Article Index

 

There are two circumstances in which a UK firm must be authorised by FSA to bid for emissions allowances, and in so doing will not be conducting MiFID business:

 

a) where a firm qualifies for an exemption under Article 2(1)(i) of MiFID and bids  in relation to either type of auction product (a two day spot or a five day future) on its own account or on behalf of clients of its main business; and

 

b) where an investment firm authorised by FSA under MiFID or a credit institution authorised by FSA under the Banking Consolidation Directive (2006/48/EC) bids in relation to a 2 day spot auction product on behalf of its clients.

 

The key and urgent task for Member States is currently to implement provisions of the Auctioning Regulation with regard to the auction participation requirements.

 

In articles ‘The eligibility to apply for admission to bid in the auction pursuant to the Auctioning Regulation’ and The requirements for financial intermediaries bidding in the auctions of emission allowances of the third trading period there were analysed questions of application of Article 18 of the Auctioning Regulation (stipulating of who is entitled to take part directly in the future CO2 emissions allowances auctions).

 

The interesting classification and approach in that regard has taken recently the UK Financial Services Authority (FSA) in the consultation document ‘Regulating bidding for Emissions Allowances under Phase Three of the EU Emissions Trading Scheme’, March 2012. It may be of interest to other regulatory institutions intending to implement Auctioning Regulation and also for market participants preparing to participate in the auctions.

 

The FSA recalls in the first place that under Commission Auctioning Regulation (referred to as a ‘CAR’), there are two types of emissions auction product which may be auctioned on the platforms: a two day spot and a five day future.

 

Depending on the type of product and the nature of firm wishing to bid, CAR defines some bidding to be business that is subject to the provisions of the Markets in Financial Instruments Directive (MiFID), some to be non-MiFID business (referred to as 'auction regulation business') and some to be exempt from MiFID and FSA regulation altogether. The said three main categories are analysed hereinafter in more detail.

 

 

Bidding in emissions auctions: a new regulated activity in the UK legal environment

 

 

FSA recalls that only the firms listed in Article 18 of CAR are able to bid in emissions auctions. Of these, CAR provides that only three categories must be authorised in order to bid:

 

a) an investment firm authorised under MiFID where it is bidding on behalf of its clients;

 

b) a credit institution authorised under the Banking Consolidation Directive (2006/48/EC) where it is bidding on behalf of its clients; and

 

c) a firm that is exempt from MiFID under Article 2(1)(i) where it is either bidding on behalf of the clients of its main business or on its own account.

 


Article 2(1)(i) of MiFID exempts persons dealing on own account in financial instruments, or providing investment services in commodity derivatives or derivative contracts included in Annex I, Section C 10 of MiFID to the clients of their main business, provided this is an ancillary activity to their main business, when considered on a group basis, and that main business is not the provision of investment services within the meaning of MiFID or banking services under Directive 2000/12/EC.

 

 

The FSA document mentions that the proposed amendments to the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (512001/544) (RAO) will cause bidding in emissions auctions to be a new regulated activity which will not form part of any other activity under the RAO. Therefore, for each of the three categories above, where a UK firm intends to bid in emissions auctions, it must apply to FSA for permission to carry on this new regulated activity.

 

 

FSA takes the view that the new bidding activity is comparable to the existing regulated activities of 'dealing in investments as principal', 'dealing in investments as agent' and 'arranging deaIs in investments'. Consequently, for a firm with existing permission to carry on these activities, unless its bidding activities would materially alter the risks posed to its business, FSA envisages the variation of permission process to be relatively straightforward.

 

 

It is not envisaged that ongoing costs for a permission will alter, unless taking on this new business fundamentally alters the nature or size of the firm in question. If it does, then ongoing supervision fees will change accordingly.

 

MiFID business

 

 

CAR defines bidding to be MiFID business where the firm carrying out the bidding is an investment firm authorised under MiFID or a credit institution authorised under the Banking Consolidation Directive (2006/48/EC) andthe emissions auction products are financial instruments within the meaning of MiFID. Under CAR, this means five day futures.

 

Consequently FSA has made changes to its Handbook to ensure that the activity of bidding on an auction platform is captured, in order to treat MiFID business bidding in emissions allowances in the same way as a firm's existing MiFID business.

 


 

 

Auction regulation business

 

 

There are two circumstances in which a UK firm must be authorised by FSA to bid for emissions allowances, and in so doing will not be conducting MiFID business:

 

a) where a firm qualifies for an exemption under Article 2(1)(i) of MiFID and bids  in relation to either type of auction product (a two day spot or a five day future) on its own account or on behalf of clients of its main business; and

 

b) where an investment firm authorised by FSA under MiFID or a credit institution authorised by FSA under the Banking Consolidation Directive (2006/48/EC) bids in relation to a 2 day spot auction product on behalf of its clients.

 

FSA underlined in its document that Article 59 of CAR lays out authorisation and conduct of business requirements for bidders not undertaking MiFID business and that these requirements are directly effective and do not require implementation by the FSA to have effect in relation to bidders.

 

However, under CAR, competent national authorities may require as a condition of authorisation: 'any other measures deemed necessary having regard to the nature of the bidding services being offered and the level of sophistication of the clients in question in terms of their investor or trading profile as well as any risk-based assessment of the likelihood of money laundering, terrorist financing or criminal activity

 

CAR also requires competent national authorities to have at their disposal the 'necessary investigative powers and sanctions that are effective, proportionate and dissuasive.

 

In view of these circumstances FSA has taken into account the fact that the very smallest operators of facilities or airlines are exempt from the EU ETS under a 'de minimis' cut-off and that those who remain within the system just above that threshold are likely to bid via the firms FSA authorises but will require allowances as a fundamental part of their business.

FSA furthermore considers that the market's end-users will usually be relatively sophisticated clients. Also given the nature of the auctions, which will be conducted using sealed bids on a regulated market, there is limited risk to the clients' money outside of the limited time window in which each auction will occur.

 

The effect is that FSA finally has chosen to use the power in Article 59(5) and to implement 59(6) so that the same anti-money laundering measures be applied to bidders as apply to other firms. FSA has also chosen to approve key individuals of a bidder both to ensure the firm's overall suitability and to provide for effective, proportionate and dissuasive enforcement powers.

 

Excluded business

 

 

FSA observed that the amendments to CAR made by Commission Regulation 1210/2011 of 23 November 2011 removed the requirement for authorisation under CAR for a MiFID investment firm or a credit institution bidding in relation to two day spot products on its own account. Accordingly, this does not form part of the proposed new regulated activity.

 

Additionally, the persons listed in Article 18 CAR - other than investment firms, credit institutions and firms exempt under Article 2(1)i) of MiFID - don't undertake a regulated activity under proposed statutory framework and FSA do not need to authorise or supervise them.The FSA recalls that Article 18 CAR sets out an exhaustive list of persons eligible to apply for admission to bid directly in auctions which includes, for example, operators that are subject to the EU ETS.

 

What is noteworthy, the FSA document sets out auction participation requirements stemming from the CAR in a transparent and understandable way. The proposed structure seems to be rather clear. Among the three categories distinguished, the MiFID business and excluded business don’t raise ambiguities, auction regulation business will, however, as always, evoke diverging views regarding the scope for exemption under Article 2(1)(i) of MiFID (in particular the notion of “ancillary activity’).

 

FSA has invited comments on the consultation paper in question. Comments should reach the addressee by 19 April 2012.