ASIC Guide – Do you need an Australian Financial Services Licence to participate in carbon markets? - Financial Services

Do you need an AFSL

An Australian Financial Services Licence (AFSL) is required if a person carries on a financial services business in Australia unless an exemption applies. The following table sets out some activities which constitute financial services in the context of the Australian carbon market and indicates whether or not an AFSL (or an AFSL variation) is required. The terms in the table are described in the article below.

Description of activity	Corporations Act activity	AFSL required
Buying units on your own behalf, including: buying carbon units from the Regulator for a fixed price buying Australian carbon credit units (ACCUs) from a person accredited under the Carbon Farming Initiative for a fixed price buying eligible international emission units (EIEUs) from a bank or intermediary for a fixed price buying carbon units in the auction buying carbon units, ACCUs or EIEUs (regulated emissions units) from a bank or intermediary for delivery at a future date with no cash settlement	Exemption from dealing s766C(3)	x
Selling units on your own behalf	Exemption from dealing s766C(3)	x
Buying carbon units (only, as opposed to ACCUs and EIEUs) for a related body corporate or associated entity that is a liable entity	Exemption from dealing Sch1, item 4 of draft Regulation	x
Buying regulated emissions units for a related body corporate or associated entity that is a liable entity for compliance purposes by that entity and you are not also making a market in derivatives	Exemption from dealing in a derivative Sch1, item 8 Reg 7.6.01(1)(ma) of draft Regulation	x
Buying regulated emissions units for a related body corporate or associated entity that is a liable entity for non-compliance purposes by that entity	Dealing	✓
Buying units on behalf of an entity which is not a related body corporate or associated entity	Dealing	✓
Selling units on behalf of another entity (including a related body corporate or associated entity)	Dealing	✓
Derivative trading – Buying regulated emissions units on your own behalf for compliance purposes from a bank or intermediary or an off shore source for delivery at a future date with a cash settlement alternative referable to the market price of the units and where you are not also making a market in derivatives	Exemption from dealing in a derivative Sch1, item 8 Reg 7.6.01(1)(ma) of draft Regulation	x
Derivative trading – Buying regulated emissions units on your own behalf for non-compliance purposes from a bank or intermediary or an off shore source for delivery at a future date with a cash settlement alternative referable to the market price of the units	Dealing	✓
Derivative trading – Buying regulated emissions units for compliance purposes for a related body corporate or associated entity that is a liable entity under a forward contract for delivery at a future date with a cash settlement alternative referable to the market price of the units and where you are not also making a market in derivatives	Exemption from dealing in a derivative Sch1, item 8 Reg 7.6.01(1)(ma) of draft Regulation	x
Derivative trading – Buying regulated emissions units for non-compliance purposes for a related body corporate or associated entity that is a liable entity, under a forward contract for delivery at a future date with a cash settlement alternative referable to the market price of the units	Dealing	✓
Derivative trading – Buying on behalf of an entity which is not a related body corporate or associated entity	Dealing	✓
Derivative trading – Selling offset project units via a derivative contract on your own behalf or on behalf of another entity (including a related body corporate or associated entity)	Dealing	✓
Arranging for an entity to engage in the conduct referred to above as an intermediary or broker rather than an agent	Dealing	✓
Regularly stating prices at which you will buy or sell regulated emissions units so that other persons can reasonably expect to trade with you at those stated prices	Making a market	✓
Providing an opinion or recommendation about regulated emissions units which may be reasonably regarded as being intended to influence someone to buy or sell regulated emissions units	Advising	✓
Operating a managed investment scheme where pooled funds are used to buy regulated emissions units¹	Managed investment scheme	✓
Holding regulated emissions units or beneficial interests in those units on trust for a third party²	Custodial or depository service unless less than 20 clients exempt under Reg 7.1.40(c)	✓

Need for a financial services licence

An AFSL is required if a person carries on a financial services business in Australia unless an exemption applies³. A financial services business is defined as "a business of providing financial services". Financial services include "dealing", "making a market" and "advising" in relation to "financial products". ASIC has stated that the test for "carrying on a financial services business" is satisfied if a person has a place of business in Australia and the financial services are undertaken with "system, regularity and continuity" and are more than a very minor part of a person's business. ASIC also states that a one off transaction, if substantial, could also amount to "carrying on a financial services business". Given that the lowest threshold for a liable entity under the Clean Energy Act 2011 (Cth) is 25,000 tonnes of attributable greenhouse gas emissions, which equates to a cost of A$575,000 in the first year of the scheme, we expect that all liable entities will fall within the test of "carrying on a financial services business".

Financial products

Regulated emissions units are financial products under the Corporations Act (2001 (Cth)⁴. An exposure draft Corporations Amendment Regulation 2012 (Regulation) was released on 17 February 2012 proposing a transitional period for inclusion of regulated emissions units as financial products. The transitional period will expire on 1 July 2012 on which date you will need an AFSL before providing a financial service in relation to regulated emissions units unless an exemption applies.

Dealing

As indicated in the examples above dealing includes buying and selling regulated emissions units and derivatives⁵ referrable to such units.

