Chapter 24

Opening New Markets in China

A journey of a thousand miles begins with a single step.

—Lao Tzu

During my frequent trips to Tokyo to promote stock index futures, my Drexel colleague who headed our Japanese operations inquired if I had interest in traveling to China with a Japanese client. I jumped on the idea. It was a chance to both maintain relationships with an existing client and see China for the first time. One of my favorite movies is Bernardo Bertolucci's The Last Emperor, the sweeping historical drama that chronicled the story of Pu Yi, the last emperor of China. It was a timely coincidence that I saw it in 1988, shortly before my first trip to Beijing.

First Encounter with China

After two days of meetings in Tokyo, I prepared for Beijing. My hosts in Japan had the art of travel down to a science. Tokyo's airport was a two-hour drive from the city, and the company arranged for me to stay at a small hotel close to the airport the day before I traveled. The room was tiny and uncomfortable, making me wonder what this augured for the journey. My concerns, however, vanished entirely after my first meeting in China.

My Japanese hosts in China were terrific, their attention to detail unrivaled. Our first meeting was with the U.S. equivalent of an undersecretary of agriculture, who had accompanied Chairman Mao on the Long March. The meeting took place in a stark government building. The minister, a stout man with a round face who spoke with an air of composure, reminded me of the Laughing Buddha. We discussed the possibility of new futures markets in China, agricultural and financial, as the country was growing rapidly and change was in the air. The undersecretary expressed his concerns about implementing a project of this scale, given the limited number of financial institutions in China. He summed up his primary concerns regarding China's economic development with a simple, yet powerful, example: “If every person ate just one egg per day, the country would have to produce over one billion eggs daily.” The lack of priority in establishing a futures market was clear.

My interaction with the undersecretary was challenging. When I asked a question or made a statement, it was first translated into Japanese by a bilingual member of our group who spoke Japanese and English, and then into Chinese by the Chinese-speaking Japanese who spoke no English. It reminded me of a game that we played as kids in Brooklyn called Telephone. About seven or eight children sat in a circle. One child whispered a few words to the person to his immediate right, who then repeated what he heard to someone on his immediate right. This continued until the circle was completed. The message that was uttered aloud by the last person in the circle often bore little or no resemblance to the original message.

The language barrier meant that it would take twice as long to do business in China. Additionally, it could potentially pose numerous problems and misunderstandings. However, a curious takeaway of the conversation was that this official seemed to be more interested in free markets than I expected. It became indelibly stamped in my mind that despite the fact that this man had lived as a communist in a dogmatic, centrally planned economy for 35 years, it was ultimately his 5,000-year Chinese commercial and trading heritage that dominated his thoughts and actions.

There were other memorable events during the trip that shaped my understanding of doing business in China. While delivering a lecture on futures markets at Peking University, I was amazed by how crowded the lecture room was and how interested the students were. While the country was nominally a socialist state, the lively Q&A session suggested quite the opposite. After the talk, students flocked around me. Their thirst for knowledge matched or surpassed all that I had seen from previous talks I had given in other countries.

Our trip had been thoughtfully planned, with ample time allocated to sightseeing historical sites such as the Great Wall, the Forbidden City, and the Summer Palace. I told the host about my interest in photography and he arranged for a guide to accompany me as I sought to learn something additional about China's artistic heritage.

Since there were no photography galleries in Beijing, my guide took me to a bookstore where I bought a colossal book called China, filled with beautiful photographs from the 1950s that were either tipped in or reproduced. Among them were images of industry and agriculture, traditional Chinese prints, and pictures of Chairman Mao. Apparently, the book can no longer be found in China. This book later became a subject of great curiosity and delight to my visitors from China and marked the beginning of my Chinese art collection. After visiting several other bookstores, my guide began to run out of ideas, so I suggested that we go to the daily newspaper.

When we arrived at the newspaper, my guide asked a staff member if I could visit the archives and look at old photographs. While the newspaper was unwilling to sell the original photographs, it was willing to sell me later prints. I acquired a number of photographs, including portraits of Sun Yat Sen; the Last Emperor, Pu Yi; Empress Dowager Cixi; and one of Nixon with Mao. I found shots of Chinese opium dens and a copy of the iconic photograph of Mao that Warhol appropriated for his paintings and silk-screens. We left the newspaper and returned to the hotel for a final night of karaoke singing.

The trip was memorable, and it was clear that China differed vastly from my expectations. The meeting with the undersecretary and the discussions with faculty and students suggested the advent of monumental change. My initial foray into twentieth-century Chinese history and photography would later prove to be extremely useful. By the end of the trip, I was convinced that it was essential for me to return to China one day. I waited in vain for an invitation that would allow me to work on the promising development of futures markets in grains or financials in China. It took almost 20 years before the right opportunity presented itself.

Satellite Broadcasts

Years after my first trip, I participated in a couple of satellite broadcasts into Hong Kong and mainland China. In 2003, I received a call from Tessa Tenant, the founder of the Association of Sustainable and Responsible Investment in Asia (ASrIA), Asia's first sustainable investment forum. She alerted me to an opportunity to participate as a keynote speaker at a conference on sustainable investing in Hong Kong.¹ Unfortunately, the SARS epidemic broke out so I had to do it by satellite broadcast. The presentation was well received and provided the introduction of the CCX concept to a Chinese audience.

Separately, in April 2004, Christine Todd Whitman asked me to do a satellite broadcast to China on the role of emissions trading in reducing acid rain in the United States. There were 20 to 30 officials from both Hong Kong and Guangdong in the audience. The level of interest displayed by these cities in emissions trading and pollution reduction was uplifting. China had come a long way in the past 15 years.

It became clear to me that these different cities in China were vying to become the home of emissions trading. This competition between Chinese cities became a recurring phenomenon during my experience there for the next six years.

An Opportunity Arises

During the early part of 2006, I received a call from the United Nations Development Program (UNDP). Maurice Strong had recommended that they ask me to be the keynote speaker at an upcoming event. I was to talk about CCX, the challenge of developing a quantitative measure of the Millennium Development Goals,² and the role of emissions trading in reducing the impacts of climate change.

