Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism by Emmy S

CARBON MARKET INTEGRITY A REVIEW OF THE AUSTRALIAN CARBON PRICING MECHANISM

MARCH 2012

About the Carbon Market Institute The Carbon Market Institute is an independent membership-based not-for-profit organisation. Our aim is to assist Australian businesses in meeting the challenges and opportunities associated with the developing national and international carbon markets and thereby build capacity to grow in a low-carbon world. Established with support from the Victorian Government, our Asia-Pacific wide membership represents a broad range of professionals, organisations and industry providers for whom carbon will have a direct impact on their businesses both in terms of liabilities and potential opportunities. The Institute has a strong research program and provides market analysis, education and training, business networking and information services and international engagement. CMI is also developing professional standards and an accreditation program. CMI incorporates and builds on the networks, partnerships and services developed by the former Asia-Pacific Emissions Trading Forum (AETF) which began operations in 1998. CMI commenced operations on 1 January 2011 with a mandate to assist Australian businesses with the implementation of climate-related markets, both in terms of managing risk and realising business opportunities. To find out more about becoming a member of CMI, email info@carbonmarketinstitute.org

Copyright and Disclaimer Copyright © 2012 the Carbon Market Institute (CMI). No part of this document may be reproduced without consent. Permission is granted for normal and limited quotation provided that credit is given to the CMI. The opinions expressed in this publication do not necessarily reflect the opinions of the CMI directors, sponsors, partners or members. No responsibility is accepted by CMI, its directors, sponsors, partners, or members or the authors of any articles for the accuracy of any information contained in this publication or the consequences of any person relying upon information. The contents of this publication should not be relied upon as a substitute for professional advice.

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AUTHOR

Centre for Law, Governance and Public Policy Patrick Keyzer (Director), Damien Lockie, John Farrar, Michael Weir, Tina Hunter, Richard Hundt The Centre for Law, Governance and Public Policy is a cross-disciplinary research centre bringing together scholars with a common interest in the development, practices, processes, outcomes and operation of public policy and regulation. Its research agenda is focused on the way that the law can promote good governance and good public policy. Scholars from the Centre are leading experts in their field. Lead author Adjunct Professor Damien Lockie is an Australian and international specialist in the field of carbon market oversight. Recognised as one of Australia’s leading law faculties, Bond Law has gained an international reputation for its innovative teaching methods, integrated skills program and the outstanding success of its graduates. Based at Bond University’s world-class campus on Queensland’s Gold Coast, the Law Faculty integrates a state-of-the-art Legal Skills Centre – a purpose built facility featuring a full complement of legal-based training facilities, including moot courts and mediation suites which use the best available technology. The Faculty’s unique programs ensure graduates are equipped with both the theoretical and practical skills training necessary in contemporary legal practice. www.bond.edu.au

PEER REVIEWED BY

Baker & McKenzie was the first law firm to recognise the importance of climate change law and policy. For more than 14 years our dedicated global practice has worked on numerous pioneering deals, including writing one of the first carbon contracts, setting up the first carbon fund, the first structured derivative transaction and the first REDD project. From governments, multinational enterprises to financial and multilateral institutions we continue to be the advisor of choice on climate change law, policy and regulation. www.bakermckenzie.com

Disclaimer This publication has been prepared for CMI and as general information for this CMI publication. You should not rely on the contents. It is not legal advice and should not be regarded as a substitute for legal advice. To the fullest extent allowed by law, Bond University and Baker & McKenzie exclude all liability whether arising in contract, for negligence (or otherwise) in respect of all and each part of this document, including without limitation, any errors or omissions.

TABLE OF CONTENTS EXECUTIVE SUMMARY 4 1. INTRODUCTION 5 2. OVERVIEW OF THE CARBON PRICING MECHANISM

3. LIABILITY UNDER THE CLEAN ENERGY ACT

4. CARBON MARKET PARTICIPATION

5. OPENING A REGISTRY ACCOUNT

6. AUCTION OF EMISSIONS UNITS

7. TRANSFER OF EMISSIONS UNITS

8. OTC TRANSACTIONS 20 9. TRANSACTIONS ON FINANCIAL MARKETS

10. SPECIAL DEALINGS 27 11. PROVISION OF FINANCIAL SERVICES

12. INDEFEASIBILITY OF TITLE 35 13. INFORMATION DISCLOSURE 39 14. GOVERNANCE MECHANISMS 41 ENDNOTES 44

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EXECUTIVE SUMMARY The Carbon Market Institute is focused on ensuring that the primary, secondary and derivative carbon markets that emerge in Australia are credible and achieve optimum efficiency and operational effectiveness. The Clean Energy Act 2011 (Cth) and 18 other acts to provide for Australia’s clean energy future (collectively, the Clean Energy law package) to start from 1 July 2012, introduce rules governing trading of emissions units in an Australian emissions trading scheme (ETS). In order to achieve optimum efficiency and operational effectiveness in carbon markets there must be market integrity. As a co-ordinated response to the global financial crisis (GFC), governments and regulators around the world have been increasingly harmonising their institutional frameworks for operation, regulation and oversight of markets. These new regulatory regimes are intended to apply to carbon markets. However, of particular note is the targeted response to disruption and loss caused by theft, fraud and other undesirable practices in the carbon markets recently enacted in new regulations governing carbon market trading in the European Union Emissions Trading System (EU ETS). In line with the global response, the Australian Government has re-evaluated domestic legislation and standards in place before the GFC – including the problem with inadequate regulation and market oversight. Through 2009-2011 the Australian Government introduced a number of changes to the Corporations Act 2001 (Cth) and Australian Securities and Investment Commission Act 2001 (Cth) to improve the operation, regulation and oversight of Australian markets. The integration of these changes with the Clean Energy law package is still in progress as at the date of this report. Market integrity allows day-to-day market transactions to be facilitated within an efficient, fair and orderly regulatory regime, and in a carbon market allows carbon units to be exchanged among economic agents without fear of disruption and loss caused by theft, fraud and other undesirable practices. This report is based on the Clean Energy Act 2011 (Cth), relevantly associated acts in the Clean Energy law package and promulgated regulations as at 15 March 2012. The report also relevantly incorporates amendments proposed in consultation draft regulations released by the Department of Climate Change and Energy Efficiency on 16 March 2012. The accompanying information briefs on overseas emissions trading schemes are based on laws and promulgated regulations as at 15 March 2012. The report notes that the Australian rules are complex and new, and they are enacted in many different acts and regulations. Importantly, many key regulations are yet to be promulgated. It is evident that the design rules for the Australian carbon markets as enshrined in the Clean Energy law package and other relevant associated acts and regulations in part reflect lessons learnt from the overseas carbon markets. However, a key question is whether the institutional framework for operation, regulation and oversight provided by the Clean Energy law package and relevant associated acts and regulations will be sufficient to protect the nascent Australian carbon markets from disruption and loss caused by theft, fraud and other undesirable practices. The Carbon Market Institute cautions that the answer to this question will unfold with the promulgation of key regulations for the Australian ETS, and thereafter, as the carbon market evolves.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

1. INTRODUCTION During 2011 the Australian Government successfully enacted laws to provide for Australia’s clean energy future (collectively, the Clean Energy law package), the Carbon Farming Initiative and other complementary measures. The Clean Energy law package establishes the governing rules for a carbon pricing mechanism – an emissions trading scheme (ETS) – to commence in Australia from 1 July 2012. The main act in the Clean Energy law package is the Clean Energy Act 2011 (Cth). The Clean Energy law package in total comprises more than 18 new acts and regulations and interfaces with the Carbon Farming Initiative and other complementary measures, including the Australian National Registry of Emissions Units Act 2011 (Cth), and other key laws, such as the National Greenhouse and Energy Reporting Act 2007 (Cth) and the Corporations Act 2001 (Cth). The ETS and the other structural reforms and institutions created by the Clean Energy law package will encourage Australia’s energy, industrial, mining and business sectors to be more resource efficient and reduce greenhouse gas (GHG) emissions.1 Desired emissions reductions are to be achieved by “liable entities” and through creating new markets – the carbon markets – in which emissions rights can be bought and sold by liable entities and others.

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The legislative objects of the ETS include the encouragement of investment in clean energy, the support of jobs and competitiveness in the Australian economy, and the support of Australia’s economic growth while reducing emissions. The Carbon Market Institute wishes to ensure that the Clean Energy law package also results in primary, secondary and derivative carbon markets in Australia that are credible and achieve optimum efficiency and operational effectiveness. Market integrity allows day-to-day market transactions to be facilitated within an efficient, fair and orderly regulatory regime, and allows carbon units to be exchanged among economic agents without fear of disruption and loss caused by theft, fraud and other undesirable practices. To gauge the extent of carbon market integrity, this report describes how the Australian ETS permits day-to-day market transactions and protects liable entities, the Government and the public. The report, and its accompanying information briefs on emissions trading schemes operational in the European Union and New Zealand, and planned for California, is based on the Clean Energy law package, relevantly associated acts and promulgated regulations as at 15 March 2012 (but also relevantly incorporating amendments proposed in consultation draft regulations released by the Department of Climate Change and Energy Efficiency on 15 March 2012).

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A guide to the legislative framework for day-to-day market transactions in the Australian carbon markets.

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Guides to the legislative framework for the European Union Emissions Trading System (EU ETS), the New Zealand Emissions Trading Scheme (NZ ETS) and the California Emissions Trading Scheme (California ETS).

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An outline of the complex web of Australian rules for regulatory oversight of markets, market participants and market transactions as they may apply to carbon markets.

The report and information briefs allow for comparison between the various emissions trading schemes, and are designed to allow a reader who is required to deal, or contemplating dealing, in emissions units, to assess the need to address carbon market integrity in the Australian carbon markets. Since the final design of the Australian carbon market, and hence its integrity, will be dependent upon the key regulations necessary to implement the Australian ETS - which have not yet been promulgated as at the date of this report - the Carbon Market Institute cautions against assuming that the Clean Energy law package and relevant associated acts and regulations will be sufficient to protect the nascent Australian carbon markets from disruption and loss caused by theft, fraud and other undesirable practices.

The report and the information briefs provide the reader with:

2. OVERVIEW OF THE CARBON PRICING MECHANISM The Clean Energy laws referenced in this report include: »»

The Clean Energy Act 2011 (Cth) (CE Act).

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The Clean Energy Regulations 2011, the Clean Energy Amendment Regulations 2012 (No 1) and consultation draft regulations ‘Clean Energy Amendment Regulations 2012 (No )’ released by the Department of Climate Change and Energy Efficiency on 16 March 2012.

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The Clean Energy (Consequential Amendments) Act 2011 (Cth) (Amending Act), an Act for providing for taxation treatment and important consequential amendments to other legislation (including changes to the Corporations Act 2001 (Cth), and the Australian Securities and Investments Commission Act 2001 (Cth).

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The Clean Energy Regulator Act 2011 (Cth) (Clean Energy Regulator Act) will establish the Clean Energy Regulator (Regulator) which

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

will take over functions from the Greenhouse Energy Data Officer and the Office of the Renewable Energy Regulator. »»

The Climate Change Authority Act 2011 (Cth) (Climate Change Authority Act) will see the establishment of a Climate Change Authority (Authority) as an independent body.

subject to a price floor and ceiling for three years. The floor (lowest) price for carbon units will be $15 (rising by four per cent in real terms), and the ceiling (highest) price will be $20 higher than the international price in 2015-2016 (rising by five per cent in real terms). The Authority will conduct a review of the price floor and ceiling in 2017. Figure 1: Fixed price carbon units

Other relevantly associated Acts and Regulations referenced in this report include: »»

The Australian National Registry of Emissions Units Act 2011 (Cth) (Registry Act), and the Australian National Registry of Emissions Units Regulations 2011 (Registry Regulations) (collectively, the Registry Act and Regulations).

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The National Greenhouse and Energy Reporting Act 2007 (Cth) (NGER Act).

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The Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth) (CFI Act).

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The Corporations Act 2001 (Cth) (Corporations Act), and the Australian Securities and Investment Commission Act 2001 (Cth) (ASIC Act). The Anti-Money Laundering and CounterTerrorism Financing Act 2006 (Cth) (AMLCTF Act).

$25.40 $24.15 $23.00

2014 - 15

2013 - 14

2012 - 13

A carbon unit is one type of “eligible emissions unit” which liable entities may surrender to the Regulator to meet their liability under the CE Act. When surrendered, each carbon unit represents the right to emit one tonne (t) GHG2 for the compliance year.

GHGs within the coverage of the CE Act are:

This report references draft regulations released for public comment up to 15 March 2012. Further regulations to support the Clean Energy law package are planned to be promulgated between April and June 2012.

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Carbon dioxide (CO2).

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Methane (CH4).

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Nitrous oxide (N2O).

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Sulphur hexafluoride (SF6).

The CE Act provides for the Australian ETS to start 1 July 2012.

These gases are made equivalent (called carbon dioxide equivalence (CO2–e)) through their global warming potential (GWP).

The ETS comprises a three-year fixed price period followed by a cap-and-trade flexible price period. The compliance period in the ETS is the financial year from 1 July to 30 June. The main unit of currency in the ETS is the carbon unit. The price of carbon units in the period from 1 July 2012 to 30 June 2015 will be fixed (figure 1), starting at $23.

Other GHGs are: »»

Nitrogen trifluoride (NF3).

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Hydrofluorocarbons (HFCs).

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Perfluorocarbons (PFCs).

A carbon unit is issued by the Regulator on behalf of the Commonwealth.3

From 1 July 2015, the flexible price ETS will be

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Each carbon unit is recorded as an entry in an account in the Australian National Registry of Emissions Units (the Registry). Each carbon unit has unique information attached to it, including an identification number, part of which identifies the financial year (ending 30 June) in respect of which the carbon unit was issued (vintage year). Once a carbon unit is “surrendered” to the Regulator, it is cancelled by the Regulator and is never re-issued.

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In addition to carbon units issued by the Government, eligible emissions units will include: »»

Australian carbon credit units (ACCUs) arising under the Carbon Farming Initiative (CFI), subject to a cap on use in the fixed price period, set at five per cent of liability, but unlimited in the flexible price period.

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In the flexible price period, eligible and prescribed international emissions units (EIEUs), including certified emission reduction units (CERs) issued under the Clean Development Mechanism (CDM), and emission reduction units (ERUs) issued under the Joint Implementation (JI) programs established by the Kyoto Protocol4 (both called Kyoto units, and also subject to a cap on use, set at 50 per cent of liability).

Surrendering a carbon unit is a different act to transferring it, relinquishing it or cancelling it. The Regulator may only issue carbon units: »»

For a fixed price during the fixed price period (1 July 2012 to 30 June 2015), and the first three years of the flexible price period (1 July 2015 to 30 June 2018), to liable entities who apply for such fixed price units and comply with the regulations.

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Free to certain liable entities who qualify under the CE Act and comply with the regulations.

At an auction clearing price for carbon units with a vintage from 2016 at auctions ahead of and during the flexible price period (from 1 July 2015) to any person with a Registry account who successfully bids for and purchases such units.

