Short Guide to Carbon
Emissions Trading
Contents of guide
A Introduction
page 3
B Purpose of the Guide
page 4
C Background to Carbon Emissions Trading
page 5
D Emissions Trading
page 7
E
The EU ETS
page 9
F
How does Carbon Emissions Trading Work?
page 14
G Ways to Trade EU ETS Allowances
page 16
H Overview of OTC Standard Contract Forms
page 17
I
Exchange Trading
page 18
J
Glossary
page 20
Appendix I -
Further information regarding the CDM and JI mechanisms under
the Kyoto Protocol
Appendix 2 -
Brief analysis of the key terms of the ISDA Agreement, the IETA
Agreement and the EFET Allowance Agreement
1
2
A
Introduction
The reduction of greenhouse gases (in particular carbon dioxide emissions –
“CO2”) is a “hot” topic from many perspectives - environmental, political, regulatory
and commercial. Its global significance is increasing rapidly.
One of the key mechanisms being used to reduce CO2 production is the allocation
and trading of CO2 allowances.
Currently the world’s largest CO2 trading scheme is the European Union Emissions
Trading Scheme (“EU ETS”). However it is predicted that trading will develop
further in the near future with the expansion of available markets for trading CO2
and, potentially, a wider range of greenhouse gases.
Whatever the industry sector in which you operate, you should be aware of the
development of this new market and the impact it could have upon your business.
3
B
Purpose of this guide
In this guide we:
1
set out the background to the development of CO2 trading;
2
explain how the EU ETS works;
3
provide an overview of exchange trading and of the contracts typically used
in over the counter (“OTC”) trading of EU ETS allowances; and
4
summarise some of the developments predicted to take place in the near
future.
We also include contact details for members of our Energy Trade and Commodities
and Trade Finance Group who can provide further advice in connection with CO2
trading.
4
C
Background to Carbon Emissions Trading
What are carbon emissions?
Carbon emissions include CO2, carbon monoxide (“CO”) and hydro-carbons. CO2
is one of the greenhouse gases to which global climate change is widely attributed.
Although CO2 is produced naturally it is also created as a result of domestic and
industrial activities, involving the burning of fossil fuels such as coal, oil and natural
gas.
Production of CO2 and other greenhouse gases has increased significantly over
recent years. Scientific evidence suggests that the earth’s natural carbon sinks
have been unable to deal with this increase. As a result, it is thought that
increased levels of greenhouse gases remain in the atmosphere causing climate
and ecological changes.
United Nations Framework Convention on Climate Change (“UNFCCC”)
The UNFCCC is a treaty (currently ratified by 189 countries) which came into force
in 1994 and which creates a framework for inter-governmental efforts to minimise
the effect of climate change.
The UNFCCC includes a list of the industrial countries (including economies in
transition) undertaking a general commitment towards reducing greenhouse gas
emissions. These countries are listed in Annex I to the UNFCCC (“Annex I”). It
does not, however, include some developing countries that are significant emitters
of greenhouse gases such as China and India.
Kyoto Protocol (“KP”)
The KP is an addition to the UNFCCC. This contains more powerful legally binding
measures for the reduction of CO2 and other greenhouse gases. The KP took effect
in February 2005 when it had been ratified by nations accounting for at least 55%
of greenhouse gas emissions.
As of the 14 February 2007, 169 states and national economic integration
organizations had ratified the KP. Each state and national economic integration
organisation listed in Annex I which has ratified the KP undertakes a specific
emissions commitment, that is to say, an individual target as set out in Annex B to
the KP (“Annex B”).
Under Annex B, 35 states and the EEC are required to cut emissions of CO2 and
other greenhouse gases by an average of 5% during the first commitment period of
2008 - 2012.
The fact that non - Annex I countries, which include large developing countries,
such as India, China and Brazil, are not currently required to meet specific targets
has led to some of the world’s major economies not ratifying the KP. In addition the
5
US (thought to be the world’s largest emitter of greenhouse gases) withdrew from
the KP in 2001.
KP Mechanisms
The KP introduces three mechanisms for lowering the cost of achieving the
emissions targets it contains. The first two of these are project based mechanisms;
the third is emissions trading:
(i)
Clean Development Mechanism (“CDM”)
This enables Annex I countries to implement projects in non-Annex I countries that
reduce greenhouse gas emissions or absorb CO2 through afforestation and reforestation activities in return for certified emission reductions (“CER’s”) which can,
in turn, be used in meeting KP targets. As explained below CER’s can be traded
under the EU ETS.
(ii)
Joint Implementation (“JI”)
Whereby Annex I countries may implement an emission reducing project or one
that enhances removals by sinks in another Annex I country in return for Emission
Reduction Units (“ERU’s”) which can be counted towards meeting KP targets. As
from 2008 ERU’s will also be capable of recognition under the EU ETS.
(iii) Emissions Trading
This enables Annex B parties to acquire units or allowances issued under the KP
from other Annex B parties which can be used to meet KP targets.
For further information about the above mechanisms please refer to Appendix 1 to
this guide.
EU/Domestic Action
In addition to introducing emissions trading between Annex B parties, the KP and
the Marrakech Accords require Annex I parties to implement domestic policies and
action to achieve their goals of reducing greenhouse gas emissions. Such policies
and actions can include emission allowance trading schemes.
The EU ETS is currently the key policy instrument implemented in the EU at
Member State level for reducing greenhouse gas emissions.
6
D
Emissions Trading
Emissions trading involves the sale or transfer of permits/allowances for the
production of a particular emission such as CO2.
Mandatory and Voluntary Schemes
There are two principal kinds of emission trading schemes currently in existence,
namely mandatory and voluntary schemes.
Of the mandatory schemes the EU ETS scheme is the largest in the world. In
Australia, New South Wales established a Greenhouse Gas Abatement Scheme in
2003 and it has recently been announced that Australia is planning to establish a
national cap and trade system similar to the EU ETS by 2010.
Other planned mandatory schemes in the US currently include the proposed
Californian Scheme and the Regional Greenhouse Gas Initiative (“RGGI”) a seven
state emissions trading scheme directed to reducing emissions from power plants
in the North East of the US.
Voluntary schemes involve a participant volunteering to reduce emissions below
certain targets. Commonly such schemes involve the allocation of allowances to
participants which can be traded with other participants in the scheme. Thus, if a
participant within the scheme fails to meet its target it will need to acquire more
allowances than another participant within the scheme. Conversely, if a participant
exceeds its target it will have a surplus to sell. Subsidies are sometimes available
from governments to those participants in voluntary schemes who meet their
targets.
There are currently no voluntary schemes in existence in the UK.
Cap and Trade
The most common type of mandatory trading scheme is a “cap and trade
scheme”. This is the basis of trading of allowances under the EU ETS.
In broad terms, participants in a cap and trade scheme are allocated allowances to
emit a specified quantity of the relevant emission. If the participant emits in excess
of its allocated quantity that participant will have to buy extra allowances to cover
the excess quantity and may also be subject to a penalty, as is the case under the
EU ETS. If a participant emits less than its allocated quantity, the participant can
sell its surplus allowances.
A domestic cap and trade scheme means that governments can regulate the
amount of emissions produced in total by setting a national cap on emissions. In
addition the allocation of tradable allowances to installations covered by the
scheme gives installations the flexibility of determining how, when and where
7
the emissions reductions will be achieved. The environmental outcome is not
affected by the flexibility of the scheme because the amount of allowances
allocated is fixed.
8
E
The EU ETS
The EU emits almost one fifth of the world’s CO2. The EU ETS is a critical tool in
helping the EU achieve its emissions reduction target of 8% by 2012 under the KP.
Overview
The EU ETS commenced on 1 January 2005. The first phase runs from 2005 2007 (“Phase 1”); the second phase from 2008 - 2012 (“Phase 2”) (i.e. until the end
of the first KP Commitment Period). Further five year periods are envisaged
thereafter.
The EU ETS covers specified greenhouse gases (currently only CO2) (the other
greenhouse gases that potentially can be included in the EU ETS are listed on
page 10).
Under the EU ETS, EU Member State governments are required to set an emissions
cap for all installations covered by the EU ETS by allocating allowances to those
installations to emit a specified quantity for the particular phase (Installations
covered under the EU ETS Directive are defined by reference to specified activities
and production output. See page 10 below).
