Then I woke up and it was all a dream - Emissions Annex Provision
EU Emissions Allowance Transaction Annex to the 2005 ISDA Commodity Definitions A Jolly Contrarian owner’s manual™ all a dream in all its glory
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Overview
There are thee discrete “then I woke up and it was all a dream” scenarios in the ISDA EU Emissions Annex.
Settlement Disruption Event
Section (d)(i)(4)(D) is the part of the Settlement Disruption Event where things seem to have ground to an irretrievable halt, and ISDA’s crack drafting squad™ has concluded the best thing to do is for everyone to just forget whatever it was they were expecting to get out of the transaction, and put everything back how they found it and walk away. Curious, we call it. Curious. And most un-ninjery.
Suspension Event
Section (d)(i)(5)(D) is the equivalent provision for Suspension Events. It is most curious and really makes me think the JC must have missed something big here, because the sort of things you would expect to be consistent across various events that delay scheduled settlement: Suspension, Settlement Disruption and so on — things like Cost of Carry compensation — are different, whereas the one thing that you would expect to, well, to not be there at all, frankly — the then I woke up and it was all a dream termination sequence — is curiously consistent.
Abandonment of Scheme
Section (d)(iv), about Abandonment of Scheme, similarly, weirdly, plumps for the just a dream scenario. You would think a Forward seller, whether outright or of an option, who thought she had got those confounded Allowances off her desk, might be dismayed to find them right back on there at just the point where they became utterly valueless.
Summary
Continuing Settlement Disruption Event
Some rather magical (in the sense of being quite impenetrable) thinking from ISDA’s crack drafting squad™ here, in the name of seeking a long-stop to a Settlement Disruption Event. Since there is this Reconciliation Deadline concept — 30 April each year — by which time, certain EUAs have to be surrendered, an ongoing settlement disruption can be a rather fraught thing. Emissions Allowances can suddenly, by government fiat, become worthless in a way that most other financial instruments cannot.
What happens? Well, after 9 delivery Business Days (or such shorter period as may be dictated by Reconciliation Deadlines) the disruption is deemed to be an Illegality — I know, I know: it isn’t even close to being an Illegality[3] — and depending on whether Payment on Termination for Settlement Disruption applies, the parties either have to perform their obligations after all — odd, since the Settlement Disruption Event is ongoing, and Q.E.D. they can’t — or the transaction is basically voided ab initio and both parties walk away, refunding any put or call premiums they may previously have received.
Suspension Event
Someone has got a mind infested by nefarious phantoms, readers: either the ISDA’s crack drafting squad™ does, collectively, or the JC does. We are totally not ruling out the JC, to be clear. But this is too weird.
A Suspension Event happens when the official infrastructure falls over so that the parties can’t transfer Allowances to settle a Transaction. It is the fault of neither party — therefore to be distinguished from a Failure to Deliver, which generally will be. While there is overlap between Settlement Disruption Events and Suspension Events (in that both are things beyond the parties’ control) Suspension Event, being narrower and related to the failure of official infrastructure, trumps Settlement Disruption Event where they both apply to the same event. Generalia specialibus non derogant, I suppose.
Note the Long-Stop Date concept, which references 1 June in a year following a set of seemingly arbitrary two-year spells in the Fourth Compliance Period and relates only to Suspension Events, not Settlement Disruption Events, and also appears to bear no relation at all to the Reconciliation Deadline at the end of April in each year.
We have compared Settlement Disruption Events and Suspension Events here.
A curiosity to which the JC has not yet found a plausible answer is why there is a Cost of Carry adjustment for Suspension Events that run over the scheduled Delivery Date, but not for other, ordinary Settlement Disruption Events (or for that matter, Failures to Deliver).
There is no at-market termination provision at a Long-Stop
Also, the “then I woke up and it was all a dream” method of resolving irreconcilable suspensions. Unlike for Settlement Disruption Event, ISDA’s Carbon Squad did not provide for “Payment on Termination for Suspension Event”. We are baffled by this, as we have mentioned elsewhere: it defaults the position to one where the person who thought they had sold forward a risk finds, for reasons entirely beyond their control, that not only was that risk transfer ineffective, but the risk has come about and the asset is, effectively worth zero. If you consider the position of someone who was, for example, financing someone else’s Allowance allocation — hardly out of the question, since that is basically the point of a Forward Purchase Transaction this is transparently the wrong outcome, since the Seller — the person who is borrowing against its Allowances — gets to keep the money. Madness.
Abandonment of Scheme
What happens if, in its infinite wisdom, the European Union decides that an Emissions Trading Scheme is a silly idea and we should just embrace a future as Venusians, or Scottish vintners or something similar. You may see people tinker around with this — our favourite is “... or there is a proposal to abandon the Scheme... ” which given its looseness (there’s always some wingnut from a minority in an some oil-burning pressure group proposing something like that) and the lack of consequences beyond the transaction should it happen or not happen — it isn’t like it is an illegality or something where you can go to prison if you blithely carry on — there really seems no sensible call for this.
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- The JC’s famous Nutshell™ summary of this clause
See also
References
- ↑ If the form of Master Agreement in which this Part is included is a 1992 ISDA the parties should specify “Additional Termination Event” or, if the form of Master Agreement which the Confirmation supplements is an 2002 ISDA the parties should specify “Illegality”.
- ↑ We think this number is superfluous, in that there is not a (II).
- ↑ In a nutshell, a real ISDA Illegality happens where, “for reasons beyond the Affected Party’s control, (not counting a lack of authorisation), it would be illegal in any relevant jurisdiction to comply with any material term of a Transaction”; Settlement Disruption is most certainly not that.