One of the long-term objectives of CCX was to participate in the development of emissions markets in China. I wanted to both attract Chinese participation in CCX and start a voluntary CO₂ market in the country. Given the reverence in China toward the United Nations, the opportunity to speak at the UNDP conference created a visible platform for CCX in China.

There were five major challenges we wanted to address in order to attain these objectives. First, we needed to raise the country's level of awareness of cap-and-trade. Second, we wanted to attract local companies to join CCX as offset providers. Third, we had to find a local strategic partner to provide intellectual and financial capital. Any voluntary or mandatory market had to be designed with Chinese partners in order to ensure that the market's environmental objectives were compatible with the country's regulatory climate and need to grow its economy. Fourth, we needed to sign a joint venture agreement with the strategic partner and choose a city to locate the exchange. Fifth, the city itself had to be a partner in the joint venture, as any local market would be required to obtain a business license and receive regulatory approval from the city.

The two satellite broadcasts had shown us that our timing was opportune—China was finally turning its attention towards sustainability. This was consistent with the observed phenomenon that as nations became more prosperous, they could better afford and were therefore more willing to deal with environmental problems.³ Despite the contradictions in China's political and economic systems and the unhappy state of its per capita wealth, the country was growing rapidly and could not afford to wait any longer to address the environmental repercussions of its growth. I asked our staff to conduct some research on China's pollution and was shocked by how bad the environmental conditions in China had become.

Convinced that China was ripe for emissions trading, I asked Paula to accompany me to China. She was an explorer and had the tenacity, credentials, and energy needed for the journey. Possessing an uncanny sense of being in the right place at the right time, Maurice Strong had moved to China in 2005. He encouraged us to come to China and helped organize parts of the trip.

My near-catastrophic hiring experience in Singapore years before had taught me that it would be essential to seek professional help locally. Rick Ferina had employed Jeff Huang, a managing director of ChiSurf Ltd., to assist Calyon in becoming the first foreign entity to have equity in a Chinese-based FCM. Calyon was the minority partner of Citic, the sixth-largest bank in China, and also a subsidiary of Citic Holdings, a major financial and industrial Chinese company. It seemed that this was the only way that a foreign entity could be involved in China. I had previously met Jeff in New York while he was traveling there, and was impressed by his political skills, business acumen, and nuanced sense of language. We retained him as a consultant to help build our network in China.

With the assembly of my advisers, the stage was set for our developing business in China. China was on the track to become the largest emitter of greenhouse gases. I was excited about the possibility of making a difference.

Returning to China

The yarn that started with the UNDP's invitation officially began in Beijing on June 21, 2006. I chose to stay at the Grand Beijing hotel over the standard five-star international chains that were identical in every major capital. The Grand Beijing captured the feel of the royal ancient China in the film The Last Emperor. It was directly east of the Forbidden City and only several blocks from the famous Wangfujing shopping street. The hotel had once been a palace until the 1960s, when Chairman Mao ordered for it to be converted into a hotel to showcase China's aptitude in the hospitality business. The hotel boasted spacious bedrooms filled with Chinese-style antique furniture. Everything about the place was authentically Chinese. This suited me, as I intended to fully immerse myself in the local culture.

That night, there was a scheduled dinner with CCX's first Chinese member, one of China's most renowned companies in energy efficiency innovations. Many projects in China were not recognized as certified emission reductions (CERs) under the Kyoto Protocol. These were perfectly viable projects that either could not enter the CER market because of high transaction costs, caused by factors such as rigid bureaucratic rules and uncertainty of approval. I explained the innovativeness and flexibility of the CCX design. China's pending CER projects could be tailored slightly to follow CCX rules and regulations, thus allowing the owners of these projects to sell their offsets through CCX. The company recognized the opportunities provided by the CCX offset program, and volunteered to help expand our network of contacts to other Chinese entrepreneurs.

As I left the dinner meeting, I took stock of our progress. The CCX offsets program was set in motion. However, a significant amount of capacity building and education remained before emissions management and trading could be achieved in China. We also needed to find our strategic partner in China—someone patient who understood our language, knew our business, and was willing to think big. We thought our natural partner would be a Chinese financial futures or commodities exchange. After all, an exchange would understand markets, and have the infrastructure and the regulatory connections. We had succeeded in Europe by partnering with a European exchange, so it seemed like the natural thing to do.

We had a meeting with a senior official from the Dalian Commodity Exchange. Dalian liked to compare itself to Chicago—its exchange traded grain and soybean futures, and hoped one day to trade in interest rate futures as well. The exchange was interested in cooperating with CCX on areas of mutual interest. They also wanted to have me serve as adviser on a report commissioned by the World Bank's Working Group of Market Research, which sought to study the failure of the Chinese bond futures market.

The Chinese government had begun issuing government bonds to raise money for its rapidly growing economy and budget deficit back in 1981.¹⁵ Between late 1990 and early 1991, the Shanghai Stock Exchange and the Shenzhen Stock Exchange were established to offer new financing channels for Chinese state-owned enterprises. The government bond futures market was introduced to institutional investors in late 1992, but it wasn't until 1993 that the government bond futures market was opened to the general public. In May 1995, however, following a series of price manipulation and trading irregularities, the bond futures market was suspended.¹⁶

Although the Chinese government bond market had met the necessary conditions for a successful futures contract, including homogeneity and price variability in a market where price was competitively determined, these were not sufficient. China still lacked an institutional framework that minimized transaction costs and preserved integrity. The country did have the appropriate governmental regulatory authority, the China Securities Regulatory Commission, along with appropriate self-regulatory authorities like exchanges. It did not, however, have a transparent spot market or a well-developed repo market.¹⁷ Futures markets, as well as spot markets, had value if and only if the costs of transactions did not exceed the value from trading. China wasn't there yet.