Each Member State has to produce a national allocation plan (“NAP”) for approval
by the Commission. This specifies the total number of allowances it intends to
issue during the particular phase and how it proposes to distribute those
allowances to installations that are subject to the EU ETS.
Member States must ensure that each installation covered by the EU ETS holds a
greenhouse gas emissions trading permit and their annual emissions must be
reported and verified. Each permitted installation will receive an allocation of
allowances based on the NAP.
At the end of each year, installations are required to ensure they have sufficient
allowances to account for their installation’s actual emissions. The installations
have flexibility to buy additional allowances or to sell surplus allowances generated
from reducing their emissions below their allocation.
Each Member State must set up a national registry for recording allowances and
trading. Any person can hold allowances and buy and sell allowances and the
national registries are open to the public.
In addition the EU has established a central administrator which maintains a
community independent transaction log of the issue, transfer and cancellation of
EU Allowances.
EU Directive and EU ETS Regulation
The legal framework for the EU ETS is provided by the EU Emissions Trading
Directive 2003/87/EC (“EU ETS Directive”) which Member States were required to
9
implement in national legislation. In the UK the EU ETS Directive was implemented
by the Greenhouse Gas Emissions Trading Scheme Regulations 2005 which came
into force on 21 April 2005.
The EU ETS Directive was amended by Directive 2004/101/EC in October 2004 to
provide for linking to the KP mechanisms and the use of credits from these
mechanisms for compliance under the EU ETS (“Linking Directive”).
Gases covered under the EU ETS
The EU ETS Directive1 covers the six greenhouse gases that are included in the KP.
Those are namely CO2, methane, nitrous oxide, perfluorocarbons,
hydrofluorocarbons and sulphur hexafluoride. However, as indicated above,
Phase 1 of the EU ETS covers only CO2 and it has been announced that Phase 2
of the EU ETS will also only cover CO2 .
Installations
Installations covered by the EU ETS2 under Phase 1 include those entities carrying
out the following activities:
•
Energy activities; e.g. boilers, electricity generators, mineral oil refineries and
coke ovens;
•
Production and processing of ferrous metals;
•
Mineral industries including, depending upon production capacity, production
of cement clinker, lime glass and ceramic products; and
•
Pulp and paper industries.
In Phase 2, the installations listed above will be extended to cover installations
carrying out the following activities:
•
Manufacturing of glass and glass fibre above a minimum threshold;
•
Manufacturing of mineral wool insulation material;
•
Manufacturing of gypsum;
•
Flaring from offshore oil and gas production;
•
Petrochemicals (crackers);
•
Integrated Steelworks; and
•
Production of Carbon Black;
NAP
As stated above the EU ETS is divided into phases for which Member States must
develop a NAP, which requires the approval of the European Commission
1 Annex II to the EU ETS Directive
2 Annex III to the EU ETS Directive
10
(“Commission”). The NAPs have to be produced 18 months before the start of
each phase. The NAPs set out the total quantity of allowances that the Member
States intend to allocate for the period in question. They also list each installation
covered by the EU ETS and how Member States propose to allocate allowances to
those installations.
The Linking Directive provides that in Phase 2 the Member States must specify in
the NAPs the percentage of the allocation up to which installations will be allowed
to use credits from the project based mechanisms.
Annex III of the EU ETS Directive sets out the criteria on which the NAP must be
based. This includes:
•
Compatibility with the KP and national climate change programmes;
•
Consistency with projected emissions - i.e. no over allocation;
•
Consistency with potential activities to reduce emissions;
•
Consistency with other EU legislation and policy instruments;
•
Information must be included in the NAP as to the manner in which new
entrants will be able to participate in the EU ETS;
•
No discrimination between installations or sectors in a way to unduly favour
certain undertakings or activities;
•
The NAP may accommodate early action;
•
Information must be included in the NAP as to the manner in which clean and
other technologies are taken into account;
•
Provisions must be made for public comments and consideration of the same;
•
The NAP must set out the installations covered and quantities of allowances
allocated; and
•
The NAP may include information as to the way in which competition from
countries outside the EU will be taken into account.
Final Allocation Decision
Once the NAPs have been approved by the Commission, Member States make a
final allocation decision which sets out the allocation to be issued to each
installation in that country. Once a final allocation decision is made, the allowances
given to an installation will be registered at the relevant national emissions registry.
National Emissions Registries
The national registries are secure systems which record allocations allocated to
and held in installation accounts; annual verified emissions for installations; the
transfer of allowances between accounts; and the annual compliance status of
installations.
11
In the UK, an operator’s holding account on the UK Emissions Registry would have
been automatically created for installations that have Greenhouse Gas Emissions
Permits subject to providing the registry administrator (the Environment Agency)
with the necessary information. Non installations operators who would like to hold
or transfer carbon allowances can also do so by opening personal-holding
accounts.
National registries have public unsecured areas. The public area allows users to
apply for an account and see publicly-available reports. The secure area allows
users to access their registry accounts and to perform various functions, including
transfers of allowances and units.
The key functions of a national registry are:
•
Account management: Allowing operators and registry administrators to
create, update and close holding accounts as well as record emissions;
•
Surrender and retirement: Allowing regulator companies and national
competent authorities to demonstrate compliance with national emissions
production targets;
•
Internal and external transfers: Allowing account holders within the same
registry and those in other national registries to transfer units and allowances
within their accounts;
•
Cancellation and replacement and carry-over of units and allowances in
accordance with the EU ETS rules. This allows the registry to comply with
both the EU and KP regulations; and
•
Reconciliation: Reconciling with the Community Independent Transaction Log
(“CITL”) and the UNFCCC Independent Transaction Log (“ITL”) on a periodic
basis to ensure registry records are consistent.
In addition to accounts held by individuals and organisations, the registry also has
national accounts. These accounts are held on behalf of the designated National
Competent Authorities, and are meant to show compliance with overall national
emissions reductions targets.
In the UK, the Designated National Competent Authorities are DEFRA, the
Environment Agency, the Department of the Environment (Northern Ireland), the
Scottish Environment Protection Agency, the National Assembly for Wales
Agriculture Department and the Department for Trade & Industry.
CITL
The Commission has established under the EU ETS Directive an independent and
supplementary web-based transaction log operated by a Central Administrator
which monitors all activities related to the EU ETS to ensure that it is consistent with
the rules of the EU ETS and records the issue, transfer and cancellation of
allowances in the national registries.
12
The Linking Directive
The EU ETS Directive initially provided that only EU ETS allowances (known as EU
ETS Allowance Units) could be recorded as trades on the EU ETS registries.
Subsequently, the Linking Directive changed the position as it allows credits
generated from Kyoto flexible mechanisms to be used for EU ETS compliance
purposes. As from 2005, CER’s generated through CDM projects can be used in
Phase 1. In Phase 2, operators can also use ERU’s generated through JI projects.
ITL
To enable trading of CER’s and ERU’s to take place a CDM Registry has been
established by the UNFCCC. The ITL, which will link the CDM Registry operated
by the UNFCCC with national registries and the CITL, has yet to be established by
the UNFCCC. The ITL is currently predicted to become effective in April 2007.
UK Emissions Trading Registry
Emissions trading started in the UK on 24 May 2005 when the UK Registry became
operational, allowing operators participating in the EU ETS to access their
allowances.
The Environment Agency is the registry administrator for the UK; it manages the UK
national Registry on a daily basis and can monitor and approve all accounts.
Any individual can open an account on the UK Registry provided they are able to
supply the necessary legal documentation and satisfy all security checks. An
administrative charge has to be paid to the Environment Agency by an applicant
for a new account.
The UK Registry’s software, developed by DEFRA, has been licensed to several
other States, including Denmark, Estonia, Finland, Hungary, Ireland, Italy, Latvia,
Lithuania, Slovenia, Sweden, The Netherlands and Norway.
13
F
How does Carbon Emissions Trading work?
As mentioned above, installations covered by the EU ETS are allocated an
emissions cap and EU ETS allowances up to the limit of the cap.
An EU ETS allowance is defined in the EU ETS Directive as meaning an allowance
to emit one tonne of carbon dioxide equivalent3 during a specified period which is
valid for the purpose of meeting the requirements of the EU ETS Directive and
which is transferable in accordance with the EU ETS Directive.
In the UK the allocation and surrender of allowances in Phase 1 takes place on an
annual basis. Allowances equivalent to the amount of CO2 actually emitted in a
relevant year have to be surrendered by each installation by 30 April of the
following year.
