On 16 October 2009 the Bank of England's Financial Markets Law Committee (the "Bank of England Committee") published a legal assessment of perceived gaps and uncertainties in respect of the carbon market.

Legal Basis

The basis of the EU Emissions Trading Scheme ("ETS") is Directive 2003/87/EC (as amended) which itself was created in order to carry out a number of the EU's obligations under the Kyoto Protocol.

What is the EU ETS?

The ETS is an EU-wide scheme for the trading of carbon allowances between scheme participants. Participation is compulsory for operators of installations carrying on processes that fall within the scheme's scope and these are listed at Annex I to the Directive (http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CONSLEG:2003L0087:20090420:EN:PDF). Amendment of the original Directive means that as of 2nd February 2010 the UK is obliged to bring laws into force that will bring aviation activities within the scope of the ETS.

The ETS is currently in its second phase (Phase II), which runs from 1st January 2008 until 31st December 2012. The basis for UK implementation of Phase II of the ETS is the UK National Allocation Plan ("NAP"). The NAP comprehensively narrates Phase II as it applies to the UK and it is not necessary to try to summarise it in this article. The document can be viewed here

The ETS Directive doesn't provide for regulation of, or even a market in, allowance trading. Instead operators can choose how they wish to trade allowances – directly with each other or via one of a number of third parties.

On 1st January 2013, Phase III will commence and this will see some significant changes to the ETS:

  • National Allocation Plans will end and there will be an EU-administered, EU-wide cap on emissions. This cap will reduce on a yearly basis by 1.74% of 2005 emissions to a level in 2020.which will be 21% of the 2005 level.
  • There will be an increase in the quantity of allowances acquired by auctioning rather than free allocation by member states. The number of allowances to be allocated will increase over time until 2020. For the power sector, all allowances will be auctioned in the UK although there are some parts of the EU where 100% auctioning will not occur until 2020 to encourage improvements to energy infrastructure.

Question marks over the legal standing of emissions allowances?

In particular, the Bank of England Committee's assessment highlighted uncertainty over fundamental legal principles that underpin that market and which provide its participants with the security they require in order to commence and maintain their participation.

Specifically, the assessment highlighted the following issue – "that nothing in the ETS provides any indication of the legal nature of emission allowances. Emission allowances have aspects of both administrative grants or licences and of private property..." As emissions allowances have the properties of both licences and private property, the assessment goes on to state that different interpretations of the legal status of allowances might occur in various member states of the EU and that there are indications of this having already occurred.

The potential consequences of this ambiguity are uncertainty over "which law properly governs the creation, transfer and cancellation of [an] allowance, and whether (and how) security rights can be created over that allowance". The assessment also refers to uncertainty over the tax and accounting treatment of allowances, their disposal following a registered holder's insolvency, whether allowances should be subject to regulation as an investment and whether allowances can be stolen.

The assessment notes that the EU ETS is just one of a number of carbon trading schemes and that there are others, some of which operate outside of the Kyoto framework. The apparent scale and diversity of the carbon market highlights the potential for its disruption by the issues raised in the assessment.

The Bank of England Committee recommends that these issues are addressed by the EU Commission, specifically the Directorate General Internal Market and Services with input and advice coming from the Directorate General Environment. Specifically, the Bank of England Committee suggests three solutions, the most feasible of which appears to be:

A "partial harmonisation" of the relevant aspects of substantive law such as:

  • "whether emission allowances constitute a form of property or a personal right, and, if the latter, against whom (e.g. the relevant national registry);
  • the effect on third parties of assignment/transmission including any necessary formal and substantive requirements to create a valid proprietary interest in emission allowances;
  • the possibility of creating security, or other limited proprietary interests, in emission allowances, including any necessary formal and substantive requirements;
  • the registerability of security interests in emission allowances; and
  • priorities between competing claims to emission allowances"

To view the full text of the Bank of England Committee's assessment click here

Pending clarification by the EU Commission or judicial interpretation, it appears that an element of uncertainty will remain over the EU ETS.

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.