The Californian Final Regulation Order belongs to legal measures regulating cap-and-trade schemes that apply the concept of strict ex ante holding limits as regards the volumes of allowances, the entity is eligible to possess.

Section 95920 of the Final Regulation Order defines the holding limit as the maximum number of California GHG allowances that may be held by an entity or jointly held by a group of entities with a direct or indirect corporate association at any point in time.


The said approach is quite unique taking into account the mechanisms of the European Union Emissions Trading Scheme. The review of the oversight measures of the EU ETS is  underway effecting these days in adopting by the European Commission the view that emission allowances should be considered financial instrument and all infrastructure of the financial market should generally apply thereto (with some exceptions – see: “MIFID II and emissions – consequences under preliminary investigation”).


Taking into account in this context the newly announced MiFID II and MiFIR Proposals it is apparent that the different regulatory measure has been considered appropriate in that regard i.e. position limits taken, however, on an individual basis and applied ex post.


The issue is quite fundamental when it comes to commercial strategies on the carbon market. It seems that emissions market participants have legitimate interests to be able to be confident in the rules that could have an impact on the possibility to execute previously agreed transactions, and not to be surprised by the sudden regulatory measures introducing, hypothetically, a ban on certain types of transactions or on certain counterparties.



Bearing in mind these arguments and legal certainty considerations, the approach taken by the Californian Regulator (Air Resources Board – ARB) has the advantage over MiFID II and MiFIR Proposals.

Legal measures considered in this article:


1. 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

available at

(“Final Regulation Order”);


2. Proposal for a Directive of the European Parliament and of the Council on markets in financial instruments repealing Directive 2004/39/EC of the European

Parliament and of the Council of 20 October 2011, COM(2011) 656 final,

available at

(“MiFID II Proposal”);


3. Proposal for a Regulation of the European Parliament and of the Council on markets in financial instruments and amending Regulation [EMIR] on OTC derivatives, central counterparties and trade repositories of 20 October 2011, COM(2011) 652 final,

available at

(MiFIR Proposal)



It is true that MiFID II and MiFIR regulate not only emission allowances but all financial instruments while Californian Final Regulation Order restricts itself only to carbon credits. Consequently, MiFID II and MiFIR Proposals, being the broader in scope, need to apply more flexible regulatory language and approach. The effect is, however, the participants in emission market in California will enjoy greater legal certainty as regards potential possibilities for regulatory interventions in emission trading than European counterparties.


Some details for the Californian regime for holding limit in emission allowances


The concept for the holding limit under the Californian cap-and-trade consist practically in principle that the total number of allowances held by a group of entities with a direct or indirect corporate association in their holding accounts must sum to less than certain amount.


An interesting feature of the design is the possibility for entities that are part of a corporate association to allocate shares of the holding limit among themselves. This holding limit allocation results in each entity having a specified percentage share of the group’s holding limit. The sum of the shares allocated among the entities must sum to one.

The group of associated entities must inform the accounts administrator of the allocation of the holding limit when registering. The holding limit allocation will remain in effect until the group of associated entities informs the accounts administrator of subsequent changes to the allocation of the holding limit.

If entities with a direct or indirect corporate association do not allocate shares of the holding limit among themselves, the accounts administrator will not record any transfer request which would result in the entities with a direct or indirect corporate association exceeding the holding limit.


The application of the holding limit will treat beneficial holding by an agent as part of the holding of the principal.



The holding limit will apply to each entity registered as a covered, opt-in covered, or voluntarily associated entity but the calculation thereof will not include allowances contained in limited use holding accounts (account in which allowances are placed after an entity qualifies for a direct allocation, allowances placed in this account can only be removed for consignment to the auction). Compliance instruments contained in an exchange clearing holding account will, according to the scheme rules, be included in the calculation of the holding limit for the entity listed as the purchaser in the transfer request reported to the accounts administrator, for the transfer request being cleared. Exemptions from the holding limit relate, inter alia, to the number of allowances transferred by a covered entity or an opt-in covered entity to its compliance account.


The holding limit is separately calculated to holdings of allowances which may be used to fulfill a compliance obligation during the current compliance year and allowances issued for future compliance years. The formulas are as follows:


Allowances which may be used to fulfill a compliance obligation during the current compliance year:


Holding Limit = 0.1*Base + 0.025*(Annual Allowance Budget – Base)

in which:

“Base” equals 25 million metric tons of CO2e.

“Annual Allowance Budget” is the number of allowances issued for the current budget year.


Allowances issued for future compliance years that may not be used for compliance during the current compliance year:


Holding Limit = 0.1*Base + 0.025*(Compliance Period Budget – Base)

in which:

“Base” equals 75 million metric tons of CO2e.