The folks at Dalian knew about my role in establishing interest rate futures and were anxious for my assistance. I felt a rush of adrenaline at the thought that there was a real opportunity for me to help develop interest rate futures in China. In the bond futures market study, I recommended that a five-year note market could be appropriate if China were to renew its efforts in interest rate futures. However, I cautioned that successful international markets often began with a longer end of the yield curve as seen with Treasury bonds in the United States, gilts in the United Kingdom, and bunds in Germany. The point on the yield curve chosen initially had to have a design that minimized per-unit transaction costs and avoided manipulation.¹⁸

We later presented the bond paper at a teleconference. I tried to convey the message that financial innovations could not be successful without the support of a web of institutions. By literally copying the contract specifications from the West, the Chinese bonds futures market was doomed to failure. The Chinese were masters at replicating industrial inventions, but perhaps did not realize that, unlike industrial inventions, the blueprint of a financial invention could not be simply copied. Without a developed spot and repo market, futures markets could not succeed. I encountered the same lack of understanding in China when it came to emissions trading. A major educational undertaking was required if China was to establish a world-class futures markets in interest rates and emissions.

After the meeting with the Dalian folks, I retired to my hotel room and carefully reviewed my presentation for the following day. The conference was especially important because it was being convened by the United Nations. I delivered the presentation in a small room. I was pleased with the size of the crowd and the high level of interest in CCX. We also participated in a seminar hosted by the Energy Research Institute (ERI) of the National Development and Reform Commission (NDRC), and had a number of other meetings with corporations and the Chinese press.

Maurice Strong had arranged for C. S. Kiang, dean of the College of Environmental Sciences at Peking University, to host a seminar on CCX at the university. The audience was dominated by undergraduate students in environmental sciences, a few business students, and some faculty members. I had dutifully prepared my slides in Mandarin and expected to have a translator. When I arrived at the podium, Dean Kiang instructed, “You can use the slides but speak in English. There's no need for a translator.” A few minutes into the seminar, the dean signaled that I needed to elevate the content of the presentation. My presentation was too basic, and below what he thought the students were able to comprehend. I was flabbergasted, but proceeded as told.

The seminar was well received and the students expressed great familiarity and knowledge of greenhouse gas markets in the European Union and the United States. One student asked, “Why was there a contango in European carbon prices?” while another inquired, “Why are the CCX allowances traded at a discount to European allowances?” Their questions were penetrating and revealed an extensive knowledge of the fundamentals. I was approached by a couple of students after my lecture. They were members of what they called the CDM Club, the university's undergraduate emissions trading club. Electrified by everyone's enthusiasm, I became even more determined to help establish an exchange in China.

Given the enormity of CCX's ambitions, every breakfast, lunch, and dinner were a means to increase our exposure and network. I spoke at a lunch hosted by the U.S.–China Business Council with well over 50 attendees, and was approached by a representative from one of the largest steel companies in China after the talk. I was amazed to learn that one of the largest steel mills in China had been moved, bit by bit, to a site 50 miles from Beijing because of the need to reduce pollution for the coming Olympic Games. The swiftness and resolution with which the Chinese government undertook major projects were not lost on me.

The final evening was spent having dinner at the Heaven and Earth Restaurant in the Forbidden City with Dr. Dai Xiansheng, vice director-general of the China National Petroleum Corporation (CNPC) and his wife, Jeff Huang, and the deputy director-general of the CSRC Futures Department. My chemistry with Dr. Dai and his wife was fantastic, and the dinner marked the beginning of a long friendship. Dr. Dai was an intellectual, as well as a successful businessman in charge of CNPC's overseas investments.

The purpose of the dinner was to develop our network in China. Jeff had presciently advised me that CNPC was potentially interested in becoming the first mover in the environmental space. Jeff further suggested that the China Petroleum Exchange (CPE), in which CNPC owned equity, could be a good joint venture partner. CNPC was China's largest oil and gas production and supply company, and among the world's largest companies. Their interests ranged from oil exploration to energy infrastructure and engineering, and had a presence in more than 70 countries. While this choice of partner might have initially seemed counterintuitive, I was open to the idea. It would be good to have CNPC acquainted with CCX and our efforts in China. Perhaps they were candidates for the CCX offset program.

Another meeting was held in Shanghai with the president of the China Foreign Exchange Trading System, in order to provide him with an education on CCX. It turned out to be as much of an education for me as it was for him. He was a wise man who was very knowledgeable about the foreign exchange markets in particular, and capital markets more broadly. Despite being a government official, he embraced change and welcomed the idea of emissions markets. He wisely remarked that in any crisis, or period of change, there was an opportunity.

The trip appeared to have achieved our objectives. We had raised the profile of CCX and emissions trading. We delivered speeches, university lectures, and UN presentations. We met with exchanges, Chinese government agencies, and more than 20 Chinese companies. Several articles featuring CCX were published in leading Chinese newspapers and journals such as the Shanghai Daily, Economic Observer, and the China Securities Journal.¹⁹

In retrospect, the length of the trip itself and its agenda of speeches, lectures, interviews, and one-on-one meetings were truly daunting. Days often began with early breakfasts and ended with dinner running late into the night. The 13-hour flights and 14-hour time difference only dragged out each event and made everything more difficult. My friend Charlie O. Finley had often told his young players, “Sweat plus sacrifice equals success.” I kept his advice in mind.

The ambitiousness with which we faced our ordeal reminded me of Charlie's attempt to bring the Beatles to Kansas City, back when he owned the Kansas City Athletics in the early 1960s.

Charlie had promised the people of Kansas City a live performance by the Beatles during the group's first tour of North America. He approached Brian Epstein, the group's manager in San Francisco, and offered $100,000 for the Beatles to play in Kansas City. Epstein refused. Undeterred, Charlie followed Epstein to Los Angeles a week later, making a new offer of $150,000. He was again rejected. Being Charlie, he somehow managed to get hold of John Lennon himself and explained his situation. Lennon good-humoredly accepted the offer on behalf of his group. And that was how the Beatles came to Kansas City. Charlie's persistence had paid off. Always the showman, he even had a photo of himself in a Beatles wig printed on the back of all concert tickets. Persistence was the key.

