    Vol. 3, No. 3, November 2012 Academic Research International         CARBON TRADING: CAPITAL MARKET CHALLENGES AND REGULATORY REFORMS FOR ISLAMIC FINANCE Naila Nazir Department of Economics, University of Peshawar, PAKISTAN. naila_nazirswati@yahoo.com ABSTRACT The present research is a first attempt that envisages the place of Emission Trading in capital markets considering the introduction of Islamic financial industry. The paper highlights the facts and challenges in the way of regulation of capital markets and explores the potential areas for investment in Emission Trading. The methodology covers the review of conventional Emission Trading and finance, complexities of carbon trade presently taking place under the conventional system, and financial opportunities for Islamic investors. Product designing and regulatory issues are highlighted with reference to environmental issues and Shariah principles. The present model of Islamic financial products would be extended to Carbon Market. Keywords: Carbon Trading, Islamic Finance, Potential investment, Capital market reforms INTRODUCTION The carbon market has grown so fast that it is estimated to be the world’s largest trading market. According to estimation the current worth of carbon market is over US$100 billion annually (Lohmann, 2009).On the other hand Islamic financial industry’s annual growth rate is about 23 percent since 1994 and Islamic financial institutions have more than $700 billion in assets globally (Hersh, 2011). The question of integration of Emission Trade and Islamic finance is twofold; one, Shariah’s permissibility for trade in carbon credits and second, how the integration is made practical and the role of financial institutions is defined. The main objective of the research is to figure out the potential projects for Islamic finance in Carbon Trading, highlight the major challenges in regulating the capital markets dealing carbon trade based on Islamic finance and suggest measures to develop a network of investors, institutions and policy experts to execute the process successfully. Carbon Trading Procedure and Capital Market Growth According to UNFCCC (2008) under Kyoto Protocol in 1997, major economies of the world; developed countries (Annex 1) and developing (Annex 2) agreed to reduce the emission level of Green House Gases (GHGs) from 1990 level. In carbon trading it is not the sale and purchase of carbon but trading is the right to emit (GHGs) in the form of units having different rules and regulations; Assigned Amount Units (AAUs), Certified Emissions Reduction Units (CERs), Emissions Reduction Units (ERUs), Removal Units (RMUs), and European Union Allowances (EUAs). Thousands of financial institutions world -wide are engaged in its trade; buyers’ companies, seller’s companies, brokers and market players, service providers, and governments and political leaders. Renowned financial institutions which are engaged in carbon trade are Morgan Stanley, Deutsche Bank, Barclays Capital, and BNP Paribas Fortis etc. Whereas new institutions have been set up for example, South Pole Carbon Asset Management, Sindicatum