Dresdner Kleinwort Wasserstein and Fortis Bank claimed today to have executed the first-ever trade of European Union Emission Allowances (EUAs) using a contract based on the International Swaps and Derivatives Association (ISDA) Master Agreement. London-based environmental and energy broker Evolution Markets LLC brokered the trade.
The two banks says the transaction, is an important milestone in the development of the EU Emissions Trading Scheme (EU ETS), by which emissions permits agreed under the Kyoto protocol can be traded. They add that the use of an ISDA master agreement will add liquidity to the market by facilitating the entry of banks and other financial institutions to the market.
“We are very pleased to have been able to execute the first ISDA based EU ETS transaction,” says Seb Walhain, Director of Environmental Products at Fortis Bank. “The financial sector will play an important role in the EU ETS in terms of adding liquidity to the market and serving the needs of corporate customers with compliance targets under the scheme. The ISDA contract paves the way forward.”
The ISDA Master Agreement already provides the legal basis for transactions between financial institutions in many of the world’s commodity and financial markets. Amongst other provisions, the Agreement allows for netting of open market positions in various markets between counterparties. ISDA have been working with banks and others to draft an annex to the ISDA Master Agreement that will allow for it to be applied to EU Emission Allowance Trading. The finalised document is expected to be published at the end of this month, although the transaction announced today uses the framework of this annex as its basis.
Ingo Ramming, Managing Director at Dresdner Kleinwort Wasserstein says the ISDA contract will offer banks and their customers the protection and regulation that they need to participate in the ETS market with confidence. “The new contract will contribute to the efficiency of the market and so in turn will enhance its development,” he says. “We are pleased to have been one of the first banks to adopt the ISDA agreement standards as we seek to establish a leadership position in this new market. We are confident that with the right legal framework in place for banks to become involved in the EU ETS, the market will see healthy expansion, greater competition and will grow to achieve its full potential.”
Currently, counterparties in the EU ETS have used contracts drafted by either the International Emissions Trading Association (IETA) or the European Federation of Energy Traders (EFET). The latter is the contract used by the Energy sector when trading energy commodities generally. However, non-financial sector EU ETS participants are now expected to utilise ISDA agreements in order to enable them to transact with financial institutions involved in the market.
“Banks are subject to the most rigorous regulatory framework in order to protect the interests of their clients. The ISDA agreement allows the bank to operate in financial markets while efficiently conforming to this regulation,” says James Emanuel, Director of Emission Trading at Evolution Markets. “We believe that all of the hard work that went into developing the ISDA contract will pay off for the EU ETS market as a whole by increasing market liquidity generally.”
Evolution Markets is the largest emissions and OTC coal brokerage firm in the world. Established in 2000, the company structures transactions in the environmental credit, renewable energy, weather derivative, and over the counter (OTC) coal markets.
Evolution Markets and MENERT spol. s.r.o., Slovakia’s leading environmental engineering and project development firm, have formed the Evolution Menert joint venture to provide a full range of environmental markets services to governments, corporations, NGOs and other participants in the Slovak and Czech Republics. Through a joint venture with Starsupply Petroleum, Evolution Markets has created Evolution Carbon International to provide expert brokerage services to the international coal trading market.
The development of an ETA market follows the Kyoto Protocoal agreement of 1997. The European Union (EU) accepted a collective emissions reduction target and subsequently reached a burden sharing agreement amongst Member States on how best to achieve it. The EU has now legislated for a mandatory Emission Trading Scheme in Europe. From 1 January 2005 every operator of an installation that carries out a specified activity will be required to hold a Greenhouse Gas Emission (GHG) Permit. The permit will relate specifically to the installation in question and will not be transferable. By the 30 April each year, from2006 onwards, the permit will oblige the operator to surrender EU emission allowances equal in number to its verified actual emissions over the preceding calendar year.
The emission trading scheme will run in phases: the first being three calendar years running from 1 January 2005 until 31 December 2007 with subsequent phases running for five calendar years thereafter.
An operator holding a GHG permit will be allocated a number of emission allowances at the beginning of each trading phase. The operator is then faced with a choice of either reducing the installation’s actual emissions or buying allowances (emission reductions achieved elsewhere) through the open market. This is known as a “cap and trade” scheme.
The market will be open to the entire European Union and as such a company is free to trade with any other company in any other Member State. In the future it is expected that emission allowance trading will become a global phenomenon.
“The market mechanism has been chosen as the most favourable method of achieving GHG emission reductions,” explains a DrKw spokeswoman. “An open market will enable emission reductions to take place where they are most economically viable in the economy and through the trading mechanism the cost of those reductions will be shared across other participants in the scheme. In this way the overall level of GHG emissions will be reduced at the lowest unit cost to industry generally.”
Failure by an installation to surrender a sufficient number of emission allowances will result in a financial penalty. In the first phase this penalty will be set at EUR40 per allowance that an operator fails to surrender. In the second phase of the trading scheme the penalty will increase to EUR100 per allowance.