Emissions trading in the UK - an overview

United Kingdom

1) Introduction

Following the Government's publication last November of its consultation paper on "A Greenhouse Gas Emissions Trading Scheme for the United Kingdom", this article is intended to provide a general introduction to the UK Emissions Trading Scheme ("ETS") in that consultation paper. The article will help the readers to identify the detailed information they need to judge broadly the likely impact of the ETS on their own business.

2) International perspective

The international community has slowly, and at times grudgingly, begun the long process towards building effective international and domestic measures to tackle greenhouse gas ("GHG") (footnote 1) emissions in response to the increasing certainty that global warming is happening and the uncertainty over its likely consequences.

That process began in Rio in 1992 when 160 countries agreed the UN Framework Convention on Climate Change ("UNFCCC"). The UNFCCC is, as its title suggests, simply a framework; the necessary detail was left to be settled by the Conference of the Parties ("CoP") to the UNFCCC.

In 1997 the CoP agreed, in what has been described as a watershed in international environmental treaty making, the Kyoto Protocol where 38 developed countries (Annex 1 countries) committed themselves to targets and timetables for the reduction of GHGs. These targets for developed countries are often referred to as Assigned Amounts. The UK's target is to reduce its emissions of GHGs by 12.5 percent against 1990 levels by the Kyoto commitment period, 2008-2012. The UK is one of the few countries likely to achieve its target and has in fact set itself a domestic target to reduce emissions of CO2 by 20 percent against 1990 levels by 2008.

One important economic reality recognised by many of the countries that signed the Kyoto Protocol is that, if countries have to rely solely on their own domestic measures, the resulting inflexible limitations on GHG growth could entail very large costs perhaps running in to many trillions of dollars globally over this century. (footnote 2) As a result international mechanisms which would allow developed countries flexibility to meet their targets were included in the Kyoto Protocol. The purpose of these mechanisms is to allow the parties to find the most economic ways to achieve their targets, such as buying Parts of Assigned Amounts ("PAA") from other Annex 1 countries who have over-achieved their targets, or funding the transfer of cleaner technologies to developing countries in return for credits to be counted towards their Assigned Amount.

There are four such international Flexible Mechanisms or Kyoto Mechanisms written into the Kyoto Protocol. Article 17 of the Protocol authorises Annex 1 countries that have agreed to emissions limitations to take part in emissions trading with other Annex 1 Countries. Article 4 authorises such parties to implement their limitations jointly, as the Member States of the EU have chosen to do. Article 6 provides that such Annex 1 countries may take part in Joint Initiatives ("JIs") in return for Emissions Reduction Units ("ERUs") to be used against their Assigned Amounts. Finally, Article 12 provides for a mechanism known as the Clean Development Mechanism ("CDM") under which Annex 1 countries may invest in emissions limitation projects in developing countries and use Certified Emissions Reductions ("CER's") generated against their own Assigned Amounts. In this article we are primarily concerned with how the Kyoto Protocol and in particular Article 17 are driving the development of a domestic emissions trading scheme ("ETS") in the UK.

However, while the Kyoto Protocol provided for these Flexible Mechanisms, it did not set out the detailed rules which would govern how these would work in practice. This was to be left to subsequent CoPs. It was hoped that the outstanding issues would finally be settled at CoP-6 in The Hague. As we now know, this did not happen. However, contrary to much of the rather negative press coverage, significant progress was made on many of the detailed rules for the Flexible Mechanisms. It is also the case that CoP-6 did not end, but is in suspension until May 2001 when it is planned to resume in Bonn. Therefore, despite some of the abortive discussions after CoP-6, there is still room for optimism that a deal will be struck.

Many of the negotiation texts for the Flexible Mechanisms are publicly available. (footnote 3) These texts offer an extremely good outline of how the Flexible Mechanisms are likely to work in practice thus providing a template for countries such as the UK to finalise their own schemes so that they are likely to be compatible with any future international schemes. The momentum in the UK is now such that even if CoP-6 is unable to reach agreement the UK is almost certain to press ahead on this basis.

