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EU Emissions Allowance Transaction Annex to the 2005 ISDA Commodity Definitions
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Section (d)(ii) in a Nutshell™
Use at your own risk, campers!
(d)(ii) Failure to Deliver.
(d)(ii)(1) Failure to Deliver by Delivering Party
If Delivering Party fails to deliver other than due to Receiving Party’s breach of Scheme Requirements, Illegality, a Settlement Disruption Event, a Suspension Event or Abandonment of Scheme, the Payment Date will be postponed, Receiving Party may give notice requiring Delivering Party to remedy the failure and:
- (A) Failure to Deliver Remedied: If Delivering Party remedies the failure by the Final Delivery Date:
- (X) when determining the Payment Date, the Delivery Date will be the date of actual delivery:
- (i) Allowance Forward Transactions: Receiving Party must pay Allowance Purchase Price x Number of Allowances on the Payment Date
- (ii) Allowance Option Transactions: Receiving Party must pay Allowance Strike Price x number of Allowances to be Delivered on the Payment Date; and
- (Y) On the same Payment Date, Delivering Party must pay interest at the Default Rate on number of undelivered Allowances on the Delivery Date x relevant Allowance Purchase Price/Allowance Strike Price from the original Delivery Date to the actual delivery date .
- (B) Failure to Deliver Not Remedied: If the failure is not remedied:
- (X) No Excess Emissions Penalty: If “Excess Emissions Penalty” does not apply, or the Delivery Date falls outside the EEP Risk Period, Receiving Party may by notice terminate the parties’ “Physical Settlement” obligations and Delivering Party must pay Receiving Party’s Replacement Cost (if positive) on the next Business Day, adjusted for any amounts it has already paid to Delivering Party (other than Premium on Allowance Option Transactions); or
- (Y) Excess Emissions Penalty applies: If “Excess Emissions Penalty” applies and the Delivery Date falls within any specified EEP Risk Period, Receiving Party may by notice terminate the parties’ “Physical Settlement” obligations and Delivering Party must pay Receiving Party’s Replacement Cost (if positive, and where it applies) on the Business Day after Receiving Party can effect a Buy-In, or otherwise purchase Allowances, adjusted to account for amounts it has previously paid (other than Premium on Allowance Option Transactions); or
- (Z) Failure to Deliver (Alternative Method): If “Failure to Deliver (Alternative Method)” applies:
- (aa) on the next Business Day Delivering Party must pay Receiving Party’s Replacement Cost (if positive), adjusted to account for amounts previously paid (other than Premium on Allowance Option Transactions), and upon payment, Delivering Party’s delivery obligation will be fully discharged; and
- (bb) if “Excess Emissions Penalty” applies, Delivering Party must pay any amount determined under “Failure to Deliver (Alternative Method) – EEP Applicable”.
(d)(ii)(2) Failure to Comply by Receiving Party: If Receiving Party fails to comply with the Requirements under the Scheme as specified below, the Payment Date will be postponed and Delivering Party may, by notice, require Receiving Party to comply, and:
- (A) Failure to Comply Remedied: If Receiving Party complies by the Final Compliance Date:
- (X) Delivering Party must deliver the Allowances to be Delivered and, on the Payment Date (where the Delivery Date will be the date of actual delivery) Receiving Party must pay:
- (i) Allowance Forward Transactions: Allowance Purchase Price x Number of Allowances;
- (ii) Allowance Option Transactions: Allowance Strike Price x number of Allowances to be Delivered; and
- (Y) on same the Payment Date, Receiving Party must pay interest at the Default Rate on number of Allowances due but not delivered x relevant Allowance Purchase Price/Allowance Strike Price from the original Delivery Date to the date of actual delivery.
- (B) Failure to Comply Not Remedied: If Receiving Party fails to comply by the Final Compliance Date, Delivering Party may, by written notice, terminate the parties’ “Physical Settlement” obligations and Receiving Party must pay Delivering Party’s Replacement Cost (if positive) on the next Business Day, adjusted for amounts previously paid (other than Premium by Receiving Party on the relevant EU Emissions Allowance Transaction.
(d)(ii)(3) EEP Amount: If “Excess Emissions Penalty” applies and, following Delivering Party’s failure to deliver, Receiving Party becomes liable for an EEP Amount, it must provide, upon Delivering Party’s request, reasonably satisfactory evidence that:
- (A) it has incurred an EEP Amount consequent on Delivering Party’s failure; and
- (B) the extent to which this results from Delivering Party’s failure; and
- (C) that it could not have used other Allowances to which it had title to reduce its liability for the EEP Amount it claims from Delivering Party.
Delivering Party’s obligation to pay any EEP Amount under “ Failure to Deliver” is subject to Receiving Party’s having used reasonable endeavours to avoid and mitigate its liability for EEP Amounts and to allocate them pro rata between all its counterparties who have failed to deliver Allowances to it provided, that the onus will be on Delivering Party to show that Receiving Party has failed to do so.
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Full text of Section (d)(ii)
(d)(ii) Failure to Deliver.
