UK: Brexit And The EU ETS – 10 Things To Consider

The precise manner of the UK's withdrawal from the EU remains unclear. A number of scenarios could apply to the UK's continued participation in the EU Emissions Trading Scheme (EU ETS) depending on whether (i) the UK parliament accepts the terms of the draft Withdrawal Agreement (WA) (as endorsed by EU leaders at a special meeting of the European Council on 25 November 2018) in the upcoming parliamentary session, resulting in an orderly departure of the UK from the EU, including providing a transition period ending 31 December 2020 (a Soft Brexit), or (ii) the UK parliament rejects the WA and no legally binding and enforceable replacement arrangements are put in place (a Hard Brexit) before 29 March 2019 (the Brexit Deadline).

This uncertainty has led to confusion among EU ETS market participants and we have received a number of similar enquiries from clients in this regard. In this client alert, we thought it would be helpful to identify and provide answers to some of the most common questions we have received.

For the purposes of this alert, we refer to EU allowances (EUAs) issued by the UK before 1 January 2019 as 'UK Pre-2019 EUAs' and to EUAs issued by the UK from (and including) 1 January 2019 to the end of Phase 3 as 'UK-2019+ EUAs'. Unless otherwise specified, references to EUAs include a reference to aviation EU allowances issued under Chapter II of the EU ETS Directive.1 In addition, we refer to allowance accounts that are subject to the supervision of the UK national administrator in the Union Registry as 'UK Registry Accounts', and allowance accounts subject to the supervision of other EU member states, as 'Member State Registry Accounts'. Please note the scope of this alert is limited to Phase 3 of the EU ETS and does not consider issues that would be relevant to Phase 4 (i.e., 2021-2030). Please note that, although other scenarios are possible (e.g. a people's vote ahead of the Brexit Deadline), the scope of this client alert is limited to only the Soft Brexit and Hard Brexit scenarios. Furthermore, the content below should not be considered legal advice as, the facts and circumstances of each person are likely to be different and therefore, the views expressed here can only be provided generically.

1. Will UK Pre-2019 EUAs continue to be valid after the Brexit Deadline?
Hard Brexit scenario Soft Brexit scenario
Yes, UK Pre-2019 EUAs will be valid for Phase 32 and beyond, with no expiry date. However, it may not be possible to access UK Pre-2019 EUAs held in a UK Registry Account. Essentially, they could become stranded, with no assurances that they can be transferred out of the UK Registry Account after the Brexit Deadline. Yes, UK Pre-2019 EUAs will be valid for Phase 3 and beyond, with no expiry date.
2. Will EUAs held in a UK Registry Account be accessible after the Brexit Deadline?
Hard Brexit Soft Brexit
No. The UK will have no guaranteed access to the Union Registry where the UK Registry Account is located. Yes. In the event of a Soft Brexit, access to the UK Registry Account is assured until the end of Phase 3 in respect of EU ETS obligations (including the Phase 3 compliance deadline)3 and beyond in respect of the UK's compliance obligations under the second commitment period of the Kyoto Protocol. Because of the timing of country compliance (true-up), this suggests that access to the Union Registry should be available until at least 2023.
3. I am holding a number of UK Pre-2019 EUAs in my UK Registry Account – what steps should I take to protect them depending on the Brexit outcome?
Hard Brexit scenario Soft Brexit scenario
Assuming you already have a Member State Registry Account, you should transfer your UK Pre-2019 EUAs to that account in advance of the Brexit Deadline. If the only account you have is a UK Registry Account, you should consider opening a Member State Registry Account before the Brexit Deadline. No steps are required.
4. Can UK market participants open a Member State Registry Account in advance of the Brexit Deadline?
Hard Brexit Soft Brexit
Yes, subject to the requirements of the Registries Regulation4 and the requirements of the national administrator for the country that operates the relevant EU member state's account, a UK applicant will be able to open an account in the Union Registry. Pursuant to Articles 18(2) and 18(3) of the Registries Regulation, national administrators may impose permanent residency or VAT registration requirements on applicants seeking to open or hold a trading account in the member state's section of the Union Registry. So the requirements of the relevant member state should be checked before applying. Yes, same answer as in the Hard Brexit scenario.
5. How long will it take to open a new Member State Registry Account?
Hard Brexit Soft Brexit
Four to eight weeks. Pursuant to the Registries Regulation, national administrators should establish accounts or reject applications for an account within 20 working days (or 40 days for aircraft operator holding accounts) following receipt of the account opening documentation. If additional time is required to assess an application, national administrators may extend the assessment process by a further 20 working days and must notify the applicant accordingly. We expect that given the increased demand for Member State Registry Accounts in the lead-up to the Brexit Deadline, these periods may be extended. Four to six weeks. National administrators have advised that the process of opening a Member State Registry Account will, in normal circumstances, take approximately one month from receipt of the account opening documents. Otherwise, the same timing requirements under the Registries Regulation apply to national administrators of member states.
6. Will UK 2019+ EUAs be valid for EU ETS compliance use after the Brexit Deadline?
Hard Brexit Soft Brexit
No. Pursuant to an amendment to the Registries Regulation (the Brexit Amendment),5 UK 2019+ EUAs will be marked with a country code and cannot be surrendered as compliance units. No, not without additional steps being taken by the European Commission to undo the impact of the Brexit Amendment.

