Emissions Anatomy
Here is the JC’s latest Anatomy™: ISDA’s emissions annex, which comes in at least two flavours: the original EU Emissions Anatomy, and the new, copycat, we absolutely-are-not-going-through-separation-anxiety, UK Emissions Anatomy. These documents are special in that they are the creature of that permanently marginalised ISDA’s crack drafting squad™ splinter group, the Carbon Squad™. These quasi-fundamentalist drafting weirdos, with all their neo-First Method, “and then I woke up and it was all just a dream” nonsense, don’t often get a look in, but ISDA’s overlords seem to have swtiched off the dash-cams and looked the other way on this occasion, and these bad-boys of carbond have not wasted the opportunity.
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EU Emissions Allowance Transaction Annex to the 2005 ISDA Commodity Definitions
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For practitioners, this is heady stuff: working out which tracts of the annex are dangerous, extremist nonsense and which are practical allocations of risk in a new and sui generis asset class is an exhilarating, seat-of-the-pants, experience.
The annexes function as sort of add-ons to the 2005 ISDA Commodity Definitions, which you access by adding a new Part with some elections to the Schedule to your ISDA Master Agreement. This is also some cross-grading into the 2006 ISDA Definitions, and you may find yourself hankering wistfully for the dear old 2002 ISDA Equity Derivatives Definitions too, if hedging disruption is something that keeps you awake at night.
Now. In our humble opinion, the level of rigour, diligence and just plain old common sense, however pedantically articulated and tediously applied, we have come to expect when beholding a new weapon from the great ISDA FWMD foundries just feels missing in action for these Emissions Annexes. Oh, fear not: pedantry and tedium abound close-up: ISDA’s crack drafting squad™ knows no boundaries when it comes to labouring what ought to be obvious, and they have spared no innocents here. But back off a few feet to beyond a bigger picture — matters of substance, not form — and you may feel Carbon Squad™ has taken some positions which strike us as being eccentric, were we to put it kindly, and utterly barking mad were we to be speaking candidly among friends.
Seeing as ISDA’s crack drafting squad™ has now duped the original EU version — the UK version is, as you would expect a very close lift — then the original has acquired some inertia. Change one and you much change both. We doubt there will be much appetite. Pity. We don’t quite understand why ISDA didn’t combine these into a single, generic annex. The amount of divergence needed to cover both regimes is very little, and perhaps it was the opportunity to re-visit the original approach and come up with something that sits a little more comfortably with the usual ISDA approach to valuing and terminating derivative transactions.
Now the blame for some of this miscomprehension may well be laid at the JC’s door: we read this cold, without the benefit of having seen its evolution, and without much knowledge of the market, much less competing products (the International Emissions Trading Association’s master agreement, for example). We’ll maybe get on to that. So he may be missing some subtlety.
But we don’t think so: those experts to whom we have spoken are all abut shoulder-shruggy about this document, and sort of mumble that we're struck with it, since a couple of key market participants are now quite attached to it.
It seems the market has taking to amending and adapting the terms of the Annex wholesale, rather than treating it as an inviolable canon, as is usually the ISDA way. So what you are faced with might not much resemble what you find here. But we offer it for what it is worth anyway.