48–50, 52–54, 196, 213, 214, 216–218, 247, 267, 270, 277, 278 environmental, social, and governance (ESG), 345–350, 352–359 European Energy Exchange, 5, 88 European Environment Agency, 67 European Union (EU), 5, 9, 64, 66–73, 75, 78, 84, 85, 105, 112, 144, 172, 178, 290, 365 European Union Allowances (EUA), 5, 68, 69, 71–78, 81, 84, 85, 87–90, 93, 95, 96, 99, 178, 187, 339 European Union Emissions Trading Scheme (EU ETS), 58, 61, 62, 66–69, 71–77, 79–87, 92, 95, 96, 102, 104–106, 113, 129, 130, 132, 138, 140, 154, 178, 360–363, exchange-traded fund (ETF), 88, 89, 90, 211, 261, 262 exchange-traded notes (ETNs), 89 externalities, v–vii, xii, 14–16, 18, 20, 36, 343, 351, 359, 365, 369 financial innovations, 13, 21, 355, 369 fish stocks, 283, 284, 287–291, 295, 309, 358 fishing rights, xiii, 360 flexible compliance, 41 flue gas desulfurization (FGD), 54–56 freshwater, 7, 232, 234–236, 239, 241, 244, 255, 259, 261, 279, 281, 365 fuel mix, 45, 46, 198 fuel switching, 50, 52, 77, 80, 85, 86, 123, 206, 363 global reporting initiative (GRI), 349 global warming potential (GWP), 64, 89, 98, 99 green tickets, 198 greenhouse gas (GHG), 5, 7, 9, 21, 29, 59–66, 68, 72, 73, 76, 78, 80, 82, 84–87, 89, 94, 96–99, 101, 102, page373 September 17, 2014 374 10:7 Sustainable Investing and - 9in x 6in b1805-index Sustainable Investing and Environmental Markets 104–114, 117, 120, 125, 129–134, 139–142, 144, 147, 152–160, 163, 164, 166, 169, 170, 172–179, 185, 187–189, 191, 193, 196, 199, 206, 211, 245, 246, 266, 339, 366, 367 Gulf of Mexico Red Snapper Individual Fishing Quota Program, 298 John H Dales, 19 joint implementation (JI), 65, 72, 182, 183 heating degree day (HDD), 49, 312, 338, 339 human capital, v, ix Hunter River, 271, 274, 275, 278 Hunter River Salinity Trading Program, 271, 272 hurricanes, 11, 50, 60, 310–315, 320, 322, 324, 328, 334, 339–341, 345, 359, 368 hydraulic fracking, 238, 264, 364, 366 Land Use, Land Use Change, and Forestry (LULUCF), 169 Limited Access Privilege Programs (LAPP), 292 low-sulfur coal, 36, 45–47, 50, 52 Improved Forest Management (IFM), 169, 174, 186 index-based insurance, 312, 327, 329–334 India, xi, 5, 10, 55, 57, 64, 66, 91, 95–97, 105, 107, 110, 133, 138, 142–147, 149–151, 157, 160, 226, 229, 232, 233, 235, 242, 258, 354, 356–358, 365, 367, 368 Individual Fishing Quota (IFQ), 298–302, 305–308 Individual Transfer Quotas (ITQ), 292, 299 Industry Loss Warranties (ILWs), 312, 323, 325, 327–330, 334 insured losses, 311–315, 318, 326, 328, 368 IntercontinentalExchange (ICE), 4, 5, 88, 90, 95, 99, 110, 111, 117, 127, 204, 205, 216 Intergovernmental Panel on Climate Change (IPCC), 169, 170 International Energy Agency (IEA), 196, 239 irrigation, 235–237, 239, 241, 242, 249, 250, 254, 258, 259, 271 Keeling curve, 63 Kyoto Protocol, 4, 61, 65, 66, 71, 98, 145, 154, 155, 177, 178 market failure, 15, 16 market mechanisms, 1, 19, 65, 67, 96, 102, 140, 358, 369 market-based mechanisms, 21, 29, 61, 120, 146, 359 megawatt hour (MWh), 197, 199, 200, 202, 203, 205, 206, 208 Murray–Darling Basin, 251, 253, 254 natural capital, v, ix, 173 natural disasters, 49, 50, 311–313, 332, 337, 340, 368 natural gas, vi, viii, 45, 50, 54, 77, 80, 86, 87, 89, 91, 139, 204, 205, 214–216, 223, 238, 354, 364 negamiles, vii negative externalities, v, vii, xii, 15, 36, 359 negatrips, vii negawatts, vii, 220 nitrogen oxides (NOx ), 1, 4, 31, 34–38, 41, 45, 47, 48, 54, 55, 58, 60, 139 non-point sources (NPS), 235, 237, 267, 269, 270, 272, 273 Nord Pool, nutrients, 7, 11, 234, 235, 237, 246, 248, 265–267, 272, 273, 280 offset market, 84, 188 Oregon Temperature Program, 275 over-allocation, 71, 78, 122, 123, 125, 127, 129 page374 September 17, 