In spite of the obstacles, my trip to China convinced me that emissions markets could be the answer to some of China's problems. Although I knew how to pioneer new markets, having done so with financial futures and emissions trading, I wasn't sure if I was prepared for the challenges that awaited me in China. I realized much later that I underestimated the difficulties of finding the right partner. We were tunneling through unknown territories and ambiguous contexts that we struggled to understand. The path forward was plagued with uncertainty.

In Search of the Perfect Exchange Partner

The CCX team made five more trips to China in the next 18 months, from June 2006 to December 2007, searching for a Chinese exchange partner. In September alone, we visited Beijing, Dalian, Guangdong, and Hong Kong. We went to Dalian to meet senior exchange staff, Guangdong to learn about the local environmental protection agency's attempts to reduce SO₂, and Hong Kong to attend the World Hedge Fund Asia Conference, where we worked to stimulate interest among investors and educate speculators on emissions as an asset class. As the province with the highest GDP in the country, Guangdong was a poster child for China's economic growth. However, with 80,000 factories and 13 million cars, its air pollution was among the worst in the country—1,177,000 metric tons of SO₂ were emitted in Guangdong in 2007 alone, and acid rain accounted for more than 53 percent of Guangdong's total rainfall in the first half of 2010.²⁰

While in Hong Kong, Tessa introduced me to her friend Christine Loh. Christine was a former trader, elected political representative, chairman of the Civic Exchange,²¹ and a board member of the Hong Kong Stock Exchange (HKEx). She invited us to a dinner that she had organized for major power companies, trading companies, and exchange members. When I stepped into the dining venue, my gaze was arrested by a poster image from the 1955 movie, Love Is a Many-Splendored Thing. Tamara, my former piano teacher, had taught me how to play its theme song on the piano. My unpracticed fingers had stumbled over the keys, trying to produce the elegant melody that I had heard at the cinema. Now, standing at the entrance of the dining venue in Hong Kong, I replayed the melody in my head and felt a strong sense of nostalgia. I found out later that Christine's childhood home was actually featured in the movie. Our trip was filled with strange, yet wondrous, surprises.

The event helped CCX reach out to more Chinese firms and offset providers. I thought that perhaps Hong Kong could be an ideal stepping stone to emissions trading in China. The SO₂ emissions problems in Guangdong, coupled with the massive financial trading base in Hong Kong, made Hong Kong an promising prospect for partnership.

I had been looking forward to the meeting with the Hong Kong Exchanges and Clearing (HKEx) staff. There appeared to be a perfect fit for a collaborative relationship. HKEx had an existing platform with well-developed infrastructure, and was forming a study group to consider its strategy in carbon markets. We positioned ourselves as partners and not consultants. However, HKEx was only interested in our role as consultants, so there wasn't a fit at the time. Nevertheless, we made some good friends with members of the management team that enabled us to work with the exchange in the future.

Our reputation in China continued to grow. I was invited to join the board of the International Advisory Council of the Guanghua School of Management, Peking University. Kellogg's dean emeritus, Don Jacobs, had led an effort to partner with the Guanghua School of Management more than a decade ago and was responsible for creating the international advisory committee there. In addition, I was later appointed a distinguished adjunct professor of finance at Peking University. All this created a very important local network, and CCX's visibility in China experienced another boost.

A Turn of Fortune

We still hadn't found the right partner. Existing futures exchanges in China were interested in the education, but had no interest in a joint venture. As a business, emissions trading was still nascent in China and there was no incentive for existing exchanges to build this new market. The path forward remained unclear. The summer of 2007, however, changed our fortunes in ways we did not anticipate.

It all started with a phone call I received from Jeff Huang one morning. “Dr. Dai has been promoted to head of CNPC Asset Management. CNPC is interested in exploring an MOU with CCX!” Jeff exclaimed. The MOU signaled CNPC's willingness to establish a joint venture in order to explore the feasibility and implementation of an emissions trading platform in China. Perhaps all our efforts—the interminable flights, jet lag, dining marathons, repetitive presentations—were finally paying off. Dr. Dai had delivered a major milestone for CCX. It was the start of a promising journey.

CNPC was the consummate partner. After all, it was the largest company in China and a state-owned enterprise. Moreover, its action on climate change, by being part of our effort, was a huge signal to other companies in China. It showcased the proactive stance of CNPC and the Chinese government. Many years later, at the Futures Industry Meeting in Boca Raton, Florida, Mr. Wang Guoliang, CFO of CNPC, was asked by a reporter about why he expected the partnership with CCX to be profitable. Mr. Wang observed, “We didn't form the joint venture for short-term profits. We are committed to using emissions markets as a way to achieve China's environmental objectives.”

To exploit the favorable turn of events, I arranged to fly to Beijing during the first week of December 2007. The game was now elevated. The trip was highly speculative, and we were uncertain that we could persuade the board of CNPC to sign the MOU. Given the level of publicity the partnership would generate, I suspected that the MOU needed to be reviewed at the highest levels of the company and the Chinese government before it could be signed. In fact, we arrived on a Monday not even knowing if a meeting with CNPC would even occur. Nonetheless, we hoped that our physical presence in Beijing would signal how important the MOU was to us. Doing business in China often made me feel like Tantalus, forever yearning for that succulent fruit that was beyond reach. As I later learned, it was common to be surprised while doing business in China. Meetings with significant government officials would materialize suddenly and we always had to be prepared for the unexpected. Most of our days deviated from the planned itinerary significantly. This constant lack of control was mentally and physically exhausting.

After four uneasy days, Dr. Dai finally arrived unexpectedly on a Friday morning and announced that he had received the consent to proceed with the MOU. The deal was back on track. We spent the morning discussing the outline of the MOU. As we negotiated, the conversation drifted from commercial terms into contemporary Chinese culture. I quoted Sun Tzu's The Art of War in English, and Dr. Dai repeated the exact quote in Chinese. We knew at that moment that this agreement would be consummated, at least in principle. The MOU was only the first step. The next step was to consummate a joint venture agreement.