(d)(ii)(1) Failure to Deliver by Delivering Party
If the failure to deliver occurs other than as a result of the failure of Receiving Party to comply with the Requirements under the Scheme as specified below, the existence of an Illegality, the existence of a Settlement Disruption Event, the existence of a Suspension Event or an abandonment of the Scheme as described in Part [7](d)(iv)(1), the Payment Date will be postponed and Receiving Party may, by notice to Delivering Party, require Delivering Party to remedy such failure, and the following provisions shall apply.
- (A) Failure to Deliver Remedied: If Delivering Party delivers the Allowances to be Delivered on or before the Final Delivery Date:
- (X) in respect of an Allowance Forward Transaction, Receiving Party shall pay to Delivering Party on the Payment Date an amount equal to the Allowance Purchase Price multiplied by the Number of Allowances and, in respect of an Allowance Option Transaction, Receiving Party shall pay to Delivering Party on the Payment Date an amount equal to the Allowance Strike Price multiplied by the number of Allowances to be Delivered (and, in each case, for purposes of determining the Payment Date, the date of actual delivery shall be deemed to be the Delivery Date); and
- (Y) Delivering Party shall pay to Receiving Party on the Payment Date (determined in accordance with Part [7](d)(ii)(1)(A)(X) above) interest on an amount equal to the number of Allowances that were required to be delivered on the Delivery Date (but which were not delivered on such date) multiplied by either the Allowance Purchase Price (in respect of an Allowance Forward Transaction) or the Allowance Strike Price (in respect of an Allowance Option Transaction) for the period from (and including) the original Delivery Date to (but excluding) the date of actual delivery at the Default Rate.
- (B) Failure to Deliver Not Remedied: If the failure is not remedied on or before the Final Delivery Date:
- (X) if “Excess Emissions Penalty” is specified not to be applicable in the Annex to this Part [7] or the Confirmation for the relevant EU Emissions Allowance Transaction, or if “Excess Emissions Penalty” is specified to be applicable in the Annex to this Part [7] or the Confirmation for the relevant EU Emissions Allowance Transaction and an EEP Risk Period is specified in that Confirmation but the Delivery Date does not fall within that EEP Risk Period, Receiving Party may, by written notice to Delivering Party, terminate the parties’ obligations under “Physical Settlement” above and Delivering Party shall pay to Receiving Party an amount determined in accordance with paragraph (1) of Receiving Party’s Replacement Cost (if a positive number) on the first succeeding Business Day, adjusted to take into account any amount previously paid (which, for the avoidance of doubt, shall not include any Premium paid by the Buyer in respect of an Allowance Option Transaction) by Receiving Party to Delivering Party in respect of the relevant EU Emissions Allowance Transaction; or
- (Y) if “Excess Emissions Penalty” is specified to be applicable in the Annex to this Part [7] or the Confirmation for the relevant EU Emissions Allowance Transaction and, if an EEP Risk Period is specified in the Confirmation for the relevant EU Emissions Allowance Transaction, the Delivery Date falls within that EEP Risk Period for the relevant EU Emissions Allowance Transaction, Receiving Party may, by written notice to Delivering Party, terminate the parties’ obligations under “Physical Settlement” above and Delivering Party shall pay to Receiving Party an amount determined in accordance with paragraph (2) of Receiving Party’s Replacement Cost (if a positive number) on the first Business Day following the day on which Receiving Party is able to effect a Buy-In (which may be a Buy-In, on any such date, of less than the entire number of Undelivered Allowances) if and to the extent that paragraphs (2)(A)(I) or (2)(A)(II)(X) of Receiving Party’s Replacement Cost apply, or the first Business Day following the day on which Receiving Party is able to effect a purchase of Allowances in accordance with paragraph (2)(A)(II)(Y) of Receiving Party’s Replacement Cost, if and to the extent that paragraph applies, in either case adjusted to take into account any amount previously paid (which, for the avoidance of doubt, shall not include any Premium paid by the Buyer in respect of an Allowance Option Transaction) by Receiving Party to Delivering Party in respect of the EU Emissions Allowance Transaction; or
- (Z) if “Failure to Deliver (Alternative Method)” is specified to be applicable in the Annex to this Part [7] or the Confirmation for the relevant EU Emissions Allowance Transaction:
- (aa) Delivering Party shall pay to Receiving Party, on the first succeeding Business Day, an amount determined in accordance with paragraph (3) of Receiving Party’s Replacement Cost (if a positive number), adjusted to take into account any amount previously paid (which, for the avoidance of doubt, shall not include any Premium paid by the Buyer in respect of an Allowance Option Transaction) by Receiving Party to Delivering Party in respect of the relevant EU Emissions Allowance Transaction, and upon payment of such amount, Delivering Party’s obligation to deliver to Receiving Party the Allowances to be Delivered shall be fully discharged and terminated; and
- (bb) if “Excess Emissions Penalty” is specified to be applicable in the Annex to this Part [7] or the Confirmation for the relevant EU Emissions Allowance Transaction, Delivering Party shall pay to Receiving Party the amount, if any, determined in accordance with the provisions of Part [7] (d)(xi)(Failure to Deliver (Alternative Method) – EEP Applicable) below on the date determined in accordance with those provisions.