In our view, the WA does not go far enough in undoing the impact of the Brexit Amendment on UK 2019+ EUAs. The WA does provide that the UK will move into a transition period, which will involve continued participation in the EU ETS until 31 December 2020. As a result, UK 2019+ EUAs ought to be valid for surrender purposes, but only if the Brexit Amendment is revoked or the European Commission does not tag any UK 2019+ EUAs upon their issuance in 2019. Given the normal timing of issuance (i.e., 9 February 2019) and its proximity to the Brexit Deadline, it is likely that the issuance of UK 2019+ EUAs will be delayed until a Soft Brexit outcome is certain.

For UK installations and aircraft operators, the 2018 year EU ETS compliance deadline has been brought forward to 15 March 2019. Please note, the Brexit Amendment prevents UK 2019+ EUAs to be surrendered in respect of that compliance obligation.
7. If someone tries to deliver UK 2019+ EUAs after the Brexit Deadline, do I have to accept them?
Hard Brexit Soft Brexit
The question of whether UK 2019+ EUAs will satisfy the contractual delivery obligations will turn on the specific terms of the arrangements under which such delivery obligations arise. For example, in the over-the-counter market, this will depend on the terms of the wording of the applicable ISDA, EFET or IETA emission trading documents. In contrast, for exchange-traded EUA futures, this will depend on the terms of the relevant exchange (ICE Futures Europe, EEX, etc.) and the terms of your arrangements with your clearing broker. It is not possible to give a single answer in respect of all of the above – we recommend that you consult your legal counsel if in doubt. If the effect of the Brexit Amendment is undone before the issuance of UK 2019+ EUAs, then yes, you will have to accept them. If not, however, then the same answer will apply as in a Hard Brexit scenario (i.e., it depends on the terms of the contractual arrangements under which the delivery obligation arises).
8. Will Certified Emission Reductions (CERs) and Emission Reduction Units (ERUs) held by a UK compliance entity be valid after the Brexit Deadline?
Hard Brexit Soft Brexit
No. In Phase 3, CERs and ERUs are not (direct) compliance units. This is because although, if eligible, they can be exchanged for an EUA on a one-for-one basis, they cannot actually be surrendered by a compliance entity in respect of its EU ETS obligations. The ability to swap CERs or ERUs for EUAs depends on a compliance entity's unused quota or level for such surrender that is carried over from Phase 2. If a compliance entity has an unused quota, it will not be able to carry out such a swap after the Brexit Deadline. Yes, to the extent that a compliance entity has any unused quota and the exchange occurs before the end of Phase 3.6
9. Will auctions of UK 2019+ EUAs continue after 1 January 2019?
Hard Brexit Soft Brexit
No. The UK has yet to confirm the schedule for auctions of UK 2019+ EUAs beyond December 2018. This position may change should the WA (and any associated political declaration) be ratified following the upcoming vote of the UK parliament. The UK government has advised that if arrangements after the Brexit Deadline are not sufficiently clear by 1 January 2019, it will suspend issuing UK EUAs (both auctioning and free allocation) between January and March 2019. The UK government would intend to lift this suspension as soon as arrangements become clear.
10. What happens after the Brexit Deadline to UK installations and aircraft operators that are subject to the EU ETS in Phase 3?
Hard Brexit Soft Brexit
UK installations and aircraft operators will continue to have monitoring, reporting and verification obligations even though the UK government will remove requirements relating to the surrender of EUAs for UK installations and aircraft operators under the EU ETS. The UK will introduce a carbon emissions tax of £16/tCO2e in place of the EU ETS obligations. The (Great Britain only) carbon price support mechanism will remain in place for those operators in the power sector. Installations will continue to be subject to the reporting, monitoring and surrender requirements of the EU ETS until the end of Phase 3.

The WA provides that the UK will implement a UK equivalent of the EU ETS (i.e., a UK ETS), presumably with a view to linking with the EU ETS, although no timeframe for the establishment of such a UK ETS is specified.

Conclusion

So what does this mean in practice? While the above may address some basic questions, a number of other issues are likely to arise for market participants that are specific to their arrangements or circumstances. These range from issues relating to bespoke OTC transactions that straddle the Brexit Deadline, and EUA futures contracts that are due to settle in April 2019, to issues relating to M&A transactions where the underlying asset is a UK compliance entity, and UK aviation operators who retain an EU ETS obligation due to their intra-EU flights.

If in doubt, please consult with your legal advisers on steps that you can or should take to prepare for the applicable Brexit outcome. Should you wish to discuss these issues in more detail, please do get in touch.

Footnotes

  1. Directive 2003/87/EC, as amended from time to time.
  2. Phase 3 of the EU ETS operates from 1 January 2013 to 31 December 2020.
  3. Article 96(5) of the WA.
  4. Commission Regulation (EU) No. 389/2013, as amended from time to time.
  5. Commission Regulation (EU) 2018/208 of 12 February 2018.
  6. CERs and ERUs, issued in respect of emission reduction in the first commitment period of the Kyoto Protocol (20082012) had to be exchanged for EUAs by 31 March 2015. Therefore, only CERs and ERUs issued in respect of the emission reductions achieved after 31 December 2012 may be swapped in Phase 3.

Originally published 5 December 2018

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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