Installations which emit less than their cap will be able to trade the surplus
allowances. Installations that emit more than their cap must buy more allowances
from the market.
It is however possible for installations to carry over allowances between years,
although not between different phases under the EU ETS.
Penalties
If an installation does not surrender sufficient allowances to cover its reported
emissions for that year, the installation will be liable to a penalty of €40 per tonne of
CO2 equivalent during Phase 1. This penalty increases to €100 in Phase 2. All
penalties have to be paid to the respective Regulator. Any company that exceeds
its allowance will also be required to make up the surrender allowance shortfall in
the following year.
Market Participants
The trading of EU ETS allowances is not confined to installations subject to the EU
ETS. Third parties can trade provided that they hold an account with a national
registry. Some of the biggest participants in the EU ETS market are financial
institutions.
Trading can also take place between installations and entities located in different
countries in the EU as EU ETS allowances can be transferred between different
national registries.
Installations can access the market to buy or sell allowances in several ways
including:
•
Trading directly with other installations covered by the EU ETS;
•
Buying or selling directly from intermediaries /financial institutions;
•
Using the services of a broker to find other buyers and sellers; or
3 One tonne of CO equivalent means one mt of CO or an amount of any other greenhouse gas listed in Annex II with an
2
2
equivalent global warming potential, albeit at present only CO2 is covered under the EU ETS
14
•
Joining one of the exchanges that list CO2 allowance products.
Thus trading can be directly with counter parties or through an exchange and, in
some cases, OTC transactions can also be cleared through an exchange.
Form of Contract
The type of contract used to buy and sell allowances under the EU ETS will
depend upon whether the transaction is an OTC or exchange trade. We set out in
the section below entitled “Overview of OTC Standard Contract Forms” a brief
summary of the common types of contract forms.
Transfer of EU ETS Allowances
Having bought or sold allowances, a trade must be honoured by transferring the
appropriate number of allowances on to a national registry, which requires the use
of a registry account in the relevant EU country.
As previously mentioned, in the UK an operator holding account on the UK
Registry would have been automatically created for installations that have
greenhouse gas emissions permits. Non installation operators who would like to
hold or transfer carbon allowances can also do so by opening personal-holding
accounts. When affecting a transfer of allowances, account users will input the
following information relating to the units being transferred:
•
Total units;
•
Country of origin;
•
Unit type;
•
Unit commitment period;
•
The acquirer’s account details.
15
G
Ways to trade EU ETS Allowances
Exchange and OTC Trading
The two main ways of trading EU ETS allowances are either through an exchange
or by way of OTC transactions.
The advantages of trading on a futures exchange include transparency,
standardization of product, clearing and potentially lower fees. The advantages of
trading OTC include greater flexibility as to product and credit facilities.
Types of product
In the case of trading EU ETS allowances, the forward and futures markets have
developed faster than the spot market, possibly because of the delay in
establishing national registries and final allocations in many of the EU Member
States which caused problems for instant delivery under spot contracts.It is clear
however that new products are now being developed including repo’s, averaging
products and options.
16
H
Overview of OTC Standard Contract Forms
There are three main standard contract forms used for OTC transactions, each
published by the International Swaps and Derivatives Association (“ISDA”), the
International Energy Trading Association (“IETA”) and the European Federation of
Energy Traders (“EFET”) respectively as follows:
•
ISDA has published a Confirmation of OTC Physically Settled EU Emissions
Allowance Option (“Confirmation”) and a Form of Part [6] of the Schedule for
EU Emissions Allowance Transactions (“Form”)4 to one of the ISDA Master
Agreements5 (“Master Agreement”); (the Confirmation, Form and the Master
Agreement are referred to below as the “ISDA Agreement”).
•
IETA has published an Emissions Trading Master Agreement for the EU
Scheme6; (“IETA Agreement”) and, for those parties who are likely to trade
infrequently, an Emissions Allowances Single Trade Agreement for the EU
Scheme (“IETA Single Trade Agreement”).
•
EFET has published an Allowance Appendix7 to the EFET General Agreement
relating to the Delivery and Acceptance of Electricity8 and an Allowance
Appendix, on very similar terms, to the EFET General Agreement relating to
the Delivery and Acceptance of Natural Gas9 (both agreements are
hereinafter referred to as the “EFET Agreement” and both appendices as the
“EFET Appendix” and are jointly referred to as the “EFET Allowance
Agreement”).
As is evident, the above agreements have been produced by three different bodies
from different commercial backgrounds. Initially there was some inconsistency
between the agreements as to the treatment of some key issues. There has
however been a concerted effort by all three bodies to achieve harmonization
where possible in relation to key issues under the current versions of the
agreements.
Appendix 2 to this guide summarises and compares some of the key terms of the
above agreements.
4
5
6
7
8
9
Current version: version 3 published in September 2006
1992 or 2002 version
Current version 2.1 published 13 June 2005
Current version 2.0 published 20 July 2005
Current version 2.1 published 20 December 2000
Current version 1.0 published March 2006
17
I
Exchange Trading
There are a number of different exchanges offering EU ETS Allowance products
such as European Climate Exchange (“ECX”), SENDECO 2, New Values, APX
Power Limited, APX B.V., STX Services, Vertis Environmental Finance, Ex Alpen
Adria (“EXAA”), Nordic Power Exchange (“Nord Pool”), Powernext SA, European
Energy Exchange (“EEX”) and Gestore de Mercato Elettrica (“GME”).
Currently, the leading exchange in terms of exchange-traded volume is the ECX.
The ECX is part of the same group of companies as the Chicago Climate
Exchange. ECX offered the first quoted and cleared product for European CO2.
ECX began trading futures on the International Petroleum Exchange (“IPE”) now
known as ICE in April 200510.
ICE ECX CFI futures contracts (“ICE ECX CFI Futures Contracts”) are one of the
leading exchange-traded products in the field. The ICE ECX CFI options contract
has also recently been launched.
ICE ECX CFI Futures Contracts
The detailed terms of the ICE ECX CFI Futures Contracts are set out in contract
rules and administrative procedures within the regulations of ICE Future (“ICE
Regulations”). The ICE Regulations cover most of the same issues addressed in
the OTC ISDA, IETA and EFET agreements but are tailored to reflect the specific
needs of exchange traded futures contracts, such as ICE EXC CFI Future’s delivery
mechanism.
Contract Specification and Terms
As is usual for exchange traded contracts the contract specifications are
standardised as to the underlying commodity (and units thereof), type of
settlement, currency, contract months and other details.
The current underlying in ICE ECX CFI Futures Contracts is EU ETS allowances.
However there is scope for other allowance types to be recognised by the ECX.
The unit of trading is currently one lot of 1000 “Emission Allowances” being an
entitlement to emit one tonne of CO2 equivalent gas. The minimum trading size is
one lot and prices are in Euros per metric tonne.
All the contracts are quarterly term contracts listed on a monthly cycle from the
current month through to March 2008. Additionally five December contracts will be
listed from December 2008 to December 2012.
LCH.Clearnet is the counterpart to all trades and guarantees the financial
performance of the ICE ECX CFI Futures Contracts registered in the name of its
members.
10 ECX and ICE Futures have a partnership whereby ECX manages the marketing of ECX Carbon Financial Instruments and
ICE Futures lists and trades the carbon contracts on the electronic trading platform owned and operated by ICE Future’s
parent company - Intercontinental Exchange Inc, known as the Interchange or ICE Platform.
18
In order to guarantee the payments under the ICE ECX CFI Futures Contracts,
LCH.Clearnet has a default fund and ensures that it retains sufficient funds to cover
the positions which it takes through margin calls that are taken in two forms: initial
margin that is called up-front and will be passed through the ICE futures clearing
member and a variation margin that will be calculated on a daily basis as positions
are marked-to-market in order to reflect daily price movements.
Delivery and Payment
The ICE ECX CFR Futures Contracts are physically deliverable by the transfer of
allowances from the holding account of the seller at the holding account of
LCH.Clearnet (if the seller is a clearing member, otherwise the seller will first have
to transfer the allowance to the holding account of a clearing member) and from
the holding account of LCH at a registry to the holding account of the buyer (if the
buyer is a clearing member, otherwise the transfer will be to the holding account of
a clearing member which will transfer the allowance to the account of the buyer) at
a registry.
The buyer has to pay the exchange delivery settlement price specified in the ICE
ECX CFI Futures Contract by the time stipulated.
