It follows from the Australian Government document that Australian emission allowances auction design can have quite original features. As a consequence bidding strategies elaborated under assumption of the EUETS rules may occur not entirely effective on the Australian carbon primary market.
On 3 February 2012 The Australian Government published the Position paper “Auctions Position paper on the legislative instrument for auctioning carbon units in Australia’s carbon pricing mechanism” (available on the Commonwealth Department of Climate Change and Energy Efficiency website at: www.climatechange.gov.au – hereinafter referred to as ‘Position paper’) and invited submissions from all interested stakeholders (submissions on Position paper close 24 February 2012).
Californian v European model for emission allowances auctions – which of them is better suited to the market
Preparations for Californian cap-and-trade auctions
Comparing the design proposed in the Australian scheme with the EU ETS single-round, sealed-bid auctioning arrangements addressed in the EU ETS Directive (2003/87/EC) and the Auctioning Regulation (1031/2010) it should in the first place be noted that the Australian cap-and-trade prefers ascending clock auction format. In this model the Regulator announces the current price, bidders nominate the number of carbon units they are prepared to purchase at that price, if, however, demand exceeds supply, the Regulator raises the price in the next round and bidders resubmit their bids. Bidders may decrease, but not increase, their bid quantities in each successive bidding round. This process continues until the number offered is equal to or greater than demand. Bidders then pay the price from the previous round.
The price paid per carbon unit will be uniform for all successful bidders under an ascending clock auction system and this feature resembles the analogous solution adopted in the EUETS (uniform clearing price).
In the Position paper an example for ascending clock auction format is displayed in which the Australian Clean Energy Regulator auctions 100 carbon units and starts bidding at $21 per unit. Participant A will buy 50 units at this price, Participant B will buy 50 units at this price and Participant C will buy 50 units at this price. As demand for units exceeds supply, the price is put to $22 per unit. Participant A will still buy 50 at this price, Participant B will also buy 50 units $22 per unit, but Participant C will lower their demand to 20 units. As demand still exceeds supply the price goes to $23. Participant A only wants 40 units at this price, Participant B also wants 40 units and Participant C wants 15 units.
This means that under ascending clock auction format 5 units will remain unsold but this issue is not decided yet – Position paper explains that for that residual supply the Regulator will only determine whether to hold intra-round bidding, and the subsequent method for the submission of intra-round bids.
The noteworthy remark - general, but burdened with multiple implications - is also that the Position paper contains a mention that auction in the Australian cap-and-trade will be conducted using an electronic platform and an electronic settlement system ‘operated by the Regulator’. This passage may suggest that an option adopted under EUETS consisting in using auction platforms being regulated markets (when it comes to EUETS in the meaning of the MiFID Directive) has not been preferred by the Australian legislators (this issue, however, is somewhat unclear).
Pursuant to the Recital 29 of the Auctioning Regulation, ‘The requirement that the auction platform is a regulated market is founded on the desire to use the organisational infrastructure available on the secondary market for the administration of the auctions.’
If the Australian carbon auction didn’t use the said organisational infrastructure available on the secondary market, it would have to build the self-standing system, which is theoretically possible but exposed to additional operational risks.
The other most interesting detailed features of the proposed Australian auction design pursuant to the Position paper are as follows:
Under the Australian cap-and-trade it is proposed that there will be no deferred payment arrangements for auctions. It is proposed that the settlement day will be three business days after the end of the auction, except where settlement is cancelled (it is also proposed that payments in Australian currency only will be allowed).
The EU ETS rules provide for the payment for the auctioned products to be made either before or at the latest upon delivery of the allowances into the bidder’s nominated holding account or the nominated holding account of its successor in title.
As regards the currency used in EU ETS payments to the auctioneers are to be made in euros or in the currency of the appointing Member State where that Member State is not member of the euro-zone, at the option of the Member State concerned, regardless of what currency payments are made by the bidders, provided that the clearing system or settlement system concerned is capable of handling the national currency in question.
2. AUCTION CALENDAR
Under the Australian cap-and-trade it is proposed that four auctions will be held during the compliance year, one in each quarter (approximately 3 months apart).
There would be eight auctions for each vintage; three advance auctions, four within the relevant compliance year and one following the compliance year before the final surrender date.
Four years of vintages will be auctioned (current vintage plus advance auctions of three future vintages).
Advance auctions of flexible price carbon units will commence in the fixed price period.
