Trading EU Emissions Allowances Could Create Compliance Risks
While shippers have focused on the practical implications of the recently approved extension of the EU’s Emissions Trading System to cover some vessels operating in the waters of the bloc’s member states from April 2024, ETS experts at legal practice Reed Smith explain that shipping companies considering bidding for, trading in or providing services relating to EU emissions allowances runs the risk of falling within the scope of regulations governing financial instruments under EU/EEA and UK laws.
Brett Hillis, a partner at Reed Smith who has specialised in financial regulatory advice, energy, carbon and commodities trading and derivatives, outlines some of the issues that shipping companies should be aware of. Hillis cautions that ship owners and managers who seek to pass on some of or all of the costs of surrendering EUAs to charterers, or who trade in EUAs to turn a profit, may fall within the scope of the EU’s financial regulations. Specialist advice may be needed to ascertain a company’s regulatory position under EU MiFID 2.
ETS
A list of the key investment activities and services covered by EU MiFID 2 is provided in Section A of Annex 1 of the EU MiFID 2 regulation but includes the receipt and transmission of orders, as well as dealing on your own account, and portfolio management.
There are a number of exemptions for market participants, including an exemption for operators with compliance obligations under the EU ETS who when dealing in EUAs do not execute client orders, provide investment services or perform investment activities other than dealing on own account. Hillis notes that this does not provide a solution to entities looking to provide services relating to EUAs or to those active in derivatives relating to EUAs. (This would include those using derivatives contracts to pass on the costs of compliance to charterers).
Hillis notes that there are additional exemptions for the provision of services exclusively for companies within a larger group, and an ancillary activities exemption. Shipping companies that wish to trade in emissions may need to consider other exemptions and in particular the ancillary activities and groups exemptions.
MiFID 2 and ETS
EU MiFID 2 is a cornerstone of EU/EEA financial regulation, and stipulates that the provision of investment services and/or the performance of investment activities as a regular occupation or business be subject to prior authorisation. Unless they can rely on an exemption under EU MiFID 2, a person acting from the EEA will need authorisation if they carry on an investment service or activity in relation to a “financial instrument” as a regular occupation or business.
Under EU MiFID 2, EUAs in and of themselves are “financial instruments.” Therefore, the spot sale or purchase of an EUA is a trade in a financial instrument. In addition, options, futures, swaps and other derivatives relating to EUAs, whether they may be settled physically or in cash, are also “financial instruments.” While both EUAs themselves and related derivatives are “financial instruments”, whether a particular transaction constitutes a “derivative” may have important regulatory consequences.
For example, if a transaction relating to EUAs is a derivative then it will fall within the scope of the European Market Infrastructure Regulation (EMIR) and its UK equivalent. EMIR sets obligations relating to the reporting of derivatives contracts as well as obligations relating to the risk mitigation and (where certain conditions are met) clearing or margining of OTC derivatives.
Related Articles
METHANOL
MONITORING, CONTROL & DIGITALISATION
MONITORING, CONTROL & DIGITALISATION