In the event of a failure to effect delivery or take delivery of allowances as a result
of seller or buyer default, the ICE Regulations set out the procedures to be followed
as regards the reimbursement of costs incurred as a consequence of such default.
The ECX also impose fines upon the defaulting party.
In the case of a seller default, LCH.Clearnet will indemnify the buyer in respect of
any reasonable costs incurred as a result of the failed delivery, which may include
the cost of going into the market and buying replacement allowances. These costs
are passed onto the defaulting seller.
In the case of a buyer default, the seller will be paid by LCH.Clearnet in any event
and the buyer is obliged to indemnify LCH.Clearnet.
The ECX excludes liability for any failures in the performance of any registry or
communication link with any registry.
19
J
Glossary
“Annex I”means the Annex I to the UNFCCC;
“Annex II” means the Annex II to the UNFCCC;
“Annex B” means the Annex B to the KP;
“CCX” means Chicago Climate Exchange;
“CDM” means Clean Development Mechanism which enables Annex I countries to
implement projects in non-Annex I countries that reduce greenhouse emissions or
absorb CO2 in return for CERs;
“CERs” means Certified Emission Reductions (see definition of JI below);
“CITL” means Community Independent Transaction Log;
“Commission” means the European Commission;
“Confirmation” means the confirmation of an emission allowance transaction under
an ISDA Agreement;
“CO2” means carbon dioxide emissions;
“COP/MOP” means conference of the parties serving as the meeting of the parties
to the KP;
“DEFRA” means Department for Environment, Food and Rural Affairs;
“ECX” means European Climate Exchange;
“EFET” means European Federation of Energy Traders;
“EFET Agreement” means EFET General Agreement relating to the Delivery and
Acceptance of Electricity (version 2.1 published 20 December 2000) and the
General Agreement relating to the Delivery and Acceptance of Natural Gas (version
1.0 published March 2006);
“EFET Allowance Agreement” means the EFET Agreement and the EFET Appendix;
“EFET Appendix” means EFET Allowance Appendix (version 2.0 published 20 July
2005) to the EFET Agreement;
“ERU’s” means Emission Reduction Units (see definition of CDM above);
20
“EU” means European Union;
“EU ETS” means European Union Emission Trading Scheme;
“EU ETS Directive” means the EU Emission Trading Directive 2003/87/EC amended
by the Linking Directive;
“Executive Board” means the executive board elected by the parties to the KP,
being comprised of 10 parties to the KP and responsible for supervising of the
CDM;
“Form” means the ISDA Form of Part [6] of the Schedule for EU Emission
Allowance Transactions (published in September 2006);
“ICE ECX CFI Futures Contracts” means the ECX CFI futures contracts, which
terms and conditions are regulated in the ICE Future Regulations;
“ICE Regulations” means the contract rules and administrative procedures within
the regulations of ICE Future;
“IETA” means International Energy Trade Association;
“IETA Agreement” means IETA Emissions Trading Master Agreement for the EU
Scheme (version 2.1 published 13 June 2005);
“IETA CDM Agreement” means the IETA CDM Emission Reductions Purchase
Agreement;
“IETA Confirmation” means the confirmation of an emission allowance transaction
under a IETA Agreement;
“IPE” means International Petroleum Exchange;
“ISDA” means International Swaps and Derivatives Association;
“ISDA Agreement” means the Form, the Master Agreements (either 1992 or 2002),
the Schedule and the Confirmation;
“ITL” means International Transaction Log;
“JI” means the Joint Implementation mechanism whereby Annex I countries may
implement emission reducing projects or projects that enhance removal by sinks in
another Annex I country in return for CERs;
21
“KP” means the Kyoto Protocol;
“LFE” means large final emitters;
“Linking Directive” means the Directive 2004/101/EC that amended the EU ETS
Directive to provide for linking to the KP mechanisms and the use of credits from
these mechanism for compliance under the EU ETS;
“Master Agreement” means one of the ISDA Master Agreements (either 1992 or
2002);
“NAP” means the national allocation plan submitted for the approval of the
Commission which specifies the total number of allowances that each Member
State intends to issue during a particular phase and how it proposes to distribute
those allowances to the installations subject to the EU ETS;
“OTC” means over the counter;
“Phase 1” means the first phase of the EU ETS that runs from 2005-2007;
“Phase 2” means the second phase of the EU ETS that runs from 2008-20012;
“RGGI” means Regional Greenhouse Gas Initiative;
“Supervisory Committee” means the supervisory committee elected by the parties
to the KP, being comprised of 10 parties to the KP and responsible for supervising
the ERUs generated by means JI projects;
“UK” means the United Kingdom;
“UNFCCC” means the United Nations Framework Convention on Climate Change;
“US” means the United States of America;
22
Appendix 1
We set out below further information regarding the CDM and JI mechanisms under
the KP.
CDM
The CDM mechanism enables an Annex I country, which is a party to the KP to
carry out projects to reduce emissions in developing countries.
The conference of the parties serving as the meeting of the parties to the KP
(“COP/MOP”) has authority over and provides guidance to the CDM. The
COP/MOP defines the general rules applicable to the CDM and takes decisions on
recommendations made by the executive board (“Executive Board”), which is
comprised of 10 members from parties to the KP.
The Executive Board supervises the CDM and is, therefore, is responsible for,
among others: (i) accreditation and recommendation of the designation of
operational entities (see below): (ii) making public available relevant information
(submitted to it for this purpose) on proposed CDM project activities: (iii) making
technical reports commissioned available to the public and providing a period for
public comments; (iv) developing and maintaining a repository of approved rules
procedures and methodologies and standards; and (v) developing and maintaining
the CDM registry. In order to perform its functions, the Executive Board can
establish committees, panels or working groups that will assist it in all
necessary matters.
CDM projects are approved by the designated operational entities, which, in
general, are responsible for: (i) the validation of the proposed CDM project
activities; (ii) verification and certification of reduction in anthropogenic emissions
by sources of greenhouse gases; (iii) compliance with applicable laws of the
parties to KP hosting the CDM project activities; (iv) submitting annual reports; and
(v) making information publicly available.
Once the CDM project activities have been approved by the operational entities
against the applicable requirements, the Executive Board registers the relevant
project activities. Such registration by the Executive Board must occur within eight
weeks after the date of receipt by the Executive Board of the request for
registration. If a project is rejected by the Executive Board, it may be submitted for
approval by the operational entity and registration by the Executive Board after
appropriate revisions.
The registration is the prerequisite for the verification, certification and issuance of
CERs. The verification is the periodic independent review and determination by the
designated operational entity of the monitored reductions in anthropogenic
emissions that have occurred as a result of the CDM project activity. This is
formalized by (1) a written assurance by the designated operational entity of the
reductions of emissions verified during a specific period of time and (2) a request
23
to the Executive Board to issue CERs equal to the verified amount of reduction of
anthropogenic emission of greenhouse gases.
JI
The JI mechanism enables an Annex I country to carry out projects to reduce
emissions in Annex I countries.
The general principles applicable to CDM are, in general, similar to those
applicable to the JI mechanism, e.g. the COP/MOP has authority over and provides
general guidance to the JI by defining the general rules applicable to the JI and
also taking decisions on recommendations made by a supervisor committee
(“Supervisory Committee”) comprised of 10 members from parties to the KP.
The Supervisory Committee must, inter alia, supervise the ERUs generated by the
JI projects activities and be responsible for: (i) accreditation of independent
entities; (ii) review of (a) standards and procedures for the accreditation and
making, if applicable, recommendations for the COP/MOP; (b) reporting guidelines
and criteria for baselines and monitoring.
Whenever a party to the KP is involved in a JI project, it must inform the secretariat
(which assists the Supervisory Committee) of its “designated focal point” for
approving projects under JI and its national guidelines and procedures for
approving such projects.
It is important to note that a country hosting a JI project has to meet the applicable
requirements and must make publicly available information on the project in
accordance with the guidelines established by the COP/MOP.
The project participants must submit to the accredited independent entity the
project design document which must contain the approval of all the countries
involved, the expected emissions reductions and the baseline and monitoring plan.
An accredited independent entity must analyse the document submitted by the
parties and must determine whether (i) the project has been approved by the
countries involved; (ii) the project would result in a reduction of emissions
anthropogenic emissions by sources or enhancements of anthropogenic removals
by sinks meeting the relevant requirements; (iii) the project has an appropriate
baseline and monitoring plan; and (iv) project participants have submitted to the
accredited independent entity documentation on the analysis of the environmental
impacts of the project activity.