Once we had the outline of the MOU, the time was ripe to meet Minister Xie Zhenhua, vice chairman of the National Development and Reform Commission (NDRC). The NDRC was one the most powerful arms of the Chinese government, responsible for the country's Five-Year Plans. The meeting took place at the NDRC headquarters, with everyone seated according to Chinese business customs. Minister Xie sat in a large chair at one end of the room. Maurice Strong, his esteemed guest and personal friend, sat to his immediate right. I sat to Maurice's right. The rest of our team was seated one after the other, according to their positions within CCX.

We received many questions about our trading volumes. I shared the story of CCX and covered the history of SO₂ emissions in the United States. We also indicated that CCX had conducted an auction of CERs on behalf of an Indian company—Tata Motors—and had realized higher prices than were available in bilateral contracts. Minister Xie expressed great interest in this activity. The meeting concluded on a very positive note, and we left feeling optimistic.

The signing of the MOU was only the first stage, and additional work remained. Due diligence had to be conducted by both parties. We also had to decide where to locate the exchange and what products to list. A lengthy and unpredictable process was expected before any real partnership could emerge. Paula and I flew back to China during the first week of January to discuss the specifics of the MOU. We hired a Chinese law firm to assist us in drafting the MOU, and were assured by our lawyers that there were no legal impediments to foreigners having equity in a Chinese exchange.

On December 18, 2007, after 18 months of promoting the CCX brand and raising public awareness of emissions trading, the MOU was finally signed with CNPC Asset Management (CNPC AM).

In broad terms, the MOU spelled out our objective of establishing a climate exchange in China that employed market-based mechanisms. We sought to both facilitate China's economic growth and improve its environment—including bolstering the health of the Chinese population. Our intent was to sign a joint venture agreement before the MOU expired. We planned to establish a joint venture and conduct a feasibility study, similar to what we had submitted to the Joyce Foundation in the early years of CCX.

In the past, numerous MOUs had been signed by non-Chinese entities with Chinese companies. My experiences in China had taught me that that these agreements were neither promises to be engaged nor actual engagements. MOUs signed in China were organic and subject to continuous change. I had a difficult time adapting to this, especially because I came from a country where an MOU unequivocally led to a deal. MOUs in the United States were often straightforward and originally tended to be executed as written originally. The experience reminded me of the insurance market, where contracts were somewhat ambiguous and were only settled after there had been a claim for a loss. Nevertheless, after extended negotiations, we signed a joint venture agreement. CNPC emerged as the majority shareholder, and equity was reserved for the city where we would be located.

The Birth of the Tianjin Climate Exchange

The location of our exchange was a trophy that was vied for by various Chinese cities. Although we met with mayors of major cities, it was a lesser known city that emerged as the champion—one that was neither China's capital nor its financial center.

I met Vice Mayor Cui Jin Du of Tianjin during the MOU signing ceremony with CNPC. He expressed an interest in collaboration, and was very specific about the benefits of establishing the climate exchange in Tianjin. The city had established the Tianjin Property Exchange (TPRE), and the People's Republic of China had enabled the formation of the Tianjin Economic Development Area (TEDA). The economic development area designation foretold the city's increasing economic importance. The Pudong area of Shanghai and the City of Shenzhen had also been granted the status of economic development areas and had subsequently become an important part of what might be termed the “Chinese miracle.” The Pudong area had been a rice field when I first visited China. It now boasted a skyline that appeared more magnificent than that of Manhattan.

Tianjin had been identified as a location for financial innovation. The city had spent several years building its understanding of emissions trading. It had even assembled an innovation team of 20 individuals, which included practitioners from the exchange world and professionals with diverse backgrounds such as business, engineering, and law.

Vice Mayor Cui led a tour of TPRE and introduced us to some of its personnel. As evidence of the sincerity of the city's interest, he showed us a new building in the young financial square in the TEDA Binhai development area where the exchange could be located. This was followed by a tour of the TEDA. I asked him why Tianjin had chosen CCX as opposed to a Chinese exchange, and received a response that reverberated with my journey as a financial innovator. “To invent, to invent, to invent,” he said. In fact, the description of his credentials read more like those of a CEO than that of a vice mayor. I joked with Dr. Dai that perhaps we had found the “third musketeer.”

The negotiations continued for the next six months. A typical day for the Chicago and New York staff of CCX began at five or six in the morning and ended after midnight. As with commercial negotiations of any sort, further face-to-face meetings had to be arranged. The team made numerous trips, to and from China, for these negotiations.

The next critical point was the division of equity and the final choice for a partner city. We settled on Tianjin, and decided to name the joint venture the Tianjin Climate Exchange (TCX). After months of negotiating and renegotiating, a two-day due diligence trip from the team at CNPC-AM paid a visit to our offices in Chicago, and capitalized the company with 100 million renminbi (RMB). It also was an opportunity for the CNPC team to meet other members of the CCX staff. We prepared briefings and presentation about all aspects of how CCX and CCFE were run, from the sales division to the role of compliance and technology, and ended each day by showing our partners the great sights of Chicago. Like the Chinese, I was proud of my cultural heritage and took the team to one of my favorite steakhouses.

We reached a final agreement, in which CNPC-AM was the majority shareholder with 53 percent. CCX retained 25 percent, and TPRE received 23 percent.

I returned to China with Ellen for the official signing of the MOU on May 9, 2008, in order to express my personal commitment to the joint venture. Ellen and I attended various lectures together and spent a day with Dr. Dai and his family. In China, family friendships were integral to any business relationship. This was crucial for anyone interested in doing business in China, where business tended to be relationship-oriented rather than transaction-oriented.

Dr. Dai brought his daughter that day and carefully explained to her my teaching credentials. Teachers enjoyed tremendous respect in the Chinese social hierarchy—perhaps a legacy of Confucius himself. Dr. Dai, and other CNPC executives, often introduced me to their children as the “American Professor,” so I could give them advice about education and studying in the United States. Education was held in high regard, and this was evident in all areas of Chinese life. The academic ring of CCX helped us build the network and credentials in China that were critical to the successes we had had to date.