3. LIABILITY UNDER THE CLEAN ENERGY ACT The ETS works by imposing a liability for a compliance year on a liable entity5 for their emissions, or if a natural gas retailer, for the potential emissions embedded in the natural gas they supply.6

(15 June or 1 February), then the surrender shortfall will be subject to a penalty emissions shortfall charge (a disincentive to encourage compliance). The penalty emissions shortfall charge is:

Liable entities must report emissions or potential emissions under the NGER Act.7

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130 per cent of the relevant fixed price during the fixed price period.

The CE Act creates the system for:

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200 per cent of the benchmark average auction charge in the preceding compliance year during the flexible price period.

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Assessing liability for emissions.

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Meeting liability for emissions through payment and surrender processes for eligible emissions units.

If the reported emissions of liable entities for the compliance year are not “covered” by the surrender of eligible emissions units by the true-up date

The liability mechanism in the CE Act is broadly similar in the fixed price and the flexible price periods, the major exception being the restriction of trading of emissions units acquired for a fixed price.8 In the fixed price period, 75 per cent of estimated

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

liability must be surrendered by 15 June in the compliance year, and the balance by 1 February in the next compliance year.

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Stationary energy.

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Industrial processes.

The true-up time in the flexible price ETS is 1 February in the year after the compliance year.

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Fugitive emissions (except decommissioned coal mines).

Liable entities under the CE Act are limited to:

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Non-legacy waste.

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The person9 with operational control of a facility emitting covered emissions10 in a covered sector in the compliance year, or

Before liability under the CE Act is attracted, scope 1 emissions11 at facility level must exceed a threshold of more than 25,000 tCO2-e in the compliance year.12

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Designated joint ventures, or

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A retailer of natural gas, or

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The person who has quoted an obligation transfer number (OTN) for the supply of natural gas, or

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A member of a controlling corporation group or financial controller that is the holder of a liability transfer certificate (LTC).

The tests for liability apply both in respect of the whole of the eligible financial year, and for a part of the year (called control days). The threshold is prorated across the number of control days if control does not exist for the whole of the eligible financial year. The quotation of an OTN avoids double-counting of GHG emissions where emissions from a facility are attributable to the combustion of natural gas obtained from an (upstream) gas supplier.13

The following covered sectors will be defined in regulations made under the NGER Act:

4. CARBON MARKET PARTICIPATION The ETS will establish the Australian carbon market. Properly configured, a cap-and-trade ETS is an efficient market-based mechanism through which GHG emissions can be reduced. In a carbon market: An emissions permit represents a tradable instrument with inherent value that can be

exchanged between sellers and buyers in an emissions permit market. This enables the movement of permits about the economy to their highest value (or most economically efficient) use, while ensuring the integrity of the volumetric control (emissions limit), imposed in order to satisfy the policy objectives of climate change mitigation.14

Figure 2: Three critical aspects to configuring a carbon market

1. Establish a fixed or reducing cap (maximum limit) on emissions

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2. Define ‘emissions entitlements’ as a commodity and assign property rights

3. Allow the commodity to be traded

THE CAP The ETS operates only for a defined subset of Australia’s GHG emissions. The Government estimates that the CE Act will apply to approximately 500 emitters, which are responsible for over half of Australia’s total GHG emissions.15 An emissions target establishes the “cap” in a cap-and-trade ETS. The target cap for Australia’s GHG emissions reduction is five per cent below 2000 levels by 2020, and 80 per cent below 2000 levels by 2050. This economy-wide cap represents a numerical emissions reduction objective that will be applicable for liable entities under the CE Act.

PROPERTY RIGHTS The carbon unit will be personal property for the CE Act. The carbon unit will also be personal property for the Personal Property Securities Act 2009 (Cth) (discussed in s 12.4). The carbon unit will be represented by an electronic entry in the Australian National Registry of Emissions Units (Registry). As noted, each carbon unit will have an identification number, including four digits representing vintage – the year – ending 30 June – of issue. The carbon unit may be cancelled, surrendered or (if issued free or after 1 July 2015) transferred. Only carbon units held on the Registry may be surrendered. Legal title in carbon units will only be transferred by entry into an account in the Registry. In the flexible price period: »»

Carbon units will have an indefinite life until cancelled or surrendered.

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Carbon units may be banked into future periods.

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Carbon units of the next vintage after the compliance period may be borrowed, subject to a five per cent cap.

The creation of equitable interests and security interests in carbon units will be permitted.

THE CARBON MARKETS The carbon markets will comprise primary, secondary and derivative carbon markets. The primary market comprises the original issues of carbon units. During the first phase of Australia’s carbon market until 30 June 2015, carbon units may be acquired by liable entities for a fixed price16 upon application in writing to the Regulator, or free under assistance programs. Post 1 July 2015, carbon units will be available for all – i.e. liable and non-liable entities – to acquire via auctions of original issues by the Regulator. Exchange of carbon units – i.e. buying and selling after the initial entry of carbon units into commerce in the primary market – establishes the secondary market. The secondary market encompasses over the counter (OTC) transactions and transactions on licensed and exempt financial markets. Legal title to carbon units that may be transferred (i.e. all carbon units other than fixed price carbon units) may be acquired by anyone and hence the secondary market for carbon units will be open to all. The CE Act will permit markets in futures, derivative and other structured or synthetic products – this is the forward or derivative market.17

Figure 3: Structure of the carbon market Derivative market

Secondary market

Primary carbon market

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

5. OPENING A REGISTRY ACCOUNT A prerequisite for any transaction involving legal title to carbon units is the existence of a Registry account in the name of a person. The law for Registry accounts is the Australian National Registry of Emissions Units Act 2011 (Cth) (Registry Act). The Registry was established by the Department of Climate Change (now the Department of Climate Change and Energy Efficiency (Department)) under the executive power of the Australian Government on 19 December 2008.19 Previously, account opening within the Registry was governed by the Registry Terms and Conditions.20 Such terms and conditions formed part of a contract made between the Department and the account holder at the time of opening of a Registry account. The new rules for opening a Registry account are dealt with in ss 10-11 of the Registry Act. Subsection 10(1) provides that regulations will make provision for and empower the Regulator to open accounts within the Registry. Further, sub-s 10(6) of the Registry Act provides that the regulations may deal with the following matters: »»

Requests to open Registry accounts.

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The approval by the Regulator of a form for such a request.

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Information that must accompany such a request.

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The fee (if any) that must accompany such a request.

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Verification by statutory declaration of statements in such a request.

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Rules for empowering the Regulator: ›› To require a person who makes such a request to give the Regulator further information in connection with such a request. ›› If the person breaches the requirement - to refuse to consider the request, or to refuse to take any action, or any further action, in relation to the request.

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Subsection 11(1) of the Registry Act provides that regulations may prescribe identification procedures which must be carried out by the Regulator before opening a Registry account. Regulations made under ss 10-11 of the Registry Act, titled “Australian National Registry of Emissions Units Regulations 2011” (Registry Regulations), commenced 1 December 2011 (promulgated 7 December 2011). Under the Registry rules which existed before the Registry was created by the Registry Act, each applicant for an account contracted directly with the Government. However, notwithstanding that applicants will continue to apply to the Regulator to open an account, the Registry Regulations will not result in the terms and conditions of account opening forming part of a binding contract between the Regulator and applicant.21 There is no section in the CE Act or the Registry Act that creates such a contract (in contrast, for example, to s 793B of the Corporations Act22 which turns market operating rules into a contract under seal). A first step to ensure that the ETS is credible is the establishment of the identity of the applicant as part of opening a Registry account. Once identity is established and a Registry account opened, universal participation in the ETS is permitted (from 1 July 2015). The mere fact of establishing identity does not discern purpose (for example, whether eligible emissions units will be held for surrender, cancellation or for sale) nor, of itself, act as a deterrent to undesirable behaviour.

of a person will need to be accompanied by the following information about the person: »»

The person’s full name, residential address and contact details.

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Date of birth and a passport or tax file number (TFN).

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Whether the person is applying as an individual, body corporate, corporation sole, body politic, local governing body or trust.

Also required are the person’s Australian Business Number (ABN) and registration number (if any) for goods and services tax (GST).25 Entities have significantly more requirements (see below).

OPENING A REGISTRY ACCOUNT INFORMATION TO BE SUPPLIED BY ENTITIES

Non-individuals must include the following information in their application for a Registry account: »»

Trading name.

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Australian Company Number (ACN).

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Registered Australian office address.

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Main place of business.

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The country in which the entity was formed, registered or incorporated.

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The state, territory or province in which the entity was formed, registered or incorporated.

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The name of the legislation under which the entity is established.

INFORMATION AND

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The date the entity was formed, registered or incorporated.

IDENTIFICATION

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The name of each company director (or equivalent) of a body corporate.

The Registry Regulations specify information that the Regulator requires in order to open a Registry account, and the applicable identification procedures.

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The name and address of each trustee of a trust.

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The name, contact details and position of:

5.1 REGISTRY REGULATIONS SPECIFY THE REQUIRED

Proof of identity (in English ) will be required by the Regulator and identification procedures will apply.

››

An individual who is authorised to make the request to open the Registry account for the entity.

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The person(s) nominated as the authorised representative in relation to the Registry account.

A request to open a Registry account in the name

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

Individuals who are sole traders must supply their business name, registration and address of main place of business.26 For a proprietary or private company, a request to open a Registry account must also include the name and address of any beneficial owner, defined to mean an individual who owns, through one or more share holdings, over 25 per cent of the issued capital in the company.27 If the person “is a trust”, the information must also include the names of each beneficiary of the trust, or if the terms of the trust identify the beneficiaries of the trust by reference to membership of a class, details about the class.28 The Registry Act provides that the regulations may declare a Registry account “transaction limit”.29 The Registry Regulations do not currently prescribe any transaction limit. If a Registry account is subject to a transaction limit, then the Regulator must not issue any emissions units to that account, or comply with an instruction to transfer units to that account, if so doing would result in the account exceeding its transaction limit. If the Regulator has closed a person’s Registry account, and the person applies to open another Registry account, then the Regulator must refuse to open a new account.30

The Regulator must have regard to the identification procedures and be satisfied proof of identity requirements have been met before opening a Registry account (r 13.2). The Regulator nonetheless retains an unlimited discretion to refuse to open a Registry account even when the identification procedure has been successfully carried out. Generally, the design of the Registry account procedures does not mandate the opening of a Registry account. For example, once the application is correctly completed and requested information is proven to be authentic, the Regulator must be satisfied that the applicant is a fit and proper person (based on specified criteria: r 13.2(c)) and an account should be opened. Notably, in the absence of legislation defining and limiting the exercise of the Regulator’s discretion to open an account, the discretion will be left to be defined (by the Regulator, with or without consultation) in future Registry Regulations and administrative practices developed by the Regulator. Section 82 of the Registry Act makes the decision to refuse to open a Registry account subject to administrative review.

Registry Regulation 13 provides that the Regulator may open a Registry account if requested to do so.

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PROOF OF IDENTITY An individual must supply certified copies of two individual identification documents. At least one of which is a primary photographic identification document or a primary non-photographic identification document. A company must supply a certified copy of their certificate of incorporation, certificate of registration or a document of similar effect, and a company identification document. An incorporated association must supply a certified copy of their certificate of incorporation or equivalent, issued under a law of a state, territory or the Commonwealth, and a non-individual identification document. A body established under legislation must supply a non-individual identification document. A corporation sole or body corporate (not mentioned above) must supply a certified copy of a document evidencing the person’s corporate status, and a non-individual identification document. A trust must supply a certified copy of the trust deed, a certified copy of an extract of the trust deed which identifies the trustees, or a document of similar effect. For each trustee, if the trustee is an individual, the documents required for individuals must be provided, or if the trustee is not an individual, a non-individual identification document.

Note that consultation draft regulations “Clean Energy Amendment Regulation 2012 (No )” proposes that any document required to be provided to the Regulator must be current at the time it is provided.

IDENTITY DOCUMENTS Primary photographic identification document: a driver’s licence, passport, state or territory identity card, national identity card, or some other document satisfactory to the authority. Primary non-photographic identification document: birth certificate, citizenship certificate, pension card or some other document satisfactory to the Authority. Company identification document: a certified copy of a document from ASIC that identifies the person’s ABN, or a non-individual identification document. Non-individual identification document: a certified copy of a document from the Australian Taxation Office which identifies the person’s ABN or GST registration number, or any other document that is satisfactory to the Authority.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

Section 64 of the CFI Act states in determining if an applicant is a fit and proper person: a. The Administrator [read, Regulator] must have regard to: i.

Whether the applicant has been convicted of an offence against a law of the Commonwealth, a state or a territory, where the offence relates to dishonest conduct.

ii.

Whether the applicant has been convicted of an offence against a law of the Commonwealth, a state or a territory, where the offence relates to the conduct of a business.

iii.

Whether the applicant has been convicted of an offence against section 136.1, 137.1 or 137.2 of the Criminal Code.

iv.

Whether an order has been made against the applicant under section 76 of the Competition and Consumer Act 2010.

Whether an order has been made against the applicant under section 224 of Schedule 2 to the Competition and Consumer Act 2010, as that section applies as a law of the Commonwealth, a state or a territory.

vi. Whether the applicant has breached this Act or the associated provisions. vii. Whether the applicant has breached the Australian National Registry of Emissions Units Act 2011 or regulations under that Act. viii. Whether the applicant has breached the National Greenhouse and Energy Reporting Act 2007 or regulations under that Act. ix. If the applicant is a body corporate - whether an executive officer of the body corporate has been convicted of an offence against a law of the Commonwealth, a state or a territory, where the offence relates to dishonest conduct. x.

If the applicant is a body corporate - whether an executive officer of the body corporate has been convicted

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of an offence against a law of the Commonwealth, a state or a territory, where the offence relates to the conduct of a business. xi. If the applicant is a body corporate - whether an executive officer of the body corporate has been convicted of an offence against section 136.1, 137.1 or 137.2 of the Criminal Code. xii. If the applicant is a body corporate - whether an order has been made against an executive officer of the body corporate under section 76 of the Competition and Consumer Act 2010. xiii. If the applicant is a body corporate whether an order has been made against an executive officer of the body corporate under section 224 of Schedule 2 to the Competition and Consumer Act 2010, as that section applies as a law of the Commonwealth, a state or a territory. xiv. If the applicant is a body corporate - whether an executive officer of the body corporate has breached this Act or the associated provisions. xv. If the applicant is a body corporate whether an executive officer of the body corporate has breached the Australian National Registry of Emissions Units Act 2011 or regulations under that Act. xvi. If the applicant is a body corporate whether an executive officer of the body corporate has breached the National Greenhouse and Energy Reporting Act 2007 or regulations under that Act. xvii. Such other matters (if any) as the Administrator considers relevant. b. If the applicant is an individual - the Administrator is satisfied that the applicant is not an insolvent under administration. c. If the applicant is a body corporate - the Administrator is satisfied that the applicant is not an externally-administered body corporate. d. If the regulations specify one or more other eligibility requirements, the Administrator is satisfied that those requirements are met.

