There is no final draft of the amendments to the EU ETS scheme yet. A draft of the provisional text was published on 8 February 2023. The final text is expected to be adopted shortly.
Under the EU ETS, in relation to each compliance year, shipping companies will be required to surrender EUAs relating to their carbon emissions in that year. Shipping companies will be provided with a free allocation of EUAs. Additional EUAs can then be purchased on the secondary market or bought in auctions arranged by the appointed auction platform (currently EEX). The deadline for surrendering EUAs in respect of a compliance year will be 30 September of the following year.3
The first compliance year for shipping companies will be 2024. In respect of that year, shipping companies will be required to surrender EUAs covering 40% of their intra-EU voyages and 20% of emissions on voyages into or out of the EU. These percentages will increase incrementally over 2024-2026 to reach 100% of emissions on intra-EU voyages and 50% of voyages into or out of the EU.
The introduction of emissions allowances to the shipping industry may be seen as presenting an opportunity. While owners and managers may themselves have primary responsibility for surrendering EUAs, they are likely to want to pass on the costs to charterers. Parties may look to trade in EUAs to turn a profit. Any party considering these approaches also needs to consider the regulatory position under EU MiFID 2. This alert provides a high-level introduction to this area.
Financial regulatory implications: EU MiFID 2
EU MiFID 2 is a cornerstone of EU/EEA financial regulation. Under EU MiFID 2, EU and EEA Member States must require that the provision of investment services and/or the performance of investment activities as a regular occupation or business be subject to prior authorisation.4 Unless they can rely on an exemption under EU MiFID 2, a person acting from the EEA will need authorisation if they carry on an investment service or activity in relation to a “financial instrument” as a regular occupation or business.
Under EU MiFID 2, EUAs in and of themselves are “financial instruments.”5 Therefore, the spot sale or purchase of an EUA is a trade in a financial instrument.
In addition, options, futures, swaps and other derivatives relating to EUAs, whether they may be settled physically or in cash, are also “financial instruments.”6
While both EUAs themselves and related derivatives are “financial instruments”, whether a particular transaction constitutes a “derivative”7 may have important regulatory consequences. For example, if a transaction relating to EUAs is a derivative then it will fall within the scope of EMIR. EMIR sets obligations relating to the reporting of derivatives contracts as well as obligations relating to the risk mitigation and (where certain conditions are met) clearing or margining of OTC derivatives.
Further, participants in EU emissions markets (both spot and derivative) also need to be cognisant of their obligations under the EU Market Abuse Regulation.8
Investment services and activities
The key investment activities and services covered by EU MiFID 2 are:9
- Reception and transmission of orders, in relation to one or more financial instruments (which includes bringing together two or more investors, thereby bringing about a transaction between those investors)10
- Execution of orders on behalf of clients (which, broadly, means acting to conclude agreements to buy or sell one or more financial instruments on behalf of clients)11
- Dealing on own account (which, broadly, means trading against proprietary capital resulting in the conclusion of transactions in one or more financial instruments)12
- Portfolio management (which means managing portfolios in accordance with mandates given by clients on a discretionary client-by-client basis where such portfolios include one or more financial instruments)13
- Investment advice (which means the provision of personal recommendations to a client, either upon its request or at the initiative of the investment firm, in respect of one or more transactions relating to financial instruments)14
- Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis
- Placing of financial instruments without a firm commitment basis
- Operation of a multilateral trading facility (MTF)
- Operation of an organised trading facility (OTF).
The inclusion of EUAs and related derivatives within EU MiFID 2 as financial instruments, and the broad range of the investment services and investments, mean that any person who does any of the following potentially needs to consider their licensing position:
- Bidding in EUA auctions
- Buying or selling EUAs (or related derivatives) as principal
- Buying or selling EUAs (or related derivatives) as agent
- Arranging transactions in EUAs (or related derivatives)
- Advising on transactions in EUAs (or related derivatives)
Exemptions under EU MiFID 2
EU MiFID 2 contains several exemptions from its authorisation requirements that may be relevant to emissions allowance activities:
- Operators subject to the EU ETS: article 2(1)(e) of EU MiFID 2 exempts operators with compliance obligations under the EU ETS who when dealing in EUAs do not execute client orders, provide investment services nor perform investment activities other than dealing on own account. Further, they must not engage in high-frequency algorithmic trading.15 This exemption is potentially very helpful to shipping companies subject to the EU ETS that buy or sell spot EUAs for themselves. But it does not provide a solution to entities looking to provide services relating to EUAs nor (on its plain words) to those active in derivatives relating EUAs (e.g., those using derivatives contracts to pass on the costs of compliance to charterers).
