"It is a volatile market of sharp fluctuations... one of the biggest drivers of this volatility is government policy," Richard Burrett, managing director for sustainable development at Dutch bank ABN AMRO, told a climate change conference in Amsterdam.
Burrett noted the example of Germany, where he said stable policy promoting renewable energy had helped drive investment in solar power.
"The carbon market is clearly the way to go ... but we need a stable, long-term regulatory framework so that the private sector knows how to invest," the World Bank's Chief Scientist, Robert Watson, said.
James Cameron, vice chairman of Climate Change Capital, an investment banking group specialising in carbon markets, said the financial community had shown itself ready to invest but needed more regulatory certainty beyond 2012.
"They will bring more capital if they see a longer-term signal," he told the "Make Markets Work for Climate" conference.
"Unless we send these long-term signals in the next 18 months to two years we will lose momentum ... capital will find somewhere else to go," Cameron said.
Cameron said investors did not know what kind of emissions markets would be operating beyond 2012, the year the first period ends of the Kyoto protocol that sets targets for cutting greenhouse gases.
"What we don't know is if the same institutions will be coninued beyond 2012," he said.
The European Commission last week started legal action against eight states for failing to submit plans that allocate how much CO2 their industries may emit in 2008-2012, the second phase of the bloc's emissions trading scheme.
The first phase of the landmark scheme, which allows companies to buy or sell permits to pollute, runs from 2005-2007.
The Commission is under pressure from environmentalists to insist on strict cuts in the second phase after data for the first year of the system showed most companies had more credits than they needed, leading to a crash in carbon prices.