European Union Allowance (EUA) means the tradable unit under the European Union Emissions Trading Scheme (EU ETS), giving the holder the right to emit one tonne of carbon dioxide (CO2), or the equivalent amount of two more powerful greenhouse gases, nitrous oxide (N2O) and perfluorocarbons (PFCs).
Article 3(a) of the EU ETS Directive defines the emission allowance as being “an allowance to emit one tonne of carbon dioxide equivalent during a specified period, which shall be valid only for the purposes of meeting the requirements of this Directive and shall be transferable in accordance with the provisions of this Directive”.
With MiFID II, emission allowances have become financial instruments under Annex I, Section C (11).
In contrast to energy markets, spot markets of emission allowances do not fall under the realm of REMIT.
Furthermore, despite being subject to weekly and daily position reporting, derivatives on emission allowances do not fall under the definition of commodity derivatives under MiFID II and are therefore not subject to position limits and position management controls (ESMA Preliminary report of 15 November 2021, Emission Allowances and derivatives thereof, ESMA70-445-7).
The EUAs are recorded within the Union Registry, strictly within the EU Transaction Log. It covers the following transaction types:
- Creation – the European Commission issues all EUAs by creating them on the EU Total Quantity Account, then transfers them for auctioning to the EU Auction Account and for free allocation to the EU Allocation Account;
- Free allocations – EUAs are transferred from the EU Allocation Account to the respective Operator Holding Account of firms entitled to receive free EUAs;
- Auctioning – EUAs are (i) transferred from the EU Auction Account to the Auction Delivery Account of the auction platform, and (ii) after being bought by market participants at an auction, they are transferred from the Auction Delivery Account to the successful bidder’s Trading Account or Operator Holding Account;
- Transfers – account holders can transfer EUAs between their own accounts, or to other accounts to settle trades made outside of the Union Registry;
- Surrender or Deletion – account holders transfer EUAs from their Operator Holding Accounts to the EU Deletion Account either as part of their annual compliance obligation, or to be cancelled without it being recorded as surrendering.
Inflows of new physical EUAs in the market occur in two ways. First, through the EU Allocation Account, which receives once a year allowances from the EU Total Quantity Account (not shown in the figure below) and subsequently releases those for free to Operator Holding Accounts (compliance accounts). Second, through the EU Auction Account which continuously receives allowances from the EU Total Quantity Account and evenly distributes those through the established auctioning platform to successful bidders.
Both sources of inflows are visible through (i) the abrupt surge of compliance accounts from free allocations (as the EU Allocation Account balances decrease) and (ii) the continuous increase of both compliance and non-compliance accounts over the calendar year from auctions (ESMA Final Report of 28 March 2022, Emission allowances and associated derivatives, ESMA70-445-38).