It appears that the regulatory work has stopped half way. Since the critical determination whether a trade has been performed in good faith would still be done in accordance with national laws it could be presumed that problems with enforcement of property rights will persist.
Even though the recent registry regulations amendments (Registry Regulation No 1193/2011) have substantially improved legal certainty with respect to the cross-border circulation of emission allowances, there is still left a wide scope for intervention.
For a careful observer of the carbon market it is clear that the weaknesses of this business line in 2010-2011 were, at least partly, caused by the non-harmonised legal status of emission allowances across the EU and problems with enforcement of property rights and pursuit of damages claims in a situation of divergent national laws applying at the same time.
Thus the need for stable and predictable legal framework in that regard can’t be overestimated.
Article 37 (2) and (3) of the Registry Regulation No 1193/2011 has acknowledged dematerialised nature and fungibility of allowances and Kyoto units in the EU regulatory environment and Article 37(4) has expressly stipulated that ‘A purchaser and holder of an allowance or Kyoto unit acting in good faith shall acquire title to an allowance or Kyoto unit free of any defects in the title of the transferor.’
As the services of the European Commission underlined in one of the tender documents, ‘The new EU ETS Registry rules protect holders or buyers of allowances that are in good faith and the same rules introduce the principle of irrevocability of transfers) most key aspects are still left to national discretion (e.g. critical determination whether a trade has been performed in "good faith" would still be done in accordance with national law).’
Considering the above observation it appears that the regulatory work has stopped half way.
Since the ‘critical determination whether a trade has been performed in "good faith" would still be done in accordance with national law’ it could be presumed that problems with enforcement of property rights will persist. The direct legislative cause for such a contention sticks probably in Article 10(5) of the Commission Regulation No 1193/2011. This provision foresees that ‘Accounts shall be governed by the laws and fall under the jurisdiction of the Member State of their administrator and the units held in them shall be considered to be situated in that Member State’s territory.’
But the issue of good faith isn’t the sole troublemaker. Similarly complicated become the cross-border collateral deals involving EUAs. A reflection comes to mind that all maters for which Article 9 of the Financial Collateral Directive was enacted are potentially involved:
(a) the legal nature of EUAs collateral and proprietary effects of title transfer arrangement or security collateral arrangement;
(b) the requirements for perfecting a EUAs collateral and, generally, the completion of the steps necessary to render such an arrangement and provision effective against third parties, especially in case of the inception of bankruptcy proceedings;
(c) whether a person's title to or interest in EUAs collateral is overridden by or subordinated to a competing title or interest, or a good faith acquisition has occurred;
(d) the steps required for the realisation of EUAs collateral following the occurrence of an enforcement event.
It is noteworthy, the above remarks remain current even if the MiFID II reform classifying spot emission allowances as financial instruments is in force (MiFID II does not intend to extend the Financial Collateral Directive to spot emission allowances trade).
It all is due to the current absence of uniform safeguards at a EU level against bankruptcy proceedings. Similarly, there is a lack of comprehensive accounting and taxation guidance in the area for the carbon market, which has led to a diversity of practices in the Member States.
In view of the above deficiencies of the legislative framework it seems, however, that the Commissions services are right in their contention, ‘It is clear that neither the EU ETS Directive nor the Registry Regulation can or should be used to address all possible legal uncertainties which may affect the carbon market.’
The separate legislative initiative is, therefore, necessary to cope with the above problems.
Being, however, in the position of EUA cross-border collateral taker, be it the title transfer or security arrangement, and having the choice between either to block the EUAs concerned at a collateral provider account in the registry or to transfer them into the collateral taker account, the latter option is clearly preferable taking into account the above-mentioned Article 10(5) of the Commission Regulation No 1193/2011.
The present text of Article 37(2) of the said Regulation (in the wording: ‘The dematerialised nature of allowances and Kyoto units shall imply that the record of the Union Registry shall constitute prima facie and sufficient evidence of title over an allowance or Kyoto unit, and of any other matter which is by this Regulation directed or authorised to be recorded in the registry.’) rises currently significant doubts, whether the first possibility i.e. blocking the EUAs, being the subject of the collateral arrangement, at a collateral provider account in the registry (with the creation of the sub-account and giving appropriate powers for the collateral taker), is legally effective - particularly when it comes to the title transfer collateral arrangement.
As regards the security collateral arrangement the above ambiguities are lesser since that form of collateral arrangement does not transfer full ownership of, or full entitlement to collateral to a collateral taker for the purpose of securing or otherwise covering the performance of relevant obligations.