5.2 REGISTRY ACCOUNTS

5.2.2 TRANSFERRING IN PRESCRIBED

FOR ELIGIBLE INTERNATIONAL

INTERNATIONAL EMISSIONS UNITS

EMISSIONS UNITS 5.2.1 REGISTRY ACCOUNTS HELD IN OVERSEAS CARBON MARKETS Persons and entities who hold a registry account in the European Union Emissions Trading System (EU ETS) or the New Zealand Emissions Trading Scheme (NZ ETS) may also wish to hold a Registry account in Australia. Liable entities and market participants who transact in overseas carbon markets will be required to separately verify their identity in the Australian carbon market. At present, there is no reciprocal recognition between Registry accounts in different jurisdictions. As carbon markets commence operating globally, account opening procedures between jurisdictions may be harmonised so that direct and indirect linking of registries will eliminate the need for each country to duplicate identification procedures for account opening.

All Kyoto units are able to be held and transferred in the Australian Registry. Transfers may occur between a foreign account and an account in the Registry, as well as between any of the account types in the Registry. The importation of Kyoto units will be a taxable event. Further, from 1 July 2015, the surrender of CERs and ERUs will be subject to the Clean Energy (International Unit Surrender) Charge Act 2011 (Cth), which is designed to complement the proposed floor price for carbon units from 1 July 2015. In December 2011, the Government released a discussion paper entitled Price floor for Australia’s carbon pricing mechanism: Implementing a surrender charge for international units outlining four options for implementing the charge under the above act. Submissions in response to the discussion paper closed on 9 February 2012. At the date of this report, no decision had been made on the method(s) for implementation.

6. AUCTION OF EMISSIONS UNITS The primary market for domestic emissions units will be auctions conducted by the Regulator for original issues of carbon units. The Minister for Climate Change and Energy Efficiency will in due course, by legislative instrument, determine the policies, procedures and rules that apply in relation to auctioning of carbon units by the Regulator.31 The auction regulations may also prescribe the type of auction format (expected to be an ascending clock auction) and limits on the total number of carbon units with a particular vintage year that may be acquired by a person or members of a corporate group as a result of a particular auction.32 The Government released a paper on 3 February 2012 discussing the auction regime entitled Position paper on the legislative instrument for

auctioning carbon units in Australia’s carbon pricing mechanism. The Government acknowledges that “an auction scheme that exhibits a high degree of integrity and is free from misconduct would provide participants with confidence in the auction process and ensure that it operates efficiently and competitively”.33 Proposals to ensure efficient and effective auctions which are free of manipulation and collusion include: »»

Empowering the Regulator to address misconduct in the auction scheme through the auction determination.

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The Regulator being responsible for conducting and monitoring the auction of units, enabling the Regulator to observe, through the auction process itself, the actions of participants directly.

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In the event that a participant breaches its contract with the Regulator by engaging in misconduct, the Regulator would have the power to terminate the contract, meaning the participant would not receive the carbon units under the contract. Replicating the prohibitions against misconduct in Part 7.10 of the Corporations Act in auctions.

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Giving the Regulator the power to disqualify participants found to have engaged in misconduct in relation to an auction from participating in future auctions (CE Act, s 113(6)).

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Limiting the maximum parcel of carbon units that can be purchased by any one bidder in any one auction to 25 per cent of all carbon

units offered in that auction round. »»

Holding up to six auctions of vintage carbon units for each eligible financial year – four auctions in the current eligible financial year, and at least one auction before the 1 February true-up date.

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Requiring applicants to lodge some form of acceptable collateral, financial guarantee or cash deposit that would ensure that bidders would be able to pay for the units they buy at auction (reinforced by the fact that the Regulator will not be able to issue a carbon unit until payment is made in any event).34

Submissions in relation to the discussion paper closed on 24 February 2012. As at the date of this report, the Government has not released the policies, procedures or rules for auctions.

7. TRANSFER OF EMISSIONS UNITS The ETS contemplates trading of carbon units.

7.1 RULES FOR TRANSFERS

However, carbon units issued by the Regulator for a fixed charge will be automatically surrendered.

Trading of carbon units is an activity different to cancelling or surrendering carbon units.

In the fixed price period from 1 July 2012 to 30 June 2015, carbon units issued free exist until they are surrendered or cancelled (automatically on 1 February in the next compliance year). A window for trading will exist between issue and surrender or cancellation.

A trade of an interest in a carbon unit will usually involve the transfer of ownership of that interest in the carbon unit from the vendor to the purchaser. In some transactions the interest in the carbon unit could be loaned rather than sold.

In the flexible price ETS from 1 July 2015, carbon units will have an indefinite life until cancelled or surrendered. Thus, once issued, they may be sold through licensed financial markets or by private treaty or OTC trading platforms. This section deals with: »»

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Rules for transfer (which are contained in both the CE Act and the Registry Act) and

For transfers of legal title, both vendor and purchaser must have a Registry account. A change in ownership of the legal title in a carbon unit will be recognised only when completed within the Registry in accordance with the CE Act and the Registry Act, by removal of the carbon unit from the transferor’s Registry account and entry of the same carbon unit into the transferee’s Registry account. Legal transfer of a carbon unit is not determined by the contract between the vendor and purchaser.

Deferral of transfers.

The transfer of the unit from one Registry account to a Registry account kept by another person involves the removal of the entry for the unit from the first Registry account, and the making of an entry for the unit in the Registry account kept by the other person.

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To complete the legal transaction, the transferor must transmit an electronic notice to the Regulator, instructing the Regulator to transfer the unit(s) from the relevant Registry account kept by the transferor to a Registry account kept by the transferee. A transfer transaction is not complete in the Registry until the Regulator complies with a removal and entry instruction.

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The integrity of the Registry.

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Prevent, mitigate or minimise abuse of the Registry.39

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Prevent, mitigate or minimise criminal activity involving the Registry.40

The Regulator must give written notice as soon as practicable after an instruction is refused.

7.2 DEFERRAL OF TRANSFERS

7.2.3 CONDITIONAL TRANSFER

There are three circumstances in which the Regulator is empowered to defer giving effect to a transfer instruction:

The Regulator may impose conditions prohibiting, restricting or limiting the transfer of units to or from the Registry account or otherwise restricting or limiting the operation of the Registry account for a specified period, either on its own motion, or upon request by written instrument.41

Protecting Registry integrity.

Indefinite refusal.

Imposing conditions on transfer.

The Regulator may also suspend a Registry account. Suspension is discussed in s 12.2.

7.2.1 UNFETTERED DEFERRAL The Regulator may defer giving effect to the transfer instruction for a period not exceeding 48 hours.35 The Regulator must be satisfied that it is prudent to defer the transfer instruction in order to ensure: »»

The integrity of the Registry.

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Prevent, mitigate or minimise abuse of the Registry.36

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Prevent, mitigate or minimise criminal activity involving the Registry.37

The Regulator is not required to give any prior notice of such deferral.

7.2.2 INDEFINITE DEFERRAL The Regulator may indefinitely refuse to give effect to a transfer instruction if notice of such refusal is provided.38 The Regulator may refuse to give effect to the instruction if the Regulator is satisfied that it is prudent to do so in order to ensure:

The Regulator must give a copy of the instrument to the account holder as soon as practicable after the instrument is made.42 A deferral of a transfer transaction resulting from the exercise of the Regulator’s discretion is not an excuse for failure to surrender eligible emissions units in accordance with the provisions of Part 6 of the CE Act. Accordingly, a liable entity may be exposed to a unit shortfall penalty if a unit shortfall arises as a result of not being able to transfer carbon units (needed for surrender) due to actions outside the control of liable entities such as a delay in transfer or the imposition of a condition or suspension of a Registry account initiated by the Regulator. The powers of the Regulator exceed regulatory powers in the EU ETS. For example, the EU registry regulations provide for a delay of 26 hours between initiation of a transaction and the transfer being communicated for finalisation. During this period, an account representative may propose the cancellation of the transaction on the grounds of suspicion of fraudulent initiation. In the EU ETS, the 26-hour delay applies to all transfer instructions. However, in order to further limit the scope of this rule, transfers between “trusted accounts” will be exempted from the time delay. (See Carbon Market Integrity: Integrity and Oversight of the European Union Emissions Trading System, section 5.2 for further analysis.) The concept of trusted Registry accounts does not apply in Australia.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

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8. OTC TRANSACTIONS In the early years of the EU ETS, the majority of trading occurred in one to one over the counter (OTC) transactions rather than on public exchanges.43 However, as the EU ETS has evolved, there has been a steady shift away from OTC transactions towards those on public exchanges. There are multiple reasons for this. Firstly, there is increased liquidity on some exchanges, which attracts trading. Secondly, the exchanges allow traders to avoid OTC counterparty credit risk. Lastly, the EU regulators are promoting reforms in response to the GFC designed to improve market transparency by the use of centralised and regulated exchanges. Accordingly, the Australian carbon markets may evolve in the same way as the EU ETS, particularly because the price of carbon units will be fixed with limited trading potential and hence liquidity in the fixed price period. Transactions in the secondary and derivative markets include private OTC trades as well as exchange trades. OTC [derivatives] are contracts whose fundamental economic terms are not standardised, and therefore require bilateral negotiation between counterparties... In OTC markets, unlike on-exchange markets, participants trade directly with each other, typically by telephone or computer... Also unlike on-exchange markets, there is no centralised mechanism for the public determination and dissemination of OTC market prices.45

The transfer of emissions units and interests in emissions units via private OTC trades and/ or through licensed or exempt financial markets will only require the transmission of an electronic transfer instruction from the vendor to the Regulator if it is necessary to reflect a change in legal ownership OTC transactions are not governed by licensed market integrity rules.

8.1 BILATERAL OTC, BROKERED OTC AND EXCHANGE CLEARED OTC TRANSACTIONS OTC transactions in Australia do not require central clearing.46 Parties may choose to deal directly with each other by private treaty (bilateral OTC) or they may seek out a broker to act on their behalf in negotiating and facilitating transaction execution (brokered OTC). In order for the parties to complete the legal transaction, the transferor must transmit an electronic notice to the Regulator, instructing the Regulator to transfer the unit(s) from the relevant Registry account kept by the transferor to a Registry account kept by the transferee.

The terms of private trades will reflect bargaining and agreement reached between the vendor and purchaser of emissions units, one to one or via brokers.

OTC trading platforms operate in the global carbon markets and offer a platform in Australia for exchange of voluntary emissions reduction units (VERs) and other environmental commodity products such as Renewable Energy Certificates (RECs). Such exchanges include Brokers Carbon, CarbonTradeXchange (CTX), Markit and Mercari FEX. At the date of this report, these are not licensed financial markets and as yet do not operate in the compliance market.

Organisations such as the International Emissions Trading Association (IETA) and the Australian Financial Markets Association (AFMA) have developed precedent purchase and sale agreements in order to standardise and streamline risks and documentation between parties, and accordingly to facilitate and implicitly regulate trade. The IETA Master Agreement and the AFMA EP Spot Contract may be freely used.

In June 2011, the Council of Financial Regulators released a discussion paper titled, “Central Clearing of OTC Derivatives in Australia” which considered the need for centralised clearing of certain financial instruments in Australia. The discussion paper did not specifically address carbon units. As at the date of this report no recommendations have been made by the Council of Financial Regulators.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

8.2 DERIVATIVES Derivative transactions47 will not appear in the Registry because they involve transactions in interests in carbon units which do not involve any change in the legal ownership of the underlying carbon units. If there is no change in legal ownership, then the rules in the CE Act and the Registry Act governing transfers of legal interests (discussed above) will not apply to the derivatives transactions.

whatsoever and whether or not deliverable), including, for example, one or more of the following: i.

An asset.

ii.

A rate (including an interest rate or exchange rate).

iii. An index. iv. A commodity.50

Derivatives are “financial products” identified (defined) in the Corporations Act48 by reference to their functions or commercial nature.49 Accordingly, the Corporations Act provides a list of conditions that must be satisfied in order to meet the definition of derivative, including: a.

Under the arrangement a person must or may be required to provide consideration at some future time.

For all contracts (other than foreign exchange contracts) settlement occurs more than one day later and the amount of the consideration, or the value of the arrangement, is ultimately determined, derived from or varies by reference to (wholly or in part) the value or amount of something else (of any nature

The rules applying to financial products are discussed in s 11. Derivatives contracts over carbon units may be structured to attract an exemption for cash or physical delivery/set-off which takes those types of derivatives contracts outside the definition for the Corporations Act. Because s 122(1) of the CE Act provides that only the registered holder of a carbon unit may surrender the carbon unit to the Regulator, the delivery of carbon units in settlement would most often be preferred in lieu of any cash payment or offset. So structured, these products would not be defined as derivatives, and hence not regarded as financial products (although carbon units will be a financial product).

9. TRANSACTIONS ON FINANCIAL MARKETS The Australian Securities and Investments Commission (ASIC) is responsible for the supervision of financial markets in Australia, and has promulgated Market Integrity Rules for these markets.51 The pathways for evolution of the Australian carbon markets may result in: »»

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The creation of one or more licensed financial markets for carbon units - a new Australian carbon exchange could be a licensed market and operated by a licensed operator, and participants in the market would be licensed brokers and/or Existing licensed financial markets in Australia trading carbon units - if carbon units were traded on the Australian Securities Exchange (ASX) or Chi-X markets, or on

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another licensed financial market, the trades would ordinarily be subject to ASIC supervision because such markets are generally supervised by ASIC under Pt 7.2A of the Corporations Act. In the EU there are five public exchange markets for carbon units. (See Carbon Market Integrity: Integrity and Oversight of the European Union Emissions Trading System, section 5.4 for further analysis.) The Australian secondary and derivative markets for carbon units would ordinarily fit the definition of a financial market.52 Protection of the public, liable entities and investors, and hence market credibility, suggests that:

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There should be at least one recognisable Australian public exchange carbon market.

Carbon units (as well as ACCUs) will be treated as cash market products.

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Any operator of that Australian carbon market exchange should be licensed.

ASIC Market Integrity Rules distinguish between the cash market and the derivatives market (both are defined as market transactions).55

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Market integrity should be addressed by ASIC Market Integrity Rules and/or market operator rules specifically tailored for this market.

A carbon unit will be a “financial product” for the Corporations Act and the ASIC Act.53

The cash market covers transactions between market participants with the right to submit trading messages into a trading platform (trading participants) in relation to cash market products. See figure 4.56

The Government has defined carbon units as financial products (inter alia) in order to reduce the risk of market manipulation and misconduct.54

The derivatives market covers transactions in relation to derivatives market contracts made between the trading participants. See figure 4.57

Figure 4: Cash market and derivatives market

Cash market products

Derivatives market contracts

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Quoted products which are financial products that have been granted official quotation on the ASX (including carbon units if quoted).

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Warrants, financial products which are a managed fund product, an ETF Security (a financial product issued by a managed fund listed on the market) or a structured product.

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Futures market contracts (defined to mean a contract in which futures contracts are authorised for trading by the ASX).

