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)
“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)
“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”).