The first auction will take place in 2013-14 financial year, most likely in early 2014. Auctions potentially held in the first and second year of the carbon pricing mechanism would be limited to 15 million carbon units per vintage.
Post-vintage year auction concept is linked to the fact that in the Australian carbon scheme the final surrender date for each compliance year is 1 February of the following compliance year (compliance year begin on 1 July, the financial years beginning on 1 July 2012, 1 July 2013 and 1 July 2014 are fixed charge years, later financial years are flexible charge years).
It is proposed that one auction of each vintage will be held after the end of the relevant compliance year in the lead-up to the final surrender date (i.e. after 1 December following the vintage year and at least four weeks prior to the final surrender date of 1 February the following vintage year). This will allow for an auction to be held after liable entities have reported their emissions and know their liability with greater certainty.
Under the EU ETS the issue of auction calendar is more complicated given separated rules regarding aviation allowances as well as op-out auction platforms.
But generally the Auctioning Regulation stipulates that auctions are more frequent and as from the sixth auction or earlier, the auction platform should conduct auctions of allowances at least on a weekly basis (with the exception of 2012 when the frequency of auctions is monthly at least) and auctions of aviation allowances at least on a two-monthly basis (due to lower volumes). Volumes of EUAs of the third trading period auctioned in so-called “early auctions” (i.e. in 2012) by each Member State is currently set out in Annex I to the Auctioning Regulation.
3. PARTICIPATION ELIGIBILITY
As regards the participation arrangements in the Australian cap-and-trade it is proposed that persons wishing to participate in auctions will need to register with the Regulator as a participant and show they meet competency and collateral requirements as determined by the Regulator. The Regulator will make public any competency requirements and details of training at least 3 months prior to an auction.
Carbon units will, however, be financial products for the purposes of the Corporations Act 2001 (Corporations Act) and the Australian Securities and Investments Commission Act 2001 (ASIC Act), which potentially triggers the market misconduct, disclosure and licensing provisions of those acts as well as general consumer protection provisions.
People who are in the business of providing financial services involving financial products will need to hold an Australian financial services (AFS) licence, issued by ASIC unless they are exempt from the requirement to hold a licence. There are some exemptions outlined in the Corporations Act, and additional exemptions are being proposed specifically for carbon units.
People who do not hold an AFS licence and are not required to do so will not have the same obligations as an AFS licence holder when for example buying units in an auction on their own behalf. Other participants, such as liable companies and individuals, will not be subject to these obligations if they purchase carbon units on their own behalf.
Under EUETS rules the MiFID Directive does not apply currently to the secondary trading in spot emission allowances while the revision of this Directive (so-called MiFID II) reclassifies emission allowances as financial instruments (see: ‘MIFID II and emissions – consequences under preliminary investigation’). The Auctioning Regulation however already contains complex provisions on market abuse (Chapter X) that would apply to two-days spot and five-days futures in the event where two-day spot or five-days futures were not financial instruments within the meaning of Article 1(3) of MAD Directive (2003/6/EC – also currently under revision).
It seems that under EU ETS the practical choice between the two-days spot (not being at present financial instruments) and five-days futures (qualifying as financial instruments within the MiFID Directive) is left to the tenderers participating in the tender for the joint procurement of common auction platform and consequently depending on the outcome of the tender. Such a view is supported by the text of the ‘Tender Specification for the Joint procurement of common auction platform’ (part II p. 14 - draft 8 November 2011), revealed by the European Commission, which contains the provision that the tenderers should describe in their offers, ‘the delivery period and whether the auctioned product falls within the definition of the two-day spot or five-day futures’.
For carbon units purchased at auctions, it is proposed under the Australian cap-and-trade that collateral be in a form that would fully cover the maximum bid and be in Australian currency, a letter of credit from an Australian authorised deposit-taking institution (ADI), a bank guarantee from an Australian ADI, another form of collateral acceptable to the Regulator, or a mixture of these.
In the EUETS auction arrangements the clearing system is generally envisioned and where a successful bidder is in default of payment one of the following shall occur:
(a) the central counterparty interposes to take delivery of the allowances and effect payment of the sum due to the auctioneer;
(b) the settlement agent applies collateral taken from the bidder to effect payment of the sum due to the auctioneer.
5. RESERVE PRICE
The reserve price is the lowest price that carbon units would be sold at the auction and it will be set for each auction at a level below the expected market clearing price for the auction.