The determination made by the accredited independent entity must be made
publicly available through the secretariat and will be deemed final 15 days after the
date on which it is made public, unless a party involved in the project or 3 of the
members of the Supervisory Committee request a review.
Emission reduction purchase agreements under CDM and JI projects
Generally emissions reduction purchase agreements for CDM and JI mechanisms
are an individually negotiated terms.
24
However IETA has published a standard agreement in respect of CDM projects
namely, the CDM Emission Reductions Purchase Agreement11 (“IETA CDM
Agreement”).
The IETA CDM Agreement is drafted so as to address certain issues that are
particular to CDM project related transactions, arising from the fact that the buyer
may enter into such an agreement at an early stage of the CDM project even
(before the CDM project itself is approved by the operational entity and registered
by the Executive Board).
The IETA CDM Agreement has, therefore, specific provisions addressing the
position concerning the validation and register of the CDM project, the granting of
authorization of the host country to CDM project entity, the financial close of the
project and circumstances in which the agreed amount of CERs are not issued.
The IETA CDM Agreement specifies events of default directly related to the
commission date of the project and achievement of financial close, and includes
provisions applicable in case the minimum agreed amount of CERs have not been
issued. In such a case, the buyer may: (i) accept the shortfall where it believes it
can be recovered in the subsequent year; (ii) require the project entity to propose a
plan of action to remedy the shortfall; (iii) require the project entity to provide
replacement of CERs in the same quantity as the shortfall amount; or (iv) terminate
the agreement if such failure is a results of an event of default.
11 Current version: version 2 published 20 August 2004
25
26
The Master Agreement provides that
the parties will be bound by the
terms of the transaction from the
moment they agree to the terms,
whether orally or otherwise.
The Master Agreement12 contains the
general terms defining the legal
relationship and obligations between
the parties and is supplemented by
the Confirmation and the Form which
includes the specific terms
applicable to EU Emissions
Allowance Transactions.
The IETA Agreement provides that
the parties intend that they will be
legally bound by way of verbal
agreement between the parties and
the parties give their consent to
record any telephone conversation to
provide evidence of such verbal
agreements. It provides for a written
“confirmation” of a transaction to be
issued three business days after it
has been entered into, although lack
of a written confirmation will not
affect the validity of the transaction.
It allows for the entry of individual
transactions of allowances by way of
verbal agreement between the
parties and the parties give consent
to record any telephone
conversations to provide evidence of
such verbal agreements. It provides
that individual transactions may be
entered by any form of
The EFET Allowance Agreement
works by providing an overlying
“umbrella” agreement defining the
legal relationship and obligations
between the parties, and then
allowing for individual transactions of
specified number of allowances
based on verbal or written
agreements within the rules
established by the umbrella
agreement, evidenced by written
confirmation.
The EFET Agreement comprises the
EFET Allowances Appendix and the
EFET General Agreement. The EFET
General Agreement comprises both
an electricity trading agreement and a
gas trading agreement which can both
be adapted for trading allowances by
the use of the Appendix.
The IETA Agreement comprises an
agreement which sets out the main
terms governing the relationship
between the parties and three
schedules (Schedule 1 - Definitions,
Schedule 2 - Agreement Information
(Elections) and Schedule 3 - Form of
Confirmation). It is an agreement
specific to EU allowance trading and
does not envisage the trading of any
other products or commodities.
The ISDA Agreement is designed to
allow trading of allowances under a
Master Agreement which can
operate as a single product or a
multi-product ISDA Agreement.
12 The comments below are on the basis that the 2002
Master Agreement applies
General Notes
EFET
IETA
ISDA
There are obviously other important and relevant terms contained in all of these agreements which we are unable to review in this
guide. However, for further information please contact us.
We set out below a summary of the key terms of the ISDA Agreement, IETA Agreement and EFET Allowance Agreement.
Appendix 2
27
Allowance is defined as meaning an
EU Alliance, a CER and an
“Alternative Allowance”. The latter
will include any allowance issued
under an emissions trading scheme
in a non-EU country, which has been
recognised by the EU.
The Form contains a broad definition
of the type of allowances that can be
traded which includes EU
Allowances, CER’s, ERU’s
recognised under the EU ETS and
any other allowance issued under an
emissions trading scheme in a nonEU country which has been
recognised by the EU under a
mutual recognition agreement
envisaged under the EU ETS
Directive.
Generally these are for the delivering
party to transfer allowances into the
receiving party’s nominated account
at a Member State registry and for
the receiving party to pay for the
number of allowances delivered.
Delivery of the allowances occurs
upon the deposit of the allowances
Definition of Allowances
Parties’ Obligations
Delivery
A transfer is considered to be
completed when the allowances are
As with the ISDA Agreement the
parties are obliged to ensure that
they have valid holding accounts in
any Member State Registry and the
general obligation is for the seller to
transfer allowances into the buyer’s
holding account and for the buyer to
pay for the number of allowances
delivered. In an IETA transaction the
parties holding accounts are
nominated in the IETA Confirmation
or in Schedule 2 to the IETA
Agreement.
IETA
ISDA
Delivery of the allowances occurs
upon deposit of the allowances into
The general obligations under the
EFET Allowance Agreement are for
the seller to transfer allowances into
the Nominated Account and for the
buyer to pay for the number of
allowances delivered.
Allowance is defined as an
allowance to emit one tonne of
carbon dioxide (C02) or equivalent
during a specified period valid for
the purposes of meeting the
requirements of applicable law and
the relevant emissions trading
scheme applicable to the buyer and
the delivery point on the delivery
date.
communication and that transactions
are binding and enforceable as soon
as terms are agreed. Formalising
transactions in written is optional, but
not necessary.
EFET
28
The buyer must pay for the amount
of allowances actually delivered.
Under the EFET Allowance
Agreement, payment must be made
in accordance to cycle A or cycle B,
as specified in part II of the EFET
Appendix: (i) if cycle A is specified
as applicable, payment must occur
on the later of either (a) the 20th day
of the calendar month after the
month in which the allowances were
delivered or (b) the 5th business day
following receipt of an invoice; or (ii)
if cycle B is specified as applicable,
payment must occur on or before the
5th business day after the later to
occur of (a) delivery date or (b) the
receipt of an invoice. Payment is to
be made in Euros.
The buyer must pay for the amount
of allowances actually delivered.
Under the IETA Agreement,
payment must be specified in
Schedule 2 as being (i) the later of
(a) the 20th day of the month
following the month in which the
delivery date occured (b) the 5th
banking day after the date on which
the statement is delivered to the
buyer pursuant to clause 8.213; or (ii)
the 5th banking day after the later of
(a) delivery date and (b) the date on
which the statement is delivered to
the buyer. Payment must be made
in Euros or in any other currency if
agreed by the parties.
The receiving party must pay for the
amount of allowances actually
delivered.
Under the ISDA Agreement, payment
occurs on the payment date, which
is nominated by the parties in the
Confirmation, usually as either the
5th business day following the later
of the delivery date and the date on
which the relevant value added tax
invoice is delivered to the receiving
party or the 20th day of the month
following the end of the month in
which the delivery date occurs.
Payments are required to be made in
“freely transferable funds” in the
currency nominated by the parties.
an account nominated by the buyer.
Under the EFET Allowance
Agreement, the relevant account can
either be nominated in the
confirmation or parties can agree to
provide a list of possible accounts in
the confirmation and later to
designate the relevant account for
delivery among those listed.
Transfer of title to the allowances
takes place upon delivery.
received in the buyer’s holding
accounts specified in Schedule 2 or
in the IETA Confirmation. Title to the
allowances and risk of loss related
the allowances or any part of them
transfer from the seller to the buyer
upon delivery.
into an account at a Member State
Registry nominated by the receiving
party. Both receiving party and
delivering party therefore have an
obligation under the ISDA
Agreement to maintain registrytrading accounts in accordance with
the EU ETS rules. Under the ISDA
Agreement, the relevant account is
nominated in the Confirmation.
13 Detailing matters such as the quantity of allowances
delivered, price and any physical or payment netting.
