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The Kyoto Protocol & Beyond: A Legal Perspective Registries & Contracts in the EU ETS. Anthony Hobley General Counsel to the Fund Director Legal/Policy ahobley@c-c-capital.com +44 (0) 20 7290 9893. 10 th June 2006. Introduction to Climate Change Capital.

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the kyoto protocol beyond a legal perspective registries contracts in the eu ets

The Kyoto Protocol & Beyond: A Legal PerspectiveRegistries & Contracts in the EU ETS

Anthony Hobley

General Counsel to the Fund

Director Legal/Policy

ahobley@c-c-capital.com

+44 (0) 20 7290 9893

10thJune 2006

introduction to climate change capital
Introduction to Climate Change Capital
  • Climate Change Capital is a specialist merchant-banking group focused on companies and financial institutions affected by the policy and capital market responses to climate change.
    • Founded in 2003, 70+ professionals
    • UK headquartered, offices in Madrid, Paris and Washington, evolving relationships beyond
    • Focus onClean Power, Clean Fuels, Clean Technology and Carbon Finance
    • Policy expertise in climate change and energy security at its core
  • Three distinct but complementary groups:
    • Advisory – providing corporate finance, M&A, financial and policy advisory services
    • Asset Management – investing in companies that facilitate the transition to a low carbon economy: Ventus I (£15mn UK windpower fund), launching Ventus II and III and a €150mn pan-European clean energy/clean tech VC fund
    • Carbon Markets – investing in projects and companies that generate carbon emission credits under the flexible mechanisms of the Kyoto Protocol: 105M$ managed under C4F andlaunching C4F-2
market size recent statistics
Market Size: Recent Statistics
  • According to the US Council on Foreign Policy, the eventual size of the CO2 trading market is $2.5 trillion to $3 trillion.
  • Total traded volumes: 1,500 Mt (799 Mt in 2005, and 94 Mt in 2004) across EU ETS, CDM and JI
  • Volumes:
    • Total volumes in EU ETS: 874 Mt (362 Mt in 2004)
    • Total volumes CDM: 620 Mt (397 Mt)
    • Total volumes JI: 70 Mt (28 Mt)
  • Value:
    • Total value of market : €27.1 billion (€9.4 bn)
    • Total value of ETS: €22.7 billion at current prices (€7.2 bn)
    • Total value of CDM: €3.8 billion at an implied average price of €6.13 (€1.9 bn)
    • Total value of JI: €335 million (€96 m)
  • China had a market share of around 70% in CDM. India was distant second with around 11%.
  • HFC projects constituted 66% of volumes.  Coal Mine Methane was second with 7%.
  • Funds bought 43% of CERs/ERUs, corporate compliance buyers 42%, and governments 3%.

2 billion tonnes of CERs forecast up to 2012

Source: Point Carbon

slide4

Who will trade?

  • Compliance v trading
  • Banks, Funds and commodity traders
    • speculative
    • risk management
  • Operators of installations
    • compliance and price risk
  • Related opportunities : regulatory arbitrage, CDM/JI
  • First mover advantage
slide5

Registries Regulation

  • Each Member State shall establish a registry
  • Standardised Secure Electronic database (not a trading platform)
  • Accurate recording of issue, holding, transfer, acquisition, surrender, cancellation and replacement of allowances
  • Assessment of compliance – reconciliation between allowances and verified emissions
  • Any person may hold allowances
  • Consolidated system with Community independent transaction log (EU Registries to be integrated with Kyoto Registries – therefore only one national GHG Registry for each member state)
  • Functional and technical specifications
registries regulation
Registries Regulation
  • Not necessary to have an account in a country in order to trade with it
  • EU ETS Directive and Registries Regulation guarantee right to make transfers which comply with the requirements of the EU ETS both inter and intra National Registries
slide7

Proposed Numbering of EU Allowances

Party of origin

(ISO 3166 standard)

Unit type

1=AAU, 3=ERU, 5=CER

Force Majeure

JI or CDM project identifier

Unique consecutive #. For non JI or CDM=0000

FR - 00 – 0 - 00 - 0000 - 000000000001 - 000000001000 - 00 - 097

End block

Issuance commitment period

Pre-Kyoto # are 00, period from 2008-2012 will be 01, etc.

LULUCF activity

This field is relevant to RMUs, for all other instruments = 00

Unique number

12 consecutive number

enables identification of instruments by block (Start)

EU tag

(ISO 31661 standard)

Shows that an AAU/ERU/CER has been converted into an EU allowance

slide8

Registries vs. transaction logs

  • Registries are places where carbon assets sit. These are:
    • CDM Registry: where CERs are born
    • National Registries
  • Transaction logs are checking and clearing mechanisms. These are:
    • International Transaction Log (ITL)
    • Community Independent Transaction Log (CITL)
slide9

National Registries (Annex B only)

  • Legal basis: Marrakesh Accords, EU ETS Directive and Registries Regulation
  • Function: Ensure accurate accounting of the issuance, holding, transfer, acquisition, cancellation, retirement, and banking of EUAs/ERUs/CERs/AAUs/RMUs
  • Run by: Designated registry administrator (e.g. for UK, the Environment Agency)
slide10

CDM Registry

  • Function: issues and transfers CERs in accordance with MOP decisions and CDM EB decisions
  • Run by: the CDM EB
  • Status:
    • Built and ready to go operational subject to agreed administrative protocols to be established by the CDM EB
moving carbon pre itl
Moving carbon: pre-ITL