The educational efforts continued. I delivered a lecture on emissions trading at the Guanghua School of Management at Peking University on the very same day I landed. We planned to start an environmental finance course at Guanghua just as we had done at Columbia. This helped to lay the groundwork for future TCX activities.

We also briefed the Development Research Center of the State Council, the institution that conducted the research for the national Five-Year Plans. The group was very interested in how China would continue its transition to a market economy. I emphasized the work of Professor Coase and was surprised to learn that almost all of the attendees knew his work. Coase's student, Wang Ning, once remarked, “To my knowledge, no other Western economist, probably with the exception of Karl Marx, has ever been so honored in China.”²² In fact, a conference titled “Coase and China” was also organized in Beijing and Shanghai to celebrate his 100th birthday.

Professor Coase had previously organized a conference in 2008 at the University of Chicago on China's Economic Transformation. It was a eclectic gathering of leading Chinese academics, practitioners, and entrepreneurs. I was honored to be the only non-Chinese speaker. I shared my experiences of starting an environmental exchange in China.²³

On May 4, after all the details of the joint venture had been agreed to, a dinner was held at the Heaven and Earth Restaurant. We thought that dining again at the location of our original meeting would be propitious. It seemed to be a custom in China that no matter how difficult the business negotiations, they were always followed by a celebratory dinner. This reminded me of my experiences at Liffe, where a casual lunch always followed the board meetings. Business dinners in China, however, were never a casual affair. In China, a great deal of importance was placed on dinner, as it was seen as a bonding experience. I was always delighted by the beautiful presentation of the dishes, and even Ellen thought it was food and art at its best. My CCX colleagues often had great difficulty with chopsticks. Upon seeing Rohan Ma struggling to pick up a piece of bean curd with his chopsticks, the waiter commented, “You are very skillful with your chopsticks. Do they have chopsticks in the United States? You are really quite skilled. … Let me get you a fork and knife.” Everyone broke into laughter.

All three partners signed the joint venture contract on July 25, to be made public on July 31. We had met the challenge of landing equity in a Chinese exchange.

Raising TCX

Since the signing of the joint venture agreement, enthusiasm levels had been high among the staff of Chicago, Beijing, and Tianjin. The Chinese industry press was filled with CNPC initiatives and successes, and every serious player in the environment market was expanding their offices in China.

The Chicago office, too, seemed to be infected with our recent successes in China. We started to see Chinese art taking over the scarcely available wall space—the result of my avid art collection. For Christmas that year, I presented each employee with a gold coin enclosed in a Chinese hong bao, or red envelope, embellished with golden dragons. “The dragon is for good luck and prosperity with all our ventures,” I toasted at the end-of-year Christmas party.

Everyone was keen on demonstrating some form of emissions transaction through TCX. This was important to show proof of concept and build trust in the new market. CCX had just completed a very successful CER auction for the Indian corporation, Tata, and I felt that the same formula could be applied in China. If we managed to pull off a Chinese CER auction, the CER price for a Chinese project would be set in Chinese soil for the first time, as opposed to overseas. Not only did this make practical sense, it would also be a source of pride for China given that the Chinese provided about half of the CER volume to the world.

Compared to the CER projects found in other parts of the world, Chinese projects tended to be much larger, the majority of which were generated by a batch of industrial manufacturing processes that had been approved by the UN CDM board. The size of Chinese CER projects was both an advantage and a disadvantage. On one hand, the big industrial companies behind these projects had already sold their tons long-term to European buyers. On the other hand, if we managed to strike a deal with one of them, not only would we be able generate meaningful business volume, but attract the other CER generators on board as well.

CCX delivered technology for auction and trading platforms. To complement this software, the research team wrote a series of manuals to educate our Chinese colleagues on auctions, electronic trading, and offset programs in general. These were all written in English and subsequently translated into Chinese. Even the technology was bilingual, accommodating both Chinese and English speakers.

One source of frustration during this education process was the tendency for management to assume that establishing markets was formulaic. They approached the problem like industrialists, not financiers. Blueprints were simply duplicated and there was little understanding of the need to build human capital and institutions to successfully build markets. We strongly advocated for the appointment of a general manager who had the knowledge and the stature to represent TCX to the CEOs in the international exchange world. The board was not persuaded. We became more determined to educate the exchange management in order to overcome their shortcomings regarding knowledge of capital markets.

Paula and Rohan had set up an office in the Grand Beijing hotel to direct the progress of TCX. Although only 24 years old and a recent college graduate, Rohan had a confidence and business aptitude that was beyond his years and was an invaluable asset throughout the process. On one occasion, he was sent to a high-level meeting with senior government officials. As the meeting began, Rohan was told that he had to say a few words on CCX's behalf. Unprepared for this, he started scribbling down notes frantically. After he made some customary remarks, someone asked, “How does TCX plan to beat out Shanghai and Beijing in this market?” Recalling what I once told him, Rohan responded, “Liquidity is king, because liquidity doesn't move once it settles. If TCX is successful early on in bringing in the important companies, we will be able to maintain our lead because of our liquidity. To win liquidity, you have to sell constantly. It's very important that we market the program 24 hours a day, 7 days a week, and 365 days a year!” What Rohan said won praise as the mayor's assistant openly extolled these ideas in front of the group.

At my request, Murali traveled to Beijing in 2008 to join Paula and Rohan to help educate our CNPC colleagues on emission allowance auctioning procedures. The summer Olympics had just ended in Beijing. The new Beijing airport had been built to coincide with the Olympics—plush monorails extended from the airport gates into an immense main terminal. The sense of pride, patriotism, and accomplishment was felt everywhere.

Murali had the name of his hotel printed out in Chinese for the benefit of his cab driver. As they drove through the highway, the car driver missed no opportunity to point out any visible signs of China's economic success. “Brand new road … brand new,” he bragged, and added mischievously, “Is Delhi like this?” The Chinese people were proud of their long history and culture. They knew their time had come and were prepared to lead. In a strange way, China and CCX shared the same aspirations.

