CARBON MARKET INTEGRITY. Integrity and oversight of

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1 CARBON MARKET INTEGRITY Integrity and oversight of the California Emissions Trading Scheme MARCH 2012

2 About the Carbon Market Institute The Carbon Market Institute is an independent membership-based not-for-profit organisation. Our aim is to assist Australian businesses in meeting the challenges and opportunities associated with the developing national and international carbon markets and thereby build capacity to grow in a low-carbon world. Established with support from the Victorian Government, our Asia-Pacific wide membership represents a broad range of professionals, organisations and industry providers for whom carbon will have a direct impact on their businesses both in terms of liabilities and potential opportunities. The Institute has a strong research program and provides market analysis, education and training, business networking and information services and international engagement. CMI is also developing professional standards and an accreditation program. CMI incorporates and builds on the networks, partnerships and services developed by the former Asia-Pacific Emissions Trading Forum (AETF) which began operations in CMI commenced operations on 1 January 2011 with a mandate to assist Australian businesses with the implementation of climate-related markets, both in terms of managing risk and realising business opportunities. To find out more about becoming a member of CMI, info@carbonmarketinstitute.org Copyright and Disclaimer Copyright 2012 the Carbon Market Institute (CMI). No part of this document may be reproduced without consent. Permission is granted for normal and limited quotation provided that credit is given to the CMI. The opinions expressed in this publication do not necessarily reflect the opinions of the CMI directors, sponsors, partners or members. No responsibility is accepted by CMI, its directors, sponsors, partners, or members or the authors of any articles for the accuracy of information contained in this publication or the consequences of any person relying upon information. The contents of this publication should not be relied upon as a substitute for professional advice.

3 AUTHOR Centre for Law, Governance and Public Policy Patrick Keyzer (Director), Damien Lockie, John Farrar, Michael Weir, Tina Hunter, Richard Hundt The Centre for Law, Governance and Public Policy is a cross-disciplinary research centre bringing together scholars with a common interest in the development, practices, processes, outcomes and operation of public policy and regulation. Its research agenda is focused on the way that the law can promote good governance and good public policy. Scholars from the Centre are leading experts in their field. Lead author Adjunct Professor Damien Lockie is an Australian and international specialist in the field of carbon market oversight. Recognised as one of Australia s leading law faculties, Bond Law has gained an international reputation for its innovative teaching methods, integrated skills program and the outstanding success of its graduates. Based at Bond University s world-class campus on Queensland s Gold Coast, the Law Faculty integrates a state-of-the-art Legal Skills Centre a purpose built facility featuring a full complement of legal-based training facilities, including moot courts and mediation suites which use the best available technology. The Faculty s unique programs ensure graduates are equipped with both the theoretical and practical skills training necessary in contemporary legal practice. PEER REVIEWED BY Baker & McKenzie was the first law firm to recognise the importance of climate change law and policy. For more than 14 years our dedicated global practice has worked on numerous pioneering deals, including writing one of the first carbon contracts, setting up the first carbon fund, the first structured derivative transaction and the first REDD project. From governments, multinational enterprises to financial and multilateral institutions we continue to be the advisor of choice on climate change law, policy and regulation. Disclaimer This publication has been prepared for CMI and as general information for this CMI publication. You should not rely on the contents. It is not legal advice and should not be regarded as a substitute for legal advice. To the fullest extent allowed by law, Bond University and Baker & McKenzie exclude all liability whether arising in contract, for negligence (or otherwise) in respect of all and each part of this document, including without limitation, any errors or omissions. 2

4 TABLE OF CONTENT 1. INTRODUCTION 4 2. OVERVIEW OF THE CALIFORNIA ETS 5 3. LIABILITY AND PARTICIPATION 6 4. OPENING A REGISTRY ACCOUNT 7 5. TRANSFER OF COMPLIANCE INSTRUMENTS SPECIAL DEALINGS INDEFEASIBILITY OF TITLE INFORMATION DISCLOSURE GOVERNANCE IN THE CALIFORNIA ETS ADDRESSING CARBON MARKET INTEGRITY IN CALIFORNIA 16 REFERENCES 19 ENDNOTES 20

5 Photo courtesy of Patrick Boury 1. INTRODUCTION California is the eighth largest economy in the world. California s greenhouse gas (GHG) emissions are anticipated to reach 400 million tonnes by 2015, 1 accounting for approximately 1.5 per cent of all global emissions, and roughly equivalent to the GHG emissions of Australia. The California Emissions Trading Scheme (California ETS) will be a cap-and-trade emissions trading scheme (ETS), commencing 1 January The California ETS will cover 600 facilities held by 360 companies in the energy and industrial sectors, which are responsible for approximately 85 per cent of California s GHG emissions. 2 California ETS turnover is estimated to exceed US$50 billion per annum. 3 The purpose of this information brief is to detail the market integrity and oversight provisions in the California ETS. This is one of three information briefs accompanying the Carbon Market Institute report, Carbon Market Integrity: A Review of the Australian Carbon Pricing Mechanism. The report and information briefs allow for comparison between the Australian, European, New Zealand and Californian emissions trading schemes. The law is stated as at 15 March