CDM Registry

EU

Annex I

Pending account

Italian National Registry

UK National Registry

CCC interim account

EU Community Independent Transaction Log (CITL)

CCC UK account

Russian National Registry

Polish National Registry

German National Registry

Greek National Registry

French National Registry

Spanish National Registry

Czech National Registry

Cyprus National Registry

CER

EUA

slide12

Registries snapshot Post ITL

CDM Registry

EU

Annex I

Pending account

Italian National Registry

UK National Registry

EU Community Independent Transaction Log (CITL)

UN International Transaction Log (ITL)

CCC UK account

Russian National Registry

Polish National Registry

German National Registry

Greek National Registry

JI SC

French National Registry

Spanish National Registry

Czech National Registry

Cyprus National Registry

CER

ERU

EUA

slide13

Moving EUAs from our account

  • Just like internet banking
    • Log on to national registry account with username/password
    • Fill out transfer order specifying quantity of EUAs to send, and the receiving national registry and account. Click OK.
    • CITL makes checks through 7 message sequence and the transfer is made
  • But, starting in 2008 (ITL operational), transfer order goes through ITL first for Kyoto checks and then CITL for EU ETS specific checks. When the transfer goes through, the sending/receiving country’s AAU balances change.
    • ITL sees only AAUs; CITL sees only EUAs
    • CITL can stop the transaction if it violates Commitment Period Reserve Rules
  • Can’t move an EUA out of the EU registry system unless mutual recognition agreement with e.g. Japan or Canada
    • In other words, can’t sell EUAs to Japanese gov’t as AAUs
legal title delivery
Legal Title & Delivery
  • Depends on what is being transferred e.g. include provisional CER?
  • May need to define nature of title & associated rights
  • Mechanism for delivery exists (eg. a Registry);
  • Quantity – Minimum or Maximum?
  • Point at which legal title passes must be specified:
    • delivery of annual verification report; or
    • delivery into buyer’s account; or
    • upon payment.
  • Buyers Account – Specified National Registry
  • Sale should be unencumbered
slide15

Annual Trading Cycle

Year 2

Year 1

1 calendar year

Jan

Dec

28 Feb

New Allowances for Year 2

31 March

Input verified emissions – if not, account of operator frozen

30 April

Surrender Allowances

  • May “borrow” forward across years, not phases
  • No vintage but EUAs have a phase
phase i leading into phase ii
Phase I leading into Phase II

Phase II

Phase I

2009

2005

1 January

2008

1 January

28 February

Issue

Phase II

EUAs

30 April

(end of Phase I)

Surrender Phase I EUAs

  • May “borrow” forward across years, not phases
  • No vintage but EUAs have a phase
  • CERs can be carried over into Phase II
slide17

Emissions Trading (ET) Contracts

  • Development of standard form trading contracts:
    • IETA (International Emissions Trading Association)
    • ISDA (International Swaps and Derivatives Association)
    • EFET (European Federation of Energy Traders)
  • Allocation of Risk
    • Credit Risk
    • Delivery Risk
  • Sale and Purchase of Allowances/Sale and Purchase of CERs/ERUs
  • Purchase of generic emissions reductions so called VERs?
slide18

EUA Contracts

Developing A European Standard Document

PROMOTING MARKET LIQUIDITY

PROMOTE CERTAINTY OF TRADING TERMS

REDUCE TRANSACTION COST AND TIME

slide19

Issues for Contracts

  • The holding account of an operator shall be blocked if an installation’s annual verified emissions for the previous year have not been entered by 31 March
  • Holdings in accounts, price information and trades are confidential
  • If there are discrepancies in processes (e.g. transfers), the registry administrator shall terminate the processes
  • EU ETS Directive and Registries Regulation guarantee right to make transfers which comply with the rules of the scheme
slide20

IETA/EFET/ISDA Contract Comparison

  • Excess Emissions Penalty provisions
  • Differences in basic mechanics e.g. payment and delivery dates
  • Differences in the force majeure / settlement disruption/ failure to deliver provisions and consequences e.g. compensation payable
  • Differences in the calculation of any termination payments
  • Differences in termination proceedings e.g. some or all Transactions?
  • Payment netting and close-out netting enforceability
  • Effect of changes to scheme
case study summary
CASE STUDY - SUMMARY

1992 ISDA

½ million EUAs

EFET

1million EUAs

POWER

GENERATOR

BANK A

BANK B

France

Germany

Luxembourg

IETA

½ million EUAs

2002 ISDA

½ million EUAs

OIL & GAS

Co

UK

slide22

CER issuance process diagram

CCC

Project

CCC UK account

contract

info

UK National Registry

Verifier

verification report

CDM EB

CDM Registry

Pending account

CITL

CCC interim account (pre-ITL)

ITL

Pending CERs

CERs

slide23

Licensing/Regulatory

Political Risk

appraisal(PDD)

registration(CDM Exec Bd)

regulatory

change

regulatory

change

tax

change

tax

change

certification

verification

host country

approval

host country

approval

monitoring

Financial

crediting

period

currency

Technology

Cost/Delay

price

ERPACounterparty

compliance

cost

completion

delay

CDM Project Risks (some…)

performance

credit

the kyoto protocol beyond a legal perspective registries contracts in the eu ets 10th june 2006

Anthony Hobley

General Counsel to the Fund

Director Legal Policy

Climate Change Capital Limited

ahobley@c-c-capital.com

+44 (0) 20 7290 9893

The Kyoto Protocol & Beyond: A Legal PerspectiveRegistries & Contracts in the EU ETS10th June 2006