Scope - Emissions Annex Provision
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EU Emissions Allowance Transaction Annex to the 2005 ISDA Commodity Definitions
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Crosscheck:
scope in a Nutshell™ Original text:
Comparison See our natty emissions comparison table between the IETA, EFET and ISDA versions of emissions trading docs
Resources and Navigation
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Overview
There is no real comparison between the three documents on scope. This is on account of their very different lineages:
ISDA
The ISDA EU Emissions Annex is crafted not as an Appendix to the 2005 ISDA Commodity Definitions — which is how it started — nor as a standalone definitions booklet, but rather as a “Part 7” to an ISDA Schedule. This explains its rather odd numbering system, and the uncomfortable fact that its main number, the 7 is square bracketed, since whether it is a 6, 7, 8 or 9 depends on whether you already have put something else as a Part 6 or 7 in your Schedule.
Seeing as the ISDA EU Emissions Annex is, in its current edition (v 7) some 38 pages long, and therefore longer than the ISDA Master Agreement in its entirety, not just the Schedule, we rather think it deserves its own booklet.
If it had its own booklet, you could integrate other similar “compliance” regimes UK Allowances, for example, and perhaps Californian ones, and you might be able to make it “master-agreement agnostic”. Just a thought.
EFET
The EFET Allowances Appendix is structured as an appendix to the EFET agreement, and you can take your pick — and it won’t matter much — whether you choose the EFET Power or Gas format.
The Annex does its work by amending terms in the EFET Master Agreement itself to be relevant to emissions trading. The terms that are not amended we have labelled green.
Power and Gas trading both involve connecting to a grid and trading a physical commodity with the attendant risks that implies: things can blow up, go off, be off-spec, and the grid needs to be balanced and so on. Emissions certificates are financial instruments and so are much easier. Much of the amendments is to overcome this difference. But some traces of the EFET’s “physical trading network” genealogy remain.
IETA
The IETA is the only dedicated Emissions trading document. This is good if you don’t want the bother of the physical energy trading bits and bobs, or if you are not a full-scale ISDA ninja — but few participants in the emissions trading market are neither energy traders nor financial derivatives traders. Financially regulated users will want the benefit of netting opinions — which they will have under the ISDA — and non-financial energy traders will want an agreement format they are used to, so we suspect the IETA will be the least commonly used of the three.
As such IETA Master Agreement starts off with a “single agreement” clause. As we go on, you will notice some similarities with the 1992 ISDA. So many, in fact, that you may start to wonder why they didn’t just use a 1992 ISDA, and make this into a specific definitions booklet. Perhaps the pioneering emissions traders weren’t ISDA ninjas, didn’t want to pay ISDA membership fees, something like that? Hard to know.
If you are an ISDA ninja, you won’t need me to tell you that this is a single agreement, or what it is for.
Summary
The EU emissions trading scheme divides into a number of “Compliance Periods”. The first was three years January 2005 to December 2007. The second was four, from from January 2008 until December 2012, coinciding with the first commitment period of the Kyoto Protocol. The Third Compliance Period was eight years, from January 2013 to December 2020. The Fourth Compliance Period, also eight years, started in January 2021 and will go until December 2030.
This is of some interest to those trading for physical settlement Allowances that might expire.
ISDA
There is an interesting limitation penned into the Scope section of the Emissions Annex: despite talking about the Third Compliance Period, and defining it, and so on, and providing for the manifold contingencies that arise when having truck with Third Compliance Period Allowances, if you believe the Scope section to be any kind of limitation, you are only meant to deal with Fourth Compliance Period Allowances.
No doubt someone will have a compelling reason for that — do write in if it’s you — but we can’t think of one.
And what are you meant to do if the Specified Compliance Period is the Third Compliance Period? Answers on a postcard.
IETA
The “single agreement” concept
Here several pieces of magic come together to create the capital foundation of the modern master trading agreement. The challenge, originally solved by the First Men, was to create an architecture that allowed discrete, unitary, complete Transactions, such that creating a new one or terminating an old one didn’t upset the economic or legal integrity of other Transactions that were currently on foot — no untoward tax consequences, that is to say — while at the same time creating an umbrella framework so that, should something regrettable happen to either party, all Transactions can be quickly rounded up, evaluated, stopped and then collapsed down — “netted” — to a single payment, payable by one party to the other.
This involved some canny financial engineering. The general rules of set-off require not just a mutuality of parties to the off-setting debts, but also amounts falling due on the same day and in the same currency — neither of which was necessarily true of the independent Transactions executed under a multi-currency, cross-border ISDA Master Agreement.
Their solution was this concept of the “Single Agreement”: the over-arching agreement that, however independent and self-contained Transactions are for any other purpose, when it comes to their early termination, they transmogrify into the single host agreement, in the process reduced to mere calculation inputs to the final amount which one party must pay the other. Thereby the process is not one of “set-off” at all, but of calculating a single net amount, the payment of which would sort out all matters outstanding under the relationship.
The JC once had the idea of doing a “boring talk” about the history of the ISDA Master, and actually pitched it to the BBC for their podcast series. It was rejected, on account of being too boring. True story.
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- JC’s “nutshell” summary of the clause
- Background reading and long-form essays