2014 10:7 Sustainable Investing and - 9in x 6in b1805-index Index over-the-counter (OTC), 3, 21, 22, 26, 29, 42, 44, 53, 62, 93, 117, 182, 205, 206, 216, 227, 337–339, 366 Perform, Achieve and Trade (PAT) program, 6, 10, 97, 105, 107, 149–151, 226 point sources (PS), 234, 267–270, 272, 273 powder river basin coal, 45 Property Claims Service (PCS), 328 property rights, xii, 15, 16, 20, 29, 39, 172, 181, 195, 226, 237, 243, 245, 246, 255, 256, 268, 358–360 Quebec, 109, 118, 129, 131–137, 159 Reducing Emissions from Deforestation and Forest Degradation (REDD), 10, 158, 159, 161, 173, 178–180, 185, 190–192 Regional Greenhouse Gas Initiative (RGGI), 5, 9, 104, 109, 120, 122–129, 133–137, 159 reinsurance market, 319, 321, 323 renewable energy, 1, 3, 4, 6, 60, 79, 81, 85, 90, 92, 96, 97, 106, 109, 110, 120, 125, 143, 146, 147–149, 159, 160, 194, 195–202, 204–206, 208, 210, 211, 215, 229, 230, 360, 364 renewable energy certificates (RECs), 3, 6, 81, 146–149, 195–212, 219, 360 renewable identification numbers (RINs), 10, 195, 196, 212–218, 229, 230, 363 renewable portfolio standards (RPS), 196, 197–199, 201, 202, 205–208, 212 resource efficiency, vi Ronald Coase’s theory of social cost, 19 safety, 13, 47, 288, 294, 295, 349, 363 scrubbers, 43–46, 50–52, 54–56, 206 seven-stage process, 21, 22, 29 shale, 364 375 socially responsible investing (SRI), 343, 344, 351, 352 SRI screens, 13, 344 solar power, 77, 91, 147, 199, 206, 360, 364 solar RECs (SRECs), 200, 201, 205–207, 210 South Korea, 9, 55, 97, 139, 151, 152, 157, 160, 191, 244, 367 sovereign risk, 49, 69, 78, 85 Special Purpose Vehicles (SPV), 324, 325 subsidies and/or taxes, 15, 18 sulfur, xiii, 1, 2, 4, 17, 21, 23–28, 35, 36, 39, 41, 43–47, 50–52, 54, 60, 64, 98, 99, 144, 199, 219, 245, 359 sulfur dioxide (SO2 ), 1, 4, 9, 17, 21, 23–29, 31, 35–58, 60, 62, 69, 76, 79, 80, 82, 83, 139, 144, 199, 206, 219, 245, 253, 256, 268, 359–361, 367 sulfur dioxide allowances, 25, 29, 36, 41, 42, 44, 46, 49–51, 53, 62, 76, 79, 360 sustainability, sustainability equity indices, 352 sustainability investing (SI), 343, 344, 346, 352 sustainability reporting, 348, 349, 353 sustainability-focused mutual funds, 13, 350–352, 354 sustainable, sustainable development, 1, 85, 137 Sustainable Fisheries Management, 283, 358, 367 sustainable stock indices, sustainable stocks, xiii, Svante Arrhenius, 59 swaps, 3, 83, 312, 327, 334, 356 Total Allowable Catch (TAC), 284, 295, 296 page375 September 17, 2014 376 10:7 Sustainable Investing and - 9in x 6in b1805-index Sustainable Investing and Environmental Markets total maximum daily load (TMDL), 11, 269 Tragedy of the Commons, 20, 284 transaction costs, 18, 20, 34, 35, 57, 75, 359, 361 U.S Renewable Fuel Standard (RFS), 196, 212–219 UN Framework Convention on Climate Change (UNFCCC), 59, 65, 97, 145, 146, 176, 177 uninsured losses, 311–313, 368 Verified Carbon Standard (VCS), 10, 158, 159, 179–181 virtual water: synthetic trading, 244 voluntary market, 6, 105, 160, 164, 166, 179, 181, 183–186, 201–204, 207–209 water, vii, xi–xiii, 1, 4, 7, 8, 11, 16, 17, 54, 59, 60, 87, 92, 144, 164, 172, 175, 193, 210, 211, 222, 230–236, 275, 277, 282, 288, 292, 306, 308, 341, 349, 350, 353–357, 360, 365–367 water infrastructure, 233, 235, 256, 257, 262 water markets, 7, 230, 231, 245, 246, 251, 254, 255, 256, 262, 268, 281, 365, 366 water pollutants trading, 246 water pollution, 16, 265–267, 269, 270, 357 water quality trading, 7, 11, 245, 247, 265, 266, 268–272, 275 water quantity trading, 11, 245, 248 water rights, 237, 241, 243, 245, 248, 249, 255, 360 water temperature trading, 247, 248, 277, 280 water treatment and filtration, 259 wealth creation, 355, 356, 359 