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Linking to Europe’s ETS: how to make it work

The Australian Government and European Union have laid out the first links between our emissions trading schemes. Phillipe Put/Flickr

Yesterday the Department of Climate Change and Energy Efficiency released its draft regulations and a consultation paper, setting out the details on linking the EU Emissions Trading System (“EU ETS”) and the Australian Carbon Pricing Mechanism (“CPM”).

As the consultation paper notes, “this arrangement represents the first step towards linking the established carbon market in Europe with developing markets in Asia-Pacific”. Combined, the linked Australian and EU markets will be the largest carbon market in the world.

What kind of link?

When the link was announced on 28 August 2012, legislation was amended to facilitate two options for registry linking.

The first is a direct link, where European Union Allowances (“EUAs”) could be imported directly into the Australian registry, making those allowances exchangeable with Australian units.

The second is an indirect registry link. This would not involve directly transferring EU allowances into the Australian registry, but would require arrangements for new units “shadowing” EUAs to be issued in the Australian registry.

The consultation paper, and associated exposure draft regulations, propose establishing an indirect registry link by 1 July 2015 so EU allowances can be used in our carbon pricing mechanism. This would transition to a direct registry link no later than the start of the full linking period with the EU ETS, expected to be on 1 July 2018.

How will an “indirect” link work?

The Australian Clean Energy Regulator will open a registry account in the EU registry system (the “Australian Government Account”). Australian liable entities who want to use EU allowances to meet their obligations in the carbon price mechanism will transfer those allowances into the Australian Government Account.

After these units are transferred, the regulator will issue an equivalent number of “Australian Issued International Units” into the liable entity’s account in the Australian registry. These act as “shadow” units to the EUAs.

These shadow Australian units can be traded in the Australian carbon market, surrendered for compliance in the carbon price mechanism, or “swapped back” into European allowances for trade in the EU ETS.

When a shadow Australian unit is swapped back into an EU allowance, the Australian unit would be cancelled in the Australian registry. To prevent the risk of double-counting, when these Australian units are surrendered, relinquished, or voluntarily cancelled in the Australian registry, the Australian government would transfer one EU allowance to the EU deletion account. Australian units will have public serial numbers, which will be independent of the serial number of the backing EU allowance.

Other measures will be developed to minimise fraud and the manipulation of the registry link. These will include a secure communications system to validate all transactions and identify any trading discrepancies.

Implications for the Australian carbon price and liable entities

The release of the draft regulations clarify how Australia and the EU propose the linking arrangements will work. This lack of certainty was one of the reasons restricting trading of EU allowances by Australian liable entities.

Some uncertainty remains as to whether a linkage will be implemented in practice. There are a number of conditions in the regulations that need to be satisfied before shadow Australian units can be issued. One is the opening of a Commonwealth account in the EU registry. If the Regulator is not given authority to open the account before the Federal election, and there is a change in government, then the Coalition government may refuse to open or defer opening of the account. Without the account, the indirect linkage couldn’t operate.

If the indirect linking arrangements are established, the indirect linking proposal will have implications for the delivery mechanics in trading documentation. The arrangements will generally favour Australian liable entities with their own accounts in the EU Registry. They will have more flexibility in purchasing and surrendering EU allowances, and they can take more advantage of the current low price of those allowances.

A matter of timing

Overall, the timely release of these draft regulations indicates Australia is on track to implement linking arrangements with the Europeans. The consultation paper (which was jointly produced by the Australian Government and the European Commission) states that the government will introduce the regulations by 1 June 2013.

Of course, there is a strong political incentive for the government to finalise the registry arrangements before the Federal election. Without these arrangements, any link with the EU may only ever exist in theory. Given the limited parliamentary sitting time before the election, the government has a very narrow window within which to table these regulations in Parliament.

Once the regulations are in place, dismantling them, like most aspects of the carbon pricing mechanism, will require support by both houses of Parliament. It is unlikely that an Abbott Government could also achieve control the Senate. If the Government can finalise the registry arrangements of the linkage before the election then this would further secure the Australian carbon market as part of our regulatory landscape.

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