In December 2008, the Federal Government released its White Paper on the proposed Australian greenhouse gas emissions trading scheme, named the Carbon Pollution Reduction Scheme (CPRS). On 10 March 2009, the Federal Government released an exposure draft of the CPRS legislation as well as detailed commentary to the primary Bill. The proposed legislation comprises:
- Carbon Pollution Reduction Scheme Bill 2009 (Draft CPRS Bill), which is the primary piece of legislation
- Carbon Pollution Reduction Scheme (Consequential Amendments) Bill 2009
- Climate Change Regulatory Authority Bill 2009
- Carbon Pollution Reduction Scheme (Charges – General) Bill 2009
- Carbon Pollution Reduction Scheme (Charges – Excise) Bill 2009, and
- Carbon Pollution Reduction Scheme (Charges – Customs) Bill 2009.
The Draft CPRS Bill and accompanying legislation provides for a ‘cap and trade’ emissions trading system, under which entities emitting greenhouse gases must acquire and surrender permits known as ‘emissions units’. The scheme is to be administered by a new body known as the Australian Climate Change Regulatory Authority (Authority).
Emissions units
The Draft CPRS Bill establishes two types of ‘eligible emissions units’ which can be used and surrendered. These are, ‘Australian emissions units’ (AEUs) and ‘eligible international emissions units’1 (EIEUs), such as certain ‘Kyoto Units’2 created under the Kyoto Protocol.
AEUs will be issued by the Authority up to the limit of the scheme cap for any particular year, as a result of auctions and as assistance in relation to emissions-intensive trade-exposed activities or coal-fired electricity generation. Additional AEUs may be issued by the Authority for a fixed charge over five years, which are aimed at acting as a transitional price cap on compliance costs.
AEUs will have a vintage year and may be used for surrender with respect to that year or later years (‘banking’). AEUs will be personal property which is able to be bought and sold on the carbon market, and will not have a ‘use-by date’. Options and derivatives over AEUs and Kyoto Units may be created and security will be able to be taken over them.
A National Registry (Registry) will be established to track the issue, transfer and surrender of AEUs. Kyoto Units will also be able to be held and transferred via the Registry, regardless of whether or not they can be surrendered in Australia. To do so, a person must have an account with the Registry, which will record ownership of the relevant units.
The government will not legislate to establish Australia’s carbon market, preferring to let the market evolve from the private sector. At this stage, a number of parties have signalled their intention to develop futures and exchange-based spot markets, including the ASX.
Regulating emissions units
Under the CPRS, AEUs and EIEUs will be treated as financial products for the purposes of Chapter 7 of the Corporations Act 2001 (Cth) (Corporations Act). This will be achieved by expanding the definition of ‘financial product’ in section 764A(1)(k) of the Corporations Act to include AEUs and EIEUs. They will not, however, be financial products for the purposes of section 12BAB(1) of the ASIC Act 2001 (Cth) (ASIC Act), which provides that a person provides a financial service if they provide a service otherwise supplied in relation to financial products.
The effect of this is that entities that provide advice, deal or make a market in relation to AEUs and EIEUs may need to hold an Australian financial services licence (AFSL). An AFSL is required where a ‘financial service’ is provided that satisfies the business test, unless an exemption in section 911A(2) of the Corporations Act applies.
Financial services
A financial service includes (amongst other things):
- the provision of financial product advice, and
- dealing in a financial product. Dealing on your own behalf however, unless you are a product issuer dealing in your own products, is exempt from the definition of dealing under section 766C(3) of the Corporations Act.
The business test
Satisfaction of the business test requires that a person provides financial services with system, repetition and continuity. One-off transactions are unlikely to satisfy this criterion.
Exemptions under section 911A(2)
A complete description of exemptions from the requirement to hold an AFSL is found in section 911A(2) of the Corporations Act and regulations made for the purposes of that provision. Some examples include:
- The provision of financial services as a representative of a licensee or a person exempt from holding an AFSL (section 911A(2)(a) of the Corporations Act).
- Certain circumstances where an entity is located and provides a financial service outside Australia. For example, where services are provided to an Australian resident or citizen and no conduct that is likely to induce people in Australia to use the service is engaged in (regulation 7.6.02AG, which inserts section 911A(2A) into the Corporations Act).