6 2. OVERVIEW OF THE CALIFORNIA ETS In 2006, the California Legislature passed and Governor Arnold Schwarzenegger signed Assembly Bill 32, the Global Warming Solutions Act of 2006 (AB 32). Under AB 32, the California Air Resources Board (CARB) was required to develop regulations in order to reduce California s GHGs to 1990 levels by 2020 and by 80 per cent below 1990 levels by On 20 October 2011, CARB released its final regulations (Regulations) for the California ETS. 4 The final rulemaking package has been approved by the California Office of Administrative Law (OAL). The California ETS will cover the Kyoto Protocol bundle 5 of GHGs: carbon dioxide (CO 2 ), methane (CH 4 ), nitrous oxide (N 2 O), sulphur hexafluoride (SF 6 ), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs). In addition, it will cover nitrogen trifluoride (NF 3 ) and other fluorinated GHGs. 6 These gases will be made equivalent (called carbon dioxide equivalence (CO 2 -e) through their global warming potential (GWP). The compliance periods for the California ETS have been divided into three phases (see table 1). 7 Table 1: Compliance periods for the California ETS Compliance Period 1 Compliance Period 2 Electricity, including imports and large industrial facilities over 25,000 tonnes CO 2 -e Suppliers of transportation fuels, natural gases and other fuels 1 Jan Dec Jan Dec 2017 Compliance Period 3 Suppliers of transportation fuels, natural gases and other fuels 1 Jan Dec 2020 The unit of currency of the California ETS is the California GHG (carbon) Allowance (CCAs). Each CCA represents the right to emit one tonne (t) CO 2 -e (for a specified compliance period). Table 2: California GHG allowances budgets Budget year Annual allowance budget (millions of CCAs) The annual allowance budgets for CCAs from are set out in table ALLOCATION OF ALLOWANCES A covered entity or opt-in covered entity in the industrial sectors will be eligible for direct allocations of CCAs if it has complied with the requirements of the Mandatory Reporting Regulation (MRR), and has obtained a positive or qualified positive product data verification statement pursuant to the MRR. 9 First compliance period Second complinace period Third compliance period Carbon Market Institute 5

7 2.2 AUCTIONING OF ALLOWANCES CCAs will be auctioned twice in 2012, and then quarterly starting in Only covered entities, including opt-in covered entities and voluntarily associated entities (VAE) such as banks and other funds, will be entitled to purchase CCAs from the reserve auction. The Regulations enable the California ETS to link with external emissions trading schemes, notably the Western Climate Initiative (WCI) (see box 1). The WCI Markets Committee released a markets design report, Design for the WCI Regional Program, in July The report recommends the design of emissions trading schemes for its partner jurisdictions, including California. These recommendations are considered throughout this brief. BOX 1: WESTERN CLIMATE INITIATIVE (WCI) Western Climate Initiative (WCI) The WCI is a collaboration between The California WCI is and a collaboration four Canadian between provinces California, to Canadian identify, evaluate, provins and and New implement Mexico emissions working together trading policies to identify, to evaluate, tackle climate and implement change at emissions a regional trading level. The policies central to tackle component climate of change at the a regional WCI strategy level. is The a flexible, central component market-based, of the WCI regional strategy cap-and-trade is a flexible, program market-based, that regional cap-and-trade caps greenhouse program gas emissions that caps greenhouse and uses gas emissions tradable permits and uses to tradable incentivise permits development to incentivise development of renewable of and renewable lower-polluting and lower-polluting energy energy sources. sources. 3. LIABILITY AND PARTICIPATION CARB Regulations provide for a modified cap-and-trade ETS for covered and opt-in covered entities. An entity which meets the requirements, but does not exceed the inclusion thresholds may elect to voluntarily opt-in to the cap-and-trade scheme. The inclusion threshold for each covered entity is based on the subset of GHG emissions which generate a compliance obligation. 11 If an entity reports annual emissions in any year from 2008 to 2011 equal or more than the prescribed thresholds, it will be deemed a covered entity as of 1 January 2013 and for all future years. Selected activity definitions and thresholds limit the coverage of the California ETS. The threshold for covered entities is 25,000 tco 2 -e per year COVERED ENTITIES Covered entities include: 13 operators of facilities involved in: cement production cogeneration glass production hydrogen production iron and steel production lime manufacturing nitric acid production petroleum and natural gas systems petroleum refining pulp and paper manufacturing Integrity and oversight of the California ETS 6