3) The UK's Emissions Trading Scheme ("ETS")

Why is the Government so determined to develop an ETS, particularly in the light of the suspension of CoP-6? Government clearly believes that there are potential economic advantages to the UK from being one of the first countries to develop a functioning ETS. It justifies this belief by stating that the early development of a domestic ETS will mean that UK Government, UK business and the City of London will be well placed to play a leading and influential role in both the development and use of these schemes in other countries and internationally. Indeed industry would generally seem to share this view, as the form of the ETS being proposed by Government is largely the result of a business-led initiative.

In June 1999 the Confederation of British Industry ("CBI") and the Advisory Committee on Business and the Environment ("ACBE") set up the UK Emissions Trading Group ("ETG") to design a UK ETS. The ETG now has a membership of over 100 major companies, professional service firms and trade associations. Following the ETG's recommendations submitted (footnote 4) in October 1999 and March 2000, the Government published its consultation paper "A Greenhouse Gas Emissions Trading Scheme for the United Kingdom, November 2000" ("Consultation Paper"). (footnote 5)

It is intended that the ETS will cover not only CO2 emissions but also the other five GHGs, provided that suitable protocols for measuring and verifying emissions have been developed (see Section 10 below). To begin with there will be two major mutually exclusive (footnote 6) ways to obtain access to the ETS: (i) voluntary Participation; and (ii) as a party to a Climate Change Levy Agreement ("CCLA").

The Consultation Paper proposes that private companies and other commercial entities ("Participants") will initially enter such an ETS on a voluntary basis. Perspective Participants will have to bid for part of a Government incentive of GBP30 million a year available over five years. In return Participants will accept an obligation to achieve absolute and binding GHG emissions reductions. These caps will relate to the entity and will not be activity or site specific: in contrast to the CCLAs which will be. There will be some basic restrictions: companies will need to bid on the basis of a minimum emissions reduction and no one company or group will be able to bid for more than 10 per cent of the incentive. The first restriction is intended to preserve the environmental integrity of the ETS and the second is to help guarantee a minimum liquidity in the market.

Detailed rules for the financial incentive and the bidding process are due to be published in March, and the current timetable envisages optimistically that bids for the incentive should be received by early autumn, even though Government does not expect the rules for the ETS itself to be finalised before late autumn!

It is proposed that the ETS start on the 1st January 2002 when Participants will be issued with allowances permitting the holder to emit a given quantity of greenhouse gases. Participants will, subject to the rules of the ETS, be allowed to trade these allowances: so-called "Cap and Trade". On 31st December 2002 it will be determined, whether or not Participants have achieved their targets, with incentive payments made in April 2003. This process will be repeated annually. It is not clear, however, whether the intention is for the ETS to end after 5 years when the incentive ends or after 10 years in which case there would be no incentive payments available for the last 5 years.

4) Future entrants and other changes

Initially, there will be a single opportunity for entities to enter the ETS as Participants. Any entities who choose to enter later will only be able to do so through a formal invitation after 2001 ("Late Entrants"). The Consultation Paper is silent on when or if such formal invitation will be issued and to whom. However, a distinction is drawn between such late entrants and entities not operating at the start of the scheme ("New Entrants") whose right to join the ETS, it is suggested, if protected under EU Law. This of course implies that Late Entrants are not so protected and could be forced to pay for their allocation of allowances in some form of auction. However, while New Entrants will be free to join the scheme there will be no incentive available. This probably means there are unlikely to be any later entrants unless and until the ETS is made mandatory by statute or additional incentive monies are made available.

Once companies have entered the ETS the intention is that they must stay in the ETS for either 5 or 10 years. However, a target agreed in 2001 may not always remain suitable; the world changes. A company may close down a facility, it may merge, de-merge, acquire new businesses or even outsource certain activities.

The CCLAs (discussed in Section 5) provide for targets to be reviewed periodically and renegotiated if significant changes have occurred, such as a significant reduction in output. For the ETS Participants it is proposed that mergers, de-mergers and acquisitions will simply be treated as variations of new or late entry. Outsourcing of activities will in effect be ignored and so targets relating to the outsourced activity must still be met. Lawyers dealing with such mergers, de-mergers, acquisitions and outsourcing involving Participants will need to address the issues in the relevant contracts.

