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Emission allowances: Difference between revisions
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An opportunity for regulatory arbitrage, created out of thin, hot air.<ref>Boom boom.</ref> Notwithstanding their close connection with the commodities markets, emission allowances are not commodities, but rather a sort of play on global energy policy. In an odd way they resemble [[crypto]], in that they are fully dependent on a collective belief (amongst the world’s governments) that climate change can, and indeed needs to, be managed by imposing financial incentives on the generation (or consumption) of carbon dioxide. [[Emission allowance]]s themselves formally resemble financial instruments, though their custody and legal form are rather unique, and lawyers will get exercised about how one effectively takes security over them. You can’t for example, in Holland. | An opportunity for regulatory arbitrage, created out of thin, hot air.<ref>Boom boom.</ref> Notwithstanding their close connection with the commodities markets, emission allowances are not commodities, but rather a sort of play on global energy policy. In an odd way they resemble [[crypto]], in that they are fully dependent on a collective belief (amongst the world’s governments) that climate change can, and indeed needs to, be managed by imposing financial incentives on the generation (or consumption) of carbon dioxide. [[Emission allowance]]s themselves formally resemble financial instruments, though their custody and legal form are rather unique, and lawyers will get exercised about how one effectively takes security over them. You can’t for example, in Holland. | ||
===Their relationship with European regulation. It’s complicated.=== | |||
== A unique asset class == | |||
The [[Emission allowances|emissions allowance]] is a fascinating, transgressive product. It challenges the traditional boundaries in finance. It is neither [[debt]] nor [[equity]], and has none of the qualities of either: it confers no [[ownership]], there is no [[credit exposure]], and at least in some jurisdictions allowances cannot be [[pledge|pledged]] or held in [[trust]], so they acquire the [[credit exposure]] of whomever you find to hold them on your behalf. In some ways they behave rather like a [[cash]] instrument: they represent an abstract value whilst having no intrinsic worth, can only be held, not owned, but unlike cash they expire, and before expiry can be redeemed — not for money, but for the release from an obligation to pay money. | |||
==== [[Regulatory derivative|Regulatory derivatives]]? ==== | |||
Emissions allowance trading schemes are a bit “[[King Cnut|Cnutish]]” in that they are a creature of unilateral government decree: the regulators declared that carbon polluters must submit these allowances, and so they did. In this way you can regard emissions trading as a form of pure, unadulterated regulatory derivative. | |||
As [[Financial instrument|financial instruments]], emissions allowances are unusually susceptible to ''further'' government decree, which may at any time change their terms or eligibility for surrender, or abolish them altogether, as governments of different stripes wax and wane on how they feel about the environment. This is a lot less likely to happen to [[Debt security|bonds]] or [[Equity securities|stocks]]. The risk increases the further into the future you look, meaning that the emissions market tends to trade over a short time-horizon of no more than a year or two. On the other hand, the forward curve is pretty steep, making it an attractive product to finance if you know how. | |||
====Redemption ==== | |||
{{redemption of emissions allowances}} | |||
== Documentation == | |||
==== Fraud, theft and tax ==== | |||
In its formative years the emissions market was also oddly vulnerable to [[fraud]], theft and tax evasion — structural shortcomings that have long since been fixed — but there are a number of decidedly counter-intuitive features and disruption events in the documentation which probably have little use these days. Legal documentation dwells at length on the risks of theft of allowances from custody, in a way it tends not to when bonds and stocks are held in [[custody]]. This should subside over time. | |||
==== “And [[Then I woke up and it was all a dream|then I woke up and it was all just a dream]]” ==== | |||
All of the documentation standards feature a seldom-seen economic close-out feature — present but never used in the 1992 ISDA master agreement, and never seen since — the “[[then I woke up and it was all a dream]]” [[close-out]] scenario, where if there is an incurable disruption scenario, at some point everyone just pretends the trade never happened and walks away. One needs to be careful when financing using the standard documentation suites, therefore. | |||
==Regulation== | |||
====Their relationship with European regulation. It’s complicated.==== | |||
{{Commodity regulation}} | {{Commodity regulation}} | ||
{{de minimis threshold capsule}} | {{de minimis threshold capsule}} | ||
{{sa}} | {{sa}} | ||
*[[De minimis threshold test]] | *[[De minimis threshold test]] | ||
{{c|Emissions}} | |||
{{ref}} | {{ref}} | ||