- Groups exemption: there is no authorisation requirement for persons providing investment services exclusively for their parent undertakings, their subsidiaries or for other subsidiaries of their parent undertakings.16
- Ancillary activities: persons who (i) deal on own account (excluding those doing so when executing client orders) or (ii) provide investment services to customers or suppliers of their main business (other than dealing on own account), in each case, in EUAs or related derivatives are exempt, provided that:
- the activity is ancillary to their main business, when considered on a group basis;
- their main business is not the provision of investment services, banking activities or market making in commodity derivatives;
- they do not engage in high-frequency algorithmic trading; and
- they report, upon request or as otherwise required,17 to the regulator the basis on which they have assessed that their activity under points (i) and (ii) is ancillary to their main business.18
Regulations19 made under EU MiFID 2 set quantitative tests for determining whether an activity is ancillary to a person’s main business, when considered on a group basis.
Note that EU MiFID 2 also allows Member States to implement certain option exemptions, some of which may be relevant to the EU ETS (e.g., article 3(1)(e) of EU MiFID 2).
In practice, to the extent that a shipping company or other entity that wishes to trade in emissions cannot rely on the operator’s exemption to exempt all its activities, it will need to consider other exemptions and in particular the ancillary activities and groups exemptions referred to above. Note that the ancillary activities exemption is more flexible than the exemption for operators, but entities looking to provide a dealing or execution service to clients in EUAs or related derivatives may find they fall outside its scope.
EU MiFID 2 applies to activities by EEA entities and third country entities with an EEA branch. While other laws20 contain certain provisions regulating cross-border activity with counterparties in the EEA, the territorial question of whether a third country entity providing investment services or performing investment activities on a cross-border basis with clients or counterparties in the EEA needs authorisation is left to individual Member States to determine.
The UK position
Leaving aside the UK’s own policy initiatives to decarbonise shipping, this section considers the treatment of EUAs under UK law.
Due to its departure from the EU, under the EU Withdrawal Acts, the UK transposed and onshored EU MiFID 2 as it was in effect at the end of the transition period, on 31 December 2020.
Under UK MiFID the position is very similar to that in the EU/EEA. In particular, EUAs and derivatives relating to EUAs (whether cash or physically settled) can be “financial instruments” for the purposes of determining the UK financial services regulatory perimeter.21 As a result, the regulatory perimeter relating to EUAs is similarly broad to that under EU MiFID 2. The main differences relate to the ancillary activities exemption, which, primarily because of post-Brexit changes to EU law, is now in slightly different terms to that under EU MiFID 2. That exemption is also currently under review by the FCA. In addition, the UK’s overseas persons’ exclusion provides a relatively liberal basis for “overseas persons”22 to deal in the UK’s wholesale markets without being subject to a UK authorisation requirement.
- The legal measures governing the EU ETS have been brought within the scope of the EEA agreement and so, in addition to the EU countries, apply to Norway, Iceland and Liechtenstein. The amendments to the EU ETS to include maritime transport would also need to be brought within the scope of the EEA agreement before that extension applies in those countries also.
- Regulation 648/2012/EU.
- This will be consistent with the position of the EU ETS more generally as in 2024 the compliance deadline is being moved from 30 April each year to 30 September each year.
- Article 5 of MiFID 2.
- Section C(11) of Annex 1 to EU MiFID 2.
- Section C(4) of Annex 1 to EU MiFID 2.
- Section C(4) of Annex 1 to EU MiFID 2.
- Regulation 596/2014/EU.
- Section A of Annex 1 to EU MiFID 2. Similar provisions apply under UK MiFID, pursuant to Part 3 of Schedule 2 to the FSMA (2000) Regulated Activities Order 2001 (the RAO).
- Recital 44 to EU MiFID 2.
- Article 4(1)(5) of EU MiFID 2.
- Article 4(1)(6) of EU MiFID 2.
- Article 4(1)(8) of EU MiFID 2.
- Article 4(1)(4) of EU MiFID 2.
- Article 2(1)(e) of EU MiFID 2.
- Article 2(1)(b) of EU MiFID 2.
- While EU MiFID 2 only requires notification upon request, some regulators require annual notification.
- Article 2(1)(j) of EU MiFID 2.
- Commission Delegated Regulation (EU) 2021/1833.
- Specifically, the Markets in Financial Instruments Regulation 600/2014/EU.
- Schedule 2, Part 1, paragraphs 4 and 11 to the RAO.
- As defined in article 3(1) of the RAO.