Template:M summ EFET Allowance Annex 4

Much of this, we feel, is configuring a sale or option contract in an underlying that is more like a financial instrument than a commodity into the wiring of a master agreement that is designed to cater for the sale and trading of power, which is a curious type of commodity in that it doesn’t have an articulated unit, but is a free-flowing source of energy measured more by its volume. This all this business about nominating Delivery Points and Transfer Points doesn’t really make a lot of sense when you are delivering a dematerialised certificate from one custody account to another, and not sending volts through an electricity grid.

4.1 Delivery, Acceptance and Scheduling Obligations

Settlement (ISDA), Scheduling (EFET), Primary Obligation (IETA) — the core provision that sets out who pays what, where and to whom, for Option Transactions and Forward Transactions.

The JC is no great fan of definitions, but God only knows, in the ISDA one would have come in handy here. You know, a “Purchase Amount” for Forward Transactions, or a “Strike Amount” for Option Transactions (or a “Payment Amount”, for both) might have been nice, given they are the key concepts in Option Transactions and Forward Transactions.

As for “Allowances to be Delivered” — okay, there is at least a term for the physical half of that, but it’s rubbish. What about “Delivery Amount”?

There is a distinction between the “Number of Allowances” — effectively the notional size of the whole trade — and the “Allowances to be Delivered” — the portion of it that is settling on any given day. The difference is that American options can settle in part, on any day in the term of the Transaction. Forwards typically don’t — they all settle on a pre-agreed settlement date

(To be fair to the Emissions ninjas at IETA, they do have this concept: “Contract Amount”).

Well, the JC has introduced these words into the nutshell summary to make life a bit easier to follow. Just remember they are not there in the real thing. Unless you put them in.

Cash Settlement: Trick question. There is no provision for cash-settlement in the emissions trading world. Will that stop counterparties asking you to specify a settlement method? Probably not. Does it matter? Also probably not. What if you want a cash settlement option? Not out of the ballpark — one’s eligibility for EMIR, and as such hedge exemptions, might depend on whether the forward is able to be cash-settled, in theory, or not. (There is no good reason for this: it springs from the paranoid brow of those toiler legal counsel who trying to parse the eligibility or Emissions derivatives under the refitted delegated regulations of MiFID 2 — our advice is just don’t go there — but you just never know.)

Delivery Points and Transfer Points

In order to shoehorn the Emissions product into the EFET Master Agreement architecture — being a power and gas trading document, it thinks in terms of grid injections and inputs and outputs to a set network of pipes and cables — the EFET Allowances Appendix calls the Holding Accounts “Delivery Points” (for the Seller’s Holding Account) and “Transfer Points” for the Buyer’s Holding Accounts). It also, variously, calls them Holding Accounts too, by the way, but worth mentioning.

Transfer from a specified Holding Account

Curious conditionality, across all three versions, where the Buyer specifies a Holding Account from which Allowances must be delivered, and not just the account to which they must be delivered. Quite why it should matter whence the Allowances come we cannot say — a vague fretfulness about theft perhaps? — but ok; let’s run with it.

Note, in any case, its moderation in IETA (5.2) whereby one has an obligation to make sure there are sufficient allowances in your account to satisfy your delivery obligation. So even though you can’t be forced to deliver from anywhere else, you can be sued for losses arising from your failure to ensure there was something to deliver in your Holding Account. All rather cack-handed, but in “fundamental upshot” terms, this does get to the right place.

The transfer is done once the Allowances hit the Seller’s account (I know, I know: you don’t say.) But wait: there is an interesting use of the word “whereupon” here, upon which we dwell in a bit more detail in the premium section.
(That whereupon is in Clause 6.1 of the EFET Allowances Appendix, by the way.

4.2 Definition of Schedule

This is mostly throat clearing stuff, though there is an odd appeal to parties being bound by customary market practice to comply with a 30 calendar day notice requirement to designate a Holding Account. Which is all fine, but, look, EFET Allowances Appendix you are a bilateral contract. You impose notice periods contractually. If you want to stipulate a fixed number of days’ notice, just say it: there is no value in also referring to it being “customary market practice”. What happens if customary market practice changes?

Instead of:

The Parties acknowledge and agree that customary industry practices shall include, to the extent it has not already done so, each Party notifying the other at least thirty (30) calendar days prior...

Wouldn’t it have been better to say either:

“The Parties will give at least as much notice as is customary market practice...”

If the document is happy to defer to customary market practice, whatever that may be, or:

“The Parties will give at least 30 calendar days’ notice ...”

if it is not?

4.3 Physical Settlement Netting

If applied, if the Parties happen to be transferring fungible Allowances to each other on the same day and between the same specified Holding Accounts, you can net settle. As with the ISDA equivalent (Section 2(c)) a physical netting clause is not really a legal thing, seeing as you either do net settle, in which case everyone gets what they need and there is nothing to sue about, or you don’t — one party forgets, so over-delivers, and there is all sorts of rebalancing, transferring back required and so on.

Here’s what the JC has to say about ISDA settlement netting:

Section 2(c) is about “settlement” or “payment” netting — that is, the operational settlement of offsetting payments due on any day under the normal operation of the Agreement — and not the more drastic close-out netting, which is the Early Termination of all Transactions under Section 6.

If you want to know more about close-out netting, see Single Agreement and Early Termination Amount.

We wonder what the point of this section is, since settlement netting is a factual operational process for performing existing legal obligations, rather than any kind of variation of the parties’ rights and obligations. If you owe me ten pounds and I owe you ten pounds, and we agree to both keep our tenners, what cause of action arises? What loss is there? We have settled our existing obligations differently.

To be sure, if I pay you your tenner and you don’t pay me mine, that’s a different story — but then there is no settlement netting at all. The only time one would wish to enforce settlement netting it must, ipso facto, have happened, so what do you think you’re going to court to enforce?

4.4 Payment for Allowances

Go see clause 13.