- The provision of financial services by a nominee company that is a wholly owned subsidiary of a licensed market participant and holds the AEU or EIEU on trust for a client of the licensed participant in the circumstances described in regulation 7.6.01(1)(v).
If an AFSL is required by an entity they will be regulated by ASIC in accordance with Chapter 7 of the Corporations Act. The ASIC Act will also be amended to enable ASIC to disclose information that it possesses about wrongdoing in connection with trading of emissions units to the Authority.
Entities that are already active in derivatives markets and who want to deal in derivatives over AEUs and Kyoto Units will generally already possess an AFSL authorising them to trade in derivatives. This is because derivates come under the definition of ‘financial product’ in the Corporations Act. Entities that wish to trade in physical ‘underlying’ AEUs will need to be specifically licensed to do so, unless an exemption applies. Accordingly, entities that already hold an AFSL may need to modify their licence to allow for this. Entities without an AFSL will need to apply for one (again, unless an exemption applies).
The government has said that it will consult the relevant industries on the appropriate adjustments that need to be made to Chapter 7 in order to fit the characteristics of emissions units and avoid unnecessary compliance costs. Certain adjustments, for example the requirement to issue disclosure documents for the issue of financial products, are clearly required. Accordingly, close attention should be paid to developments in this area, particularly in relation to when exemptions will be applied so that AFSLs may not be required for certain trading activities. AFSL applications and modifications can take considerable time, so early action is important.
Pros and cons of the government’s approach
The government’s stated aim is to develop and promote market confidence in a carbon market. It believes that bringing AEUs under Chapter 7 of the Corporations Act will provide a strong regulatory regime to reduce the risk of market manipulation and misconduct. The Corporations Act provides a well-understood framework which can be used to regulate dealing in emissions units.
However regulation under Chapter 7 of the Corporations Act brings with it a raft of obligations, for example in relation to disclosure, compliance and conduct. There are also considerable upfront and ongoing costs associated with obtaining and maintaining an AFSL. As a result, the number of market participants may be reduced, leading to a loss of market depth and liquidity. Such a result would diminish the effectiveness of the CPRS.
Some submissions made on this point (in response to the government’s Green Paper) have suggested adopting less onerous rules similar to those that apply to the over the counter markets. While this may not be likely, the Chapter 7 regime will need to be significantly varied if the government is to achieve a balance between strong regulation and an open, flexible and accessible market for AEUs and Kyoto Units and derivatives over them.
What next?
Despite the Draft CPRS Bill largely reflecting the White Paper, recent political discussions surrounding the CPRS indicate that the government will need to negotiate on the CPRS to have it passed through the Senate, and therefore it may need to concede on various matters.
Climate change issues are diverse and complex and span the range of commercial legal issues. Our Climate Change team is uniquely placed to supply the breadth and depth of the legal services required by this evolving area of policy and law.
Our team is fully informed by overseas and local developments. It offers legal services that are alert to the commercial ramifications of these developments and that are coordinated across all the relevant areas of law including: environmental, banking and finance, corporate, infrastructure development and intellectual property. Our team’s legal services cover the full range of compliance, contractual and market-related issues.
This article was written by Michael Ziegelaar, Partner, Renee Garner, Solicitor and Nick Golding, Solicitor, Melbourne.
Endnotes
1. Defined in the Draft CPRS Bill as: (a) a certified emission reduction (CER) (other than a temporary or long-term CER), (b) an emission reduction unit, (c) a removal unit, (d) a prescribed unit issued in accordance with the Kyoto rules (regardless of whether the unit has been issued within or outside Australia), or (e) a non-Kyoto international emissions unit.
2. Kyoto Units exist in many different forms. They are defined in the Draft CPRS Bill as: (a) an assigned amount unit, (b) a CER (which may also come in temporary and long-term variations), (c) an emission reduction unit, (d) a removal unit, or (e) a prescribed unit issued in accordance with the Kyoto rules. As you will see, not all Kyoto units are EIEUs. For example, an assigned amount unit is not an eligible emissions unit and therefore cannot be surrendered by an entity to meet its obligations under the scheme.
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