However, it is, surprisingly, suggested that if significant changes occur to the activity (such as a site closing down entirely) on which targets were originally set, no account will be taken of this on the basis that to do so will impose increased administrative burden on Participants. Therefore, in theory, a Participant could close down a site, move it to another country, potentially with greater resultant emissions and continue to collect (and presumably sell) allowances. Such a scenario seems to threaten the environmental integrity of the UK ETS.

5) Climate change levy negotiated agreements

From the 1st April 2001 a climate change levy ("CCL") of GBP0.43/kwh for electricity and GBP0.15/kwh for gas and coal, paid as part of energy bills, will apply to all commercial energy users in the UK (except the transport sector). This "downstream energy tax" (footnote 7) is to apply to all energy used, whether or not such energy is derived from fossil fuel (i.e. it is not a carbon tax). However, those considered to be heavy users of energy will be eligible for an 80 percent discount from the CCL if they enter into Climate Change Levy Agreements ("CCLAs") with the Government, thereby taking on emissions or energy targets linked to tonnes of CO2 emitted. Unlike the Participants in the ETS, parties to a CCLA will be able to chose between either an absolute target (linked to absolute emissions of CO2) or a relative target (linked to emissions of CO2 relative to output). Therefore under relative targets a company's emissions may increase in line with the company's increased output but the targets may still be met. What constitutes a high energy user for this purpose is beyond the scope of this article except to point out that it is linked to descriptions of the most polluting industries as described in Parts A1 and A2 of the EU's Integrated Pollution Prevention and Control Directive. (footnote 8)

The important point for this discussion is that the parties to the CCLAs are to be permitted to trade allowances to meet their targets, both between themselves and, with some restrictions on those with relative targets, into the ETS itself. However, they will only be able to obtain allowances to sell when they perform above their targets; this is referred to in the Consultation Paper as "baseline and credit". In effect, Companies in a CCLA will only be able to sell allowances obtained after each of the two-year compliance dates e.g. 1st April 2003, 1st April 2005 etc.

It is proposed that those in the relative (rather than the absolute) sector should have certain restrictions placed on their freedom to trade so as to reduce the potential for allowance "inflation". Allowance inflation could arise where those with relative targets achieve their targets even where emissions have actually increased. The allowances thus generated could then flow unfettered into the ETS, in effect devaluing all allowances and potentially the credibility of the entire ETS both domestically and internationally.

The major restriction proposed is a "gateway" which would work on a "one in, one out" basis between the ETS and the relative sector. The gateway would only permit allowances from the relative sector into the ETS to the extent that the same number of allowances had previously moved in the opposite direction. In essence this would mean there could be no net movement of allowances from the relative sector to the ETS. There would be no restriction on the number of allowances moving in the opposite direction. The Government is also proposing that this gateway should be closed permanently from 1st January 2008.

It is also proposed that while companies in the ETS, including those with absolute targets under the CCLAs, will be able to bank allowances into future commitment periods and to buy allowances from international and domestic emissions reduction projects, those with relative targets will not.

6) Other ways to generate allowances

In time there are likely to be other domestic schemes which could generate allowances tradeable in ETS e.g. green certificates relating to the Renewable Energy Obligation, credits from Energy Efficiency projects in businesses other than those in the main trading schemes and other. (footnote 9) Allowances from some overseas trading schemes are also likely to be recognised by the ETS before 2008 as discussed in Section 8.

One of the biggest potential headaches for Government will be to ensure that the ETS does not double count emissions reductions achieved as a result of other policy measures. For example, there may be a link between the ETS and the Renewable Energy Obligation under the Utilities Act 1999, which now requires energy generators and suppliers to obtain 10 per cent of their supply from renewable sources by 2008. Compliance with this obligation will be based on a system of "green certificates", the Consultation Paper suggests the possibility that those generators who over-achieve could convert excess green certificates to tonnes of CO2 equivalent allowances recognisable by the ETS. Double Counting could arise if green certificates were used twice, once to satisfy the 10 percent renewable energy obligation and then again in the ETS. This would be double counting because each of these policy instruments, namely the ETS and the Renewable Energy Obligation is designed to achieve emissions reductions, and the reductions from both are needed if the UK is to achieve its national targets.