Dealing exemption – Dealing in regulated emissions units is a financial service unless the exemption in section 766C(3) (or another exemption set out below) applies which provides that a person is not taken to be dealing if the person is dealing on their own behalf and is not an issuer of the financial product⁶. The issuer of regulated emissions units is the Regulator of the scheme establishing the creation of those units. Dealing in derivatives referrable to such units is not exempt under section 766C(3) because while a party might be entering the derivative on its own behalf it is taken to have issued the derivative under section 761E(5).

Proposed extension to dealing exemption – The Regulation⁷ proposes an extension to section 766C which provides that a person is not taken to be dealing if the financial product is a carbon unit and the dealing is on behalf of a related body corporate or associated entity that is a liable entity under the Clean Energy Act. This exemption only applies to carbon units and not to eligible international units or Australian carbon credit units.

Proposed compliance exemption – The Regulation⁸ proposes an additional exemption to be set out as 7.6.01(1)(ma). This states that an AFSL is not required to deal if the person only deals in one or more of the following; regulated emissions units, derivatives over regulated emissions units or foreign exchange contracts, where all of the following are satisfied:

the person is dealing on their own behalf or on behalf of a related body corporate or associated entity
the dealing is to manage a financial risk in relation to the surrender, cancellation or relinquishment of regulated emissions units by the person or on behalf of a related body corporate or associated entity
the person is not also making a market for, derivatives referrable to regulated emissions units or foreign exchange contracts
the dealing is not the principal purpose of the person's business.

The change of emphasis from the dealing being a "significant" part of the person's business⁹ to it being the "principal purpose" will assist many liable entities fall within the exemption. However, ASIC points out that an entity who holds excess units to their immediate requirements may not fall within the exemption on the basis that such an entity may not satisfy the test that the dealing is required to "manage a financial risk in relation to the surrender, cancellation or relinquishment". In addition anyone selling regulated emissions units via a derivative or making a market in derivatives will fall outside the exemption.

Making a market

A person makes a market if the person regularly states prices at which they will buy or sell regulated emissions units so that other persons can reasonably expect to trade at those stated prices.

There are no exemptions from this category of financial service which means that all liable entities who intend to operate a trading desk to buy (or buy and sell) regulated emissions units are likely to require a AFSL covering this activity.

Advising

Advising includes providing an opinion or recommendation about regulated emissions units which may be reasonably regarded as being intended to influence someone to buy or sell those units. The statements are considered in the overall context in which they are made. Pricing predictions given to potential buyers of regulated emissions units or to offset project proponents under the Carbon Farming Initiative would be likely to fall within "advising".

There are no relevant exemptions from this category of financial service which means that all liable entities who intend to advise in relation to regulated emissions units are likely to require a AFSL covering this activity.

Wholesale or retail clients

If an AFSL is required, the obligations on a licensee are significantly more onerous if the licensee wishes to deal with retail clients rather than be limited to only dealing with wholesale clients. A wholesale client is an entity purchasing a financial product whose value exceeds A$500,000, a person with net assets of at least A$2.5 million and professional investors including AFSL licensees, listed entities and banks.

AFSL process and consequences

If you need an AFSL (or a variation of your existing AFSL) you will need to apply to ASIC and the Guide sets out the tools available to assist an applicant obtain a licence. We have assisted many clients in the energy industry obtain licences and our experience is that the process takes upwards of six months, requires significant management and administrative time and the introduction of a risk and compliance regime from board level downwards. You will need to appoint qualified personnel as "responsible managers" to manage the financial services business.

ASIC has issued a Consultation Paper 175 Carbon Markets which sets out proposed training requirements for responsible managers and financial requirements for licensees. Comments are due by 10 April 2012. The training requirements propose to classify regulated emissions units as Tier 1 products which means that specific training will be required from licensees who wish to be licensed as "advisers". An 18 month transition for training is proposed.

The Consultation Paper also proposes that licensees must meet base level financial requirements which requires the licensee to remain solvent at all times, meet cash requirements in Regulator Guide 166.23 – 166.41 and meet audit requirements. Licensees who are licensed to make a market will also need to meet adjusted surplus liquid fund requirements which require the licensee to hold assets of a specified level and not to enter transactions without board approval if its assets fall below those levels.

The obligation to hold an AFSL starts 1 July 2012 and ASIC has stated that it will accept applications before that date.

Footnotes

¹ Consideration of managed investment funds is beyond the scope of this article.
²Consideration of custodial and depository services is beyond the scope of this article.
³Section 911A(1).
⁴Section 764A(ka) and (kb).
⁵ Section 761D Corporations Act 2001 (Cth) a derivative is a forward contract for sale of a commodity with cash settlement alternative referrable to a market price.
⁶ Section 766C(3)
⁷ Item 4 in Schedule 1 of the Regulations.
⁸ Item 8 in Schedule 1 of the Regulations
⁹ This is the requirement in Regulation 7.6.01(1)(m) currently applying to derivatives and foreign exchange contracts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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