8 self-generation of electricity or stationary combustion first deliverers of electricity: electricity generating facilities electricity importers of specified sources of electricity electricity importers of unspecified sources of electricity where the applicable threshold for electricity delivered from unspecified sources is zero MWh. suppliers of natural gas suppliers of reformulated gasoline blendstock for oxygenate blending (RBOB) and distillate fuel oil suppliers of liquefied petroleum gas, and carbon dioxide suppliers. Entities emitting under the 25,000 tco 2 -e threshold may opt-in (by submitting a request to the Executive Officer for evaluation and approval), 14 and if approved, become covered entities. Such entities are then subject to all the same reporting, verification, enforcement and compliance obligations that apply to the mandatory covered entities. 15 An entity may opt-out of the California ETS if its annual emissions levels for any data year remain below the inclusion thresholds. 16 An interested entity that is not a covered entity or opt-in covered entity may apply to the Executive Officer for approval as a VAE WCI DRAFT RECOMMENDATIONS WCI draft recommendation five recommends that broad market participation in the secondary markets would be beneficial and narrow participation harmful. 18 Accordingly, the WCI Markets Committee concluded that limiting participation to compliance entities would not be an effective policy to reduce the potential for market manipulation OPENING A REGISTRY ACCOUNT An entity must obtain approval from the Executive Officer to qualify as a registered participant. 20 The Executive Officer is the Executive Officer of CARB or his or her delegate. 21 The application for approval must contain the following information: 22 name and type of organisation statement of basis for qualifying for registration identification of all other entities registered that have an indirect and direct corporate association, along with a brief description of the association identification of all entities for whose benefit the registered entity holds compliance instruments. 4.1 REGISTRATION DEADLINES If an entity meets or exceeds the inclusion thresholds, it must register with the Accounts Administrator. The Accounts Administrator is the entity acting in the capacity to administer the compliance accounts. 23 The Executive Officer will serve as the Accounts Administrator or may contract with an entity to serve as Accounts Administrator. 24 The account registration must be completed: within 30 days of the reporting deadline if the entity is not a covered entity as of 1 January 2013 by 31 January 2012 or within 30 days of the effective date of the Regulations, whichever is later, for an entity that exceeds the inclusion thresholds of 25,000 tco 2 -e for any data year 2008 through Carbon Market Institute 7

9 An opt-in covered entity must register with the Accounts Administrator by 30 November of the year prior to the first year it voluntarily elects to be subject to compliance obligations. 26 All VAEs that intend to hold CCAs must register with the Accounts Administrator prior to acquiring such CCAs. 27 Registration is completed when the Executive Officer approves the registration and informs the entity and the Accounts Administrator of the approval. 28 An entity cannot hold a compliance instrument until the Executive Officer approves the entity s registration with CARB. 4.2 ACCOUNT TYPES The Executive Officer will not approve registration for more than one set of accounts for an entity. 29 There are four types of accounts available (see table 3). Table 3: Account types Holding Accounts When the Executive Officer approves registration for a covered entity, opt-in covered entity, or VAE, the Accounts Administrator will create a holding account for the registrant. Limited use holding accounts When an entity qualifies for a direct allocation, as described in section one of this Information Brief, the Accounts Administrator will create a limited use holding account. Compliance accounts When the Executive Officer approves a registration for a covered entity or opt-in entity, the Accounts Administrator will create a compliance account for the entity. Exchange clearing holding accounts When the Executive Officer approves registration for an entity identified as a VAE, such as a bank or Fund, then the Accounts Administrator will create an exchange clearing holding account for the entity. 4.3 DISCRETIONS OF THE EXECUTIVE OFFICER Applicants may be denied registration based on: 1. Information provided. 2. If the Executive Officer determines the applicant has provided false or misleading information, or has withheld information pertinent to its application. 30 Integrity and oversight of the California ETS 8

10 Photo courtesy of Pierre SUBIGER

11 5. TRANSFER OF COMPLIANCE INSTRUMENTS 5.1 GENERAL RULES FOR TRANSFER All trades must be reported to the Accounts Administrator within three calendar days of the transaction, unless it is undertaken by the Executive Officer. 31 Under the Regulations, transfer of a compliance instrument means the removal of the serial number of a compliance instrument from one account and placement into another account. 32 All transfers between the two entities must involve transfers between holding accounts and/or an exchange clearing holding account. A compliance instrument means a CCA, CARB offset credit or sector-based offset credit. Trading is subject to holding limits. 33 The holding limit will apply to each entity registered as a covered entity, opt-in covered entity or VAE. The holding limit is the maximum number of CCAs that may be held by an entity or jointly held at any point in time by a group of entities with a direct or indirect corporate association. The holding limit is calculated as follows: For all other participants, there is an auction purchase limit of four per cent INFORMATION REQUIREMENTS Before any transfer of CCAs can be recorded within the tracking system, the following information must be reported to the Accounts Administrator as part of a transfer request: holding account number and authorised account representative of seller and purchaser serial number of the compliance instruments date of the transaction agreement settlement date, if not the same as the date of the transaction agreement price of the compliance instrument holding account number and authorised representative of an entity for whom the compliance instrument is to be held in benefit. Holding Limit = 0.1 x Base x (Annual Allowance Budget Base) Where Base is 25 million metric tonnes of CO 2 -e, and Annual Allowance Budget is number of allowances issued for the current budget year. In addition to holding limits, the Regulations also establish auction purchase limits. The aim of these measures is to curb the risk of market manipulation. Both covered and opt-in covered entities are subject to a maximum limit of 15 per cent of all CCAs offered at auction. 34 However, only electrical distribution utilities are exempt from this limit WCI DRAFT RECOMMENDATIONS Transfer of units may eventually occur within the WCI partner jurisdictions. 37 The California Regulations are consistent with the draft recommendations of the WCI. Integrity and oversight of the California ETS 10