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Options market contracts.

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Any other contracts authorised for trading as a derivatives market contract.

9.1 LICENSED MARKET, OPERATOR AND PARTICIPANTS As noted, as at the date of this report, an Australian carbon market is not defined as a financial market licensed (or to be licensed) under the Corporations Act, nor has any Australian carbon market been made the subject of its own market integrity rules.

9.1.1 LICENSED MARKET

If an Australian carbon market was licensed as a financial market it could be subject to two regulators (ASIC and the Regulator). The Minister for Financial Services (on advice from ASIC) will grant a financial market licence if satisfied: »»

The application was made in accordance with the Act.

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The applicant (the operator of the licensed market) will comply with its obligations.

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The applicant has adequate operating rules and procedures in place to ensure the market is fair, orderly and transparent.

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The applicant has adequate clearing and settlement arrangements for transactions.

An Australian licensed financial market is a financial market licensed under the Corporations Act.58

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There is no unacceptable control situation.

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No disqualified person appears to be involved in the application.59

The Minister for Financial Services holds substantial powers over the licensee. The Minister may impose, vary or revoke conditions as well as cancel or suspend market licences. Once a licence is granted, the operating rules of a licensed market have the legal effect of a contract between the licensee and each participant, as well as between participants.60

9.1.2 LICENSED OPERATOR A licensed market operator is the holder of an Australian market licence. It is an offence to operate a financial market in Australia without a licence.61 The MInister for Financial Services may provide an exemption from the licence requirement.62 Effective 1 August 2010, ASIC recognised six financial markets in Australia and promulgated market integrity rules. The six markets and rules are: »»

ASIC Market Integrity Rules (ASX Market) 2010.

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ASIC Market Integrity Rules (ASX 24 Market) 2010.

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ASIC Market Integrity Rules (APX Market) 2010.

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ASIC Market Integrity Rules (IMB Market) 2010.

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ASIC Market Integrity Rules (NSXA Market) 2010.

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ASIC Market Integrity Rules (SIM VSE Market) 2010.

In 2011, a further two markets were recognised and corresponding market integrity rules were made:63 »»

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The Chi-X Australia market will compete with the ASX market as the Australian stock exchange for exchange of shares in publicly listed Australian companies.64

9.1.3 PARTICIPANTS The definition of market participant in ASIC Market Integrity Rules follows the definition of participant in s 761A of the Corporations Act;65 this is generally a person, in relation to a financial market, who is allowed to directly participate in the market under the market’s operating rules. A participant in the ASX market admitted under the ASX Operating Rules67 is a market participant. The ASX rules provide for direct admission to the ASX market either as a “Market Participant” or “Market Participant (Principal Trader)” into the “Cash Market” and/or the “Derivatives Market”. Admission to each market and for each type of participant is governed by the ASX Operating Rules. Any entity prescribed by regulations made under the Corporations Act required to comply with the ASX Market Integrity Rules is also considered a regulated entity. No regulations prescribing other entities have been promulgated. The meaning of participant makes a distinction between direct and indirect participation. Brokers who are licensed as financial services providers need to be admitted as Market Participants by the ASX in order to be authorised to deal on behalf of their clients in financial products (discussed in s 11). The ASX Operating Rules bind only the exchange and brokers, not the exchange and clients, or the exchange, brokers and clients.

9.2 ASIC MARKET INTEGRITY RULES The Corporations Act permits ASIC, with the written consent of the Minister for Financial Services and Superannuation and by legislative instrument, to make rules (called market integrity rules) which deal with:

ASIC Market Integrity Rules (Chi-X Australia Market) 2011.

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The activities or conduct of Australian licensed markets.

ASIC Market Integrity Rules (Competition in Exchange Markets) 2011.

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Persons in relation to those markets.

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Financial products traded on those licensed markets.

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It is a civil penalty not to comply with the market integrity rules.

ASX and ASX 24 markets”.75 The expressions are not defined in any ASIC Market Integrity Rules.

Market integrity rules are limited to on-market trading in the covered markets; each are domestic financial markets licensed under s 795B(1) of the Corporations Act.68

Justice Perram of the Federal Court of Australia considered the meaning of the expression “fair, orderly and transparent market” in the case of Transmarket Trading Pty Ltd v Sydney Futures Exchange (2010) 188 FCR 1. Perram J concluded that the expression is a “composite phrase to be interpreted as a whole and not in parts”.76 Further, he concluded that the phrase suggests a link “between the notion of fair and orderly markets and the conduct of a more efficient and effective market”.77 He continued:

The following entities must comply with the market integrity rules: »»

Operators of licensed markets.

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Participants in licensed markets.

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Entities prescribed by the regulations.

It is, I think, impossible to give an exhaustive statement of what is comprehended in the notion of a fair, orderly and transparent market. It suffices for present purposes, however, to observe that it appears to have at least two concepts at its core. One relates to a state of affairs in which all market participants are placed in an equal position such that there is a level playing field. The second, which is encompassed by the word ‘orderly’, is the notion of reliable market operations displaying price continuity and depth, and in which unreasonable price variations between sales are avoided.78

All of the Australian market integrity rules follow a similar approach. The structure of the regime, the expectation of behaviour and the compliance frameworks are replicated across all markets targeted by the rules. The Financial Services Reform Act 2001 (Cth) (FSR Act) also requires that participants in licensed markets that provide services for retail clients have compensation arrangements in place. The arrangements take the legal effect of a contract between the operator and each participant as well as between participants.69 The Government has promised appropriate adjustments will be made to existing market integrity regimes to fit the characteristics of carbon units and a carbon market and hence avoid unnecessary compliance costs. No proposals have been forthcoming as at the date of this report.

The general rule is that a market participant is required to allocate market transactions fairly.

9.3 FAIR AND ORDERLY MARKET

If a Trading Participant has or receives an Order to buy or sell an Underlying Financial Product in the Underlying Market which may materially affect:

The ASIC Market Integrity Rules deal extensively with all facets of trading activity.70 Under the ASIC Market Integrity Rules (ASX Market) 2010, ASX Limited, as the market licensee, is required to do all things necessary (to the extent it is reasonably practicable) to ensure that the ASX market is “fair, orderly and transparent”. The ASX Market Integrity Rules apply the same requirement to participants. The maximum penalty for breaching these rules is $1 million. The expressions “fair and orderly market”73 and “integrity of the market”74 are not defined in the ASX Market Integrity Rules or in Regulatory Guide 214 “Guidance on ASIC market integrity rules for

Special rules apply to unexecuted orders in underlying financial products:79

The market price of the Underlying Financial Product in the Underlying Market.

The level of an Underlying Index, the level of which is calculated by reference to the value of that Underlying Financial Product and other Products.

The Trading Participant must not make Bids or Offers to enter into an Options Market Transaction over that Underlying Financial Product as Principal until the order in the Underlying Financial Product has been executed in the Underlying Market. For a derivatives market contract, the underlying

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

financial product would be the carbon unit, and the underlying market would be the ‘market in the instruments, commodities, securities or other things which underlie the derivatives market contract”.80 The expression “Options Market Transaction” is limited to a market transaction for one or more options market contracts, defined as a contract on the terms of an option series, which is a set of contractual terms on which options are authorised for trading by the ASX.81 The special rules are limited to options contracts and to the timing of placing of bids for such contracts. The creation or entering into of other structured or synthetic products is not prohibited. The rules apply only if the order for the underlying product (the carbon unit) would materially affect the market price of the underlying financial product in the underlying market (i.e. the ASX), and automatically ceases to apply when the order is placed in the underlying market. If a retail client82 has vested a market participant with discretion in the management of the client’s portfolio assets (a managed discretionary account), then a market participant must not enter into market transactions “where the size or frequency … may be considered excessive having regard to the investment objectives, financial situation and needs of the client and the relevant markets”.83 The excessive trading rule does not apply to trading activity which occurs upon instruction or to trading with discretion for large sophisticated corporations such as financial intermediaries in carbon units who do not meet the description of retail client. Other ASIC Market Integrity Rules (applicable to carbon units) will also promote a fair and orderly carbon market. Notably: »»

Rules are prescribed (ASX Market Integrity Rules, Pt 5.3, Large Order Facilitation) (assuming that carbon units would be prescribed as an underlying commodity) for action a market participant must take when there are insufficient opposite orders in futures markets contracts.

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Internal consent must be obtained for every trade by connected persons.

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A trading participant must have in place arrangements for determining the origin of all orders and trading messages, thereby facilitating record keeping and audit and investigation by the Regulator.

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A market participant is prohibited from taking advantage of a situation arising as a result of a breakdown or malfunction in the ASX’s procedures or systems, or an error in any trading message submitted by the market operator.

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A trading participant must have and maintain the necessary organisational and technical resources to ensure that: ›› Trading messages (including automated trading) submitted by the trading participant do not interfere with the efficiency and integrity of the market or the proper functioning of a trading platform. ›› The trading participant complies at all times with the relevant Rules.

The application of the fair trading rules is objective; strict liability is imposed on market participants for acting and failing to act, and their conduct may be judged by whether the result of acting or failing to act is an unfair or unorderly market. Doing or failing to do anything would include merely placing an order on behalf of a client.

9.4 ENFORCEMENT OF MARKET CONDUCT ASIC has established a Markets Disciplinary Panel (MDP).84 ASIC intends to refer to the MDP all market conduct matters which ASIC considers could be dealt with by an infringement notice and/or enforceable undertaking.85 However, the MDP will operate entirely in retro-active mode. An 11-stage process has been established,86 with the MDP aiming to complete stage four (to convene a sitting panel of the MDP to consider the matter) within six months of identification of an alleged breach of the market integrity rules, and to complete stage seven (reaching a decision as to whether or not to issue an infringement notice) within nine months. Corporations Act enforcement action is targeted at brokers, not their clients.87 The Federal Court of Australia has the power to order compliance with or enforcement of the operating rules. Companies are deemed to be under an obligation to comply with the market integrity rules for the purposes of enforcement.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

10. SPECIAL DEALINGS Special market integrity rules could potentially apply to certain dealings in carbon units and interests in carbon units if undertaken on ASX and ASX24 (and any futures licensed markets with similar market integrity rules). This section addresses: »»

Short-selling.

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Wash trades.

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Corners.

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Dealing and dealing on own account.

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Manipulative trades.

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Monopoly conduct.

10.1 SHORT SELLING The Corporations Act permits limited short selling of certain securities and financial products (called s 1020B products), and bans “naked short selling”.88 Generally, a person must only sell s 1020B products if at the time of the sale (which includes the time of the offer to sell) the seller has a presently exercisable and unconditional right to vest the products in the buyer.89 Thus the seller must already own the products (or own them subject only to payment and/or transfer conditions).90 Exposure draft amendments to the Corporations Regulations (Corporations Amendment Regulations, first released 30 October 2009 and re-released (in part) 22 November 2011) would have added eligible emissions units (carbon units, ACCUs and EIEUs such as CERs and ERUs) to the list of s 1020B products by adding an additional paragraph to the list of prescribed financial products in the Corporations Regulations.91 Such a rule would mirror the requirement for a transferee of a carbon unit to already hold a Registry account. The rule would have stopped selling (spot sales) of eligible emissions units which were not already owned, but would not have stopped other derivatives transactions.92

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Short selling prohibitions operating in tandem with other Corporations Act rules against market misconduct and market manipulation would benefit orderly trading in carbon units. However, an exposure draft of Corporations Amendment Regulations 2012, released 3 February 2012, does not include eligible emissions units as listed s 1020B products, thereby permitting their short sale if the regulations are promulgated as drafted.

10.2 WASH TRADES The ASX Market Integrity Rules specifically deal with futures market transactions. The intention of the wash trades rule is that it captures the one “client” taking both positions in the one transaction. The general rule is that a market participant must not affect any futures market transaction “where the account on behalf of which the Market Participant enters into the Futures Market Transaction is the same on both sides of the transaction”. The maximum penalty for doing so is $100,000.93

10.3 CORNERS ASIC may suspend dealings and give directions in relation to financial products if they deem that it is necessary or in the public interest to protect people dealing in the financial product.94 ASIC is empowered under the ASX Market Integrity Rules to intervene in the market (this is real-time intervention) if it believes that one person is, or two or more persons acting in concert are, attempting to corner the market.95 ASIC’s discretion will be triggered if in its opinion, a level of control of a quoted product has been acquired such that the quoted product cannot be obtained for delivery on existing contracts except at prices, or on terms arbitrarily dictated by the holder(s) of the quoted product which are unfair, harsh, or unconscionable. In such circumstances, ASIC may:

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For the purpose of enabling equitable settlement to be effected on the contracts, postpone (or from time to time further postpone) the times for deliveries on contracts for any such quoted product.

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At any time declare that if a quoted product is not delivered on any contract requiring delivery on or before the time to which delivery has been postponed, such contract will be settled by payment to the party entitled to receive the product, or by the credit to such party of a fair settlement price.96

in relation to a carbon unit refers to the person who has a Registry account with an entry for the unit.97 The CE Act is silent as to whether the holder of the carbon unit must be its beneficial owner because the CE Act will permit the creation of equitable interests and security interests in carbon units. Section 12 of this report discusses title to carbon units.

10.5 MANIPULATIVE TRADING

10.4 DEALING, AND DEALING

Market misconduct and other prohibited conduct relating to financial products and financial services is the subject of Corporations Act rules. Examples of market misconduct include:

ON OWN ACCOUNT

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Persons “dealing” in carbon units will require an Australian financial services licence (AFSL). The rules for AFSLs are discussed in s 11.

Manipulation of the price for trading in financial products on a financial market operated in the jurisdiction.

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Engaging in false or misleading appearances of active trading or creating an artificial price for trading in financial products.

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Engaging in fictitious transactions which result in the price for trading in financial products on a financial market being maintained, inflated or depressed.

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Engaging in dishonest conduct in relation to a financial product or financial service.

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Civil liability for misleading or deceptive conduct in relation to a financial product or a financial service.

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Insider trading of specified products.

A market participant must “deal fairly and in due turn” with clients’ orders, and between client orders and an order on its “own account”. The maximum penalty for breaching this market integrity rule is $1 million. An order for cash market products (i.e. carbon units) would be to the account of a market participant (as opposed to a client) where the product would be beneficially owned by the market participant. An order for a derivatives market product would only be to the account of a market participant if the order was entered on its behalf. The meaning of dealing as principal extends to associated and related persons and entities, other than where the market participant deals as a trustee of a trust in which there is no direct or indirect beneficial interest (for example, as a nominee). The registration of an equity security in the name of a market participant is prohibited if the market participant is not the beneficial owner of the equity security. The use of the expression “beneficial ownership” in the ASX Market Integrity Rules does not require that the market participant be the “holder” within the meaning of that term in the CE Act. The carbon units need not reside in a Registry account in the name of the market participant. A person will hold an eligible emissions unit if the person is the registered holder of the unit. The registered holder

Failure to comply with any of these provisions is an offence. Offenders are liable for a civil penalty of up to $22,000 or up to five years imprisonment.98 The ASX Market Integrity Rules also deal with manipulative trading. Manipulative trading is specifically targeted at the creation of a false or misleading appearance of: »»

Active trading in any product.

