Final Regulation Order, version of October 2011 on California cap on greenhouse gas emissions and market-based compliance mechanisms has been currently posted on the website of the Californian Air Resources Board, together with accompanying documentation, among others, four Compliance Offsets Protocols.
Considering the potential participation in both GHG compliance programs: the European Union Emissions Trading Scheme and its Californian counterpart, it is noteworthy that the registry rules provided for in the Californian scheme are founded on the fundamentally different principle in the practical and legal functioning as regards the finality of transfers.
Elaborations on the design of the Californian scheme finished
In an electronic release of 11 October 2011 ARB reminds that at the December 2010 hearing, ‘the Board directed ARB staff to finalize a cap-and-trade regulation. The cap-and-trade program covers major sources of GHG emissions in the State such as refineries, power plants, industrial facilities, and transportation fuels. The regulation includes an enforceable emissions cap that will decline over time. The State will distribute allowances, which are tradable permits, equal to the emissions allowed under the cap. Sources under the cap will need to surrender allowances and offsets equal to their emissions at the end of each compliance period. If adopted, the program will become effective in 2012, with emissions compliance requirements starting in 2013. Two 15-day notices of regulatory changes were issued during the cap-and-trade rulemaking. The Final Cap-and-Trade regulation order, now available for download, incorporates these changes to the regulation considered by the Board in December 2010. The four final compliance offset protocols identify the project types and quantification methods to generate ARB offsets eligible for use under the cap-and-trade regulation. The protocols are part of the regulatory package and are also available for download’.
According to the said notice, Final Regulation Order, version of October 2011, of the Subchapter 10 Climate Change, Article 5, Sections 95800 to 96023, Title 17, California Code of Regulations, Article 5: CALIFORNIA CAP ON GREENHOUSE GAS EMISSIONS AND MARKET-BASED COMPLIANCE MECHANISMS has been published on the website http://www.arb.ca.gov/cc/capandtrade/finalregorder.pdf (hereinafter referred to as the “Final Regulation Order”.
The state of play is that on October 20, 2011 the Air Resources Board will conduct a public hearing to consider approval of the proposed California Cap on Greenhouse Gas (GHG) Emissions and Market-Based Compliance Mechanisms Program.
So, it seems that the elaborations of the final proposal of the ARB for the instrument regulating the Californian cap-and-trade have come to an end and wait for the necessary regulatory and legislative approvals.
In the meantime, let’s consider the one of several interesting discrepancies which appeared between the European and Californian models for carbon credits trading in connection with the way of functioning of registry rules.
Notwithstanding the similarity of the basic elements of both schemes, some specificities exist that likely could make trouble for participants that get accustomed to solutions adopted under each regulatory regime.
What’s the problem with the finality of transfers?
§ 95921(b)(2) of the Final Regulation Order stipulates that ‘If the accounts administrator detects a deficiency in a transfer request after it is recorded into the tracking system:
(A) The accounts administrator will inform the entities submitting the request and the Executive Officer of the deficiency; and
(B) If the entities that submitted the deficient transfer request cannot correct the deficiency within 5 business days after notification by the accounts administrator, the Executive Officer may instruct the accounts administrator to reverse the transfer’ (underlining comes from an author).
It follows from the above that the reversal of the transfers relates to the situation where a transfer request has been recorded into the tracking system. It follows, furthermore, that the carbon credits being the subject of the said reversed transfer could have been – before the potential reversal – entered by the purchaser into further circulation. What could be the effect of the reversed transfer on the subsequent transactions with the emission allowances concerned? The Final Regulation Order does not elaborate on this issue.
Generally, the said provision § 95921(b)(2) does not specify, what kind of deficiencies, the gravity thereof is so significant that effect in the reversal of the transfer, are mentioned. From such a formula there could be, therefore, inferred that any deficiency matters. Taking into account the provisions of the Final Regulation Order, the requirements for the content of the transfer request are, however, quite standard. The Final Regulation Order stipulates that the following information must be reported to the accounts administrator as part of a transfer request before any transfer of allowances can be recorded on the tracking system:
(1) Holding account number and authorized account representative of seller;
(2) Holding account number and authorized account representative of purchaser;
(3) Serial number of the compliance instruments;
(4) Date of the transaction agreement;
(5) Settlement date, if not the same as date of transaction agreement;
(6) Price of the compliance instrument in U.S. dollars. If California links to Canadian provinces, the price of the compliance instrument may be reported in Canadian dollars; and
(7) Holding account number and authorized representative of an entity for whom the compliance instrument is to be held in benefit;
What deficiencies could be made by the parties to the transaction in these simple formulated items that may not be observed sufficiently early by the registry administrator (using appropriate checking software) in such a way that the most far-reaching legal sanctions – being the reversal of transfer – must be applied?