weather, weather funds, 340 weather risk, xiii, 311, 340 weather-related investable indices, 339 page376 September 17, 2014 10:7Sustainable Investing and - 9in x 6inb1805-abt-author page377 ABOUT THE AUTHORS Richard Sandor (Ph.D., Dr Sc h c.) is Chairman and CEO of Chicago-based Environmental Financial Products (EFP), LLC, which specializes in inventing, designing, and developing new financial markets EFP was established in 1998 and was the predecessor company and incubator to the Chicago Climate Exchange (CCX), the European Climate Exchange (ECX), the Chicago Climate Futures Exchange (CCFE), and the Tianjin Climate Exchange (TCX) Dr Sandor is the Aaron Director Lecturer in Law and Economics at the University of Chicago Law School and a Visiting Fellow with the Smith School of Enterprise and the Environment at Oxford University He was honored by the City of Chicago for his universal recognition as the “father of financial futures” and named one of TIME magazine’s “Heroes of the Environment” for his work as the “Father of Carbon Trading.” In October 2013, Dr Sandor was awarded the title of Chevalier dans l’ Ordre de la L´egion d’Honneur (Knight in the French National Order of the Legion of Honor), for his accomplishments in the field of environmental finance and carbon trading Dr Sandor taught at the University of California, Berkeley; Stanford University; Columbia University Graduate School of Business; and the Kellogg Graduate School of Management at Northwestern 377 September 17, 2014 378 10:7Sustainable Investing and - 9in x 6inb1805-abt-author page378 Sustainable Investing and Environmental Markets University He served as Distinguished Professor of Environmental Finance at Guanghua School of Management at Peking University and as a member of its International Advisory Board He holds an honorary degree of Doctor of Science, honoris causa, from the Swiss Federal Institute of Technology (ETHZ) Dr Sandor is a Board Member of the Clean Energy Trust; a Member of the Advisory Board of the Center for Financial Stability and the Smithsonian Tropical Research Institute; and a Senior Fellow of the Milken Institute He served on the Board of Directors of American Electric Power and of leading commodity and futures exchange in the United States and Europe Dr Sandor is the author of Good Derivatives: A Story of Financial and Environmental Innovation, also published in Chinese by People’s Oriental Press He received his Bachelor of Arts degree from Brooklyn College and holds a Ph.D in Economics from the University of Minnesota Murali Kanakasabai (Ph.D.) is a Managing Director of Environmental Financial Products (EFP), LLC His career has focused on designing marketbased risk management and financial instruments for capital, commodity, and environmental markets He has over a decade’s experience working on climate change issues and helping build and launch environmental markets At EFP, Dr Kanakasabai leads design and implementation efforts for environmental markets, new environmental finance products, and guides strategy and analysis for investments in clean energy projects Dr Kanakasabai was among the founding team members at the Chicago Climate Exchange (CCX), where he served as Senior Vice President with primary responsibilities in research and new product innovation Dr Kanakasabai was part of the core team that helped establish first markets for greenhouse gas emissions in six countries across four continents, September 17, 2014 10:7Sustainable Investing and - 9in x 6inb1805-abt-author page379 About the Authors 379 including exchanges in Europe, North America, and China In these ventures, Dr Kanakasabai was extensively involved in building