There were other challenges. We had to win the approval of the Chinese government in order to conduct our proposed auction. To land approval, we needed to make the transaction a completely Chinese-driven process, with our ventures backed by a Chinese identity that reflected the spirit of Chinese people. One productive piece of advice emerged while discussing the name of the auction. It was suggested that instead of calling it an auction, it would be better to call it a bidding market. Our partners felt this sent the nuanced message that we were seeking buyers.

Keen to finally put a face on the Chinese associates they had been working with for so long, the team took the new super-fast trains from Beijing to Tianjin. I recalled marveling at how clean and modern the new stations were. The TCX offices in the Binhai Tianjin complex had rows of glass buildings that playfully resembled rows of mobile cell phones standing upright. Newly appointed staff sat together in the open reception area in the building. It reminded me of the setup that CCX had when it first started, where we all sat around a big table, discussing and learning about the new market. This setup fostered interaction and the sharing of ideas.

A young team from Chicago led the training of the TCX auction platform and trading platform for the TCX staff. It was attended by everyone in the TCX hierarchy, from the IT staff to the CEO. Our partners at TCX were quick to grasp certain elements of the auction platform, but struggled to understand others. Relatively quickly, they were able to design and administer basic auctions, but seemed to be baffled by other concepts like escrow accounts. While our past experiences were helpful, they were at best guideposts in this new territory. Many questions were asked, and procedures had to be fine-tuned to Chinese realities. Everything from the auction specifications to legal contracts had to be understood and reworked to fit the Chinese framework. The CCX team and TCX team had a lot to learn from each other.

When touring the TCX office, Murali's attention fell on a room that had no windows, an ironclad door lined with multiple locks. “The person in this room must be very important,” he jested. He was later told that the room was where the exchange intended to keep all their daily revenues from trading. The complete electronic nature of transactions had to be explained. There was much internal education to be done.

By the end of the CCX mission in China, we had managed to create a wide level of discussion on the auction opportunity. The grand opening of TCX was not far away, and we wanted to have a demo to showcase the opening. TCX successfully concluded an auction of SO₂ allowances at the end of 2008, marking its first commercial activity. Finally, after receiving the approval of the Ministry of the Environmental Protection and the Ministry of Finance, TCX conducted an online auction of 50 metric tons of SO₂ emissions allowances in a demonstration project. With seven active bidders competing, the settlement price was 3,100 yuan per ton, with Tianjin Hongpeng Co., Ltd as the winner.

In just over two years, the CCX team had built a vast network and concluded a path-breaking agreement. CCX became the only foreign entity to hold equity in a Chinese exchange. We established an exchange that could implement emissions trading as a policy tool in China. Imitators had emerged during this period in both Beijing and Shanghai and had announced their formation before we did. Unperturbed, we moved on to conduct the first auction of SO₂ emissions at TCX. It was amazing to think that all of this was accomplished with our limited resources.

The trust and respect between the partners continued after we had signed the agreement. The agreement provided that CNPC would designate a chairman, vice chairman, and five directors. Dr. Dai became chairman, I joined the board as vice chairman, and Paula became a director of the exchange.

The Opening of TCX

On August 15, 2008, Tianjin Climate Exchange was granted a business license by the Tianjin Municipal Authority to start a pilot program. Approval was granted by the Ministry of Finance and the Ministry of Environmental Protection in three separate areas: SO₂, chemical oxygen demand (COD), and a measure of water quality and energy efficiency.

TCX opened its doors formally on September 25, 2008. It was vital to send a signal to China and the rest of the world that TCX was an important institution. The partners lavished the opening ceremony with a level of care and attention that was generally reserved for an official visit of the head of state in the United States. Despite the fact that our opening coincided with the summer of 2008 when China was diverting all national resources to Beijing to prepare for the Olympics, no detail was left to chance. The stage was adorned with red velvet, and signs were placed on major highways to direct guests through the maze of construction to the new TCX headquarters. Students from Renmin University even volunteered to direct traffic and handle protocol.

A huge screen at the TCX office displayed the new TCX auction and trading platform, with a demo provided by a CNPC employee. The office included a special exhibit on the history of climate change, complete with taxidermy of extinct species. The walls downstairs were plastered with posters and photos commemorating milestones in the negotiation of the joint venture agreements. Video screens were also set up that displayed the actions each partner in the joint venture had taken to address climate change.

Among the 300 guests in the opening day were friends and dignitaries such as the China director for the World Bank, the managing director of the Davos World Economic Forum, and numerous high-level Chinese and business officials. Dr. Dai invited me to speak on behalf of the partnership, and I presented an overview of the objectives of the new exchange and cited the historic nature of the occasion. Mr. Wang, CFO of CNPC, also spoke about the strategic importance of TCX and noted the high level of attention that the new exchange had received at his firm. He proclaimed that the establishment of the exchange marked a new stage in the development of emission rights trading in China and could provide the country with a long-term mechanism for energy conservation and economic development. He and Vice Mayor Cui proceeded to unveil a beautiful, glistening plaque, complete with a cannon shooting golden confetti. A festive lunch for guests was held at the TEDA International Center, followed by an academic seminar in the afternoon featuring leading Chinese academics discussing climate change and emissions trading.

Immediately following the seminar, Mr. Wang, Dr. Dai, Maurice Strong, Paula DiPerna, Jeff Huang, and I held a private dinner to celebrate and discuss next steps for the partnership.

We had hired photographers and videographers to document the opening ceremony, and our colleague from CNPC eventually sent me an ornate box filled with photos and video footage of the ceremony. On the box, written in gold, were the words “cap and trade.”

During my personal experiences in the United States and Europe, individuals seemed more driven by guilt than by shame. My experiences in China demonstrated the reverse. I was growing more conscious of mian zi, or face. I met with the CFO of CNPC, Wang Guoliang, only after proving myself to Dr. Dai. Similarly, I only met with the vice president and president of CNPC after I earned the confidence of Wang Guoliang. I had to prove myself at each stage so that none of the men who supported our efforts would lose face. I was later invited to give a lecture at a conference for the top 100 executives at CNPC. The CNPC conference was broadcast on the company's website only after being well received by the 100 top members of their management.

