The objective of the requests for proposals currently released by the Air Resources Board in California is to administer financial and transaction services to support up to six quarterly GHG allowance auctions and up to six “reserve sales” to implement the California cap-and-trade program. ARB is anticipating the first California allowance auction will take place in late 2012. The auctions will continue based on the calendar quarter for the remainder of the program.

The deadline for receipt of proposals is December 2, 2011.

 


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.

 

 

It becomes evident now which participants of the emissions trading infrastructure are systemically important for carbon markets – and these findings will gain the rank of the regulatory text. This pivotal position of only certain installations will not give them any special privileges – but rather burdensome obligations and strict responsibility.

 


Currently, MiFID does not apply to the secondary trading of spot emission allowances.

What are the pivotal elements of the Commissions proposal on MiFID II as regards emissions? The issue of reclassification of emission allowances as financial instruments was extensively covered by media but is this really the case that capturing spot emissions trading by financial market legal infrastructure effects in entirely win-win situation for everybody? No, it isn’t and the Commission itself admits so in accompanying documents to the MiFID II/MiFIR proposals.

 


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.

 

 

Initiating transactions and processes in the Union emissions registry after the new draft regulation enters into force will require careful consideration because the reversal of potential errors, mistakes and irregularities will be, in principle, legally and technically impossible.

Article 36(5) of the Regulation provides literally that during the 24-hour delay ‘an account representative may propose to the national administrator the cancellation of the transfer on the grounds of a suspicion that the transfer was initiated fraudulently’. Such a wording may create some doubts as regards the issue whether an account representative may propose to the national administrator the cancellation of the transfer on the grounds of a erroneously or mistakenly initiated transfer.


As follows from Article 7(4) read in conjunction with Article 7(2) of the EMIR, for the qualification whether an OTC transaction regarding any derivative contract set out in Annex I Section C numbers (4) to (10) of the MiFID (including, consequently, also derivatives for which the underlying asset are emission allowances) entered into by the commodity firm, is subject to the clearing obligation, the decisive significance have two premises:

1) the positive: the breach of the clearing threshold value (to be specified by the European Commission through a delegated act),

2) the negative: the ability of the OTC derivative contracts entered into by a commodity firm to be objectively measured as directly linked to the commercial activity of that counterparty.

 


One of the most interesting things for investors in the Australian emission trading scheme will surely be the eligibility of international emissions units as compliance instruments under the scheme rules.

 


In the period from 1 July 2012 to 1 July 2015 the new Australian emission market won’t really be a fully-fledged cap-and-trade.

 

 

As was reminded also in the accompanying documents to the MIFiD Directive recent review, the legal classification of emission allowances is not uniform in EU Member States. The said documents observed that some Member States consider emission allowances as property rights, whereas others consider them personal rights.

The nature and characteristics of these allowances (certificate giving the right  to emit 1 metric tonne of CO2) could lend themselves to be classified as an intangible asset or a physical commodity. Emission allowances themselves are not classified as financial instruments under MiFID. On the other hand, derivative contracts on these allowances (and other environmental credits) are financial instruments under MiFID under the same criteria as derivatives on commodities.

 

This interesting theoretical, but burdened also with multiple practical implications, discussion have moved recently into other continents with the spreading of cap-and-trades.

 

 

From the systemic point of view there is no reason, why gas would be treated differently, for the purposes of establishing a coherent regulatory regime for the integrity and transparency of the wholesale energy products, than other fuels for the production of the electricity - like coal, oil and even biomass.

 

 

On the surge of recent criticism as regards poor performance of the EU ETS as a means of emission reductions, EPS is minded as a regulatory backstop which will limit the emissions from new fossil-fired power stations. It has to be taken into account in any power generation business projections – in the UK for now.