Richard Sandor is one of the pioneers in financial derivatives and the environmental markets world as founder of the Chicago Climate Exchange. Now with his second book, Sustainable Investing And Environmental Markets, Sandor says this asset class has come a long way over the past 12 years but has a long way to go from here.

“I think we’ve made enormous progress,” he says. “You wouldn’t necessarily believe it was true because of the lack of federal action in the the United States. But I think that would be naive. In fact, you have proposals pending by the EPA that suggest there may be cap-and-trade.”

To date, Washington has thwarted any cap-and-trade markets in the US. But Sandor said he looks abroad for progress. The European carbon market is functioning, but needs to address some structural changes to help force behavior changes among industrial polluters. South Korea launched its carbon market in January. China has created seven pilot programs with the Shenzhen exchange listing carbon as the only mainland commodity that is convertible into US dollars.

“I think the Chinese are sending us a signal,” he said of China’s concerns about the environment. “All you have to do is open up the papers and realize that they are concerned about local pollution. They are concerned about how to use markets to deal with pollution. They recognize they have water problems, air problems and if they are to continue the Chinese miracle, then they must deal with environmental issues.”

“The point we try to make is, you need to look outside the lack of activity at the federal level, study more deeply what the EPA is doing, and most importantly look to California, look to China.”

But Sandor sees the markets evolving elsewhere with instruments for catastrophic insurance,

“If Hurricane Sandy had taken a right turn (in 2012), we would have had hundreds of billions of dollars of losses,” he said.

The last great asset class is water, he says, and this commodity may be traded in several different ways but one solution could be a conservation credit market that rewards firms or industries that conserve water and forces others to pay more for the natural resource.

“There are only three parts of the world that are long water – North America, South America and Europe – everyone else is short,” he said adding that India, China and Australia would each be considered short on water. “We need a market for conservation credits. We cannot continue to grow cotton at zero priced water in the desert.”

Sandor said that such markets are “not about preventing individuals from the right to fresh water supplies,” said Sandor, adding that the average person requires about 30 gallons of water per day for drinking, bathing and cleaning. “Price the conservation of water, not water itself. We call them water conservation credits, as opposed to water.”

Going forward, Sandor predicts gradual acceptance and growth for these markets over the next 10 to 20 years.

“It’s our hypothesis, that a water market may be a catalyst for peace,” he said.

“We have a price mechanism that is the envy of everybody in the world that gets poultry, pork, beef, vegetables, row crops – beans, corn wheat – all of that and people can argue that you are putting a price on food. How can you do that?” he said. “It’s my belief that its no different for air and water. Food is critical. It’s worked for hundreds of years. Why not use those very principles developed here in Chicago – and apply them to air, water, endangered species.”

This is the dawn of a “whole new asset class,” he said.

“Just like we never thought there was much potential for financial futures – you couldn’t commoditize the stock market, you couldn’t commoditize the interest rate market. I believe, as widespread as interest rate management is today, we will have those same opportunities and needs in these new asset classes.”

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