market readiness, market architecture, and new product innovation As the principal lead for CCX business development efforts in South Asia, he led the development and expansion of CCX membership in India He was a senior contributor to the development of several of the world’s first derivative instruments for hedging environmental risks and promoting sustainable development Dr Kanakasabai has led the effort for integration of agriculture, forestry, and rural environmental credits into the global environmental markets He was a senior team member of the CCX carbon offsets team which managed a significant carbon offset portfolio and pioneered the development of several offset protocols and standards Dr Kanakasabai has contributed extensively to the literature on environmental markets He is the author of Farm Adaptation to Climate Change: Approaches to Modeling Farm Decision Environment under Uncertainty Dr Kanakasabai was selected as an Emerging Leader by the Chicago Council of Global Affairs in 2011 Dr Kanakasabai holds degrees from the Tamil Nadu Agricultural University and the Indian Agricultural Research Institute, and a Ph.D in Agricultural Economics from the University of Kentucky Rafael Marques is a Managing Director of Environmental Financial Products (EFP), LLC Prior to this position, Mr Marques served as Senior Vice President of the Chicago Climate Exchange (CCX) where he was actively involved in all phases of the feasibility and design phases of the Chicago Climate Exchange and worked on the program’s membership outreach and expansion into Latin America He also worked in research relating to business opportunities in carbon sequestration and sustainable forestry management He was also actively involved in the September 17, 2014 380 10:7Sustainable Investing and - 9in x 6inb1805-abt-author page380 Sustainable Investing and Environmental Markets development and implementation of CCX international activities and joint ventures Mr Marques previously worked as a researcher at the Brazilian Embassy in Washington, where his responsibilities included research and analysis of trade-related issues Nathan Clark is Vice President of Wabashco, LLC, a clean fuels, carbon offset, and renewable energy development company and formerly a Managing Director of Environmental Financial Products (EFP), LLC Prior to his work at EFP, Mr Clark was Senior Vice President and Managing Director of Offset Programs for Chicago Climate Exchange (CCX) In that capacity, Mr Clark managed the process of defining and implementing project-based emission reduction initiatives Mr Clark provided strategic leadership on research related to the CCX offsets markets and was the chief liaison for grant related activities on offsets Mr Clark also participated in product innovation, design, and maintenance for futures and options contracts on offsets Mr Clark served as Chair of the Subcommittee on Permanence for the Novecta Soil Carbon Sequestration Standards Committee and was a member of the Greenhouse Gas Evaluation Task Group of the American National Standards Institute ... Cataloging -in- Publication Data Sandor, Richard L Sustainable investing and environmental markets : opportunities in a new asset class / Richard Sandor, Nathan Clark, Murali Kanakasabai, Rafael... discussed in detail later September 17, 2014 10:6 Sustainable Investing and - 9in x 6in b1805-ch01 page4 Sustainable Investing and Environmental Markets Environmental Asset Classes Environmental asset. .. 10:6 Sustainable Investing and - 9in x 6in b1805-ch01 page6 Sustainable Investing and Environmental Markets Renewable Energy and Energy-Efficiency Assets This category of environmental finance,