The World Is Getting Flatter!

During my many trips to China and India trying to establish emission markets, I was constantly reminded of the competitive world we lived in. A humorous incident in Mumbai, India, proved insightful into the complex outcomes of this globalizing world.

In their many travels through the congested roads of Mumbai City, Mike Walsh and Murali frequently passed by a traffic-ridden intersection known locally as Prabhu Chowk, which connected southern Mumbai to the city center. Talk about entrepreneurship—the kids from the local slum found the intersection to be the perfect spot to market various wares to the folks caught in traffic. Mike's gaze fell upon a kid holding a pile of recently released books in his arms. There was Al Gore's An Inconvenient Truth, Stephen Hawking's A Brief History of Time, and, of course, Tom Friedman's The World Is Flat. “How much?” Mike asked. “100 rupees,” the kid replied in a business-like manner. This was roughly $2. The same book on U.S. shelves sold for $16. Out of curiosity, Mike bought the book. As Mike examined his new possession later on, he noticed that every page of Tom's original book had been photocopied on cheaper paper. It was the same content but delivered at a cheaper cost and manufactured locally. Here was a kid who was telling us the world was indeed flat by selling us The World Is Flat. About halfway into the book, the pages were blank.

This funny incident highlighted many lessons for our own adventures. The combination of their long cultural histories and growing economies made China and India formidable forces in the future. Both possessed huge intellectual capital and a growing community of entrepreneurs who were hungry to lead. The world was truly changing. The lower barriers to economic innovation and wealth creation were leading to more efficient ways of production.

However, this transformation was not always smooth or fair, at least in the eyes of some. Corruption remained prevalent in some countries, and the regards for intellectual property rights were scant. Massive infrastructure needed to be built before these economies could advance. Given the right institutional base, India and China had the right ingredients to be major contributors to financial innovation in the future.

The People's Bank of China

As part of our educational and outreach efforts, Jeff Huang arranged a visit to the People's Bank of China, where I met with the head of the Bank's Research Bureau. It was evident that the bank had an interest in the environment and its impact on the Chinese economy. The idea for a potential collaboration between CCX, TCX, and the bank began to germinate.

On one of my next trips, a personal meeting was arranged for me with Dr. Zhou Xiaochuan, head of China's central bank. It was important for central bankers to understand emissions trading. I had already met with Ben Bernanke, his U.S. counterpart, to brief him on CCX, and he had been interested in our progress.

Dr. Zhou was a soft-spoken intellectual with impeccable academic credentials. During our conversation, Dr. Zhou mentioned that he had attended the Nobel Memorial Lecture in Stockholm in 1991 when Ronald Coase had received his Nobel Prize. It was an auspicious coincidence that we both had been influenced by Professor Coase. Equally surprising was Dr. Zhou's outstanding grasp of emissions trading as a policy tool. It was refreshing and humbling to see one of the most powerful central bankers in the world appreciating what we were doing. I also mentioned my interest in establishing a futures market for interest rates in China. This seemed inevitable as China gradually adopted flexible exchange rates and market-determined interest rates. “I hope you will continue to promote this idea in China,” Dr. Zhou said sincerely.

Our meeting provided the impetus to formalize the creation of a China–U.S. Low-Carbon Finance Research Center under the auspices of PBC. The center would be housed in Chicago and Beijing, providing a forum where Chinese and American academics and practitioners could share expertise in the development of a tow-carbon future for China. We failed to complete this project, unfortunately, because we were focused on selling CLE.

We sold Climate Exchange PLC to ICE in July 2010. I had personally briefed our Chinese partners about the sale one week after it was signed, assured them of ICE's stature, and expressed my willingness to help in the future. I subsequently introduced the CEO and CFO of ICE to Vice Mayor Cui and the head of CNPC AM.

I sometimes look back on those astounding years and wonder how the story will turn out. To this day, I follow it with great interest and anxiously await my next trip.

A Postscript on China

The offices of TCX are now located in the new Bonsai Financial Area, the “Wall Street of Tianjin,” connected to Tianjin proper by a fast new bullet train that has turned a formerly nightmarish one-hour car trip into a fast 10-minute train ride. Tianjin itself is now connected to Beijing. A trip from downtown Beijing to the new TCX offices takes 1.5 hours, compared to the three-hour car trip when our joint venture discussions began. When Dr. Dai's daughter first came to the United States, I offered to have someone escort her from the airport to Penn Station. When she entered Penn Station, she remarked, “Oh, this is what China used to look like!” How things have changed.

Remarkable changes have also occurred in the Chinese futures market. China established a futures market in equity indexes on April 16, 2010. It has since become the fastest-growing futures market ever to be introduced in the world.²³ When China opened its economy in 1982, futures exchanges started to emerge in the country with astounding speed. By 1994, China had 40 futures exchanges.²⁴ Market abuse and non-enforcement of contracts, however, were problematic. By 2004, these 40 futures exchanges eventually merged into three exchanges and 188 futures brokerages.²⁵

As the Chinese economy grows and becomes even more open, interest rates will become more volatile. As a result, asset liability management may become more desirable to Chinese banks. Another opportunity for China lies in currency futures, given that China's currency, the RMB, will cease to be fixed at some point in the future. There are also prospects for energy markets. Local products like natural gas and power may begin to emerge, and China may begin to seek its own benchmark for crude oil.

TCX has stimulated interest in the role of emissions markets in reducing pollution. There are currently three environmental exchanges in China, not including the ones in Hong Kong,²⁶ and seven emissions trading schemes.²⁷ There has been a growing fondness for markets among the government, industrial sector, and academic circles. The 12th Five-Year Plan has called for a reduction in energy intensity of 40 to 45 percent below 2005 levels by 2020. While this is a voluntary commitment, we should not underestimate the political will underlying this objective. Once a consensus has been reached in the PRC, swift action generally follows. I would not be surprised if China developed a national cap-and-trade program before the United States does.