'Borrowing' is means the use of compliance instruments from future vintage years for current compliance.
Under the California emission trading program allowances issued for a future year cannot be used for surrender in an earlier compliance period.
To fulfil compliance obligation, a compliance instrument must be issued from an allowance budget year within or before the year for which an annual compliance obligation is calculated or the last year of a compliance period for which a triennial compliance obligation is calculated, unless:
- the allowance was purchased from the Allowance Price Containment Reserve; or
- the allowance is used to satisfy an excess emissions obligation.
This approach is adopted to prevent the threat of so-called 'cascading borrowing.' This situation occurs when entities are able to use future allowances for current compliance, and it creates a growing shortage of instruments in later compliance periods.
Restrictions on borrowing were considered necessary under the California cap-and-trade scheme, given that allowances will be issued for vintage years through 2020 at the beginning of the program. In some cases, such as allowances sold at the advance auction, allowances from future vintage years can be purchased and held, but not used for surrender.
If borrowing were allowed, the California legislators argue, the added supply would reduce current market prices for instruments. This would lead to a reduction in the level of direct emissions reductions, as well as a greater surrender of instruments compared with a scenario of no borrowing. In turn, this would lead to a smaller supply of instruments in future compliance periods, leading to an even greater reliance on borrowing. Ultimately, either the borrowing would lead to the cap being violated or covered entities having to make drastic reductions in a short period of time.