Payment
EFET
IETA
ISDA
29
14 Multiple Transaction Payment Netting.
Replacement Costs / Cover Costs
Payment netting and physical
netting of deliveries
There are specific provisions for
calculating replacement costs in the
event that either the receiving party
fails to take delivery of the
Allowances or the delivering party
Seller’s Replacement Costs
Under the IETA Agreement, if the
buyer fails to accept delivery of the
allowances and if that failure is
remedied within one banking day of
the date of the notice given by the
Provision is made for determining
the replacement costs for the failure
to deliver or accept allowances.
Under the EFET Allowance
Agreement these are referred to as
cover costs and not, as under the
If specified as applying, allowances
of the same allowance type and
compliance period will be
automatically satisfied and
discharged and, if applicable,
replaced by the obligation of the
party from whom the larger
aggregate number of allowances
would have been transferable to
schedule and transfer to the other
party a number of allowances equal
to the excess of the larger aggregate
number of allowances over the
smaller aggregate number of
allowances.
Payment netting for allowances is
permitted under the EFET Allowance
Agreement. Parties can agree to
cross-net against electricity
payments, but the default position is
that allowances and electricity are
netted discretely. The buyer is
obliged to pay for any allowances
which the seller has actually
delivered into the nominated account
at the scheduled date for delivery in
accordance with the seller’s
obligations under the EFET
Allowance Agreement.
Netting of payments of different
allowance transactions is permitted
and, unless otherwise specified in
Schedule 2, physical netting of
allowance transactions is also
permitted.
Payment netting applies to amounts
payable in respect of the same
transaction and in the same
currency. However the ISDA
Agreement specifically provides that
the parties can elect that a net
amount will be payable with respect
to all outstanding or specific groups
of transactions under the ISDA
Agreement which are due for
payment on the same day and in the
same currency14.
The ISDA Agreement permits
physical nettings of allowance
transactions in respect of two or
more EU Emissions Allowances
Transactions between the parties for
the same allowance type and
specified compliance period
between the same pair of trading
accounts of the parties.
EFET
IETA
ISDA
30
The seller’s replacement cost is the
positive difference between the
contract price and the price that a
seller would receive in an arm’s
length transaction for the shortfall
quantity plus interest, reasonable
costs and expenses including broker
fees and legal fees.
Receiving party’s replacement costs
The receiving party can choose from
three different bases for assessing
the applicable replacement costs in
the event that the delivering party
fails to make delivery of the
allowances and make an election as
to which basis is to apply. Broadly
the replacement costs are based
upon the difference between the
contractual allowance price and the
price that the receiving party would
have to pay to purchase the
allowances in an arm’s length
transaction at the times specified
defined in the ISDA Agreement
(which will depend upon the election
made by the Buyer) together with
interest. However the receiving party
Buyer’s Replacement Costs
Under the IETA Agreement, if the
seller fails to deliver the allowance
and (i) if such failure is remedied
within one banking day of the date of
the notice given by the buyer of the
notice requiring the seller to remedy
the failure, the seller must pay to the
buyer interest on an amount equal to
the contract price multiplied by the
seller of the notice requiring the
buyer to remedy the failure (“the
Final Delivery Date”) the buyer must
pay to the seller interest of an
amount equal to the contract price
multiplied by the number of
allowances not transferred for the
period from the delivery date to the
actual date of transfer. If the buyer
does not remedy the failure to
transfer by the Final Delivery Date
the seller may terminate the
transaction and the buyer must pay
to the seller replacement costs for
any underlivered allowances before
the third banking day following the
receipt of such notice of termination.
fails to make delivery of allowances
other than as a result of a settlement
disruption event.
Delivering party’s replacement costs
In the event that the receiving party
fails to take delivery of the
allowances, the delivering party’s
replacement costs are based upon
the difference between the
contractual allowance price and
price per allowance that the
delivering party would receive in an
arm’s length transaction on the final
compliance date (as defined in the
Form section of the ISDA
Agreement) together with interest.
IETA
ISDA
Buyer’s Cover Costs
If the seller wrongfully fails to deliver
allowances the buyer is entitled to
claim the buyer’s cover costs. These
costs are equal to the amount by
which the price which the buyer is
able, or would have been able, in a
calculation agent’s determination, to
purchase replacement allowances in
the market exceeds the price
payable for the delivered allowance
Seller’s Cover Costs
If the buyer wrongfully fails to accept
a transfer of allowance and the seller
has not agreed to a deferred
acceptance date the buyer is
obliged to pay the seller’s cover
costs. These costs are equivalent to
the difference between the re-sale
price which the seller received or
would receive if acting in a
commercially reasonable manner in
an arm’s length transaction and the
contract price if lower than the resale price plus any reasonable
incidental costs incurred in the
resale and interest.
The EFET Allowance Agreement
includes an express mechanism
whereby both the seller and the
buyer can waive cover costs by
agreeing to deferred acceptance or
delivery dates.
ISDA and IETA Agreement
replacement costs.
EFET
31
However the buyer can also elect
that the seller indemnify the buyer in
respect of any excess emissions
penalty in Schedule 2 or the IETA
Confirmation. If the election is made
and the buyer becomes liable to pay
an excess emissions penalty, then if
reasonably requested by the seller,
the buyer must provide evidence that
(i) the buyer has incurred in the
excess emission penalty consequent
on the seller’s failure to deliver; (ii)
the extent to which the requirement
for the buyer to pay the excess
emission penalty results from the
Under IETA, the replacement costs
for the failure to deliver are
essentially the positive difference, if
any, between the contract price and
what the buyer would pay in an
arm’s length transaction to replace
the shortfall in the allowances, plus
reasonable costs and expenses
including broker fees and legal fees.
under the EFET Allowance
Agreement plus transmission costs,
interest accrued and calculated
according to the EFET Allowance
Agreement and other verifiable costs
incurred including, if specified as
applicable, any excess emissions
penalty.
number of allowances not transferred
for the period from the delivery date
to the actual date of transfer. If the
failure to deliver is not remedied by
the seller on or before the final
delivery date, the buyer may
terminate the affected transaction
and the seller must pay the buyer’s
replacement costs for any
undelivered allowances before the
third banking day following the
receipt of such notice of termination.
can also elect to include
indemnification in respect of any
Excess Emissions Penalty payable. If
this election is made the delivering
party has to indemnify the receiving
party in respect of any Excess
Emissions Penalty payable by the
receiving party in respect of the
shortfall of allowances in the event
that the receiving party has been
unable to buy in replacement
allowances by the reconciliation
deadline (as defined in the
agreement).
The seller has the right to ask the
buyer to provide evidence that any
emissions penalty was incurred as a
result of the seller’s failure to deliver
and of the buyer’s commercially
reasonable endeavours to mitigate
the exposure to any excess
emissions penalty although the
burden of proof in challenging these
factors remains on the seller.
EFET
IETA
ISDA
32
Given the importance of the
reconciliation deadlines if delivery is
due close to that deadline, and there
is a termination event, force majeure
event15, settlement disruption
event16 or some other event which
causes there to be an authorised
delay in delivery, the time periods
specified under the ISDA Agreement
will be modified to take account of
the reconciliation deadline as
The reconciliation deadline is
defined under the ISDA Agreement
as 30 April every year or such later
date as may be determined under
the EU ETS for the surrender of
allowances pursuant to the EU ETS.
There is also a definition of an end of
phase reconciliation deadline which
corresponds to the end of any phase
under the EU ETS.
Under the IETA Agreement, there is
also a reconciliation deadline of 30th
April every year or such other date
as may be reflected under the EU
ETS Rules and a definition of end of
phase reconciliation deadline. Whilst
the force majeure provisions of the
IETA Agreement reflect the impact of
the end of phase reconciliation
deadline, unlike the ISDA Agreement
other provisions concerning delay in
delivery do not appear to do so.
seller’s failure to deliver; and (iii) the
buyer could not have used
allowances to which it had title in any
holding account to avoid or reduce
its liability to which it claims from the
seller as part of the replacement
costs.
IETA
Under the EFET Allowance
Agreement the reconciliation
deadline if the 30 April in any
calendar year.