“Compliance Period Budget” is the number of allowances issued for the future compliance period from which the allowances were sold at the advance auction.


If the ARB 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 regulator shall not approve the transfer request. If the violation is not discovered until after the transfer request is recorded, then the transfer request may be reversed and penalties may be imposed.


MiFID II and MiFIR approach as regards position limits


EU ETS legislatory framework does not contain a strict equivalent for a holding limit regulated by the Californian scheme.


As a part of the reform of the oversight regime for emissions allowances market and consequent to the introduction of carbon credits under financial regulatory umbrella of MiFID, the relevant provisions for position management powers of ESMA have been inserted into new Proposals.


Update on MiFID II legislative developments on emission allowances position limits see here.



The national authorities under MiFID II Proposal will have sufficient powers to influence trading practices on the emissions market not only on the general basis (as in the case of the above-mentioned Californian holding limit) but also in an individual sphere. They will be entitled, among others to:

a) require the cessation of any practice or conduct that is contrary to the provisions of MiFIR and the provisions adopted in the implementation of MiFID II Directive and to desist from a repetition of that practice or conduct;

(b) request the freezing and/or the sequestration of assets;

(c) adopt any type of measure to ensure that investment firms and regulated markets continue to comply with legal requirements;

(d) require the suspension of trading in a financial instrument;

(e) require the removal of a financial instrument from trading, whether on a regulated market or under other trading arrangements;

(f) request any person that has provided information in accordance with the above-mentioned Article 71(2) (i) to subsequently take steps to reduce the size of the position or exposure.


Pursuant to the Article 35 of the MiFIR Proposal, also ESMA will have the power for taking one or more of the following measures:

(a) request from any person information including all relevant documentation regarding the size and purpose of a position or exposure entered into via a derivative;

(b) after analysing the information obtained, require any such person to take steps to reduce the size of the position or exposure;

(c) limit the ability of a person from entering into a commodity derivative.


It is interesting, however, that while the point (b) above applies to emission allowances, the point (c) literally refers to the “commodity derivative” and, the definition thereof, pursuant to the Article 2(1)(15) of the MiFIR, does not capture carbon credits (they are in point 11 of the Annex I to the new MiFID Directive – and the point 11 is not mentioned by the definition of the “commodity derivative”).



The same relates to the Article 72(1)(g) of the MiFID II Proposal as regards the remedies to be made available to competent authorities, which are given, within the limits provided for in their national legal frameworks, the power to “limit the ability of any person or class of persons from entering into a commodity derivative, including by introducing non-discriminatory limits on positions or the number of such derivative contracts per underlying which any given class of persons can enter into over a specified period of time, when necessary to ensure the integrity and orderly functioning of the affected markets” (underlining comes from an author).


Notwithstanding this, all remaining competences of the national authorities and ESMA will be able to severely impact carbon market as a whole as well as individual strategies.


ESMA will be only entitled to take a decision concerned if all of the following conditions are fulfilled:

(a) the measures listed address a threat to the orderly functioning and integrity of financial markets including in relation to delivery arrangements for physical commodities, or the stability of the whole or part of the financial system in the Union;

(b) a competent authority or competent authorities have not taken measures to address the threat or measures that have been taken do not sufficiently address the threat (the delegated act of the European Commission specifying the relevant criteria and factors is envisioned in that regard).


It is provided very short notice period - the notification of measures taken by ESMA shall be made not less than 24 hours before the measure is intended to take effect or to be renewed. In exceptional circumstances, ESMA may make the notification even less than 24 hours before the measure is intended to take effect where it is not possible to give 24 hours notice.


Considering the lack in the EU ETS of the general and permanent holding limit, as in its Californian counterpart, it is noteworthy that the measures available for ESMA under Article 35 of the MiFIR Proposal have ex post and temporary character. A said measure shall take effect when the notice is published or at a time specified in the notice that is after its publication and shall only apply in relation to a transaction entered into after the measure takes effect. ESMA is obliged, furthermore, to review its measures at appropriate intervals and at least every three months. If a measure is not renewed after that three month period, it shall automatically expire.


According to the Article 83(6) of the MiFID II Directive in relation to emission allowances, competent authorities should cooperate with public bodies competent for the oversight of spot and auction markets and competent authorities, registry administrators and other public bodies charged with the supervision of compliance under Directive 2003/87/EC in order to ensure that they can acquire a consolidated overview of emission allowances markets.


All these regulatory measures increase significantly the firepower available to regulatory authorities responsible for the supervision of the EU ETS, specifically in fighting frauds occurring sometimes on the carbon markets, but it seems that introducing clear and stable general position limits, as in the Californian cap-and-trade, would be more transparent and would give carbon market participants more legal certainty and confidence in the EU ETS.