Who Makes the Market?

Ask a carbon industry roundtable how to get more liquidity and the answer comes back: more buyers. Ask a capital markets trader and the answer is: more market makers.

The more-buyers answer is a statement about aggregate demand, not liquidity. It describes wanting a higher price, not a deeper market. Liquidity is the ability to transact in size, at a visible price, at the moment you choose, and it does not come from the number of people who want to buy or sell. It comes from institutions that stand between them: banks and trading houses with balance sheets large enough to quote a buying price and a selling price continuously, and warehouse the inventory that leaves. Every market you think of as liquid has them. With them, a price is standing there when you arrive. Without them, you find a counterparty first and discover the price second.

Market makers want this business: volume is revenue, and a new asset class with structural demand behind it is what a desk looks for. What no desk can do is quote a price in something it cannot hold. The position has to be financeable. It has to report honestly, because inventory that cannot be marked is inventory nobody carries. And it has to be exitable into demand still there tomorrow.

Carbon has almost no market makers because raw credits fail the first two tests: the position cannot be safely held or financed, and cannot be reported at what it is worth. In security form both are answered, and intermediaries can take principal risk in carbon for the first time. That leaves the third test: the buy side.

Retirement demand, the more-buyers demand, is legislated. Compliance schemes require surrender, aviation requires offsetting under CORSIA, and national targets increasingly rely on authorized units. This is not a speculative bid that evaporates in a drawdown. It is a legal obligation with a known implementation roadmap.

The standard objection to financialization is that intermediaries add cost without adding climate benefit. That causation is backwards.

Start with the buyer. A compliance buyer needing a million tonnes cannot assemble them by calling projects one at a time. Somebody must be holding inventory when the order arrives. You cannot retire what you cannot find.

Now the seller. A developer that cannot sell its production, or borrow against it, does not build, and those tonnes are never produced. You will not develop what you cannot sell.

Both are solved by the same entity: the market maker. Without someone in the middle carrying inventory, buyers cannot source at scale and producers cannot finance at scale, which is the market we have today. Nor do credits linger: every one a compliance buyer takes is retired permanently, and a market maker was holding it on the way. Intermediation does not delay retirement; it is the condition for retirement at scale.

Next up: What About Permanence Risk?

Part of No New Parts, a sixteen-part series by Andrew Gilmour.