12 A centralised WCI tracking system will collect basic information and hold records of the ownership of compliance instruments. 38 Thus, in order to transfer compliance instruments, draft recommendation 10 suggests the following information must be provided: name of the authorised person for the account of origin number of the account of origin name of the authorised person for the account that receives compliance instruments account receiving compliance instruments serial numbers of the compliance instruments being transferred, and the compliance instrument price DEFERRAL OF TRANSFER Transaction reporting violations of a registered entity will vary depending on whether the violation is detected before it is recorded in the tracking system or after. If detected before recording, then the Accounts Administrator will inform the entity submitting the request. 40 If the entities fail to submit an acceptable transfer request within three calendar days, then they must either withdraw the transfer request or submit a new request for transfer. If it is detected afterwards and the deficiency is not corrected within five business days after notification, then the Executive Officer will direct the Accounts Administrator to reverse the transaction and adjust the accounts involved accordingly LIMITED USE HOLDING ACCOUNTS The entity may not transfer compliance instruments: 42 from other accounts into the limited use holding account from the limited use holding account to any account other than the auction holding account COMPLIANCE ACCOUNTS A covered entity or opt-in covered entity may transfer compliance instruments to its compliance account at any time. However, a compliance instrument transferred into a compliance account may not be removed by the entity EXCHANGE CLEARING HOLDING ACCOUNTS Entities may transfer compliance instruments to exchange clearing accounts only for the purpose of transferring control of the instruments to the entity performing the clearing function. 44 The clearing entity may only transfer the compliance instruments in its exchange clearing holding account to the account designated by the entity receiving the CCA under the transaction being cleared CARB OFFSET CREDIT Ownership and transferability of CARB Offset Credits are outlined in of the Regulations. The initial ownership of a CARB offset credit will be with the registered Offset Project Operator, Authorized Project Designee, or another third party as provided in 95974(a)(1), unless otherwise required by 95983, which involves Forestry Offset Reversals. 46 A CARB offset credit may be sold, traded, or transferred, unless: it has been retired, surrendered for compliance, or used to meet any GHG mitigation requirements in any voluntary or regulatory program it resides in the Forest Buffer Account pursuant to it has been invalidated pursuant to SECTOR-BASED OFFSET CREDITS Sector-based offset credits are generated through reduced or avoided GHG emissions from within, or carbon removed and sequestered from the atmosphere by a specific sector in a particular jurisdiction. 48 Carbon Market Institute 11

13 5.5 OTC TRANSACTIONS Over-the-counter (OTC) transactions in the secondary and derivative markets include private trades as well as regulated and unregulated exchange trades. The Regulations provide that a derivative clearing organisation may apply to the Executive Officer for approval as a VAE if it is registered with the US Commodity Futures Trading Commission (CFTC). 49 The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (US) (the Dodd-Frank Act) has increased regulation in financial markets on private exchanges. Accordingly, derivative markets for carbon units will be subject to greater regulation. To this end, CARB has been working in collaboration to connect with the CFTC s existing market surveillance program, which monitors the daily activities of large trades, key price relations, and relevant supply and demand factors. 50 The Dodd-Frank Act changes to oversight governing transactions on private exchanges include: increased disclosure, transparency and oversight of OTC derivative markets mandatory exchange trading and centralised clearing for standardised contract public reporting of price and transaction data for both cleared and uncleared derivatives transactions. 51 advisors who hold accounts in the tracking system would be required to register as market professionals draft recommendation eight recommends that all orders for secondary market transactions should be reported to a so-called hard central limited order book in order to centralise liquidity and enhance transparency. 54 The WCI partner jurisdictions have stated their joint commitment to working with commodity derivative regulators to ensure oversight of compliance instrument markets are robust and fully integrated TRANSACTIONS ON PUBLIC EXCHANGES The Executive Officer may serve as a reserve sale administrator to conduct sales from the Allowance Price Containment Reserve (APCR), or designate an entity to serve as a reserve sale administrator. 56 If the California ETS links with emissions trading schemes of other participants in the WCI, then the linkage agreement will specify whether covered entities in partner jurisdictions will be eligible to purchase from a jointly operated reserve, or whether each ETS will operate separate reserves. 57 The Dodd-Frank Act significantly increased the regulation of US financial markets and its reforms, including oversight by the CFTC which will extend to the California ETS. 58 WCI DRAFT RECOMMENDATIONS Several of the WCI Markets Committee s draft recommendations concern transactions on private exchanges: draft recommendation one recommends that compliance instruments be treated within the same framework and by the same regulators as commodities for the purpose of derivatives regulations 52 draft recommendation six recommends the registration of specific intermediaries as market professionals. 53 Under this recommendation, brokers, merchants and Integrity and oversight of the California ETS 12