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The market for any product.

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The price of any product.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

The rule against manipulative trading prohibits a market participant from making a bid or offer, or dealing in any product (cash products and derivatives products) either as principal or on account of any other person: »»

With the intention of creating a false or misleading appearance.

»»

If that is another person’s intention.

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If the market participant ought to reasonably suspect that that is another person’s intention, objectively determined from the circumstances.99

A market participant must have regard to the following matters when determining the circumstances of an order (i.e. the bid, offer or other dealing): »»

Whether the order or execution of the order would be inconsistent with the history of or recent trading in that product.

»»

Whether the order or execution of the order would materially alter the market for, or the price of, the product.

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The time the order is entered or any instructions concerning the time of entry of the order.

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Whether the person on whose behalf the order is placed, or another person who the market participant knows to be a related party of that person, may have an interest in creating a false or misleading appearance of active trading in any product or with respect to the market for, or the price of, any product.

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Whether the order is accompanied by settlement, delivery or security arrangements which are unusual.

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Where the order appears to be part of a series of orders, whether when put together with other orders which appear to make up the series, the order or the series is unusual having regard to the matters referred to in the market integrity rules.

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trading in or with respect to the market for, or price of, any product. »»

Whether the transaction, bid or offer will involve no change of beneficial ownership.100

Failure to have regard to the above factors attracts a $1 million maximum penalty.

10.6 MONOPOLY CONDUCT Participation in the carbon market and liability under the CE Act are not the same concept. There is no rule in the CE Act preventing monopoly conduct in carbon units.101 Generally, anti-competitive conduct in Australia is addressed by the Competition and Consumer Act 2010 (Cth) (C&C Act) (formerly the Trade Practices Act 1974 (Cth)). The C&C Act makes provision for monopolistic and market-making conduct, but only where a dominant market participant makes an attempt at cornering the market. The C&C Act provides that a corporation must not make a contract or arrangement, or arrive at an understanding, if a provision of the proposed contract, arrangement or understanding has the purpose, or would have or be likely to have the effect of substantially lessening competition.102 Further, if a corporation has a substantial degree of market power it shall not take advantage of that power in that or any other market for the purpose of: »»

Eliminating or substantially damaging a competitor of the corporation or of a body corporate that is related to the corporation in that or any other market.

»»

Preventing the entry of a person into that or any other market.

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Deterring or preventing a person from engaging in competitive conduct in that or any other market.103

Whether there appears to be a legitimate commercial reason for that person placing the order, unrelated to an intention to create a false or misleading appearance of active

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11. PROVISION OF FINANCIAL SERVICES Most financial services (figure 5)104 provided in relation to carbon units – such as the provision of trading advice, brokerage services, trading platforms, support services, and derivatives over carbon units – will require the service provider to hold an Australian financial services licence (AFSL).

11.1 CARRYING ON A FINANCIAL SERVICES BUSINESS A person who carries on a financial services business in Australia must hold an AFSL authorising the provision of the financial services, unless exempted under the Corporations Act or Corporations Regulations.105 Entities that trade futures and options over carbon units in the financial markets on behalf of clients must hold an AFSL.106 Persons dealing in, making a market for, aggregating and providing advice in relation to carbon units (including ACCUs and EIEUs) may be required to: »»

Hold an AFSL with the appropriate financial services and financial product authorisations from ASIC.

»»

Produce a financial services guide (FSG) where applicable (this requirement is removed for carbon units).

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Direct clients to read the statements published on the website of the Clean Energy Regulator which provide a description of the relevant type of unit.

If a person is merely bidding in auctions, then the requirement for a licence will be exempted.107 Further, it is proposed that an exemption would apply to liable entities dealing in regulated emissions units for the purposes of managing their financial risk in relation to the surrendering, cancelling or relinquishing of regulated emissions units, and to liable entities dealing in regulated emissions units on behalf of a related or associated entity for the same purpose (meaning that they would not require an AFSL for this dealing activity).108

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

Figure 5: Financial services Section 766A of the Corporations Act states that a person provides a financial service if they:

market. Generally, if a person is providing financial services as part of a financial services business, and does not satisfy any of the exceptions, then they will require an AFSL.114 All AFSLs are subject to conditions arising from r 7.6.04 of the Corporations Regulations as well as Pro Forma 209 Australian financial services licences conditions (PF 209).

Provide financial product advice.

Deal in a financial product.

Make a market for a financial product.

Operate a registered scheme.

Generally, a person will be deemed to have provided a financial service if they:

Provide a custodial or depository service.

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Provide financial product advice.

Engage in conduct of a kind prescribed by regulations.

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Deal in a financial product.

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Make a market for a financial product.

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Provide other financial products associated with emissions units by:

Acquiring and disposing of carbon units by a financial intermediary will not amount to dealing, and therefore a financial service if the financial intermediary only trades on its own account (i.e. for its own profit, even if the trades are conducted by a broker).109 The rules applicable to dealings with retail clients impose considerably more onerous obligations than dealing only with wholesale clients (including prohibitions on making unsolicited offers to purchase financial products off market). A new regulation 7.7.10AI of the Corporations Regulations is proposed to modify the Corporations Act s 949A(2)(c) so that warnings which must be given in relation to the provision of general advice would operate if the general advice relates to the acquisition of eligible emissions units.110 This anti-hawking rule111 would require the website address of the Regulator to be disclosed, and inform the client that the client should obtain and consider the emissions unit statement that the Regulator would make under s 202 of the CE Act before making any decisions to acquire the product.112 The operation of commodity trading desks of liable entities (and their related and associated entities) will be sanctioned without a financial services licence, provided that the market dealings do not make a market for the carbon units, EIEUs or derivatives, and the purpose of trading is to manage price risks in eligible emissions units (carbon units, ACCUs, or EIEUs) in relation to their surrender, cancellation or relinquishment.113 In Regulatory Guide 236, published 9 March 2012, ASIC outlined its views about whether an AFSL is required in order to participate in the carbon

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›› Operating a registered managed investment scheme. ›› Providing a custodial or depository service. ›› Providing a traditional trustee company service.

11.1.1 PROVIDING FINANCIAL PRODUCT ADVICE RG 236 differentiates between two types of financial product advice; personal and general advice.115 A person will provide personal advice where:116 »»

The provider of the advice has considered one or more of the person’s objectives, financial situations and needs.

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A reasonable person might expect the provider to have considered one or more of those matters.

General advice covers the remainder of situations that are not deemed to be personal.117 Section 766B of the Corporations Act provides that a person will have provided financial product advice if they put forth a recommendation, or a statement of opinion or a report where they have the intention, or could reasonably be taken to have the intention to influence another person’s decision in relation to a financial product.118 RG 236 adopts this same definition.119

PROVIDING A FINANCIAL SERVICE FOR REGULATED UNITS The important question is: when will a person have provided financial services for regulated emissions units? Merely providing information on regulated units to another person is not necessarily providing a financial service, unless that person has the requisite intent as discussed above.120 RG 236 provides four examples of what may be considered providing advice in this context:121 1.

Advice to liable entities to assist them to make a decision about acquiring or disposing of regulated emissions units. Advice to persons engaged in voluntary offsetting of their emissions (voluntary offsetters) about how to acquire or dispose of regulated emissions units. Advice relating to an offset project in the context of the Carbon Farming Initiative, or to persons seeking to produce EIEUs through the development or operation of international offset projects. Advice to any person about regulated emissions units or products associated with emissions units or environmental units (e.g. derivatives or managed investment schemes).

As noted above, when a person is providing a financial service for regulated emissions units, the Corporations Act makes a distinction between whether the person is a retail or wholesale client. Retail clients are protected by the imposing of additional obligations which “vary depending whether the advice is personal or general”.122 A person providing personal advice to retail clients must comply with provisions of the Corporations Act as well as the Regulatory Guidelines. These include:123 »»

Making reasonable inquiries into the relevant personal circumstances of the client, and having a reasonable basis for the advice.124

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Warning the client if the advice is based on incomplete or inaccurate information.125

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Directing the client to the description of the unit on the website of the Clean Energy Regulator.

Normally when providing financial advice a Statement of Advice (SoA) must be provided,126 but this requirement is replaced by simply providing a direction to the website if the advice concerns emissions units.127

11.1.2 DEALING IN REGULATED EMISSIONS UNITS A person that deals in ACCUs may require an AFSL if the activities constitute dealing in a financial product.128 This occurs where a person is dealing on behalf of others. Some examples of this are:129 »»

Brokering a transaction between two parties.

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The activities of persons such as financial institutions involved with trading units or specialist entities.

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The activities of persons whose business involves acquiring and disposing of units.

11.1.3 MAKING A MARKET IN REGULATED EMISSIONS UNITS A person may be providing a financial service if they are involved in making a market for regulated emissions units. Generally, there are two components for making a market in this context. Firstly, the person regularly states the price to buy or sell units on their own behalf. Secondly, other people can reasonably expect to regularly purchase and sell at the stated prices.130 If those two elements are met, a person may require an AFSL.

11.1.4 LICENCE REQUIREMENT FOR PROVIDING FINANCIAL SERVICE OF REGULATED UNITS In general, those that seek to provide a financial service with respect to emissions units will be required to obtain an AFSL. However, this will not be true in every case.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

First and foremost, the financial service provider must be carrying on a financial services business in Australia to require a licence.131 The expression “carrying on a financial business in Australia” is largely defined by the Corporations Act, but since the statute is not exhaustive, the common law may be considered when making a determination.132

In 2011 the European Commission highlighted the need to prevent money laundering and terrorist financing.138

ABUSE IN THE EU ETS

Secondly, if an exemption applies, a person that is providing financial services as a financial services business in Australia will not require a licence.

The European Commission has highlighted the need to prevent and address other forms of abuse, including money laundering and terrorist financing.

ASIC’s Regulatory Guidelines suggest the following exemptions should be considered most relevant to the carbon market:

In 2011 Liechtenstein launched two investigations into suspected money laundering and document forgery.

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Persons dealing in units on their own behalf.133

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Liable entities that deal in units to satisfy compliance liability under the CPM or some other voluntary scheme.134

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Dealings by liable entities involved in offset projects.135

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Exemptions for persons dealing in derivatives over regulated emissions units and foreign exchange contracts in some circumstances.136

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Exemptions for foreign financial services providers.137

11.2 ANTI-MONEY LAUNDERING AND COUNTER-TERRORISM FINANCING ACT 2006 Under the Anti-Money Laundering and CounterTerrorism Financing Act 2006 (Cth) (AMLCTF Act), a reporting entity must verify a customer’s identity before providing a “designated service.” A designated service is defined as trading, acquiring or disposing of carbon units (including ACCUs, EIEUs and their derivatives) in the course of carrying on a business of acquiring or disposing of carbon units in the capacity of an agent, i.e. as a broker or financial institution. The action to be taken in the event of money laundering is specified in the Anti-Money Laundering and Counter-Terrorism Financing Rules Instrument 2007 (No 1) (Cth) (AML/CTF Rules).

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One investigation involves laundering money through the trade of stolen emissions units. The second probe is investigating allegations that fake documents were used to open registry accounts.

The AMLCTF Act and the AML/CTF Rules operate in tandem with the Registry Act.139 For an individual, the AML/CTF Rules include having “risk-based systems and controls that are designed to enable the reporting entity to be reasonably satisfied in instances where the customer is an individual, that he or she is who they claim to be.” This is often referred to as “know your customer” (KYC) policy. Information that is collected and verified by reliable and independent documentation under this policy includes the full name, date of birth and residential address of the customer, and if a sole trader, the business name, ABN and principal place of business. For an Australian incorporated company, the information to be collected and verified includes the full name of the company as registered by ASIC, the full address of the company’s registered office, the full address of the company’s principal place of business (if any), the ACN issued to the company, details as to whether the company is registered by ASIC as a proprietary or public company, and if the company is registered as a proprietary company, the name of each director of the company. Liable entities and market participants who transact in the carbon markets through a reporting entity will be required to verify their identity twice. The proof of identification under the AML/CTF Rules is duplicated in the proof of identification under the Registry Act.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

12. INDEFEASIBILITY OF TITLE The CE Act defines the carbon unit as personal property.140 The registered holder of the carbon unit is the legal owner, and may deal with the carbon unit at their pleasure, including discharging it in exchange for any consideration.141 Regulations will also provide similar title over prescribed international units.142 The intention of the CE Act is to give the registered holder indefeasible title. However, the general principles will only protect a person who deals with the registered holder of the unit as a purchaser:143

12.1.1 FRAUD In order to ensure the Registry accurately reflects unit holdings and transactions, making a false entry in the Registry or submitting falsified documents are offences under the Registry Act.146 In addition to facing penalties under the Registry Act, a person convicted of an offence involving fraudulent conduct in relation to carbon units may be ordered by a Court to relinquish the carbon units.147 The Cybercrime Act 2001 (Cth) (dealing with serious computer offences) makes it an offence to open an account in a false name by tendering a false identification document.148

»»

In good faith for value.

MAKING A FALSE ENTRY IN THE

»»

Without notice of any defect in the title of the registered holder.

REGISTRY

As noted in s 7 of this report, a transfer of a carbon unit is of no force until it is registered in the Registry. Accordingly, a bona fide purchaser of carbon units is protected only if they purchased the units for value, and without knowledge of any defects in the registered holder’s title to the affected carbon units. Issues of title may come into question should there be fraud, theft or some other breach of the Registry’s security, including computer error.

An offence is committed if a person makes an entry, causes an entry to be made, or concurs in the making of an entry in the Registry that they know is false.149 The penalty for a falsified entry is imprisonment for up to seven years or a fine of up to $220,000, or both.

FALSIFIED DOCUMENTS

12.1 REGISTRY SECURITY

An offence is committed if a person produces or tenders a document which falsely purports to be a copy of or extract from an entry in the Registry.150 The penalty for tendering falsified documents is imprisonment for up to 12 months or a fine of up to $6,600, or both.

Carbon markets have not been immune from criminal conduct.

REGULATOR’S DISCRETION TO PREVENT

In combination, the CE Act144 and the Registry Act will contain measures designed to maintain the integrity of the Registry and prevent against fraudulent or dishonest conduct.145 If fraud, theft and other types of dishonest conduct seen in overseas emissions trading schemes is attempted in Australia, how will they be handled by the ETS?

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INTERNATIONAL FRAUD The Regulator may refuse to make an entry in the Registry account for prescribed international emissions units or incoming transfers of prescribed international emissions units if there are reasonable grounds to suspect that the instruction is fraudulent.151

The Regulator’s discretion may not extend to other types of fraud if the instruction given to the Regulator is not itself fraudulent.

VAT FRAUD IN GERMANY In Germany, six men have recently been accused of conspiring to evade over €230 million in VAT between September 2009 and April 2010. To date, German prosecutors have identified approximately 170 suspects, including seven employees of Germany’s largest bank.

