Financial regulation poses liquidity threat to EU ETS

08 April 2014 15:52 Source:ICIS

An updated EU financial regulation could reduce again the amount of independent traders active on the EU emissions trading system from late 2016 or early 2017 because of the additional costs they will need to meet, market sources said.

In January, EU lawmakers finally thrashed out after many failed attempts a political agreement on the updated Markets in Financial Instruments Directive, known as MiFID II.

The definition of a financial derivative in the directive includes EU allowances, and so in theory a company will need a MiFID licence to trade the certificates once the updated directive comes into force. But some energy companies can apply for an exemption from MiFID II. Utilities, for example, with generation assets or installations, can claim that the trading of emissions is ancillary to their business, and so will likely be exempted from MiFID.

For independent traders or companies without upstream assets, the situation is less clear and it is likely they will need to apply for a MiFID licence to trade EUAs.

“What we can say is that companies without installations could struggle to maintain their current business model and should carefully review their strategic set-up going forward,” said Simon Tywuschik, an energy expert consultant with PA Consulting Group.

This is because, apart from needing to apply for a MiFID licence, companies not exempt would also need to meet onerous capital requirements and put in place procedural requirements. And several sources think the extra costs that come with the licence, in addition to underlying difficulties of trading within the EU emission trading system given weak fundamentals, would push many independent traders out. This would come on top of independents that have leaked out of the market in recent years ( see EDCM 15 January 2014 ).

Who can apply for an exemption from being regulated by the directive will depend a lot on the how widely or narrowly ancillary services is defined in the regulated technical standards. The European Securities Markets Authority must publish the standards within a year of MiFID II being published in the EU’s official journal, but the draft version should be out before then and make the issue a lot more clear.

The European parliament is expected to vote on the MiFID text on 16 April, which would mean the directive would come into force in Q4 2016 or the first quarter of 2017. And it is then that independent traders might need to gain a MiFID licence to trade EUAs. Fionn O’Raghallaigh

By Fionn O'Raghallaigh