14 6. SPECIAL DEALING 6.1 GENERAL PROHIBITIONS There is a general prohibition on all trading of compliance instruments where: an entity acquires CCAs and holds them in its own holding account for another entity, except when disclosed as a beneficial holding relationship 59 a trade involves: 60 any manipulative or deceptive device a corner or attempt to corner the market fraud or an attempt to defraud a false, misleading, or inaccurate report of information or conditions which affects or tends to affect the price of a compliance instrument a false or misleading application, report, statement or document any trick, scheme or artifice to falsify or conceal a material fact. A fact is material if it could probably influence a decision of the Executive Officer, CARB or the staff of CARB DISCRETIONS OF THE EXECUTIVE OFFICER If an entity violates one of the prohibitions, the Executive Officer may: 62 reduce the number of compliance instruments a covered entity or opt-in covered entity may have in its holding account below the amount allowed by the holding limit increase the annual surrender obligation above the 30 per cent obligation suspend or revoke the registration of opt-in covered entities, VAEs, and other entities

15 limit or prohibit transfers in or out of the holding account all of the above. 6.3 FURTHER AUTHORITY OF THE EXECUTIVE OFFICER If found in violation of any of the provisions under the California ETS, the Executive Officer may: suspend, revoke or place restrictions on holding accounts of a VAE 63 suspend revoke or modify any Executive Order issued, including an order accrediting a verifier. WCI DRAFT RECOMMENDATIONS The WCI Markets Committee discussed participants manipulating the market, including through large holdings. Under draft recommendation seven, the Committee commissioned a report on holdings limits for participants as a solution. The findings of the report will be considered in the release of the WCI Markets Committee s final recommendations 66 (not released as of the date of this information brief). place restrictions on a holding account of a covered entity or an opt-in covered entity INDEFEASIBILITY OF TITLE A CARB offset credit will remain valid unless and until it is invalidated under the AB 32 or the Regulations. 67 Generally, CARB may determine a CARB offset credit is invalid within a period of eight years (reduced in the limited circumstances discussed below to three years) after its creation based on any of the following reasons: 1. an Offset Project Data Report contains errors which overstate the amount of GHG reductions by more than five per cent 2. the offset project activity and implementation of the offset project was not in accordance with all local, state, or national environmental and health and safety regulations during the reporting period 3. CARB determines that offset credits have been issued in any other mandatory or voluntary program for the same project for which CARB offsets were issued. 68 The Regulations effectively make holders of carbon credits from non-forestry offset projects that are invalidated primarily responsible for replacing them. 70 Offset project developers are secondarily liable if the current holder is no longer in business. 71 For forestry offset projects, forestry owners are primarily liable to replace any offsets later deemed invalid. 72 WCI DRAFT RECOMMENDATIONS WCI draft recommendation four recommended a system for recognising ownership interests in a compliance instrument. Tracking beneficial ownership interests together with legal ownership in the account tracking system would establish obligations for participants, 73 including jurisdictional powers, 74 as well as disclosure and registration requirements. 75 Offset credits generated by ozone-depleting substance projects, livestock projects and forest projects may be subject to invalidation only within three reporting periods so long as certain conditions are met. 69 Integrity and oversight of the California ETS 14

16 8. INFORMATION DISCLOSURE The CARB requires strict disclosure of trading activities in order to preserve market integrity and prevent manipulation. Information disclosure during registration and transfer are outlined earlier in this brief. 8.1 CONFIDENTIAL AND PUBLIC INFORMATION Under the Regulations, beneficial holding and information relating to the identity of real persons will be treated as confidential by the Accounts Administrator and CARB. 76 However, all other registration information collected may be made publicly available by the Accounts Administrator INFORMATION REPORTING BY HOLDERS OF EXCHANGE CLEARING HOLDING ACCOUNTS Holders of exchange clearing holding accounts must make the transaction records available to CARB within 10 calendar days of a request from the Executive Officer. 78 The holders of exchange clearing holding accounts must retain transaction records containing the required information for 10 years WCI DRAFT RECOMMENDATIONS The WCI Markets Committee outlined its public disclosure proposals in draft recommendation 11 involving secondary market holdings and transfer (see table 4). 80 Table 4: WCI Markets Committee - draft recommendation 11 Tracking system account information should be publicly disclosed on an ongoing basis Account representative for compliance and trading accounts Owner/operator associated with compliance accounts Names of beneficial owners of compliance units held within account State or province in which account representative is located Market information publicly disclosed through tracking system Compliance account holdings Market information not publicly disclosed Names of counterparties and beneficial owners to each transaction Fraction of each beneficial owner s interest in an account Trading account holdings Carbon Market Institute 15

