Australia: Will I need an AFS Licence to deal in regulated carbon emissions units?


As readers may be aware from previous Norton Rose Australia alerts, it was proposed that "Australian carbon credit units" and "eligible international emissions units" and "carbon units" (Regulated Emission Units) be regulated as "financial products" under the Corporations Act 2001 (Cth) (Corporations Act). This was in line with the government's aim to "provide a strong regulatory regime to reduce the risk of market manipulation and misconduct" in relation to such carbon products.

The proposed characterisation of Regulated Emissions Units as "financial products" will apply from 1 July 2012 and will mean that entities that are involved in transactions involving these products need to assess whether such transactions trigger the need for an Australian financial services licence (AFS Licence).

Regulations passed recently (New Regulations) operate to make "appropriate amendments to the regime to fit the characteristics of units and avoid unnecessary compliance costs". The New Regulations also provide for a transition facility enabling entities to provide financial services in relation to Regulated Emissions Units until 31 December 2012 without having to hold an AFS licence during that period provided they meet certain conditions including registering with ASIC before 1 July 2012 (see the last section of this article).

This alert provides an outline of some of the key changes proposed under the New Regulations (although several of these changes were already contained in the previous drafts of the legislation) and briefly examines the need for an AFS licence in relation to dealings in Regulated Emissions Units.

Activities requiring a licence

Generally, a firm that undertakes any of the following activities (among others) in relation to financial products may be regarded as carrying on a financial services business and potentially require an AFS Licence:

  • Providing financial product advice
  • Dealing in a financial product
  • Providing a custodial or depository service
  • Making a market
  • Operating a registered managed investment scheme

Financial product advice?

As Regulated Emissions Units will be regarded as financial products, a firm that provides "financial product advice" in relation to Regulated Emissions Units will require an AFS Licence. The concept of "financial product advice" is broadly defined and would encompass a recommendation or statement of opinion that is intended to influence a person in acquiring, disposing of, or otherwise dealing in a Regulated Emissions Unit, or that could reasonably be regarded as being intended to have such an influence. This could, for example, regulate certain marketing material issued by certain traders or intermediaries involved in Regulated Emissions Unit trading.

However communications about a Regulated Emissions Unit which consists only of factual information or advice of a technical nature about carbon offset projects (as opposed to emissions units emanating from the project) will generally not be regarded as financial product advice (although firms would need to ensure the information is not presented in a manner that may reasonably be regarded as suggesting or implying a recommendation relating to a Regulated Emissions Unit).

Dealing in a financial product?

"Arranging" for a person to acquire or dispose of Regulated Emissions Units could constitute "dealing" and may require an AFS Licence.

Also, an entity that acquires or disposes of Regulated Emissions Units may also need to hold an AFS Licence. An exemption would be available however if the entity deals in Regulated Emissions Units "on their own behalf" (whether directly or through an agent).

The New Regulations propose to supplement the "on own behalf" exemption by introducing an exemption in respect of dealings in Regulated Emissions Units entered into on an entity's own behalf or on behalf of a related body corporate or associate in circumstances where the dealing is for the purpose of managing financial risk in relation to the surrender, cancellation or relinquishment of Regulated Emissions Units provided the entity does not deal in Regulated Emissions Units as the principal purpose of the entity's business (Hedging Exemption). The Hedging Exemption would not apply if the entity is also involved in the making of a market in Regulated Emissions Units.

There is also a dealing exemption available where the relevant service is dealing in Regulated Emissions Units on behalf of a related body corporate or an associated entity that is a liable entity entered in the information database under the Clean Energy Act 2011.

The above exemptions should enable many firms looking to deal in Regulated Emissions Units for compliance purposes to do so without needing an AFS Licence, however advice should be obtained on whether particular activities will be caught.

Making a market?

An entity that "makes a market" in Regulated Emissions Units may also be regulated and require an AFS Licence. An entity would make a market if they regularly state the price at which they propose to acquire or dispose of Regulated Emissions Units and other persons have a reasonable expectation that they will be able to regularly effect transactions at the stated prices. The New Regulations provide an exemption for an entity who holds a free carbon unit (within the meaning of the Clean Energy Act 2011) that has been issued to the entity by the Clean Energy Regulator.

Custodial service?

