In January 2005, the European Union Emission Trading Scheme commenced operation as the largest multi-country, multi-sector Greenhouse Gas emission trading scheme world-wide.

Under this scheme, investment bank Dresdner Kleinwort Wasserstein (DrKW) and Sampo Bank, Finland’s leading bank specializing in long-term savings, have executed the first ever cash trade on EU CO2 allowances.

Completed on December 20, 2004, the transaction, for a substantial volume of EU CO2 allowances at an undisclosed price, marks the first time that an EU CO2 emissions trade has been settled in cash, rather than by the physical delivery of a specified amount of EU allowances between a seller and buyer.

The use of cash settlement will allow both improved hedging and price risk management for emissions trading market participants. As opposed to the physical settlement of allowances, counterparties in a cash-settled forward transaction agree to pay at a predefined day in the future (generally known as the valuation date) the difference between the reference price (determined at the trade date) and the actual price at the valuation date.

Karri Lehtinen, head of commodities at Sampo Bank, commented: We at Sampo Bank Treasury see cash-settled CO2 financial swaps as an important service to our industrial customers, especially those in energy sector, and as well as to all Finnish businesses that fall under the Kyoto protocol.

Lehtinen added: Cash-settled transactions provide price protection across the EU’s 25 member states, allowing them to trade or protect themselves with cash-settled CO2 swaps. CO2 hedging will be added to many corporations’ risk management practices to reduce investment or product price risk. Its purpose is to reduce CO2 price volatility by reducing the risk of loss.