Flying below the American radar, a tax scandal has been rocking the global carbon markets. Ironically, it is emanating from Copenhagen, the city that six months ago hosted the world’s largest climate summit. But back in 2007, long before COP 15 arrived, the Danes began working behind the scenes to host a growing cadre of carbon brokerage firms, which have become central to trading the world’s fastest growing commodity.

To make it easier for these financial firms to set up shop in the Danish capital, the Ministry of Finance decided to skip background checks on companies being vetted to trade on the country’s national carbon exchange. According to a string of reports in the Danish newspaper Ekstra Bladet, all the government asked companies to provide was an email address. This laissez-faire attitude succeeded in channeling close to a third of all EU carbon trades through Denmark, and has since backfired badly.

The paper reported that one firm after another was little more than a front company for transacting complicated financial scams. In fact, more than 80 percent of the carbon trading firms registered on the Danish exchange closed down after the media probe began, according to a statement (pdf) by the country’s Environment Minister, Lykke Friis.

The fraud is known as a “tax carousel.” Danish-registered companies buy carbon credits from brokers in other European countries. This intra-European trading of credits to meet EU emissions standards (and the trades made by speculators betting on the price of these credits) are not taxed. But when the buyer and seller are trading in the same country, in this case Denmark, a value added tax, or VAT, is imposed.

In Denmark, VAT is a hefty 25 percent on each transaction — one of the highest rates in Europe. But rather than turn the tax monies over to the Danish treasury, the traders packed up and disappeared. Three-quarters of the carbon traders registered in Denmark during the past year have either been dismantled by their owners or were shut down by the authorities.

According to a Reuters report, EuroPol estimates the scheme has so far cost treasuries in Denmark and other European countries some 5 billion euros (about US$7 billion) in lost revenues, while throwing into question the veracity of thousands of carbon trades.

Bo Elkjaer, the Danish reporter who broke the story, explained over email that his further investigations suggest the scandal is by no means confined to Denmark. Many of the same firms are suspected of running similar schemes in the Netherlands, Germany, Norway and the UK. EuroPol reports that after the governments of France, the UK, the Netherlands and Spain changed their tax codes to close the loophole, the volume of carbon trading in those countries collapsed by 90 percent.

Meanwhile, the media blitz has raised questions about the EU’s new commissioner for climate action, Connie Hedegaard, who was Denmark’s climate minister when many of the fraudulent deals were set in motion. Hedegaard said publicly that she knew nothing about the fraud before Mr. Elkjaer and his newspaper began reporting on the case last December.

In May, the Guardian reported that it had obtained a document from inside the Danish ministry drawing attention to the tax fraud problem, which Ms. Hedegaard had initialed back in August 2009. Since then, she has admitted she was aware of the problem but says that at the time she signed the report, she saw it as a tax issue and, therefore, not her responsibility.

EuroPol is in the middle of a full scale investigation into the scam, and hundreds of arrests have been made across Europe.

Elkjaer says the scandal highlights the vulnerability of a system based on trading an intangible asset. “It’s just a computer certificate, moved from account to account in endless loops,” he said. “A trade can be performed from a single laptop anywhere in the world. All it needs is an internet connection.”

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Mark Schapiro specializes in international and environmental stories. His award-winning work appears in all media: in publications such as Harpers, The Atlantic, Mother Jones and Yale 360; on television, including PBS FRONTLINE/World and KQED; on public radio including Marketplace; and on the web. He is currently writing a book for Wiley & Co. investigating the backstory to our carbon footprints. His previous book, "EXPOSED: The Toxic Chemistry of Everyday Products and What’s at Stake for American Power," reveals the health and economic implications of the tightening of environmental standards by the European Union.