VAT FRAUD IN FRANCE In France, the tax office is demanding €350 million from BlueNext, a French environmental trading exchange, for unpaid VAT-related trades.

For example, through 2009 and 2010, fraud involving the sale of European Unit Allowances (EUAs) within the EU ETS is estimated to have deprived European Union (EU) revenue authorities in excess of €5 billion of value added tax (VAT) due on transactions with EUAs.152 Also known as missing trader or carousel fraud, this type of fraud in Australia would consist of charging and collecting goods and services tax (GST) in a supply of goods or services without remitting the GST to the Government. Transactions involving supplies of carbon units will be GST-free, thus eliminating this risk. However, normal GST rules will apply to transactions involving financial derivatives of carbon units. Powers of the Regulator in relation to suspect instructions will not extend to GST fraud involving derivatives.

12.1.2 THEFT Theft of carbon units is a crime punishable under the Criminal Code Act 1995 (Cth). Theft of carbon units in the EU ETS was perpetrated through hacking of Registry computer systems and phishing scams. These thefts deprived honest entities of millions of their EUAs.

CYBER THEFT IN EUROPE Cyber theft of European emissions allowances in late December 2010 and early January 2011 resulted in the European Commission suspending all transactions in all national registries in the EU ETS (other than allocation and surrender) in early January 2011. The spot market progressively reopened in early March 2011 through to mid-April 2011.

Until discovered, transfer instructions to give effect to the movement of the EUAs from one account in the Registry to another account in the Registry were executed as if the instructions themselves were not fraudulent, although the underlying transfer had been procured by fraudulent means. The discovery and publication of the thefts raised the issue of potential for dealing in stolen goods. Another unresolved issue was the validity of the surrender of EUAs acquired for value and without notice of the fraud. In Australia, the Commonwealth Crimes Legislation Amendment (Telecommunications Offences and Others Measures) Act (No 2) 2004 (Cth) prohibits credit card skimming and internet banking fraud, including phishing.154 Superseded rules for opening an account with the Registry required the account holder to agree to the terms and conditions in the relevant Application

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

Pack (for non-individuals or individuals). These terms and conditions include: »»

»»

Agreeing to not transfer any units to another Registry account or foreign account that the account holder knew, or should reasonably have known, were erroneously transferred to its account, or did not rightfully belong to the account holder.155 Indemnifying the Regulator against all loss or damage in connection with any breach by the account holder of the terms and conditions.156

Will the Regulator have sufficient power under the Registry Act to arrest theft of carbon units?

COURT POWERS OF CORRECTION If a person is aggrieved by an entry wrongly removed from the Registry, he or she may apply to the Federal Court of Australia for the rectification of the Registry.162 The Regulator may take the same course of action.163 However, the Court must not make an order that defeats title properly acquired, as discussed above.164

12.2 SUSPENSION OF OPERATION OF THE REGISTRY

REGISTRY ACT AND REGISTRY

AND REGISTRY ACCOUNTS

REGULATIONS - POWERS OF

The vulnerabilities and potential for abuse of the Australian Registry drew the attention of the Australian Crime Commission in its report entitled Organised Crime in Australia 2011. The Commission has warned that organised crime groups could seek to exploit the complexity of the financial processes involved in emissions trading.165

CORRECTION The Regulator may alter the Registry to correct an entry: »»

Wrongly existing in the Registry.

»»

Wrongly removed from the Registry.157

If the Regulator alters the Registry, the details of the alteration must be published on Regulator’s website.158 However, the Regulator must not exercise this power of correction in a manner which defeats title properly acquired, as discussed above.159

ENTRIES WITHOUT SUFFICIENT CAUSE The Regulator may alter the Registry to correct an entry made in the Registry without sufficient cause.160 Causing an entry to be made in the Registry that a person knows to be false could amount to insufficient cause. Such an entry would include the situation of giving an instruction to move units from one account to another where there is knowledge that the underlying transaction is not legal.161

Cognisant of this warning, the Regulator is entrusted with the integrity of the Registry and empowered to protect it from abuse. This includes the power to temporarily suspend the operation of the Registry if it is prudent in order to:166 »»

Ensure the integrity of the Registry.

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Prevent, mitigate or minimise abuse of the Registry.

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Prevent, mitigate or minimise criminal activity involving the Registry.

If an account is suspended, the Regulator must not give effect to any instruction to transfer units to or from the Registry account, or issue any Australian carbon credit units to the Registry account.167 The exercise of the power to suspend specific accounts must be evidenced by written instrument.168 The Regulator must provide the account holder with a copy of the instrument as soon as practicable after making the instrument. As noted above, the EU is implementing new security measures, including improved spot trading rules, stronger client checks, and allowing

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authorities to delay deliveries or freeze accounts due to suspicious activity.169 The power to suspend specific accounts is critical in order to avoid, or at least minimise, some of the misconduct experienced in Europe. However, the power of the Regulator to close Registry accounts is essentially unfettered. The Registry Act and Regulations provide no guidance on the circumstances in which the Regulator can close accounts.

12.3 COMPUTER ERRORS The Registry will be an electronic register. Therefore the Registry system and communications may be subject to computer errors from time to time.

12.3.1 EXTENSION OF SURRENDER

12.3.3 INFORMATION TECHNOLOGY SECURITY The Government has built the Registry with rigorous technical architecture in line with Defence Signals Directorate information technology (IT) security requirements and standards under the United Nations Framework Convention on Climate Change. In addition to the proof of identity regime that must be passed before users obtain system access credentials, hosting arrangements, system password and login procedures also accord with the Australian Government Protective Security Policy Framework. However, as transactions, communications and other operations will be done on the internet, they will be subject to online-based threats, including viruses.

DEADLINE

REGISTRY ACT AND REGISTRY

The CE Act permits the Regulator to extend the surrender deadline if two or more persons are unable to surrender eligible emissions units during 15 June (in a fixed charge year) or 1 February, and the inability to surrender the units is attributable to a fault or malfunction relating to a computer system under the control of the Regulator, a fault or malfunction relating to a facility, or a fault or malfunction relating to a carriage service provided to the public.170

REGULATIONS

The Regulator may extend the deadline for the surrender of eligible emissions units beyond 15 June or 1 February, as the case may be, if it would be reasonable to do so. For transparency purposes, if such a determination is made, the Regulator must publish a copy of the determination on its website.171

12.3.2 BUY-BACK OF EMISSIONS UNITS During the period between 1 September in a fixed price vintage year and the following 1 February, a liable entity may request that a free emissions unit be bought back and cancelled by the Regulator. The price for the buy-back will be discounted by a factor specified in the regulations.172 The buy-back period may be extended for circumstances similar to those for an extension of surrender deadline.173

The Registry Regulations for opening an account with the Registry require the account holder to agree that the applicant and the applicant’s authorised representatives will not: »»

Attempt to damage or corrupt the Registry (including by the introduction of any virus, Trojan, worm, logic bomb or other malicious or technologically harmful material).

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Attempt to gain unauthorised access to the Registry, the Registry’s server or any other server, computer or database connected to the Registry.174

Further, the account holder indemnifies the Regulator against all loss or damage in connection with any misuse by the account holder or its authorised representatives, including: »»

Introducing viruses, Trojans, worms, logic bombs or other malicious or technologically harmful material.

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By attempting to gain unauthorised access to the Registry, the Registry’s server or any other server, computer or database connected to the Registry.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

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By attacking the Registry via a denial-ofservice attack.

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Any negligent or unlawful act, omission or wilful misconduct.175

Recently the EC issued a warning about a Trojan virus called Nimkey, which was possibly targeting registry systems. Trojan viruses like Nimkey have the capacity to gather private key certificates, keystrokes and clipboard data, and compromise the system’s security. The EC responded to Nimkey by issuing a reminder to Registry users to update their virus detection software and maintain personal protection.

The powers of the Regulator to suspend access to Registry accounts discussed above should enable

the Regulator to take steps to address electronic vulnerabilities and breaches of security which threaten the integrity of the system.

12.4 PERSONAL PROPERTY AND SECURITIES ACT 2009 (CTH) The Personal Property and Securities Act 2009 (Cth) (PPSA) established a national Personal Property Securities Register (PPSR). Both commenced 31 January 2012.176 Security over carbon units must be registered because the PPSA does not include carbon units as interests to which the PPSA does not apply. Regulations may also make provision for, or in relation to the Registration of equitable interests in relation to Kyoto units177 and prescribed international units178 in the PPSR.

13. INFORMATION DISCLOSURE Market efficiency and operational effectiveness are enhanced by removing information barriers. All Registry account information will be published by the Regulator. Specifically, the Regulator must publish on its website the name of each account holder and their address. The Regulator is responsible for maintaining the accuracy of this information.179 Disclosure of information about carbon units, and disclosure of significant holdings is also required. Details about liable entities and carbon units will be publicly available in an electronic, web-based Liable Entities Public Information Database. The Regulator and Authority will become agencies to which ASIC may disclose information.180 A divide exists between the transparency that would be legislated for primary markets for carbon units and the opaqueness that may exist in the secondary and derivatives markets. For example, information content could be embedded in hedging positions, but it would not be disclosed. Undisclosed nominee relationships and mismatch in beneficial ownership and registration of carbon units in the Registry will also result in opaqueness. As noted, the CE Act will permit the creation of

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equitable interests and security interests in carbon units, treatment consistent with an open derivatives market. The rules for disclosure of positions in carbon units also do not extend to disclosure of positions in derivatives in carbon units. Unidentified transactions in off-market, OTC and derivatives carbon markets leads to under-disclosure, which is at odds with the intent of the ASX Market Integrity Rules to promote disclosure. The ASX Market Integrity Rules prohibit the registration of an equity security in the name of a market participant if the market participant is not the beneficial owner of the equity security. The definition of equity security does not extend to financial products, and therefore the rule would not apply to carbon units and their derivatives. In June 2009, the Australian Treasury released a discussion paper entitled, “Improving Australia’s Framework for Disclosure of Equity Derivative Products: Determining the degree of effective control obtained through equity derivatives and identifying appropriate disclosure requirements”. However, this discussion paper did not consider carbon markets. In June 2011, the Council of Financial Regulators released a discussion paper titled, “Central Clearing of OTC Derivatives in Australia” which

considered the need for centralised clearing of certain financial instruments. The discussion paper did not specifically address carbon unit derivatives.

As at the date of this report no recommendations have been made by the Council of Financial Regulators.

INFORMATION ON THE LIABLE ENTITIES PUBLIC INFORMATION DATABASE »»

The name of an entity that is, or is likely to be a liable entity.

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The emissions number for the eligible financial year (to be entered as soon as practicable after the report is lodged under the NGER Act, or after an assessment is made by the Regulator).

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An estimate of any unit shortfall, and potential penalty (including details of an assessment of unit shortfall).

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The unpaid penalty amount.

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The number and breakdown of eligible emissions units surrendered.

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The number and breakdown of eligible emissions units voluntarily cancelled (by liable and non-liable entities).

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The transfer of Kyoto units to a voluntary cancellation account, and the cancellation of non-Kyoto international units.

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The number of carbon units relinquished under the CE Act or under the Jobs and Competitiveness Program.

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Per unit charges for the issue of carbon units, and the number of carbon units issued in the latest auction.

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The six-monthly average auction charge for carbon units (to May and to November) (disregarding issues of future vintage years).

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The total number of fixed charge carbon units issued.

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The name of an entity that receives free carbon units, and the total number and vintage of free carbon units issued to that person.

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Details by entity, and by quarter for each activity that is an assisted activity.

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Details of carbon units which are banked or borrowed.

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Details of Kyoto units.

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Emissions number totals for all liable entities and total shortfalls.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

14. GOVERNANCE MECHANISMS The Australian Government remains responsible for the broad policy decisions when it comes to climate change. There will be several statutory bodies that will contribute to, and help reinforce the core aims of the Government’s policies.181 Chief among them will be the Clean Energy Regulator, the Climate Change Authority and the Productivity Commission

(see figure 6). The Australian Competition and Consumer Commission (ACCC) will also supplement other Regulators to help protect the dealings of businesses and consumers.

Figure 6: Statutory Bodies

GOVERNMENT AND PARLIAMENT Responsible for broad policy decisions

CLEAN ENERGY

CLIMATE CHANGE

PRODUCTIVITY

REGULATOR

AUTHORITY

COMMISSION

Will administer the:

Will review, advise and monitor the:

Will review and report on the:

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Carbon Pricing Mechanism.

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International pollution reduction actions.

Operation of carbon price.

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Other climate change mitigation initiatives.

Jobs and Competitiveness Program.

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Progress towards pollution reduction targets.

Fuel excise and taxation regime.

»»

Level of pollution caps.

Carbon Farming Initiative.

»»

Renewable Energy Target.

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National Greenhouse and Energy Reporting Systems.

14.1 CLEAN ENERGY REGULATOR The Clean Energy Regulator will be established182 on 2 April 2012 to administer the ETS and related laws, including the NGER Act.

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Providing education about the ETS.

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Allocating units including freely allocated units, fixed charge units and auctioned units.

»»

Applying legislative rules to determine if a particular entity is eligible for assistance in the form of units to be allocated administratively, and the number of other units to be allocated.

»»

Administering the NGER Act, the Renewable Energy Target (RET) and the CFI.

»»

Accrediting auditors for the CFI and NGER Act.

The Regulator will be responsible for: »»

Assessing emissions data to determine each entity’s liability.

»»

Operating the Registry.

»»

Monitoring, facilitating and enforcing compliance with the ETS.

Carbon Market Institute

It is outside the scope of this report to evaluate the powers of the Regulator in monitoring, facilitating and enforcing compliance with the ETS, and the

penalty regime that supports the Regulator in carrying out those functions. The Regulator is not given direct supervision of the carbon markets, or a role in helping liable entities and others price carbon units and derivatives in carbon units through the disclosure of information that relates to, and facilitates their exchange. Carbon market integrity will therefore be important to the success of the carbon markets.

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The extent to which a liable entity should be able to avoid liability for unit shortfall charge in relation to an eligible financial year by surrendering a carbon unit with a vintage year that is later than the eligible financial year.

»»

The arrangements for the governance and administration of the CE Act and the associated provisions.

There will be ongoing reviews of the ETS, by 31 December 2016, by 31 December 2018, and thereafter in regular five-yearly intervals.

14.2 CLIMATE CHANGE

Reviews have already been planned for:

AUTHORITY

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The future emissions caps by 2014.

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The role of the price ceiling and price floor in 2017.

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The restriction that liable entities must meet at least 50 per cent of their annual liability with domestic permits or credits until 2020 in 2016.186

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The integrity of international units including recommending which units should be accepted and which should be prohibited.187

The Climate Change Authority will be established as an independent body to conduct research and reviews, and provide advice on key aspects of the ETS and the Government’s climate change initiatives.183 The Authority will be made up of nine experts.184 The functions of the Climate Change Authority relevant to the operational effectiveness of the carbon market include:185 »»

The effectiveness and efficiency of the CE Act.

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Any changes to Australia’s medium-term and long-term targets, and carbon budget for reducing net greenhouse gas emissions.