17 9. GOVERNANCE IN THE CALIFORNIA ETS 9.1 JURISDICTION A person consents to the jurisdiction of California, including administration of CARB and the Superior Court of California by engaging in any of the following actions: registration with CARB purchasing or holding CCAs receipt of compensation of any kind, including sales proceeds and commissions, from any transfers of allowances or offset credits issued by CARB verification of an offset credit to be issued by CARB. 9.2 PENALTIES Price Containment Reserve (APCR), which would be available for purchase via auction if the reserve is activated. The International Emissions Trading Association (IETA) has criticised this based on the forced withdrawal of allowances. 81 Californian ETS non-compliance measures may also include monetary penalties assessed pursuant to California Health and Safety Code In determining any penalty, CARB will consider all relevant circumstances, including: 82 the extent of the harm caused nature and persistence of the violation length of time over which the violation occurs frequency of past violations the financial burden to the defendant. 83 The Regulations provide that in the event of a surrender shortfall, one allowance must be retired for each tonne of surrender shortfall. Additionally, three CCAs are to be placed into the Allowance 10. ADDRESSING CARBON MARKET INTEGRITY IN CALIFORNIA 10.1 CARBON MARKET OVERSIGHT recommended by the Interagency Working Group for the Study of Oversight of Carbon Markets as it might be applied to the California ETS. The CFTC was charged under 750 of the Dodd-Frank Act with the task of establishing an interagency working group to conduct a study on the oversight of existing and prospective carbon markets to ensure efficient, secure and transparent carbon markets, including oversight of spot markets and derivative markets. 84 The Interagency Working Group for the Study on Oversight of Carbon Markets released its report on 18 January 2011 titled Report on the Oversight of Existing and Prospective Carbon Markets. Table 5 summarises the market oversight Integrity and oversight of the California ETS 16

18 Table 5: Summary of market oversight recommended by the interagency working group for the study of oversight of carbon markets Primary market tracking of initial ownership of allowances/credits upon introduction to the market oversight of allowance auctions (includes implications of the auctions for efficiency, participation, price discovery, and the potential for manipulation) oversight of the creation and verification of offset credits. Secondary market authority to register and track allowances and monitor trading authority to prosecute for manipulation authority to obtain information on allowance holdings authority to obtain information on traders that hold positions in futures markets. Derivatives market regulatory oversight by the CFTC, including registration of dealers and major participants exchange traded futures and options contracts to be subject to speculative position limits OTC environmental swaps to be subject to the same regime. CARB has established a Market Monitor and a Market Surveillance Committee. The Market Monitor will provide independent reviews, audits and ongoing monitoring of auctions and reserve sale procedures to ensure fairness. It will also monitor allowance holding and transfer activity to detect design flaws in the market operating rules, standards, procedures and practices or detect structural problems in the market. The Market Monitor will analyse and report back to CARB on relevant market activity, concerns and trends. 85 The Market Surveillance Committee will also support California s market oversight efforts. The Committee will be made up of experts in economics, trading and commodity markets. The chief responsibilities of the Market Surveillance Committee will be to advise and recommend measures to CARB on market design, surveillance and oversight CONFIDENTIAL INFORMATION AND MARKET OVERSIGHT The Executive Officer will ensure the Accounts Administrator will release all information on the transaction price and quantity of CCAs in a timely manner. However, it will treat all other information obtained through transaction reports as confidential, except as needed for market oversight and investigation purposes by the Executive Officer WESTERN CLIMATE INITIATIVE INC In September 2011, the WCI announced the creation of Western Climate Initiative Inc (WCI Inc). WCI Inc is a non-profit corporation established to provide administrative and technical support to the state and provincial schemes partnered under the WCI. Carbon Market Institute 17

