Partial Settlement - Emissions Annex Provision
EU Emissions Allowance Transaction Annex to the 2005 ISDA Commodity Definitions
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(d)(iii) in all its glory
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For the Seller doesn’t deliver the full quota of allowances to be delivered, the Buyer only has to pay the agreed strike/purchase price for those that are delivered, and the remainder of the Transaction will be closed out as if it were a Failure to Deliver. This is a bit curious — why wouldn’t it just be closed out under normal Section 6 close-out methodology and the undelivered portion be treated as an Unpaid Amount? But it probably gets to a similar place (though perhaps it pauses Section 2(a)(iii) at least until the pro-rata partial payment is made. Again; as to why, search us.
Decoupling of Phase 3 and Phase 4 Allowances: a wild guess
One possible reason — though it is unlikely and we are really reaching here — is the outside contingency of wehat we have seen described as a “Fungibility Event”: that the Seller is holding Phase 3 Allowances and they, by regulatory decree, unexpectedly become ineligible for surrender past a specified date or some such thing. (We think this is a highly remote contingency, seeing as the Allowance futures contracts don’t differentiate between Phase 3 and Phase 4, so market participants can hardly control which type of Allowances they hold, and it would be perverse and counterproductive behaviour for ESMA to suddenly deem part of the market ineligible.) But, look — no-one is denying regulators do ill-advised and counterintuitive things; so you never know.
But we don’t think that is it: for one thing, if that event happens there will almost certainly be plenty of notice. Phase 3 and Phase 4 Allowances currently trade as if fungible. They will rapidly decouple, and the best mechanism would be for Buyers — whom we expect to be end users, right? — to accelerate delivery of expiring Phase 3 Allowances so they can surrender those first. Sellers — financiers in the main — won’t wildly care as long as their funding break is taken care of. In any case having to wait until final settlement, and then being discovering tendered Allowances are worthless, seems a bit of a head-in-sand tactic.
There’s no easy solution to this, which makes us think that even if the EU regulators do such a silly thing, they will quickly change their minds when they see the resulting market confusion and dismay.
- The JC’s famous Nutshell™ summary of this clause