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Tapping into California’s Carbon Market: WisdomTree’s Breakthrough ETP for European Investors
Sunday, 4th June 2023
Megha Jha

cCarbon recently spoke to WisdomTree about their newly launched California Carbon ETP and its impact on carbon market investment opportunities with Nitesh Shah. Nitesh is the Head of Commodities and Macroeconomic Research at WisdomTree, and a global economist with experience across commodity, ETF, equity, FX, debt, and structured capital markets.

Key Takeaways:

  • WisdomTree’s newest exchange-traded product, California Carbon (WCCA), allows European investors to invest in California’s carbon credit system.
  • The WCCA offers key features such as a synthetic structure based on a rolling futures strategy, liquidity focus on the most liquid part of the futures curve, and full collateralization to minimize credit risk. This structure makes it easier for investors to participate in the market without the complexities of dealing with underlying CCAs directly.
  • The introduction of the WCCA complements the WisdomTree Carbon ETP (CARB) by offering a different carbon market with a historically low correlation, providing investors with diversification opportunities.

cCarbon.info – Can you explain the key features and purpose of the WisdomTree California Carbon ETP (WCCA)?

Nitesh Shah, WisdomTree – WisdomTree California Carbon ETP (WCCA) provides investors exposure to California’s Carbon Allowance (CCA) futures market. It is the first European exchange-traded product (ETP) to provide access to this market. Following the launch of WisdomTree Carbon (CARB), an ETP providing exposure to European Union Allowances (EUAs), and as a global leader in commodity ETPs, WisdomTree seeks to further democratize access to global carbon markets by providing a CCA exposure in a structure suitable for European investors. We lean on the strengths demonstrated in the design of our existing products in this range.

Key features include:

  • Synthetic structure based on a rolling futures strategy (so no danger of the fund or investor having to deal with the delivery of the underlying CCA).
  • Liquidity-focused: by providing exposure to December futures, the product focuses on the most liquid part of the futures curve. That is important because market makers and authorized participants should be able to hedge themselves when making creations and redemptions better and thus be able to reduce the trading spreads on the product as a result.
  • The fund is fully collateralized, which minimizes the credit risk to the investor. So should the swap provider or WisdomTree have a credit event, there is a pool of assets that the investor will have access to in order to make them whole.

cCarbon.info – What factors influenced WisdomTree’s decision to introduce this ETP specifically in Europe?

Nitesh Shah, WisdomTree – Carbon markets are essential for governments to meet their climate goals. Investors who understand the need for these markets are keen to get exposure. The path to net-zero emissions will mean that these markets could get increasingly tighter, subsequently driving prices higher. Investors also recognize that their involvement can boost the liquidity of the futures and markets, enhance price discovery and therefore make the carbon futures market a more effective tool for commercial users to hedge.

Our European Union Emission Allowance ETP has received significant interest from European investors and we wanted to expand the carbon product range with the next most liquid carbon market, California. It’s unique because there are no other CCA ETP products available in Europe.

WisdomTree California Carbon ETP (WCCA) and CCAs

cCarbon.info – How does the WisdomTree California Carbon ETP (WCCA) provide exposure to the performance of California Carbon Allowances (CCA)?

Nitesh Shah, WisdomTree – The product tracks the Solactive California Carbon Rolling Futures TR Index, which is an index following the front December future of the current vintage of the CCA market. The index rolls to the December contract of the next year vintage in October, well in advance of the front December contract maturing (which would happen in November). The December future is where most of the liquidity is concentrated.

The index is a total return index (i.e. incorporates the effect of roll yields and collateral yields).

The ETP achieves the return through a total return swap agreement with BNP Paribas. Full collateralization (and mostly over collateralization) provides a layer of credit protection.

cCarbon.info – How does the WisdomTree California Carbon ETP (WCCA) complement the WisdomTree Carbon (CARB) ETP?

Nitesh Shah, WisdomTree – CCAs have historically had a low correlation with every major asset class. Even with EUAs, its correlation is only 0.23 (see sources under Fig 1). To put that in context, the correlation between S&P 500 and MSCI Europe – two equity indices – is about 0.74 (over the same time frame and source as Fig 1). For two carbon markets to be so uncorrelated with each other and the other assets speaks volumes about their potential as a portfolio diversified.

Figure 1 – Correlation between market assets, Data, and Image Source: WisdomTree

WisdomTree WCCA’s impact on investors 

cCarbon.info – How does WisdomTree’s WCCA remove barriers for investors and provide access to the carbon allowance asset class? The process to invest in CCAs before, and how the ETP has changed that?

Nitesh Shah, WisdomTree – Buying and holding underlying CCAs is tricky as it’s not a market designed for investors. Holding limits mean banking large numbers of allowances is not possible. Additionally, trading futures may not be easy for many investors. Knowing how to roll contracts and having credit arrangements with exchanges can all act as barriers.

A product that trades on major European exchanges (London Stock Exchange, Xetra, Borsa Italiana), that can be accessed via broker accounts makes access easier. The product tracks a rolling futures strategy. The rolling mechanism in the underlying index is simple and transparent, but the investor doesn’t need to operate the transactions at each roll period themselves.

cCarbon.info – What potential impact do you anticipate this ETP will have on the broader investment community and the transition toward a low-carbon economy?

Nitesh Shah, WisdomTree – The product gives investors another tool to hedge their portfolios against climate change risk. Investors who believe the CCA market will tighten (and hence prices will rise) can act on that conviction. Investor participation in the CCA futures market can add liquidity to the market and enhance the price discovery process. An under-priced CCA market could lead to an overproduction of carbon and so aiding the price discovery process has a real benefit.

Other ETPs offered by WisdomTree

cCarbon.info – Can you provide an overview of the other ETPs offered by WisdomTree in the energy transition suite? Any new products that may interest the market?

Nitesh Shah, WisdomTree – We have built out a suite of products in the energy transition theme, including baskets of energy transition metals futures, battery metal futures, battery value chain equities, and recycling and decarbonization equities. Most of these products allocate weights to constituents based on an outlook for the sector that they belong to. That contrasts with many commodity strategies where weights are based on backward-looking metrics.

Analyst Contact

Megha Jha (mjha@ckinetics.com)

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