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The process that should apply to the setting of carbon emissions caps.

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Policies and procedures that should apply to the auctioning of carbon units.

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The provisions that should apply in relation to the issue of carbon units for a fixed charge.

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The provisions that should apply in relation to minimum reserve charges for the issue of carbon units as a result of an auction.

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The provision that should apply in relation to charges for the surrender of eligible international emissions units.

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The extent to which units other than carbon units should be able to be surrendered.

14.3 PRODUCTIVITY COMMISSION The Productivity Commission will independently review and report to the Government on: »»

Industry assistance under the Jobs and Competitiveness Program (in the third year of the carbon price, 2014-2015), competitiveness of emissions-intensive and trade-exposed industries,188 and the assistance rates or the carbon productivity contribution that applies to any particular activity.189

»»

Industry assistance under the Coal Sector Jobs Package.

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The carbon emissions reduction activities undertaken by Australia’s trading partners internationally.190

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

14.4 AUSTRALIAN COMPETITION AND CONSUMER COMMISSION The role of the Australian Competition and Consumer Commission (ACCC) is to promote competition, encourage fair business dealings and protect consumers from misleading and deceptive conduct.191 These objectives will now extend to the ETS. The Government announced on 13 July 2011 that the ACCC would receive $12.8 million in funding over four years to assist with education, investigation and enforcement of false claims and price gouging as a consequence of the introduction of a price on carbon. Businesses may be liable under the Competition and Consumer Act 2010 (Cth) for penalties up to $1.1 million per contravention for misleading consumers or providing false information. Claims about the impact of a carbon price must be truthful and accurate, based on reasonable and substantiated grounds, and must not mislead consumers. In its publication, “Carbon price claims: Guide for business” released 14 November 2011, the ACCC caveats that its role does not include setting or restricting price increases related to the impacts of a carbon price, and further, that business is not generally required to justify or explain why prices have increased. The direction given to the ACCC from the Australian Government is for the ACCC to undertake a compliance and enforcement role in relation to claims made about the impact of a carbon price. Accordingly, the ACCC will undertake activities to ensure that the Competition and Consumer Act 2010 (Cth) is not contravened.

Carbon Market Institute

ENDNOTES Greenhouse gas (GHG) emissions are considered to be a negative externality – a cost or a benefit that is not reflected in the price of a good or service (James E Meade, The Theory of Economic Externalities (A W Sijtoff, 1973)) – because the negative costs to the environment (e.g. incurred from emissions from electricity generation) are not reflected in the cost of the final product (i.e. electricity used in an industrial factory). 1

GHG within the coverage of the CE Act is carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O) and sulphur hexafluoride (SF6). These gases are made equivalent (called carbon dioxide equivalence (CO2–e)) through their global warming potential (GWP). Other GHG include nitrogen trifluoride (NF3), hydrofluorocarbons (HCHCs) and perfluorocarbons (PFCs).

Section 5 of the CE Act defines “person” exclusively to be any of the following: 9

An individual.

A body corporate.

A trust.

A corporation sole.

A body politic.

A local governing body.

Clean Energy Act 2011 (Cth) (CE Act) s 94.

Kyoto Protocol to the United Nations Framework Convention on Climate Change opened for signature 16 March 1998, UN Doc. FCCC/CP/1997/7/Add.1 December 10, 1997 (entered into force 16 February 2005).

Excluded emissions include emissions from agriculture, emissions from entities with facilities in non-covered sectors, emissions captured under the related Clean Energy law package, emissions from de-commissioned underground mines, and legacy emissions from landfill and closed landfill. 10

A “liable entity” is defined in the CE Act as a “person” who is liable under the CE Act. 5

Scope 1, 2 and 3 emissions as specified in the GHG Protocol 2004 of the World Business Council for Sustainable Development (WBCSD) and the World Resources Institute (WRI) are as follows: 11

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Scope 1 emissions: Direct GHG emissions (excluding emissions not covered by the Kyoto Protocol) occurring from sources that are owned or controlled by the entity, and emissions from chemical production in owned or controlled process equipment. Excludes direct CO2 emissions from the combustion of biomass.

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Scope 2 emissions: Electricity indirect GHG emissions from the generation of purchased electricity consumed by the entity and physically occurring at the facility where electricity is generated. Purchased electricity is defined as electricity that is purchased or otherwise brought into the organisational boundary of the entity.

»»

Scope 3 emissions: Other indirect GHG emissions (an optional reporting category allowing for the treatment of all other indirect emissions that are a consequence of the activities of the entity) that occur from sources not owned or controlled by the entity.

Related legislation in the Clean Energy law package applies an equivalent carbon price to: 6

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Business transport emissions.

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Non-transport use of liquid and gaseous fuels.

»»

Synthetic greenhouse gases.

Measurement and reporting of emissions under the National Greenhouse and Energy Reporting Act 2007 (Cth) (NGER Act) must be in accordance with the National Greenhouse and Energy Reporting Regulations 2008 and the National Greenhouse and Energy (Measurement) Determination 2008. 7

Free permits issued to liable entities may be sold during the year in which they are eligible for compliance, and up to 1 February in the following compliance year (at which point they are cancelled) both to the Government under a buy-back scheme and on the open market. 8

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

The Clean Energy Regulator (Regulator) is empowered to make a determination to cancel the benefit of a threshold.

The forward market involves agreements to buy or sell, or the option to buy or sell, or swap an asset (which can be of any kind) at a set price on an agreed future date. Forward trading can occur on an exchange through standardised futures contracts or on the OTC market by transactions negotiated through brokers or directly between counterparties.

Double counting is avoided by quoting an obligation transfer number (OTN). 13

Ross Garnaut, “Final report to the Commonwealth, State and Territory Governments of Australia” (report, Garnaut Climate Change Review, 30 September 2008) 322. 14

“Australian Government, Securing a Clean Energy Future” (report, Australian Government, Department of Climate Change and Energy Efficiency, 10 July 2011) 27. 15

The fixed price is called a safety valve.

The Corporations Act 2001 (Cth) (Corporations Act) (s 761) defines a derivative as an arrangement in which one party is required to provide consideration at some future time, the value of which is ultimately determined, derived from, or varies by reference to the value or amount of something else. The Interagency Working Group for the Study on Oversight of Carbon Markets described a derivative, or a derivative contract as: 17

A financial instrument whose value is based on, or derived from, the value of an underlying asset (e.g. a stock), commodity (e.g. wheat and oil) or measurable event (e.g. weather or a bankruptcy). In carbon markets, derivative contracts could be based on the price of carbon emission allowances or offset credits. Interagency Working Group for the Study on Oversight of Carbon Markets, “Report on the Oversight of Existing and Prospective Carbon Markets” (report, U.S. Commodity Futures Trading Commission, 18 January 2011) 15. The forwards or derivatives market therefore should primarily be risk management and price discovery markets where the price is tied to the price of the underlying carbon unit. Actual transfer of a carbon unit cannot occur in this market because of ss 104 and 110 of the CE Act [noting that s104 deals only with how transfers of carbon units are affected for the purposes of the CE Act, not all transfers of carbon units. As described by Collins and Palmer (2008):

Anthony Collins and Sally Palmer, “The Role of Financial Markets in Emissions Trading” (2008) 27 Australian Resources and Energy Law Journal 41, 45. Consistently with the Corporations Act 2001 (Cth) (Corporations Act) the term “derivatives market” is used in this report to describe this market. The Australian National Registry of Emissions Units Act 2011 (Cth) (Registry Act) will be amended by the Clean Energy (Consequential Amendments) Act 2011 (Cth). 18

The Australian National Registry of Emissions Units (Registry) was initialised with the International Transaction Log (ITL) managed by the UNFCCC Secretariat. Because the Registry will link with the ITL it will link indirectly with the registry accounts for emissions trading schemes in the European Union and New Zealand. 19

DCCEE, Application Pack (for individuals) Australian National Registry of Emissions Units (2009) Australian Government, Department of Climate Change and Energy Efficiency<http://www. climatechange.gov.au/government/initiatives/~/ media/publications/international/anreu-individual_ pack-pdf.ashx>. 20

Corporations Act s 793B.

Section 793B of the Corporations Act makes the operating rules of a licensed market have effect as a contract under seal between the market operator and each participant in the market and between all participants in the market and under which each of those persons agrees to observe the operating rules. 22

Identity documents must be in English, or translated into English by an authorised translation service. 23

Australian National Registry of Emission Units Regulations 2011 r 9.4. 24

Carbon Market Institute

Australian National Registry of Emission Units Regulations 2011. 25

Ibid sch 4, s 28B(3).

Ibid sch 4, s 28C.

Ibid sch 4, s 28B(3).

Ibid.

Ibid r 10. The purpose of this regulation is to address the money laundering technique of using a ‘front’ company to undertake transactions: Australian Government Department of Climate Change, “Commentary on the exposure draft regulations relating to dealings with emissions units and the operation of the Australian National Registry of Emissions Units” (Issues Paper, Australian Government, Department of Climate Change, November 2009) [61]. 27

Ibid r 9.4. The term “trust” is not defined in the regulations. In s 5 of the CE Act, “trust” is defined to mean a person in the capacity of trustee or, as the case requires, a trust estate. “Trustee” and “trust estate” are defined to have the same meaning as in the Income Tax Assessment Act 1997 (Cth) (1997 Tax Act). A trust is the relationship that subsists between a person (the trustee) that holds trust property and the objects for whose benefit that trust property is held. 28

Australian National Registry of Emission Units Act 2011 (Cth) s 11. 29

Ibid s 16(6).

Clean Energy Act s 113(1).

Ibid s 113(2)(k)-(l).

Australian Government, “Position paper on the legislative instrument for auctioning carbon units in Australia’s carbon pricing mechanism” (Discussion paper, Australian Government, Department of Climate Change and Energy Efficiency, 3 February 2012) 13. 33

Clean Energy Act s 100(6).

Clean Energy (Consequential Amendments) Act 2011 (Cth) sch 4, s 28A. 35

Ibid sch 4, s 28A.

Ibid sch 4, s 28A(3).

Ibid sch 4, s 28B.

Ibid sch 4, s 28B(2).

European Commission, “Memo/11/34”, Directorate-General on Climate Action, 21 January 2011. The European Commission also noted that the spot market accounted for 20 per cent of total market activity. 43

PricewaterhouseCoopers, “Carbon market evolution: Lessons from financial and commodity markets”, (Report, Carbon Market Institute, 2012). 44

Corporations and Markets Advisory Committee, “Regulation of on-exchange OTC Derivatives Markets” (June 1997) 22. 45

The Council of Financial Regulators, Central Clearing of OTC Derivatives in Australia: A discussion paper issued by (June 2011), 2. 46

Only derivative contracts that proceed to physical settlement will result in a change of legal ownership. For example, a Dec 2012 CER forward contract (OTC) or futures contract (exchange traded) will result in delivery of the underlying CERs unless the contract is cancelled by a covering position or is cash settled. Settlement is the act of consummating the contract, and can be done in one of two ways: 47

Physical delivery - the amount specified for the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. Physical delivery is common with commodities and bonds. In practice, it occurs only on a minority of contracts. Most are cancelled out by purchasing a covering position that is, buying a contract to cancel out an earlier sale (covering a short), or selling a contract to liquidate an earlier purchase (covering a long). The Nymex crude futures contract uses this method of settlement upon expiration. Cash settlement - a cash payment is made based on the underlying reference rate, such as a short-term interest rate index such as Euribor, or the closing value of a stock market index. The parties settle by paying/receiving the loss/gain related

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

to the contract in cash when the contract expires. Cash settled futures are those that, as a practical matter, could not be settled by delivery of the referenced item - i.e. how would one deliver an index? A futures contract might also opt to settle against an index based on trade in a related spot market. ICE Brent futures use this method. See further: www.investopedia.com 48

Corporations Act s 761D, s 764A.

The Parliamentary Secretary to the Treasurer, Hon David Bradbury MP, requested the Corporations and Markets Advisory Committee (CAMAC) to examine the existing definition of derivatives and propose a new definition by 30 September 2011. CAMAC concluded that no legislative amendment was required. 49

Corporations Act s 761D.

Corporations Act s 798F. In the definitions of terms in the Corporations Act, a “licensed market” is defined to mean a financial market, the operation of which is authorised by an Australian market licence, s 795B(1). Div 4 of pt 7.2 of the Corporations Act deals with the granting of an “Australian market licence”. 51

Issues of carbon units by the Regulator will be exempt from the requirements of the Corporations Act. A “financial market” is defined in s 767A of the Corporations Act as:

any other service is provided in relation to these units other than those types of financial service listed in s12BAB(1)(a)–(f). Explanatory Memorandum, Clean Energy (Consequential Amendments) Act 2011 (Cth) [7.36-7.37]. 54

The ASX Operating Rules also distinguish between the cash market and the derivatives market. 55

ASX Market Integrity Rules r 1.4.3.

Ibid.

Corporations Act s 795B(1).

Corporations Act s 795B; see also Gail Pearson, “Financial Services Law and Compliance in Australia” (Cambridge University Press, 2009) 109. 59

Corporations Act s 793B; see also Pearson, 110.

Ibid s 791A.

Ibid s 791C.

In addition, amending rules have been made as follows: 63

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ASIC Market Integrity Rules (ASX Market) Amendment 2011 (No 1).

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ASIC Market Integrity Rules (ASX Market) Amendment 2011 (No 2).

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ASIC Market Integrity Rules (ASX 24 Market) Amendment 2011 (No 1).

A facility through which: a.

Offers to acquire or dispose of financial products are regularly made or accepted. Offers or invitations are regularly made to acquire or dispose of financial products which are intended to result or may reasonably be expected to result, directly or indirectly, in: i.

ii.

The making of offers to acquire or dispose of financial products.

Additionally, there are four licensed financial markets that are not subject to ASIC supervision under Pt 7.2A and ASIC Market Integrity Rules. They are: BGC Partners (Australia) Pty Limited, Bloomberg Tradebook Australia Pty Ltd, Mercari Pty Ltd and Yieldbroker Pty Limited. See Corporations Regulation 10.15.02. 64

Section 761A of the Corporations Act defines “participant” as: 65

The acceptance of such offers. a.

Amended s12BAB(1)(g) of the Australian Securities and Investment Commission Act 2001 (Cth) (ASIC Act) only excludes ACCUs and EIEUs from Pt 2 Div 2 of the ASIC Act to the extent that 53

Carbon Market Institute

In relation to a clearing and settlement facility, a participant is a person who is allowed to directly participate in the facility under the facility’s operating rules, and when used in any of the following provisions, also includes a

recognised affiliate in relation to the facility: i.

should not be assumed that any or all trading will take place on the ASX.

Paragraph 821B(2)(b). Corporations Act s 792A(a). This provision replicates §11A of the Securities Exchange Act of 1934 (US) 15 USC. 71

ii.

Sub-section 822B.

iii.

Sub-section 915F(2). 72

iv.

Any other provisions prescribed by regulations made for the purposes of this subparagraph.

