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Good Derivatives: A Story of Financial and Environmental Innovation

ISBN: 978-0-470-94973-3
640 pages
April 2012
Good Derivatives: A Story of Financial and Environmental Innovation (0470949732) cover image
Through the eyes of an inventor of new markets, Good Derivatives: A Story of Financial and Environmental Innovation tells the story of how financial innovation – a concept that is misunderstood and under attack - has been a positive force in the last four decades. If properly designed and regulated, these “good derivatives” can open vast possibilities to address a variety of global problems. Filled with provocative ideas, fascinating stories, and valuable lessons, it will provide both an insightful interpretation of the last forty years in capital and environmental markets and a vision of world finance for the next forty years.

As a young economist at the Chicago Board of Trade, Richard Sandor helped create interest rate futures, a development that revolutionized worldwide finance. Later, he pioneered the use of emissions trading to reduce acid rain, one of the most successful environmental programs ever. He will provide unique insights into the process of creating these new financial products. Covering successes and failures, the story describes the tireless process of inventing, educating and creating support for these new inventions in places like Chicago, New York, London, Paris and how it is unfolding today in Mumbai, Shanghai and Beijing.

The book will tell the story of the creation of the Chicago Climate Exchange and its affiliated exchanges (European Climate Exchange, Chicago Climate Futures Exchange and Tianjin Climate Exchange, located in China). The lessons learned in these markets can play a critical role in effectively addressing global climate change and other pressing environmental issues. The author argues that market-based trading systems are a far more effective means of reducing pollutants than “command-and-control”. Environmental markets may ultimately help to find solutions to issues such as rainforest destruction, water problems and biodiversity threats.

Written in an engaging, narrative style, Good Derivatives will be of interest to both practitioners and general readers who want to better understand the creative process of financial innovation. In the middle of so much distrust of markets, it is also a recipe of how transparent, well-regulated markets can be a force for good in the environmental, health, and social areas.

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Foreword ix

Preface xiii

Acknowledgments xxi

Chapter 1 The Early Years 1

Chapter 2 Trying to Change the World 23

Chapter 3 The Berkeley Years 47

Chapter 4 The Chicago Board of Trade Years: The Commodity Futures Contract 65

Chapter 5 The Chicago Board of Trade Years: Financial Futures Contract 89

Chapter 6 Educating Users and Building the Market 125

Chapter 7 Treasury Bond and Note Futures 139

Chapter 8 The Decade of the Eighties 167

Chapter 9 Globalizing Chicago Exchanges 191

Chapter 10 Environmental Finance 205

Chapter 11 Blame It on Rio 223

Chapter 12 The Beginning of the Entrepreneurial Years 239

Chapter 13 You’re Gonna Trade What? 265

Chapter 14 From the Pit to the Box 291

Chapter 15 Conceiving a New Kind of Exchange 313

Chapter 16 The Twenty-First Century Lighthouse 327

Chapter 17 CCX Market Architecture 351

Chapter 18 Chicago Climate Exchange 375

Chapter 19 The Rise of the Chicago Climate Exchange 393

Chapter 20 The Fall of the Chicago Climate Exchange 413

Chapter 21 The Chicago Climate Futures Exchange 429

Chapter 22 The European Climate Exchange 453

Chapter 23 India 479

Chapter 24 Opening New Markets in China 501

Chapter 25 Good Derivatives 533

Appendixes 559

Acronyms 575

Glossary 577

Index 593

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Richard L. Sandor is Chairman and Chief Executive Officer of Environmental Financial Products LLC, which specializes in inventing, designing, and developing new financial markets with a special emphasis on investment advisory services. EFP was established in 1998 and was the predecessor company and incubator to the Chicago Climate Exchange (CCX), the European Climate Exchange (ECX), and the Chicago Climate Futures Exchange (CCFE). Dr. Sandor was honored by the City of Chicago for his contribution to the creation of financial futures and his universal recognition as the "father of financial futures." In October 2007, he was honored as one of Time magazine's "Heroes of the Environment" for his work as the "Father of Carbon Trading." Dr. Sandor is a Distinguished Professor of Environmental Finance at Guanghua School of Management at Peking University and a Lecturer in Law at The University of Chicago Law School.

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April 02, 2012
Richard Sandor Talks Sense About Financial Innovation

Renowned financial innovator Dr. Richard Sandor gives a personal, first-hand account of the creation and expansion of financial futures and environmental markets worldwide in Good Derivatives: A Story of Financial and Environmental Innovation (Wiley; ISBN: 9780470949733; Hardcover & E-Book; $45; April 2012). The foreword is written by Nobel Laureate in Economics Ronald Coase.

Widely regarded as the father of financial futures and named by TIME magazine the “father of carbon trading,” Sandor takes on the issues of financial innovation at a time of public distrust of derivatives and a vigorous debate among policy makers about financial markets’ role in the global economy.

In Good Derivatives, Sandor uses his personal experience in the global markets to tell the story of how financial innovation has been a positive force in the last four decades.  Through the eyes of an inventor of new markets, he explains that if properly designed and regulated, these “good derivatives” can open vast possibilities to address a variety of global problems. 

Sandor explains two most common misconceptions when it comes to markets, “One is that markets magically appear. In fact, new markets and products require a lot of hard work, perseverance and collaboration. They are really more like inventions.  The other misconception is that all derivatives have been the cause of the great recession of 2008.  In fact, some unregulated and opaque markets have caused the troubles we are in. Regulated, transparent exchanges performed flawlessly and none of them required a bailout. This is a story that is never told.”

As a young economist at the Chicago Board of Trade, Richard Sandor helped create interest rate futures, a development that revolutionized worldwide finance. Later, he helped pioneer the use of emissions trading to reduce acid rain, one of the most successful environmental programs ever.

Sandor provides unique insights into the process of creating these new financial products. Covering successes and failures, including an attempt to start an all-electronic exchange in the late sixties, the story describes the relentless educational effort that was required to build support for these new inventions in places like Chicago, New York, London, Paris and how their impact is unfolding today in Mumbai, Shanghai and Beijing.

“My career has been in regulated and transparent markets,” notes Sandor.  “All products I have been involved in have brought more transparency, greater access to capital and, in the case of the environment, measurable reductions and improvements. I hope this book can also be of interest to young entrepreneurs in places like Southeast Asia, Central and South America and Africa.”

Good Derivatives leads readers through events leading up to the creation of the Chicago Climate Exchange and its affiliated exchanges (European Climate Exchange, Chicago Climate Futures Exchange and Tianjin Climate Exchange, in China). The lessons learned in these markets can play a critical role in effectively addressing global climate change and other pressing environmental issues.

“Market-based trading systems are a far more effective means of reducing pollutants than ‘command-and-control'. Environmental markets may ultimately help to find solutions to issues such as rainforest destruction, water problems and biodiversity threats,” Sandor says.

Sandor also provides both an insightful interpretation of the last forty years in capital and environmental markets and a vision of world finance for the next forty years.

“We have witnessed massive changes and shifts in the futures industry in the last forty years. New products were created, human capital was formed and the futures industry has expanded to new geographies, like China and India,” he says. “These new geographies also face challenges in infrastructure and environmental issues. If properly designed and regulated, transparent markets can be a force for economic and social improvement in these countries.”

Written in an engaging, narrative style, Good Derivatives will be of interest to practitioners, policy makers, entrepreneurs and general readers who want to better understand the creative process of financial innovation. In the middle of so much distrust of markets, it is also a recipe for how transparent, well-regulated markets can be a force for good in environmental, health, and social areas.

See More
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