An entity will require an AFS Licence in order to provide a custodial or depository service in respect of Regulated Emissions Units. This would arise if the entity holds Regulated Emissions Units on trust for or on behalf of another person. There are limited scenarios that could fall within one of the carve outs provided by the Corporations Act as not constituting the provision of a custodial or depository service, including:

  • provision of such services to a related body corporate or associate of the provider; or
  • the provider and its associates have no more than 20 clients in aggregate for all such services they provide.

A custodial exemption is also available in the case of Australian carbon credits units issued to:

  • a special native title account in accordance with section 49 of the Carbon Credits (Carbon Farming Initiative) Act 2011; or
  • a nominee account in accordance with section 141 of that Act.

Operating a registered managed investment scheme?

Examples of arrangements in the carbon markets that may constitute managed investment schemes include:

  • schemes that pool investor money to trade Regulated Emissions Units for the purposes of providing returns to investors that may be in the form of money or in kind; and
  • schemes that pool Regulated Emissions Units contributed by investors for the purpose of providing returns to investors from the eventual sale of the Regulated Emissions Units.

Certain managed investment schemes will also need to be registered with ASIC.

Exemption for foreign entities dealing with Australian persons

Overseas based firms looking to deal in Regulated Emissions Units with Australian clients need to also consider whether their activities require an AFS Licence. The New Regulations extend an existing exemption from the AFS licence requirement in the Corporations Act which is generally available to an entity that is not in Australia and that provides certain financial services to a "professional investor" in Australia. The financial services (which only cover dealing in, providing advice or making a market) cover derivatives and foreign exchange contracts. Under the New Regulations, this exemption now extends to Regulated Emissions Units. The exemption would also apply to dealings in derivatives over Regulated Emissions Units.

Other implications

Characterisation as a financial product will have other implications that need to be considered by firms that deal in Regulated Emissions Units. We have not sought to address these in any detail, however briefly, these include:

  • the anti-hawking provisions, which restrict unsolicited calls or meetings with "retail clients" in relation to dealings in Regulated Emissions Units;
  • rules governing the handling of client monies ahead of the transfer of Regulated Emissions Units;
  • rules aimed at preventing market misconduct, including insider trading and misleading or deceptive statements;
  • compliance with anti money laundering requirements; and
  • disclosure requirements eg in respect of advertising, in particular, if distributed to "retail clients".

Also, firms that provide financial product advice to "retail clients" will be subject to various disclosure and other compliance obligations of the kind that apply to financial planners. The New Regulations however seek to modify the disclosure obligations to replace the need for a product disclosure statement (issued in respect of typical managed funds) with a more tailored disclosure statement.

Effective date

The New Regulations effectively operate to regulate Regulated Emissions Units as financial products from 1 July 2012. Firms wishing to provide financial services in relation to Regulated Emissions Units from 1 July 2012 can apply beforehand to ASIC for an appropriate AFS licence or rely on the transition facility made available by ASIC (see below).

Transition facility - registration process

In order to give firms time to gear up for the new regime, ASIC has established an early registration system under the Corporations Regulations as an interim measure for carbon market participants before they obtain an AFS licence or have their existing AFS licence varied.

Entities registered with ASIC can effectively provide financial services in relation to Regulated Emissions Units without holding an appropriate AFS licence during the period from 1 July 2012 to 31 October 2012. Entities that have registered with ASIC before 1 July 2012 must then apply for a new AFS licence or licence variation by 31 October 2012 if they wish to continue to provide those financial services.

Registration applications must be in the approved form and, among other things, must specify the types of financial services the applicant intends to provide in relation to Regulated Emissions Units. Registration applications close on 30 June 2012. An entity that relies on registration to provide financial services from 1 July 2012 is still required to comply with various financial services laws that would otherwise apply if it held an AFS licence.

ASIC has indicated that all registrations will be cancelled by 31 December 2012 and accordingly after this date (ie from 1 January 2013) an entity will need to hold an AFS licence with appropriate authorisations covering Regulated Emissions Units in order to provide financial services in relation to such products.

Registration is not the only option. Entities can still apply directly to ASIC for an AFS licence to cover regulated activity from 1 July 2012. ASIC is currently accepting such licence applications.

How we can assist

Norton Rose Australia delivers the Advanced Diploma in Financial Licensing Management course offered by the Australian Financial Markets Association. Norton Rose Australia can assist with advice on the application of the new regime to firms that look to undertake transactions involving Regulated Emissions Units, and if necessary, assist with an application for an AFS Licence.

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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