In relation to a financial market, means a person who is allowed to directly participate in the market under the market’s operating rules, and when used in any of the following provisions, also includes a recognised affiliate in relation to the market:

ASX Market Integrity Rules r 5.9.1 provides: A Market Participant must not do anything which results in a market for a Product not being both fair and orderly, or fail to do anything where that failure has that effect.

Ibid r 5.9.1.

Ibid r 5.5.2.

The terms “fair and orderly market” and “integrity of the market” are not defined in the rules they superseded: see Table 1, RG214.59. cf Transmarket Trading case. 75

Paragraph 792B(2)(b).

ii.

Section 793B.

iii.

Section 883A.

iv.

Sub-section 915F(2).

Transmarket Trading Pty Ltd v Sydney Futures Exchange (2010) 188 FCR 1, 25. 76

Ibid.

Paragraphs 923B(3)(a) and (b). Ibid. The US Securities and Exchange Commission suggests: 78

vi.

Any other provisions prescribed by regulations made for the purposes of this subparagraph.

A “fair” market is free from manipulative and deceptive practices, and affords no undue advantage to any participant. An “orderly” market is characterised by regular, reliable operations, with price continuity and depth, in which price movements are accompanied by appropriate volume, and unreasonable price variations between sales are avoided.

“ASX Operating Rules” (Policy, ASX Limited, 2010); “A Guide to Becoming an ASX Participant” (Guidance Statement, ASX Limited, 2011). 66

Explanatory Memorandum, Corporations Amendment (Financial Market Supervision) Act 2010 (Cth) reinforces the distinction between broker and client. The reasoning of Justice Perram in the 2010 Federal Court case of Transmarket Trading Pty Ltd v Sydney Futures Exchange (2010) 78 ACSR 507 further reinforces the distinction between broker and client. 67

Excluding markets of BGC Partners (Australia) Pty Limited, Bloomberg Tradebook Australia Pty Ltd, Mercari Pty Ltd and Yieldbroker Pty Ltd: ASIC Regulatory Guide 214, RG214.3. 68

Financial Services Reform Act 2001 (Cth) (FSR Act) Part 7.5 Division 3; Corporations Act, 22 881A, 883A. 69

S 9.3 uses the ASX market as an example. It

US Securities and Exchange Commission, “Order Instituting Administrative and Cease-AndDesist Proceedings” (Exchange Act Release No 34–49500, 82 SEC Docket 1903 (promulgated March 30 2004)) para 4. In the case of Re: Labranche Securities Litigation (2005) 405 F Supp 2d 333, Sweet DJ considered that inter-positioning, trading ahead and improperly effecting proprietary trades, for example were activities by a broker that were manipulative and deceptive. 79

ASX Market Integrity Rules r 25.4.1.

Ibid r 1.4.3 (definitions).

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

Ibid r 1.4.3 (definitions).

Retail client is defined by reference to ss 761G and 761GA of the Corporations Act. The definitions exclude sophisticated investors, corporations that are not small businesses and wholesale investors. 82

Corporations Regulations, 7.9.80B.

Australian Securities and Investments Commission, “Markets Disciplinary Panel” (Australian Securities and Investment Commission, Regulatory Guide 216, July 2010), RG 216.16.

Lockie, 82-83.

Regulatory Guide 216, RG 216.19. The infringement notice and enforceable undertaking under the Corporations Act are to be distinguished from the infringement notice and enforceable undertaking under the NGER Act and CE Act.

Corporations Act s 798J.

ASIC Market Integrity (ASX) Rules 2010 r 5.8.5.

ASX Market Integrity Rules, r 3.3.2.

Damien L Lockie, Closing Pandora’s Box - A case for carbon market integrity after the Global Financial Crisis: conditioning ownership of the right to emit greenhouse gases in an Australian emissions trading scheme (PhD Thesis. Bond University, 2011) 82. 90

Regulatory Guide 216.31.

Corporations Act s 793C provides:

Ibid r 5.8.6. This rule provides that if a fair settlement price cannot be agreed upon then it is to be determined by arbitration. 96

Clean Energy Act s 5.

If a person who is under an obligation to comply with or enforce any of a licensed market’s operating rules fails to meet that obligation, an application to the Court may be made by:

Corporations Act sub-s 1311(3) and sch 3.

ASX Market Integrity Rules r 5.7.1.

100

Ibid r 5.7.2.

ASIC.

101

ii.

The licensee.

iii.

The operator of a clearing and settlement facility with which the licensee has clearing and settlement arrangements.

iv. 2.

ASIC, ASIC Market Integrity (ASX) Rules 2010 (at 11 February 2011) r 5.8.2. 93

ii.

102

Competition and Consumer Act s 45(2).

103

Ibid s 46(1).

104

Corporations Act s 766A.

105

Ibid s 911A; see also Lockie, 78.

106

Lockie, 80.

107

Ibid.

A person aggrieved by the failure.

After giving an opportunity to be heard to the applicant and the person against whom the order is sought, the Court may make an order giving directions to: i

In chapter 8.5 of the White Paper, “Competitive market free of manipulation”, DCC broadly canvassed concerns about market manipulation and anti-competitive behaviour in relation to carbon units and the role of financial intermediaries in the ETS.

The person against whom the order is sought. If that person is a body corporate the directors of the body corporate; about compliance with, or enforcement of, the operating rules.

Proposed Regulation 7.1.35C would modify Corporations Act s 766C(3); see Lockie, 78. 108

109 88

Corporations Act 766C; see also Lockie, 78.

Corporations Act s 1020B. Proposed Regulation 7.7.10AI of the Corporations Regulations is proposed to modify 110

Ibid s 1020B(2).

Carbon Market Institute

Corporations Act s 949A(2)(c). Section 949A is not an anti-hawking rule per se. It applies in situations where general advice is given, and clients must be warned that the advice has been given without considering their objectives, financial situation or needs. For most financial products, s 949A requires the provider of the general advice to warn clients that they should consider the PDS relating to any products that are the subject of the advice. For emissions units, this requirement has been replaced with a requirement to direct clients to the relevant concise statement relating to the particular type of unit. This is the modification of s 949A(2)(c) referred to, but the requirement to provide warnings when general advice is given remains. 111

112

Lockie, 84.

A proposed new regulation 7.6.01 of the Corporations Regulations would provide that for s 911A(2)(k) of the Corporations Act, the provision of the following services would be covered by an exemption from the requirement to hold an Australian financial services licence:

c. An associated entity of the person. iv. The person does not deal in those derivatives, units or foreign exchange contracts as the principal purpose of the person’s business. v. The dealing is entered into: a. On the person’s own behalf. b. On behalf of a related body corporate of the person. c. On behalf of an associated entity of the person. 114

ASIC, Regulatory Guide 236, 6-7 [236.13].

ASIC, Regulatory Guide 235, 11 [236.24]. 115

113

(ma) A financial service provided by a person in the following circumstances: i.

The service consists of one or more of the following: a. Dealing in derivatives over carbon units, Australian carbon credit units or eligible international emissions units. b. Dealing in a carbon unit, an Australian carbon credit unit or an eligible international emissions unit.

116

ASIC, Regulatory Guide 236, 11 [236.24].

117

ASIC, Regulatory Guide 236, 11 [236.24].

118

Corporations Act s 766B(1).

119

ASIC, Regulatory Guide 236, 11 [236.21].

120

ASIC, Regulatory Guide 236, 24 [236.76].

121

ASIC, Regulatory Guide 236, 25 [236.77].

122

ASIC, Regulatory Guide 236, 25 [236.78].

ASIC, Regulatory Guidelines, 25 [236.80, 236.149]. 123

124

Corporations Act s 945A.

125

Corporations Act s 945B..

126

Corporations Act s 946A.

127

ASIC, Regulatory Guidelines 15 [236.149].

128

ASIC, Regulatory Guidelines 27 [236.86].

129

ASIC, Regulatory Guidelines 27 [236.88].

130

ASIC, Regulatory Guidelines 28 [236.94].

131

ASIC, Regulatory Guidelines 32 [236.110].

132

ASIC, Regulatory Guidelines 33 [236.113].

c. Dealing in foreign exchange contracts. ii. The service does not involve the making of a market for those derivatives, units or foreign exchange contracts. iii. The dealing is entered into for the purpose of managing financial risk in relation to the surrender, cancellation or relinquishment of carbon units, Australian carbon credit units or eligible international emissions units by: a. The person. b. A related body corporate of the person.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

Corporations Act s 766C(3); ASIC, Regulatory Guidelines 34 [236.119]. 133

134

ASIC, Regulatory Guidelines 34 [236.120].

135

ASIC, Regulatory Guidelines 37 [236.124].

136

ASIC, Regulatory Guidelines 37 [236.127].

137

ASIC, Regulatory Guidelines 37 [236.127].

Sophisticated fraudsters illegally obtained usernames and passwords, including through fake websites, to gain access to the accounts of market participants. See Leigh Phillips, “Cyber-scam artists disrupt emissions trading across EU” (3 February 2010) <http://euobserver.com/885/29403>. 153

Farrar, John H. (2001) “Fighting Identity Crime,” Bond Law Review: Vol. 23 : Iss. 1, Article 5 <http:// epublications.bond.au/blr/vol23/iss1/5> 94. 154

138

European Commission “Towards an enhanced market oversight framework for the EU ETS” (report, European Commission, DirectorateGeneral of Climate Action, 21 December 2010).

155

The AML/CTF rules do not apply to the Regulator.

156

139

140

Australian National Registry of Emissions Units (ANREU) Application Pack (for individuals) s 5.4(d); see also ANREU Application Pack (for nonindividuals), s 5.4(d). ANREU Application Pack (for individuals) s 14.2(d); see also ANREU Application Pack (for non-individuals), s 14.2(d).

Clean Energy Act s 103. Australian National Registry of Emissions Units Act 2011 (Cth) Part 2, s 19(1)(b). 157

141

Ibid s 103A(1).

Clean Energy (Consequential Amendments) Act s 49A(1). 142

158

Ibid Part 2, s 19(4).

Clean Energy Act (Consequential Amendments) 2011 (Cth) s 242A. 159

Clean Energy Act s 103A(2); Clean Energy (Consequential Amendments) Act s 49A(2). 143

Australian National Registry of Emissions Units Act 2011 (Cth) s 19(c)-(d). 160

144

Clean Energy Act Part 10.

Regulations made under ss 10-11 of the Registry Act, titled, “Australian National Registry of Emissions Units Regulations 2011” commenced 1 December 2011 (promulgated 7 December 2011). 145

Explanatory Memorandum, Australian National Registry of Emissions Units Act 2011 (Cth) [5.10].

Explanatory Memorandum, Australian National Registry of Emissions Units Act 2011 (Cth) [5.11]. 161

Australian National Registry of Emissions Units Act 2011 (Cth) Part 2, s 22(1). 162

146

147

Clean Energy Act Part 10.

John H. Farrar, ‘Fighting Identity Crime,’ (2011) 23 Bond Law Review Article 5. <http:// epublications.bond.au/blr/vol23/iss1/5> 94.

163

Ibid Part 2, s 22(2).

Clean Energy Act (Consequential Amendments) 2011 (Cth) s 242B. 164

148

Australian National Registry of Emissions Units Act 2011 (Cth) s 23.

Australian Crime Commission, “Organised Crime in Australia 2011” (report, Australian Crime Commission, 2011) 38. 165

149

150

Australian National Registry of Emissions Units Act 2011 Part 2, s 28. 166

Ibid s 24. Clean Energy Act (Consequential Amendments) 2011 sch 4, s 28(5). 167

151

Ibid Part 3, s 36(2) and Part 4, s 53(2).

Nina Chestney, “UK tax authority names carbon fraud suspects’, Thomson Reuters, Business & Financial News (London), 27 January 2011. The valued added tax (VAT) procedures for EUAs have been changed to combat carousel fraud. 152

Carbon Market Institute

168

Ibid sch 4 s 28D(2).

“EU nations back new CO2 trade security measures” (17 June 2011) <http://www.pointcarbon. com/news/1.1550543?date=20110617&sdtc=1>. 169

170

Clean Energy Act 2011 (Cth) s 142(1).

171

Ibid s 142(4).

Ibid s 116. See Clean Energy Amendment Regulation 2012 (no. 1).

iii.

the name of the audit team leader appointed to carry out the audit.

iv.

the findings of the audit.

172

173

Ibid s 116A.

The Register will disclose the names of each affected group member of a controlling corporation’s group.

174

ANREU Application Pack (for individuals) s 5.3; see also ANREU Application Pack (for nonindividuals) s 5.3.

178

ANREU Application Pack (for individuals) s 14.2(b); ANREU Application Pack (for nonindividuals) s 14.2(b).

179

175

Clean Energy Act (Consequential Amendments) 2011 sch 4, item 42, inserting s 54A in the Australian National Registry of Emissions Units. Australian National Registry of Emissions Units Act s 58. Clean Energy Act sch 1, Part 1, item 49; sch 1, Part 2, item 256A. 180

Personal Property Securities Register, ‘Registration Commencement Time’ <http://www. ppsr.gov.au/www/ppsr/ppsr.nsf/Page/AboutPPS_ AboutPPS>. 176

Consultation draft regulations “Clean Energy Amendment Regulation 2012 (No )” propose that the Register also set out the following information for each person registered: 177

the registered person’s name, identifying details and trading name (if any). the section of the act under which the person applied for registration.

“Securing a clean energy future: The Australian Government’s Climate Change Plan” <http:// www.cleanenergyfuture.gov.au/wp-content/ uploads/2011/07/Consolidated-Final.pdf> 31-32. 181

182

Clean Energy Regulator Act 2011 (Cth) s 11.

183

Climate Change Authority Act 2011 (Cth) s 11.

184

Ibid ss 17-18.

185

Clean Energy Act s 288.

“Securing a clean energy future: The Australian Government’s Climate Change Plan” <http:// www.cleanenergyfuture.gov.au/wp-content/ uploads/2011/07/Consolidated-Final.pdf> 107. 186

the reporting year for which the person was first registered.

information about the person’s compliance with the act, including information about: i. whether the person has been convicted of an offence under the act.

187

Ibid 108.

188

Clean Energy Act s 156(j).

ii. whether a court order has been made against the person for the contravention of a civil penalty provision in the act.

“Securing a clean energy future: The Australian Government’s Climate Change Plan”<http:// www.cleanenergyfuture.gov.au/wp-content/ uploads/2011/07/Consolidated-Final.pdf> 56; see also: Clean Energy Act s 156.

information about greenhouse and energy audits carried out in relation to the person, including information about:

190

189

whether a greenhouse and energy audit has been carried out in relation to the person.

Clean Energy Act s 156(2)(d); see also: “Securing a clean energy future: The Australian Government’s Climate Change Plan” <http:// www.cleanenergyfuture.gov.au/wp-content/ uploads/2011/07/Consolidated-Final.pdf> 31. “Role and responsibilities of the ACCC” <http://www.accc.gov.au/content/index.phtml/ itemId/665070>. 191

ii.

the type of audit carried out.

Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism

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