The European Commission's recent proposals to revise and recast the Markets in Financial Instruments Directive, or MiFID, and the Market Abuse Directive, or MAD, include, for the first time, regulating carbon emissions allowances as financial instruments. If implemented, certain spot emissions market participants would become subject to the full panoply of financial regulations, such as conduct of business rules, client classification and regulatory capital requirements. In addition, the proposals would potentially create a new duty to disclose inside information for the largest emitters under the EU Emissions Trading System.
The EU Emissions Trading System
The EU Emissions Trading System (the "ETS") began on 1 January 2005 in order to implement EU policy to reduce the emission of greenhouse gases. Under the ETS, Member States are allocated national emission caps and then distribute EU allowances ("EUAs") to operators of installations falling within the scope of the ETS. An EUA is an allowance to emit one tonne of carbon dioxide equivalent, and operators of covered installations must surrender a sufficient number of EUAs each year to cover their emissions for the previous year. The intention of the scheme is to create financial incentives for polluters to reduce their emissions and, in doing so, to bring down greenhouse gas emissions in the EU and help combat global warming.
Other emissions units issued pursuant to the Kyoto Protocol, such as Certified Emission Reductions (or "CERs") and Emission Reduction Units (or "ERUs"), are also recognised for compliance under the ETS and are therefore widely held and traded in the EU. Any person, in addition to operators of covered installations, can buy or sell EUAs or Kyoto units, whether privately, over-the-counter (using a broker), by trading on spot markets or by entering into a commodity derivative that goes to delivery. The European carbon market has grown substantially, from €6 billion turnover in 2005 to €90 billion in 2010.1
In preparation for its third trading period which begins in 2013, the ETS is transitioning from the allocation of EUAs to installations by Member States to a centralised allocation by the European Commission. In addition, it is transitioning to a system where allocation will increasingly occur by auctioning rather than free distribution.2
Various further changes are being proposed to bring additional regulation to the trading of EUAs, CERs and ERUs in Europe, justified by the European Commission in its legislative proposals as a response to recent scandals affecting the ETS. The infrastructure of the ETS has recently been compromised by recent incidents of fraudulent activity. In January 2010, 250,000 EUAs worth €3 million were "phished" from an account held at the German registry. In November 2010, 1.6 million EUAs were "hacked" from an account held at the Romanian registry. Further hacking incidents reportedly followed from accounts in the Greek, Austrian and Czech registries. The value of stolen credits up to the end of January 2011 was estimated at up to €45 million. In connection with some of the later thefts, which were made from accounts in Member States whose property laws may protect victims rather than purchasers, uncertainty arose as to who "owns" EUAs that had previously been misappropriated. These issues contributed to a crisis in confidence in the European carbon market.
It is in this context that the European Commission recently proposed, among other measures, enhanced security measures for a new centralised European Union registry for emissions allowances, as well as clarifying that transactions involving emissions allowances will be deemed final and irrevocable absent clerical error.3 Proposals to update two pieces of financial regulation — MiFID and MAD — have now been made with a view to...