A key tool for Australia's carbon emission reduction efforts, Australian Carbon Credit Units (ACCUs) have come under increased focus for their value and potential as a 'financial product'. With positive initiatives planned by the Clean Energy Regulator (CER) to further propel their prominence and address growing demand, ACCUs could be more than just offsets on the path to net zero - if implemented correctly, they could be a valuable class of collateral which can be used as security to finance net zero initiatives.
Overview of ACCUs
ACCUs are created and issued under the Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth) (CFI Act). Each ACCU represents one tonne of carbon dioxide that is abated through an eligible offsets project (being a project which avoids the emission of greenhouse gases or removes them from the atmosphere).
Since their creation, demand for ACCUs has been largely driven by the Commonwealth Government through its Emissions Reduction Fund (ERF). The private sector has been the next largest source of demand, initially stimulated by large emitters needing to offset emissions to meet their legal baseline emissions requirements. Looking forward, we expect private sector demand to play an even bigger role in response to stakeholder pressure to take steps to decarbonise operations and meet other environmental, social and governance (ESG) targets.
The catalyst for even greater ACCU demand would be to allow ACCUs to be purchased and transferred to international carbon registers, as contemplated by article 6 of the Paris Agreement.
In recognition of the growing demand for ACCUs, the CER is:
- designing a carbon trading platform (an exchange for carbon
credits), which is open, transparent and low-cost as opposed to the
existing system under which ACCUs are traded over the counter;
- accelerating the supply of ACCUs, by expanding the range of projects that are eligible to earn ACCUs through the development of a broader range of methodologies (for example, carbon capture and storage projects),(together, the CER Initiatives).
Taking security in ACCUs
ACCUs are personal property, specifically investment instruments, for the purposes of the Personal Property Securities Act 2009 (PPSA) and therefore can be used as collateral for a company's general financing arrangements or in bespoke financings targeted at eligible offsets projects.
For financiers, the CER's initiatives to bolster the tradability of ACCUs through the implementation of a carbon exchange means there will be a simple and transparent method for realising the value of collateralised ACCUs, should a need to enforce security arise. Moreover, a financier's support for eligible offsets projects is likely to contribute to the financier's ESG targets, potentially allowing project proponents access to better financing terms.
Risks with using ACCUs as collateral
While we expect the CER Initiatives will bolster the use of ACCUs as a financial product and collateral, the implementation of a carbon exchange will exacerbate practical issues in perfecting the security interests. Similar to taking security in shares, these issues should be considered by financiers when taking security over ACCUs.
Security interests in ACCUs may be perfected either by registration or by control.
Perfection by registration
Registration is the most common method of perfecting security interests and may be effected simply by registration on the Personal Property Securities Register (PPSR).
Generally, a registration on the PPSR is notice to the world at large that a person has a security interest over the personal property to which it relates. Under the PPSA, third-party purchasers will take ACCUs free from any security interests if the purchasers have given value for the ACCUs and take possession or control - unless the purchasers have actual or constructive knowledge that this will constitute a breach of an underlying security arrangement.
At present it is unknown how ACCUs will be traded over the carbon exchange - whether they will be linked to the holder of the ACCU or traded on an anonymous basis. It would be prudent for a carbon exchange to require the ACCU to be linked to a holder, so the status of the ACCU can be checked on the PPSR. Otherwise, a bona fide purchaser without notice may take the ACCU free of the security interest.
While the risk of losing security interests to third-party purchasers is not exclusive to trading over a carbon exchange, it will be exacerbated in relation to ACCUs by the greater frequency of trading which can be expected. This risk is partly mitigated, however, as the security interests will continue in the proceeds obtained from an unauthorised sale of the ACCUs.
Perfection by control
Perfection by control offers financiers more protection and trumps perfection by registration in terms of priority between competing security interests. It is generally preferred for perfecting security interests in investment instruments due to the high frequency and volume in which investment instruments are traded.
For instruments such as shares, control may be obtained by taking possession of the share certificates and transfer forms (if shares are certificated) or entering into an arrangement with the Clearing House Electronic Subregister System (CHESS) operator (if shares are uncertificated and listed on the ASX). For ACCUs it is more difficult as their nature as a statutory creation gives rise to unique considerations.
ACCUs are uncertificated and, similar to entering into arrangements with the CHESS operator, financiers may obtain control and management rights over ACCUs by entering into an arrangement to act as authorised representatives of the security providers' Australian National Registry of Emission Units (ANREU) accounts (an account for holding and owning ACCUs). A risk exists in that security providers may remove authorised representatives from the relevant ANREU account at any time. This can be managed through contractual undertakings and representations in finance and security documents.
Financiers may also obtain control by taking title and ownership to the ACCUs. To do so, financiers must establish their own ANREU Account and comply with account maintenance requirements (non-compliance with which could lead to a cancellation of the ACCUs). This option should be considered carefully as there may be tax consequences with the financier taking title and ownership and may simply not be practicable.
Security interests in ACCUs may become worthless if there are underlying problems with the eligible offsets projects from which ACCUs were earned. Under the CFI Act, ACCUs may be mandatorily relinquished if:
- their issue was attributed to the giving of false or misleading
- the project no longer complies with the CFI Act; or
- the emissions abated have been reversed.
These relinquishment obligations apply against the project proponent who is responsible for sourcing ACCUs to relinquish to the CER and so are less of an issue for ACCUs which have been transferred on the secondary market.
ACCUs may also be voluntarily surrendered by their owner or cancelled for breaches of rules relating to the owner's ANREU Account.
Finally, the integrity of the ACCU system has come under attack with recent allegations that as many as 80% of all ACCUs produced to date have not achieved the level of abatement prescribed by their methodologies. These allegations have cast doubt on the quality of ACCUs and may have serious consequences on the demand for ACCUs.
While we do not comment on the legitimacy of these allegations, as they relate to the technical and environmental accounting for the abatement, we note that ACCUs are considered relatively more credible than other carbon offsets available for purchase internationally. Nevertheless, the controversy has highlighted the need to closely scrutinise the methodologies for creating ACCUs and for transparency on the methodology under which they are being created. These are serious risks which financiers must consider, however, the risks are not dissimilar to insolvency or project failure risks inherent in traditional finance arrangements. Risks of failure cannot be avoided but can be managed with proper due diligence and contractual safeguards.
ACCUs are under increased focus as a valuable asset for financiers of eligible offsets projects to consider as part of a broader security package. Given that ACCUs are statutory creations, it is important that financiers are aware of the legislative framework and take steps to appropriately mitigate risks. Financiers must also carefully consider the underlying methodology giving rise to each ACCU and make a decision on whether it will only purchase ACCUs derived from certain methodologies or audited by certain entities.
We anticipate that as the carbon exchange is set up some of these concerns will be considered and addressed.
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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