As part of the price floor arrangements for the first three years of the flexible price period under the Australian cap-and-trade it is proposed that there will be a minimum auction reserve for the vintage years 2015-16, 2016-17 and 2017-18 (respectively 15, 16 and 17.05 Australian dollars).
For auctions of units that are not subject to the above-mentioned legislative price floor, it is proposed that the Regulator will determine the reserve price for each auction having regard to elements included in the legislative instrument. The reserve price for the said auctions will be determined and published at least 14 days before the relevant auction.
In that regard EUETS auctioning arrangements have at their disposal Article 7(6) of the Auctioning Regulation according to which, ‘Where the auction clearing price is significantly under the price on the secondary market prevailing during and immediately before the bidding window when taking into account the short term volatility of the price of allowances over a defined period preceding the auction, the auction platform shall cancel the auction.’ – see: ‘Buying allowances in the auctions versus on the secondary market - pros and cons’.
6. PARCEL SIZE
Parcel size means the minimum and maximum number of units in a bid.
The lowest number of units that a participant can bid on is set under the Australian cap-and-trade at one carbon unit.
The maximum parcel bid size will be no more than 25 per cent of the total number of carbon units sold at each auction for a particular vintage. It is interesting that pursuant to the said Position paper the maximum parcel limit will apply to individual participants, rather than the bid aggregation of a number of participants who are controlled by the same corporation.
It seems that such a design expose the future Australian carbon auction to the risk of market manipulation (see for instance as regards the Californian cap-and-trade scheme: 'Beneficial holdings disclosure requirements for emissions agents under the California cap-and-trade').
In this aspect the difference in comparison with the EUETS is significant because the volumes of the bids in European carbon auction arrangements must be integral multiples of lots of 500 or 1 000 allowances (depending on the type of the auctioned product). The Auctioning Regulation binding in the EUETS does not specify currently – as opposite to the legislative instruments regulating Californian carbon auction - the maximum bid-size.
Article 57 of the Auctioning Regulation stipulates that a maximum bid-size, or any other remedial measures necessary to mitigate an actual or potential discernible risk of market abuse, money laundering, terrorist financing or other criminal activity, as well as anti- competitive behaviour, may be imposed by any auction platform after consulting the Commission and obtaining its opinion thereon, provided that implementation of a maximum bid-size or any other remedial measures would effectively mitigate the risk in question.
In such an event the maximum bid-size may either be expressed as a percentage of the total number of auctioned allowances in any given auction or a percentage of the total number of auctioned allowances in any given year, whichever may be most appropriate to deal with the risk of market abuse. For these purposes maximum bid-size means the maximum number of allowances that may be bid for, directly or indirectly, by any group of persons which belong to any of the following categories:
(a) the same group of undertakings including any parent undertakings, its subsidiary undertakings and affiliate undertakings;
(b) the same business grouping;
(c) a separate economic unit having an independent power of decision where they are controlled, directly or indirectly, by public bodies or state-owned entities.
Comparing the Australian propositions presented in the Position paper that the maximum parcel limit will apply to individual participants, rather than the bid aggregation of a number of participants who are controlled by the same corporation with its European and Californian counterparts there are arguments that the Australian stance in that regard is isolated.
7. SUSPENSION OR CANCELLATION OF AUCTION
Under the Australian cap-and-trade it is proposed that the Regulator will have the authority to suspend or cancel auctions if the Regulator believes that trading or bidding conditions have or did become disorderly or not transparent, including through system failure, mistaken bidding or non-compliance with the auction rules. It is proposed that an auction can be suspended for up to three hours to allow the Regulator to carry out investigations, during which time bids will remain in place. The auction will resume if the suspension is lifted within the three hour time period, but will be cancelled if suspended for more than three hours. The auction can also be cancelled any time before settlement.
Cancellation of an auction will only have effect if the cancellation is announced prior to settlement. All bids will be null and void. The Regulator may defer settlement for up to five business days pending investigation whether an auction should be cancelled. The Regulator will determine whether to hold a replacement auction, within seven days of the cancelled auction.
As was said at the beginning the time-line for submissions on Position paper lapses 24 February 2012. In the mid-2012 it is envisioned the publication of the exposure draft of the legislative instrument for auctioning Australian carbon units. It is to be seen whether by that time the Australian Government will stand by the above assumptions for the details of future auctioning system or changes the approach for some particular items.