Emission market participants should prepare for clearing with CCP OTC emissions trades under circumstances specified by EMIR. In order to comply with the clearing obligation, a counterparty must become a clearing member, a client or establish indirect clearing arrangements. Determination of the most beneficial option is made sometimes difficult by the fact that these notions and their implications are often confused. ESMA Consultation Paper has shed, however, some light on these issues.
MiFID and EMIR emissions trades interlinkages
Pursuant to Article 2 point 5 and 7 of EMIR (European Market Infrastructures Regulation - Regulation of the European Parliament and Council on OTC derivatives, central counterparties and trade repositories)
'derivative contract' or 'derivative' means a financial instrument as set out in points (4) to (10) of Section C of Annex I to Directive 2004/39/EC as implemented in Article 38 and 39 of Regulation (EC) No 1287/2006, and
'over-the-counter derivative' means a derivative contract the execution of which does not take place on a regulated market as within the meaning of Article 4(1)(14) of Directive 2004/39/EC or on a third-country market considered as equivalent to a regulated market in accordance with Article 19(6) of Directive 2004/39/EC.
It should be recalled that MiFID II proposals consisted inter alia in additions made in Annex I to the Directive 2004/39/EC, particularly in Section C of the said Annex I (containing thelegal catalogue of financial instruments) point 4 was modified by the Commission’s proposal of 20 October 2011 (COM(2011) 656 final, and entirely new point 11 was added (see: MIFID II and emissions – consequences under preliminary investigation). According to the said point 11, a new class of financial instruments (if the MiFID II Commissions proposal becomes binding law) will be “emission allowances consisting of any units recognised for compliance with the requirements of Directive 2003/87/EC (Emissions Trading Scheme).”
When it comes to point 4 of Section C of the said Annex I, emission allowances were added to the existing list of “options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields, or other derivatives instruments, financial indices or financial measures which may be settled physically or in cash.”
These changes in MiFID II are not reflected in the EMIR draft which builds on the existing MiFID Directive wording. However, as can be anticipated, if the legislative developments contained in MiFID II become law, it will enforce consequential amendments to the EMIR text and the scale of EMIR’s applicability to emissions trades even broadens.
It is noteworthy that also under Australia carbon price framework emission allowances are classified as financial products (broadly an Australian equivalent for financial instruments under MiFID) – see Australian Carbon Register – how Australian financial market participants accommodate to legislative developments considering emission units as financial products.
This move reflects current legislative tendencies and the growing belief that the financial market infrastructure poses more safe environment for emission allowances trading than the quasi-commodity arrangements existing so far.
Regardless of the above considerations, even under the legislative framework currently in force, EMIR may drive emission market participants to clear their trades with the central counterparties (CCPs) – for particulars see: The implications of the European Market Infrastructure Regulation (EMIR) for commodity firms trading on the emissions market.