EFET
15 Included in the 2002 Master Agreement but not the 1992 Master Agreement
16 Transactions are suspended for the duration of the settlement disruption event, except for the cases described in Part [6], (c), (5), where settlement disruption event continues: (a) during a
period ending 9 delivery business days after the original date that, but for the settlement disruption event, would have been the delivery date for an emissions allowance transaction; (b) if such
9 delivery business day period would end after the reconciliation deadline on or immediately following the original date that, but for the settlement disruption event, would have been the
delivery date for an emissions allowance transaction, during the period ending on that reconciliation deadline; or (c) if such 9 delivery business day period would end after the day that is 3
delivery business days preceding the end of phase reconciliation deadline on or immediately following the original date that, but for the settlement disruption event, would have been the
delivery date for and emissions allowance transaction, during the period ending on the day that is 3 delivery business days preceding that end of phase reconciliation deadline.
Reconciliation Deadline
ISDA
33
17 Under the 1992 Master Agreement
18 Under the 2002 Master Agreement
Force Majeure / Settlement
Disruption Event
A settlement disruption event is
defined as an event or
circumstances beyond the control of
the party affected that cannot be
reasonably overcome and which
makes it impossible for that party to
perform its obligations to either
accept or deliver allowances under
the transaction.
Force majeure events under the
2002 Master Agreement are broadly
defined as a force majeure event or
act of state which is beyond the
control of the party and which
prevents, makes it impossible or
impracticable for that party to
perform certain obligations which
event or act the party could not
reasonably have overcome. There is
no definition of force majeure in the
1992 Master Agreement, however
the Form includes a definition of a
settlement disruption event.
appropriate e.g. by adding an
additional termination event17 or
event of illegality18 if a settlement
disruption event continues after a
reconciliation deadline or within three
days of an end of phase
reconciliation deadline.
ISDA
The IETA Agreement provides for the
parties to elect in Schedule 2
Force majeure is broadly defined
under the IETA Agreement as being
an occurrence beyond the
reasonable control of a party that
could not after using all reasonable
efforts be overcome and which
makes it impossible for a party to
perform obligations to deliver or
accept allowances.
Under the force majeure provisions
of the IETA Agreement, an affected
party is released from any
obligations, which are affected by an
event of force majeure. However if
the force majeure event continues for
a period of nine delivery banking
days or up until three delivery
banking days prior to any end of
phase reconciliation deadline either
party may upon written notice
terminate the agreement.
IETA
The EFET Allowance Agreement
contemplates the availability of
contingency arrangements if there is
a failure of the registry systems or
processes. If there is an event of
force majeure, the affected party is
released from any obligations which
are affected by an event of force
Under the EFET Allowance
Agreement, if the German law is
nominated, the German law
principles of interpretation and body
of law for concepts such as force
majeure will be applicable.
Under the EFET Allowance
Agreement, a force majeure is an
occurrence which is beyond the
reasonable control of a party, which
could not reasonably be avoided or
overcome, and which makes it
impossible for a party to perform its
delivery or acceptance obligations.
Specific events are excluded.
EFET
34
Events of Default
(i) Non-payment;
(ii) Representation and
warranties that have proved to
be false or materially misleading
at the time they were made;
(i) Failure to pay or deliver;
(ii) Breach of agreement and
repudiation of agreement;
(iv) Misrepresentation – a
representation (other than
payee and payer tax
representations) that is proved
(iii) Failure to perform a material
obligation under the IETA
Agreement;
The following events constitutes
material reason for purposes of
termination of the EFET Allowance
Agreement:
Under the IETA Agreement, the
occurrence of any of the following
events constitutes an event of
default:
Under the ISDA Agreement, the
occurrence of any of the following
events constitutes an event of
default:
(iii) Credit support default;
majeure. Obligations under the
affected transactions are released
after notification of the force of
majeure for the period of time and to
the extent (except as provided
below) that the force majeure affects
performance. The parties may
terminate the allowance transaction
if the force majeure continues for a
period of time on the earlier to occur
of: (a) a period of 9 business days
from the date that, but for the force
majeure, would have been the
Delivery Date of the relevant
allowance Transaction(s); (b) the
Reconciliation Deadline; or (c) the
day which falls 3 business days prior
to the End of Phase Reconciliation
Deadline.
whether a force majeure termination
payment shall be made and, if so,
two alternative bases for such
payment.
If a settlement disruption event has
not been remedied by (1) the ninth
business day after the delivery date,
or (2) the nine business day period
would end after the reconciliation
deadline or (3) the nine business day
period would end on a day that is
three business days preceding the
end of the phase reconciliation
deadline, the settlement disruption
event is deemed an additional
termination event (under the 1992
Master Agreement) or illegality
(under the 2002 Master Agreement).
(iii) Winding-up, insolvency and
attachment;
(ii) Cross-default and acceleration;
(i) Non performance - the failure of
the party to make payment,
deliver the allowance or not
comply with any other material
obligation;
EFET
IETA
ISDA
35
(vi) Cross-default: unless specified
by the parties in Schedule 2 not
to apply; it will apply in case of
(a) default, event of default or
similar condition or event in
respect of a party or any credit
support provider under one or
more agreements in an
aggregate amount of not less
than the cross default threshold
(as defined in Schedule 2) or (b)
default by that party or its credit
support provider in making one
(v) Force majeure (please see item
“Force Majeure” of this section
above);
(v) Credit support: this comprises
effectively (a) a failure to comply
with obligations under the credit
support agreement which is not
remedied within 3 banking days
of notification, or (b) expiration or
termination of a credit support
agreement not remedied within 3
banking days of notification; or
(c) repudiation, rejection,
disaffirmation, disclaimer or
challenge of a credit support
document by the party or credit
support provider;
However, it is important to mention
that if “automatic early termination” is
specified to apply to a party, upon
occurrence of an event of default
specified in 10.5(c)20, the
terminating party does not need to
send the notice.
Under the EFET Allowance
Agreement, if a material reason with
respect to a party has occurred and
is continuing, the other party may
terminate the agreement by giving
the other party notice. The date of
the early termination may not be
earlier than the date that the notice
is deemed to be received nor later
than 20 days of such receipt.
(vi) Representation and warranties
proved to have been incorrect or
misleading in any material
respect.
(iv) Failure to deliver or accept;
EFET
(iv) Insolvency;
IETA
19 See footnote 21 below
20 “W
Winding-up/Insolvency/Attachment. A Party or its Credit Support Provider: (i) is dissolved (other than pursuant to a consolidation, amalgamation or merger); (ii) becomes insolvent or is unable
to pay its debts or fails or admits in writing its inability to generally to pay its debts as they become due; (iii) makes a general assignment, arrangement or composition with or for the benefit of its
creditors; (iv) institutes or has instituted against it a proceeding seeking a judgment of insolvency or bankruptcy or any other relief under any bankruptcy or insolvency law or other similar law
affecting creditors’ rights, or a petition is presented for its winding-up or liquidation, and of specified in the Election Sheet, is not withdrawn, dismissed, discharged, stayed or restrained within
such a period as specified in the Election Sheet; (v) has a resolution passed for its winding-up, official management or liquidation (other than pursuant to a consolidation, amalgamation or
merger); (vi) seeks or becomes subject to the appointment of an administrator, provisional liquidator, conservator, receiver, trustee, custodian or other similar official for it or all or substantially all
its assets; (vii) has a security party take possession of all or substantially all its assets or has a distress, execution, attachment, sequestration or other legal process levied, enforced or sued on or
against all or substantially all its assets; (viii)causes or is subject to any event with respect to it that, under the applicable law of any jurisdiction, has an analogous effect to any of the events
specified in clauses (i) to (vii) above (inclusive); or (ix) takes any action in furtherance of, or indicating its consent to, approval of, or acquiescence in, any of the acts referred to in this 10.5(c).”
(vii)Bankruptcy19; and
(vi) Cross Default – if the parties
specify that cross-default is
applicable it will apply in case
of (a) default, event of default
or similar condition or event in
respect of a party or any credit
support provider under one or
more agreements in a total
amount of not less than the
threshold amount (as defined in
the ISDA Agreement) or (b)
default by the party or its credit
support provider in making one
or more payment on the due
date in a total amount not less
than the threshold amount (as
defined in the ISDA Agreement);
(v) Default under specified
transactions – the parties may
specify in the Schedule if
default under determined
transaction will be considered
an event of default under the
ISDA Agreement;
to be incorrect or misleading in
any material respect at the time
it is made;
ISDA
36
(viii) Merger without assumption – if a
party or its credit support
provider consolidates,
amalgamates with, merges with
or into, or transfers all or
substantially all its assets, or
reorganises, reincorporates or
reconstitutes into or as another
entity and: (a) the resulting,
surviving or transferee entity fails
to assume all the obligations
under the ISDA Agreement or
credit support document or (b)
the benefits of any credit support
document fail to extend to the
performance by the resulting,
surviving or transferee entity of
its obligation under the ISDA
Agreement.