19 WCI Inc will coordinate the acquisition and delivery of services through: 1. the development of a compliance tracking system that tracks both allowances and offsets certificates 2. the administration of allowance auctions 3. the market monitoring of allowance auctions and allowance and offset certificate trading. The WCI is moving forward on its tracking system. In early 2012, WCI Inc issued a Request for Proposals to obtain contractor services for the Compliance Instrument Tracking System Service (CITSS) PRICE VOLATILITY Price volatility of California s carbon allowances on the Intercontinental Exchange (ICE) is also a concern worth noting. Price volatility is a common feature of environmental commodities, particularly in the days following the launch of a new market. Point Carbon s California Carbon Allowances Over the Counter Assessment can be seen in Graph Graph 1: California ETS allowances and spreads CCA Price /06/11 31/07/11 31/08/11 30/09/11 31/10/11 30/11/11 31/12/11 31/01/12 29/02/12 Dec 2013 Bid Dec 2013 Offer Source: Point Carbon The graph shows Point Carbon s OTC assessment for the Barclays CAFTA contract for December 2013 delivery of vintage 2013 allowances, and the bid-offer spread RELATIONS WITH AUSTRALIA CARB has commenced dialogue with foreign trading programs, including the European Union Emissions Trading System (EU ETS) and the Regional Greenhouse Gas Initiative (RGGI) to minimise the risks of international market manipulation. However, at the time this report was published, Australia and California do not have plans to link their trading schemes. Should the opportunity arise in the future, CARB may approve such a linkage after public notice and opportunity for public comment is given in accordance with the Administrative Procedure Act. 90 Integrity and oversight of the California ETS 18

20 REFERENCES Global Warming Solutions Act of 2006 [Assembly Bill (AB) 32]. California Code of Regulations, Title 17, sub-ch 10 (Climate Change, art 5, ss ) (California Cap on Greenhouse Gas Emissions). United States Code. Carbon Market Institute 19

21 ENDNOTES 1 Point Carbon, California to give official kick off to carbon market (25 October 2011) < pointcarbon.com/aboutus/pressroom/ ?da te= &sdtc=1>. 2 CARB, California Air Resources Board adopts key element of state climate plan (Press release 11-44, 20 October 2011) < newsrel/newsrelease.php?id=245>. 3 Calculation based on numbers of California GHG allowances to be issued. 4 CARB, California Air Resources Board adopts key element of state climate plan (Press release 11-44, 20 October 2011) < newsrel/newsrelease.php?id=245>. 5 Kyoto Protocol opened for signature 16 March 1998, UN Doc. FCCC/CP/1997/7/Add.1 December 10, 1997 (entered into force 16 February 2005). 6 California Code of Regulations art 5, sub-art 3, Ibid art 5, Ibid art 5, Ibid art 5, Note: Mandatory Reporting Regulation or MRR means ARB s Regulation for the Mandatory Reporting of Greenhouse Gas Emissions as set forth in California Code of Regulations, Title 17, ch 1, sub-ch 10, art 2 (commencing with section 95100). 10 Ibid sub-ch 10, art 5, Western Climate Initiative, Draft Recommendations [ ]. 19 Ibid 20 California Code of Regulations sub-ch 10, art 5, 95830(b). 21 Ibid sub-ch 10, art 5, 95802(a)(93). 22 Ibid sub-ch 10, art 5, 95830(c). 23 Ibid sub-ch 10, art 5, 95802(a)(1). 24 Ibid sub-ch 10, art 5, 95830(a). 25 Ibid sub-ch 10, art 5, 95830(d)(1). 26 Ibid sub-ch 10, art 5, 95830(d)(2). 27 Ibid sub-ch 10, art 5, 95830(d)(3). 28 Ibid sub-ch 10, art 5, 95830(c). 29 Ibid sub-ch 10, art 5, 95831(a)(1). 30 Ibid sub-ch 10, art 5, 95830(c)(1)(E). 31 Ibid sub-ch 10, art 5, 95921(a)(1)(A). 32 Ibid sub-ch 10, art 5, 95802(a) Ibid sub-ch 10, art 5, 95920(b). 34 Ibid sub-ch 10, art 5, 95911(c)(4)(A). 35 Ibid sub-ch 10, art 5, 95911(c)(4)(B). 11 Ibid sub-ch 10, art 5, 95812(a). 36 Ibid sub-ch 10, art 5, 95911(c)(4)(c)). 12 Ibid sub-ch 10, art 5, Ibid sub-ch 10, art 5, Ibid sub-ch 10, art 5, 95813(b). 15 Ibid sub-ch 10, art 5, 95813(a). 37 California Cap and Trade < climatechange.ca.gov/cap_and_trade/index.html>. 38 Western Climate Initiative, Draft Recommendations [ ]. 39 Ibid [ ]. 16 Ibid sub-ch 10, art 5, 95813(f). 17 Ibid sub-ch 10, art 5, California Code of Regulations, sub-ch 10, art 5, 95921(b)(1). 41 Ibid sub-ch 10, art 5, 95921(b)(2). Integrity and oversight of the California ETS 20

