14. Emission Allowances as Financial Instruments

The author discusses the topic of emission allowances in relation to the MiFID II framework. While the structure and the mechanisms that underpin the functioning of the EU Emissions Trading System (ETS) system are, by now, well known, discussions on the protection of the environment and the development of secondary markets for emission allowances have stimulated a process of gradual inclusion of CO₂ allowances in the perimeter of financial markets regulation. A first, significant step in this direction was taken by MiFID I: building on the definition of commodity derivatives introduced by the Investment Services Directive of 1993, MiFID I enlarged and amplified the catalogue of derivatives that would be considered as falling into its scope. The catalogue included then derivatives on emission allowances. The landscape set by MiFID I was, however, just a first step towards the inclusion of emissions trading in the scope of financial markets legislation. A second step has been taken by MiFID II, as the latter directly classifies rights on emission allowances falling in the EU regime as financial instruments. The author argues that the reasons that led to the qualification of emission allowances as financial instruments in MiFID II are basically a consequence of the tremendous evolution that secondary markets of allowances have seen in the last few years. The growing amount of transactions and the need to preserve and ensure the transparency and integrity of secondary markets convinced the European Commission of the opportunity to include emission allowances in the scope of MiFID II and, therefore, in the scope of the Market Abuse Directive (now Market Abuse Regulation or MAR). Looking at the positive effects for environmental protection that may derive from the inclusion of emission allowances in the scope of capital markets legislation, these are basically linked to the fact that—as a consequence of the approach stemming from MiFID II—secondary markets should effectively become more transparent, efficient and secure. However, according to the author, some potential drawbacks must be considered. Trading in emission allowances has become more expensive after MiFID II, and transaction costs might impact negatively on the liquidity of the market. The application of the Capital Requirements Directive (CRD IV, now CRD V) prudential requirements might also require the absorption of important levels of capital that would be distracted from direct investments in the industry. The effect that this might have on the system is, at the moment, unclear. The landscape introduced by MiFID II is also quite complex: there are at least two, if not three, different sets of comprehensive legislation that may potentially be relevant for trading emission allowances, either on the spot, or on the derivatives market, i.e. the “old” EU ETS; MiFID II and MAR; more tangentially, the Regulation on the wholesale Energy Market Integrity and Transparency (REMIT). The author discusses the implications of each of them and argues that opting in and out of each of these systems, through a complicated system of exemptions and exclusions, does not benefit the overall coherence of the regulatory approach.