UK: Rules Released for the United Kingdom´s Greenhouse Gases Emissions Trading Scheme

The United Kingdom's Emissions Trading Scheme is now only a matter of weeks away from ‘going live’. An auction for allowances will take place on February 25, and the Scheme will become operative as of April 2.

The Scheme, which will commence on a voluntary and non-statutory basis, is founded on Rules developed by the Department of Environment, Food and Rural Affairs (DEFRA) and issued in late December 2001. The Rules apply in the context of the earlier Framework Document for the Scheme and also a Guidelines Document for the Measurement and Reporting of Emissions. Some further development of these Rules is expected in the very near future. However, this is not expected to alter greatly the Rules already as presently published and upon which this Alert has been written.

Herbert Smith involvement

Herbert Smith has been closely involved in the development of the UK Emissions Trading Scheme through its involvement in the business-led UK Emissions Trading Group’s Legal Liaison Group and the UK Environmental Law Association’s Climate Change Working Group. Through its involvement with the Climate Change Working Group,H erbert Smith has most recently assisted DEFRA in considering the complicated legal issues involved in the development of the detailed Rules of the Scheme.

The Scheme

An on-line market will open on April 2, 2002. It will be the world’s first economy-wide trading system covering all greenhouse gases. Central to the operation of this market will be the Emissions Trading Registry which will be established and maintained by the Secretary of State for the Environment, Food and Rural Affairs. The Registry wille nable the trading and transfer of "allowances" to occur. For the purposes of the Scheme, an "allowance" is a unit of account, representing one tonne of carbon dioxide equivalent.

Anyone wishing to buy or sell allowances (a trading participant) must have entered into a trading participant agreement with the Secretary of State and must have opened a trading account in the Registry.

There will also be three other ways to participate in the market:

• as a direct participant (see below)
• as an agreement participant (in relation to a Climate Change Levy Agreement);
• as a project participant (in relation to allowance-generating activities).

Thep ublication of Rules in relation to agreement participants and project participants is not expected until after the market has opened in April 2002.

A company can only participate in the Scheme as a direct participant if it is a successful bidder in theA uction of the Financial Incentive. To encourage participation in theS cheme by companies that emit greenhouse gases, and to ensure that the Scheme operates to reduce UK greenhouse gas emissions overall, the government iso ffering a financial incentive of £215 million over 5 years. The government has decided to allocate the financial incentive by an on-line ‘descending clock’ auction which will begin at 0900 (GMT) on February 25, 2002.

In order to take part in the auction a potential direct participant must:

• demonstrate its eligibility to be a direct participant;
• calculate its source list of emissions and obtain the approval of the Secretary of State for the calculations;
• calculate its baseline emissions (the reference point for future emissions) and obtain a verification statement; and
• enter into a direct participation agreement with the Secretary of State, undertaking that if it is successful in the Auction the prospective direct participant will comply with the Rules of the Scheme.

The auction will operate by each prospective participant bidding (each time an allowance price is announced) in terms of a quantity of tonnes of carbon dioxide equivalent (tCO2e) by which it will reduce its greenhouse gas emissions. To protect the environmental and economic integrity of the market, no prospective participant will be able to bid for more than ten per cent of the total incentive money.

Direct participants who are successful in the auction will have agreed to reduce their greenhouse gas emissions by a certain amount (‘overall emissions reduction target’) over the five year ‘commitment period’ of the Scheme. For compliance purposes this target is divided into five ‘annual emissions reduction targets’, and consequently, provided a direct participant complies with the Rules in a particular ‘commitment year’, it will receive one fifth of the financial incentive that it successfully bid for in the auction.

Allowances will be credited to a direct participant’s ‘compliance account’ in the Registry on April 2, 2002. The number of allowances allocated to a direct participant will be equivalent to its verified baseline less its ‘annual emissions reductiont arget’. A direct participant will then be able to purchase and sell allowances as it sees fit according to the Rules of the Scheme.

The first ‘commitment year’ will run from January 1, 2002 to December 31, 2002. A direct participant must at the end of this period calculate and verify its total annual emissions for that year and send a verification statement to the Secretary of State by March 31, 2003 (the end of the first ‘reconciliation period’). If a direct participant holds enough allowances in its compliance account to reconcile against itsv erified annual emissions for that commitment year, it will have met its annual emissions limitation commitment and will therefore be entitled to receive its annual incentive payment. As a part of this reconciliation process, the Secretary of State will transfera llowances used to reconcile a direct participant’s verified annual emissions into the national retirement account in the Registry.

A range of non-compliance ‘penalties’ may be imposed on a direct participant by the Secretary of State for failure to meet its annual emissions limitation commitment or failure to comply with the monitoring, reporting and verification of emissions requirements set out in the Rules.

The number of allowances allocated to a direct participant for the second commitment year will be equivalent to its verified baseline less double its annual emissions reduction target. The Secretary of State will allocate the allowances for the second commitment year afterr eceiving the direct participant’s verification statement for the previous commitment year. This process is similarly repeated for the third, fourth and fifth commitment years of the Scheme.

The Rules in relation to adjustments to source lists, baselines and targets will be critical to protecting the environmental integrity of the Scheme and are expected to be released in the very near future.

"© Herbert Smith 2002

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