22 42 Ibid sub-ch 10, art 5, 95831(3). 43 Ibid sub-ch 10, art 5, 95831(4)(a)-(b). 44 Ibid sub-ch 10, art 5, 95831(5)(a)-(b). 45 Ibid sub-ch 10, art 5, 95831(5)(a)-(b). 46 Ibid sub-ch 10, art 5, 95984(a). end users and regulators regarding energy and environmental markets and their regulation. Dodd-Frank Act, 750, California Code of Regulations, sub-ch 10, art 5, 95921(e)(1). 60 Ibid sub-ch 10, art 5, 95921(e)(3). 47 Ibid sub-ch 10, art 5, 95984(a). 61 Ibid sub-ch 10, art 5, 95921(e)(3)(G). 48 Ibid sub-ch 10, art 5, Ibid sub-ch 10, art 5, 95921(f). 49 Ibid sub-ch 10, art 5, 95814(3). 63 Ibid sub-ch 10, art 5, 96011(a) 50 CARB, Cap and trade: market oversight and enforcement (Fact sheet, 20 October 2011) < pdf>. 51 Joshua Schneck and Jonas Monast, Financial Market Reform and the Implications for carbon trading January 2011, Nicholas Institute Report, Western Climate Initiative, Draft Recommendations [ ]. 53 Ibid [ ]. 54 Ibid [ ]. 55 Western Climate Initiative, Status update on market oversight recommendations (22 July 2010) < remository/func-startdown/276>. 56 Ibid sub-ch 10, art 5, 95913(a). 57 Ibid sub-ch 10, art 5, 95913(b). 58 There are two provisions that specifically involve carbon trading in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (US) (the Dodd-Frank Act): 1. the creation of an Interagency Working Group to conduct a study on carbon market oversight of existing and prospective carbon markets to ensure an efficient, secure, and transparent carbon market 2. the creation of an Energy and Environmental Markets Advisory Committee to hold discussions and report on exchanges, firms, 64 Ibid sub-ch 10, art 5, 96011(b) 65 Ibid sub-ch 10, art 5, 96011(c) 66 Western Climate Initiative, Draft Recommendations [4.3.1]. 67 Ibid sub-ch 10, art 5, 95985(a). 68 Ibid sub-ch 10, art 5, 95985(c). 69 Ibid sub-ch 10, art (b)(1). 70 By announcing these new rules, CARB ignored IETA s recommendation in August that that such a measure will hinder the development of a functional offset market and effectively drive up prices for emissions allowances. Point Carbon, California Regulators stand firm on offset liability rule (13 September 2011) < com/news/ ?date= &sdtc=1>. 71 California Code of Regulations, sub-ch 10, art 5, 95985(h). 72 Ibid sub-ch 10, art 5, 95985(i). 73 Western Climate Initiative, Draft Recommendations [ ]. 74 Western Climate Initiative, Status update on market oversight recommendations (22 July 2010) < remository/func-startdown/276>. 75 Western Climate Initiative, Draft Recommendations [ ]. 76 California Code of Regulations, sub-ch 10, art 5, 95830(g)(1). Carbon Market Institute 21

23 77 Ibid sub-ch 10, art 5, 95830(g)(2). 78 Ibid sub-ch 10, art 5, 95921(g)(1). 79 Ibid sub-ch 10, art 5, 95921(g)(2). 80 Western Climate Initiative, Draft Recommendations [ ]. 81 International Emissions Trading Association, IETA Response on CARB Cap-and-Trade Program Rules (Submissions, International Emissions Trading Association, 6 December 2010). < content&view=article&id=218:ietaresponse-on-carb-cap-and-trade-programrules&catid=24:position-papers&itemid=91>. 82 California Code of Regulations, sub-ch 10, art 5, California Health and Safety Code, s 42403(b). 84 Interagency Working Group for the Study on Oversight of Carbon Markets, 3. This statutory work proceeded, notwithstanding that the progress towards a US ETS stalled in late CARB, Cap and trade: market oversight and enforcement (Fact sheet, 20 October 2011) < pdf>. 86 California Code of Regulations, sub-ch 10, art 5, 95921(d). 87 CARB, Market Tracking System (18 January 2012) < cc/capandtrade/markettrackingsystem/ markettrackingsystem.htm>; see also: Western Climate Initiative, Inc, Request for Proposals (17 January 2012) < cc/capandtrade/markettrackingsystem/ markettrackingsystem.htm>. 88 Point Carbon, CCA OTC Assessment (Report, Point Carbon, 13 March 2011) < pointcarbon.com/news/marketdata/ca/forward/ cca/>. 89 Point Carbon, Carbon CCA OTC assessment (8 November 2011) < news/marketdata/ca/forward/cca/>. 90 California Code of Regulations, sub-ch 10, art 5, Integrity and oversight of the California ETS 22

24 If you have any questions, please contact Lloyd Vas, Markets and Research Manager at Carbon Market Institute Level 1, 486 Albert Street, East Melbourne VIC 3002 Australia P E info@carbonmarketinstitute.org To find out more about becoming a member, info@carbonmarketinstitute.org