EU ETS position
I underlined myself the words ‘reverse the transfer’ in the citation of § 95921(b)(2) of the Final Regulation Order, because they seem to express the rule quite opposite to the newly proposed regulation for the EU ETS emission allowances registry (see: ‘The draft of the Commission Regulation establishing a Union Registry – the finality of transfers rules and other details for the new security measures revealed’). The said post referred to the draft Commission Regulation establishing a Union Registry for the trading period commencing on 1 January 2013, and subsequent trading periods, of the Union emissions trading scheme pursuant to Directive 2003/87/EC of the European Parliament and of the Council and Decision 280/2004/EC of the European Parliament and of the Council and amending Regulations (EC) No 2216/2004 and (EU) No 920/2010 (hereinafter referred to as ‘EU ETS Registry Regulation’) according to which, subject to very limited exceptions under the EU ETS Registry Regulation transfers of allowances and Kyoto units in the Registry are final and irrevocable upon finalisation of the transaction.
Pursuant to the Article 37(2) of the EU ETS Registry Regulation ‘no law, regulation, rule or practice on the setting aside of contracts and transactions shall lead to the unwinding of a transaction that has become final and irrevocable under this Regulation’. Article (37(1) stresses that ‘holding an allowance or Kyoto unit in the Union Registry shall constitute conclusive evidence of the account holder's ownership of the allowance or Kyoto unit. Transfer of an allowance or Kyoto unit in the Union Registry shall constitute conclusive evidence of the change of ownership of the allowance or Kyoto unit’.
The one of the sparse exceptions relates to a transaction completed after a relevant judicial or administrative authority has handed down a decision opening insolvency proceedings in respect of the account holder initiating the transaction (as regards other above-mentioned limited exceptions to the said rule see: ‘The surrender of allowances initiated in error - the only reversible transaction pursuant to the draft of the Commission Regulation establishing a Union Registry of emission allowances’).
It would be appropriate to recall that the recital (12) in the preamble to the EU ETS Registry Regulation underlines that allowances and Kyoto units exist only in dematerialised form and are fungible, so their ownership should be established by their existence in the account of the Union Registry in which they are held. Moreover, to reduce the risks associated with the undoing of transactions entered in a registry, and the consequent disruption to the system and to the market that such undoing may cause, it is necessary to ensure that transactions cannot be reversed, revoked or unwound, other than as defined, after a moment set out by the rules of the registry. EU ETS Registry Regulation makes the reservation that it shouldn’t prevent an account holder or a third party from exercising any right or claim resulting from the underlying transaction that they may have in law to recovery or restitution in respect of a transaction that has entered a system, e.g. in case of fraud or technical error, as long as this does not lead to the reversal, revocation or unwinding of the transaction.
The Californian emission allowances registry rules do not seem to apply equivalent principles. The general conditions for effecting transfers, pursuant to the Section 95921 (titled: Conduct of trade) require that the accounts administrator will not register a transfer of compliance instruments between accounts into the tracking system until:
(A) The two parties to the transfer submit a request for the transfer to the accounts administrator within three calendar days of settlement of the transaction agreement; and
(B) The Executive Officer has determined the transfer request and the transaction meet the requirements specified in the Final Regulation Order.
When the deficient transfer requests are at issue the following provisions in the Californian cap-and-trade scheme apply:
1) If the accounts administrator detects a deficiency in a transfer request before it is recorded into the tracking system:
- The accounts administrator will inform the entities submitting the request and the Executive Officer of the deficiency;
- The entities submitting the transfer request may resubmit the request with the deficiency corrected within the time limit of three calendar days of settlement of the transaction agreement; and
- If the entities fail to submit an acceptable transfer request within the time limit, then they must either withdraw the transfer request or submit a new request for transfer.
2) If the accounts administrator detects a deficiency in a transfer request after it is recorded into the tracking system the rules described at the beginning are binding (with the possible reversal of transfer recorded already in the tracking system).
Taking into account the far-reaching legal consequences of the potential applicability of the finality of transfer rule in the emission allowances registry regime, the above-described divergences could, to my view, be one of the obstacles in possible future linking of both schemes. Notwithstanding this, in the meantime, so different legal regimes will influence on possible divergent juridical verdicts in analogous factual circumstances.
After placing this post on the website I found in the Final Regulation Order another instance which in my opinion causes serious legal uncertainty when it comes to trading in California emission allowances. The problem relates to the Holding Limit provided for in Section 95920(b)(4) of the Final Regulation Order which stipulates that if the Executive Officer determines that a reported transfer request not yet recorded into the tracking system would result in an entity’s holdings exceeding the applicable holding limit, then the Executive Officer shall not approve the transfer request. If the violation is, however, not discovered until after the transfer request is recorded, then the transfer request may be reversed and penalties may be imposed. Hence, the situation at issue (and potential problems for acquirers of the allowances concerned at subsequent levels of circulation) is analogous to the above-described procedure for handling deficiencies in transfer requests.