ISDA
(viii) Material adverse change - a
failure, upon request, to provide
or increase a performance
assurance where a party
believes in good faith that one of
the following has occurred (a)
adverse changes in the credit
rating of the party and the credit
support provider; (b) entering
into any control or profit transfer
agreement; (c) impairment of the
ability of a party or its credit
support provider to perform the
obligations under the IETA
Agreement; (d) credit event upon
merger i.e. the ability of a
relevant entity to perform its
obligation under the IETA
Agreement in case of a change
of control, consolidation and
amalgamation (or similar
transactions) or if the resulting
entity has a weaker
creditworthiness compared to the
(vii)Default under specified
transaction - the parties may
specify that in case of default in
relation of determined
agreements/transactions, default
in making payment due or on
early termination, or repudiation /
rejection of such agreement /
transaction would be considered
a default under the IETA
Agreement; and
or more payment on the due date
in an aggregate amount not less
than the cross default threshold
(as defined in Schedule 2);
IETA
EFET
37
In case of occurrence of any event of
default and its continuing, the nondefaulting party upon at least 20
days notice to the defaulting party
specifying the relevant event of
default may designate a early
termination date which may not be
earlier than the day such notice is
effective. However, it is important to
note that if “automatic early
termination” is specified to apply to a
party then with respect to such party
a termination date will occur
immediately upon the occurrence of
a bankruptcy event of default as
specified in the ISDA Agreement21.
If an event of default occurs and is
continuing, the non-defaulting party
may upon at least 20 days notice to
the defaulting party of the relevant
event of default designate a early
termination date which may not be
earlier than the day such notice is
effective. However, it is important to
note that if “automatic early
termination” is specified to apply to a
party in Schedule 2, then with
respect to such party a termination
date will occur immediately upon the
occurrence of certain of the
insolvency events of default as
specified in the IETA Agreement22.
party or credit support provider;
(e) decline in tangible net worth;
(f) failure in fulfil any financial
covenant.
IETA
EFET
21 Automatic termination will apply in respect of the following, namely: Section 5(a)(vii)(1), (3), (4), (5), (6) (8) of the ISDA Master Agreement 2002 which provides: “Bankruptcy. The party, any Credit Support Provider or
such Specified Entity of such party: - (1) is dissolved (other than pursuant to a consolidation, amalgamation or merger); (…); (3) makes a general assignment, arrangement or composition with or for the benefit of its
creditors; (4) (A)institutes or has instituted against it, by a regulator, supervisor or any similar official with primary insolvency, rehabilitative or regulatory jurisdiction over it in the jurisdiction of its incorporation or
organisation or the jurisdiction of its head or home office, a proceeding seeking a judgment of insolvency or bankruptcy or any other relief under any bankruptcy or insolvency law or other similar law affecting creditors’
rights, or a petition is presented for its winding-up or liquidation by it or such regulator, supervisor or similar official; (B) has instituted against it a proceeding seeking a judgment of insolvency or bankruptcy or any other
relief under any bankruptcy or insolvency law or other similar law affecting creditors’ right, instituted or presented by a person or entity not described in clause (A) above and either (I) results in a judgment of insolvency or
bankruptcy or the entry of an order for relief or the making of an order for its winding-up or liquidation or (II) is not dismissed, discharged, stayed or restrained in each case within 15 days of the institution or presentation
thereof; (5) has a resolution passed for its winding-up, official management or liquidation (other than pursuant to a consolidation, amalgamation or merger); (6) seeks or becomes subject to the appointment of an
administrator, all or substantially all its assets; (…); (8)causes or is subject to any event with respect to it which, under the applicable law of any jurisdiction, has an analogous effect to any of the events specified in
clauses (1) to (7) above (inclusive) (…)”.
22 Automatic early termination will apply in respect of the following: Section 12.2(d)(i), (iii), (iv), (v), (vi), (vii), (viii) of the IETA Agreement namely: “Insolvency. The party or any Credit Support Provider of the Party: (i) is
dissolved (other than pursuant to a consolidation, amalgamation or merger); (…); (iii) makes a general assignment, arrangement or composition with or for the benefit of its creditors; (iv) institutes or has instituted against
it a proceeding seeking a judgment of insolvency or bankruptcy or any other relief under any bankruptcy or insolvency law or other similar law affecting creditors’ rights, or a petition is presented for its winding-up or
liquidation, and in the case of any such proceeding or petition instituted or presented against it, that proceeding or petition (A) results in a judgment of insolvency or bankruptcy or any other relief or the making of an order
for its winding-up or liquidation or (B) is not withdrawn, dismissed, discharged, stayed or restrained in each case within thirty days of the institution or presentation thereof; (v) has a resolution passed for its winding-up,
official management or liquidation (other than pursuant to a consolidation, amalgamation or merger); (vi) seeks or becomes subject to the appointment of an administrator, provisional liquidator, conservator, receiver,
trustee, custodian or other similar official for it or all or substantially all its assets; (vii) has a security party take possession of all or substantially all its assets or has a distress, execution, attachment, sequestration or other
legal process levied, enforced or sued on or against all or substantially all its assets and that secured party maintains possession, or that process is not withdrawn, dismissed, discharged, stayed or restrained, in each
case within fifteen days of that event; (viii)causes or is subject to any event with respect to it that, under the applicable law of any jurisdiction, has an analogous effect to any of the events specified in clauses (i) to (vii)
above (inclusive) (…)”.
Early termination /
Automatic early termination
ISDA
38
Suspension
Termination Events
Credit event upon merger; and
Additional termination event.
(v)
(vi)
Although there is no express right of
termination under the ISDA
Agreement the performance of a
party’s obligations to make payment
or delivery is subject to the condition
precedent that no event of default, or
potential event of default or early
termination date has occurred or
been designated as being
applicable.
The right to terminate the ISDA
Agreement upon occurrence of a
termination event will vary according
to type of termination event and
whether there is only one affected
party or both parties are affected by
such an event.
Tax event upon merger;
(iv)
(iii) Tax event;
(ii) Force majeure event;
(i) Illegality;
In addition, the ISDA Agreement
specifies the following list of events
that will constitute a termination
events:
ISDA
In addition, the IETA Agreement also
provides that in case of any a
Without prejudice to the right to
terminate the agreement, after the
occurrence of any event of default,
the non-defaulting party may, subject
to liability, suspend or withhold
payments or suspend the allowance
transfer. There is no such equivalent
provision in the ISDA Agreement.
IETA
EFET
39
Law and Jurisdiction
Under the ISDA Agreement the
parties are offered the choice of
either English or New York law as the
governing law. However parties can
choose other governing laws by
specifying the same in the schedule
to the Master Agreement.
ISDA
The IETA Agreement provides that it
shall be governed by English law
unless the parties elect otherwise in
Schedule 2.
illegality i.e a change in applicable
law after the date on which the
agreement was entered which would
make unlawful for a party to perform
any obligation to make a payment or
delivery (and in the case of the
credit support documents to comply
with the continent obligations related
to the transaction) unless agreed in
writing any of the parties may elect
to terminate the relevant transaction.
IETA
It was drafted with multiple European
civil law and English common law
principles in mind, and the default
law is German, although other
governing laws can be nominated.
EFET
Contacts
Kyri Evagora
+44 (0)20 7772 5896 direct
+44 (0)20 7539 5220 fax
[email protected]
Siân Fellows
+44 (0)20 7772 5806 direct
+44 (0)20 7539 5767 fax
[email protected]
Diane Galloway
+44 (0)20 7772 5884 direct
+44 (0)20 7539 5115 fax
[email protected]
Suzanne Bainbridge
+44 (0)20 7772 5991 direct
+44 (0)20 7539 5353 fax
[email protected]
Richard Swinburn
+44 (0)20 7772 5887 direct
+44 (0)20 7539 5304 fax
[email protected]
Paul Dillon
+44 (0)20 7772 5899 direct
+44 (0)20 7539 5130 fax
[email protected]
Nola Beirne
+44 (0)20 7772 5901 direct
+44 (0)20 7539 5359 fax
[email protected]
Celia Gardiner
+44 (0)20 7772 5933 direct
+44 (0)20 7539 3360 fax
[email protected]
Reed Smith Richards Butler LLP
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