The Kyoto Protocol

1
The Kyoto Protocol Beyond A Legal
PerspectiveRegistries Contracts in the EU ETS
Anthony Hobley General Counsel to the
Fund Director Legal/Policy ahobley_at_c-c-capital.com
44 (0) 20 7290 9893

• 10thJune 2006

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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 on Clean 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, MA,
  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 and launching
  C4F-2

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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
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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

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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

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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

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Proposed Numbering of EU Allowances
Party of origin (ISO 3166 standard)
Unit type 1AAU, 3ERU, 5CER
JI or CDM project identifier Unique consecutive
. For non JI or CDM0000
Force Majeure
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
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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)

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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)

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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

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Moving carbon pre-ITL
CDM Registry
EU
Annex I
Pending account
UK National Registry
Italian National Registry
CCC interim account
EU Community Independent Transaction Log (CITL)
CCC UK account
Russian National Registry
German National Registry
Polish National Registry
Greek National Registry
French National Registry
Spanish National Registry
Czech National Registry
Cyprus National Registry
CER
EUA
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Registries snapshot Post ITL
CDM Registry
EU
Annex I
Pending account
UK National Registry
Italian National Registry
EU Community Independent Transaction Log (CITL)
UN International Transaction Log (ITL)
CCC UK account
Russian National Registry
German National Registry
Polish National Registry
Greek National Registry
?
JI SC
French National Registry
Spanish National Registry
Czech National Registry
Cyprus National Registry
CER
ERU
EUA
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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
  countrys AAU balances change.
• ITL sees only AAUs CITL sees only EUAs
• CITL can stop the transaction if it violates
  Commitment Period Reserve Rules
• Cant move an EUA out of the EU registry system
  unless mutual recognition agreement with e.g.
  Japan or Canada
• In other words, cant sell EUAs to Japanese govt
  as AAUs

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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 buyers account or
• upon payment.
• Buyers Account Specified National Registry
• Sale should be unencumbered

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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

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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

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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?

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EUA Contracts Developing A European Standard
Document
PROMOTING MARKET LIQUIDITY
PROMOTE CERTAINTY OF TRADING TERMS
REDUCE TRANSACTION COST AND TIME
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Issues for Contracts

• The holding account of an operator shall be
  blocked if an installations 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

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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

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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
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CER issuance process diagram
Project
CCC
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
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CDM Project Risks (some)
performance
credit
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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_at_c-c-capital.com
• 44 (0) 20 7290 9893