Template:M summ EUA Annex (d)(ii)

This one is sure to have those with a liberal arts education clutching at their breasts, if not outright pleading for mercy — but one thing we can say is this is a delivery failure that doesn’t arise through caprice of governments, regulators, market dislocation, or the overwhelming lack political will to care less about carbon emissions any more. This is where the Seller has, to put it bluntly, stuffed up.

Now you might say — and you would be right — that it is typical in the equities market to disapply Failure to Deliver as an Event of Default — this happens in the 2010 GMSLA and the 2002 ISDA Equity Derivatives Definitions — but there the theory is, look, the settlement market for equities is notoriously failure prone; that ninety-nine times out of a hundred a failure has nothing to do with the counterparty, and if the counterparty has blown up there will be other indications of that (failure to post margin, failures to pay under other contracts, cross default and so on. So perhaps that applies here too?

Well, yes — except that the Carbon Squad has busily drawn out and separately dealt with the sorts of things that cause many settlement failures: Suspension Events and Settlement Disruption Events. What we are left with, beyond credit implosion, is upstream counterparty failure and operational error. The EUA market hardly being the liquid morass that is the equities market there aren’t as many settlement chains and operational failure — okay, but in this age of chatbots and smart contracts you would like to think as futuristic a market as the EU ETS wouldn’t tolerate this kind of thing, either.

Failure to Deliver under (d)(ii) and Event of Default under 5(a)(i)

Here is the question we put to all EU Emissions Allowance Ninjas out there — and there must be some, Lord only knows there must; it can’t just be me out here wrestling with this, can it? Can it? CAN IT? — why is a Failure to Deliver — one that specifically isn’t caused by some mendacious circumstance outside the Delivering Party’s control, like a Settlement Disruption Event, or Suspension of the European infrastructure, Abandonment of Scheme, Force Majeure or any of those other things — why is an inexcusable Failure to Deliver an Emissions Allowance when due not just a normal old Section 5(a)(i) Failure to Pay or Deliver Event of Default like it would be for any other asset class? Or, perhaps, is it, a normal old ISDA Event of Default, but as an alternative? Blunt close-out doesn’t seem to be excluded as an alternative, at any rate.

This strikes us as quite different to the common experience of settlement fails in the stock loan and repo markets, for example, which are famously not Events of Default, precisely because they happen all the time.

We are beginning to understand why. So real European “operators” — those who belch hot air into Mediterranean skies, as they generate energy from their coal-fired power-stations — must pay their European overlords for the privilege of doing so. They must do this by 20 April in each year — the so called Reconciliation Deadline. If they are late in surrendering their Allowances, such that they have emitted more carbon than they have, in effect, paid for, they can become liable to pay Excess Emissions Penalties under the EU ETS directive. This is something like EUR100 per tonne of uncertificated carbon.

Dabei, if you, as a counterparty to such an operator, cannot without fair excuse, deliver the Allowances you owe that operator and, the operator thereby misses its Reconciliation Deadline, you must pay compensation. This is translated through to your Transactions as long as you remember to apply EEP, and an EEP Risk Period, in your Confirmation.

EEP Risk Period

And if you forget to specify whether EEP applies, you are hardly likely to remember to designate an EEP Risk Period, are you? The EEP Risk Period is relevant to the consequences of a Failure to Deliver when Excess Emissions Penalty applies. In that regard see:

(i) Paragraph (d)(ii)(1)(B)(Y) (yes, seriously) which might have been entitled “Failure to Deliver by Delivering Party where Failure to Deliver is not Rememedied and Excess Emissions Penalty applies”.

(ii) Paragraph (d)(xi), which is entitled Failure to Deliver (Alternative Method) - EEP Applicable.