- (d)(ii)(2) Failure to Comply by Receiving Party: If the failure to deliver occurs as a result of the failure of Receiving Party to comply with the Requirements under the Scheme as specified below, the Payment Date will be postponed and Delivering Party may, by notice to Receiving Party, require Receiving Party so to comply, and the following provisions shall apply.
- (A) Failure to Comply Remedied: If Receiving Party complies on or before the Final Compliance Date:
- (X) Delivering Party shall deliver to Receiving Party the Allowances to be Delivered and, in respect of an Allowance Forward Transaction, Receiving Party shall pay to Delivering Party on the Payment Date an amount equal to the Allowance Purchase Price multiplied by the Number of Allowances and, in respect of an Allowance Option Transaction, Receiving Party shall pay to Delivering Party on the Payment Date an amount equal to the Allowance Strike Price multiplied by the number of Allowances to be Delivered (and, in each case, for purposes of determining the Payment Date, the date of actual delivery shall be deemed to be the Delivery Date); and
- (Y) Receiving Party shall pay to Delivering Party on the Payment Date (determined in accordance with Part (d)(ii)(2)(A)(X) above) interest on an amount equal to the number of Allowances that were required to be delivered on the Delivery Date (but which were not delivered on that date) multiplied by the Allowance Purchase Price or Allowance Strike Price, as applicable, for the period from (and including) the original Delivery Date to (but excluding) the date of actual delivery at the Default Rate.
- (B) Failure to Comply Not Remedied: If Receiving Party fails to comply on or before the Final Compliance Date, Delivering Party may, by written notice to Receiving Party, terminate the parties’ obligations under “Physical Settlement” above and Receiving Party shall pay to Delivering Party an amount equal to Delivering Party’s Replacement Cost (if a positive number) on the first succeeding Business Day, adjusted to take into account any amount previously paid (which for the avoidance of doubt, shall not include any Premium paid by the Buyer in respect of an Allowance Option Transaction) by Receiving Party to Delivering Party in respect of the relevant EU Emissions Allowance Transaction.
(d)(ii)(3) EEP Amount: Subject to the paragraph below, if “Excess Emissions Penalty” is specified to be applicable in the Annex to this Part [7] or the Confirmation for the relevant EU Emissions Allowance Transaction and as a result of Delivering Party’s failure to deliver the Allowances to be Delivered (in whole or in part) on the Delivery Date Receiving Party becomes liable to pay any EEP Amount, then Receiving Party shall provide to Delivering Party, upon its reasonable request, evidence to the reasonable satisfaction of Delivering Party:
- (A) that Receiving Party has incurred an EEP Amount consequent on Delivering Party’s failure to deliver the Allowances to be Delivered (in whole or in part); and
- (B) the extent to which the requirement for Receiving Party to pay any EEP Amount results from Delivering Party’s failure to make such delivery; and
- (C) that Receiving Party could not have used Allowances to which it had title in any Holding Account(s) in any Registry in order to avoid or reduce its liability to pay any EEP Amount which it claims from Delivering Party as part of Receiving Party’s Replacement Cost.
Delivering Party’s obligation to pay any EEP Amount in accordance with “ Failure to Deliver” under Part [7] of the Schedule to this Agreement is subject to Receiving Party’s overriding obligation to use its reasonable endeavours to avoid becoming liable for such EEP Amount or, when liable, to mitigate the payment obligation in relation to such EEP Amount and to allocate any such EEP Amount pro rata between all counterparties of Receiving Party that have failed to deliver Allowances to Receiving Party provided, however, that where Receiving Party confirms it has been unable to avoid becoming liable for any EEP Amount, it shall be for Delivering Party to show that it has been as a result of Receiving Party failing to use its reasonable endeavours to do so.
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Comparison
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Content and comparisons
Just what happens if, without excuse, a Delivering Party fails to deliver, or a Receiving Party fails to accept delivery of, Allowances is a key part of any self-respecting emission allowances trading document. Though each Carbon Squad approaches it in its own charmingly idiosyncratic way, the good ninjas of ISDA, EFET and IETA broadly get to the same place. Broadly.
The provisions are these:
ISDA: Sections (d)(ii) (Failure to Deliver)
EFET: Clause 8.5 (Remedies for Failure to Transfer or Accept after Cessation of Suspension Event)
IETA: Clause 12 (Transfer or Acceptance Failure)
Specifically for ISDA, and for those who like cake, and eating it, there is a normal Failure to Deliver and an alternative method Failure to Deliver.
Summary
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 the 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: {{{{{1}}}|Suspension Event}}s and {{{{{1}}} Settlement Disruption Event}}s. 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 a market as futuristic as the EU ETS wouldn’t tolerate this kind of thing, either.
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.
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.
See also
References