A derivative in which the underlying is CO2 emission allowances (carbon credit or the so-called carbon emission certificates- EUA: European Union Allowances). Trading in emission allowances is typically carried out using a global carbon currency (known as CERs– certified emission reductions) which is fully bankable and can be used across time lines by businesses and governments all over the world.

The market for emission allowances (EUAs) comprises a variety of instruments including financially-settled swaps, physically-settled spot and forward trading transactions, and investment products. Emission allowances are basically used to meet compliance with preset emission targets. Furthermore, investors and traders can trade EUAs through carbon derivatives, especially to identify mispriced contracts and take views on the price differential between allowances in two different phases of a given scheme. EUAs can also be used to arbitrage across different geographic regions, where a trader could buy and sell these allowances to exploit the differential.

As CERs are quoted and traded as a percentage of EUAs, investors can carry out spread trades to take advantage of the difference between CERs and EUAs. For example, if an investor believes that the percentage is too high, i.e., CERs are too expensive with respect to fair value, he would sell the CER and buy the EUA, and vice versa.

Carbon derivatives are also known as emission derivatives.