As mentioned in Section 2 the Kyoto Protocol provides for four international Flexible Mechanisms. It should also be noted that credits could be generated from those international emissions reductions projects authorised under the Kyoto Protocol, i.e. JI and CDM. The Consultation Paper makes it clear that Government intends to let Participants in the UK ETS use credits from JI and CDM projects to meet their targets but probably not before the detailed rules for JI and CDM have been settled at CoP-6. If the CoP-6 conference fails to reach agreement when it resumes in Bonn in May, it is an open question whether the use in the ETS of JI- and CDM-derived credits will be ruled out for the time being, or whether the Government will choose to set out its own rules for approval of some form of international projects analogous to JI and CDM.

7) UK-based emissions reduction projects

Whilst the Government is proposing to delay a final decision on whether or not to accept credits from JI & CDMs into the UK ETS it does intend to press ahead with approval of UK-based emissions reduction projects. It is hoped that such projects will encourage emissions reductions in areas not covered by the ETS or CCLAs e.g. transport, household energy efficiency and businesses not covered by either the ETS or CCLAs.

The rules that govern such domestic projects have yet to be finalised but are likely to follow closely the rules for JI projects. The main requirement will be that such projects will need to demonstrate that any proposed emissions reductions will be additional to a "business as usual" baseline. In essence this means that the project would not have been undertaken as a part of the company's normal development or expansion, but has been implemented solely or largely for the purpose of achieving emissions reductions. It is also envisaged that such projects will be subject to monitoring and verification procedures to at least the same standards as overseas JI and CDM projects will be.

The Consultation Paper considers it unlikely that all the necessary detail and rules for project approval will be in place for the beginning of the ETS. However, it does state that the Government is considering drawing up an interim list of projects with pre-agreed baselines that can be approved before all the necessary rules and approvals have been finalised, so that a number of such projects can be authorised and begun. Such projects may include some renewable energy technologies, but will almost certainly exclude carbon sequestration projects such as forestry initiatives.

8) International trading

As trading is authorised by the Kyoto Protocol, an international treaty binding on nation states only, businesses or companies will only have access to trading within a nation state if that states domestic law provides for it. Further, if two companies each resident in a different Annex 1 state wish to trade with each other, domestic law in each state will need to recognise the allowances of the other state.

Moreover, the Kyoto Commitment Periods and therefore Assigned Amounts do not in fact have any legal basis before 1st January 2008. Thus, it remains unclear if international trading can actually take place before then. Although Parts of Assigned Amounts ("PAAs") will not exist under international law before that date, it is entirely possible, and in fact likely, that some sort of pseudo or precursor PAAs will be traded before then. This is likely to happen where countries (such as Denmark and the UK) recognise each other's allowances before 2008.

If such international trading is to be recognised under the Kyoto Protocol from 2008 it will have to take place through the relevant registries in each country such as the ETA (see Section 11). Before 2008, this will probably require bilateral agreements between the registries in each country. Such bilateral agreements will almost certainly have to follow as closely as possible any international rules agreed pursuant to the Kyoto Protocol so that such international trading can continue smoothly into 2008 and beyond. After 2008 it is hoped the whole process, and in particular the need to make individual bilateral agreements, will be addressed by a central international registry in Bonn administered by the UNFCCC Secretariat.

9) Tradable units

The tradable units within the ETS will be emissions reductions "allowances". Allowances will be created by Government unless imported from recognised international sources. These allowances, as provided for under the Kyoto Protocol, will be denominated in tonnes of CO2 and each will have a unique serial number.

Whether or not an allowance or credit will be freely tradeable will depend on whether it is identical or interchangeable with other allowances or credits; this principle is often referred to as fungibility. However, other than stating that Allowances are to exist in electronic form, the Consultation Paper says nothing about the legal status of these allowances and in particular the rights of ownership associated with them. What it does say is that the registry in the form of the Emissions Tracking Authority ("ETA") (see Section 11) will hold an allowance account for each target-holder and others such as brokers. This registry will make a transfer of allowances between accounts when it receives approval from representatives of both the transferor and the transferee.

This may be workable for simple bilateral trade between the Participants to the ETS and parties to CCLAS. However, it is probably too primitive a system for more complicated financial mechanism such as the "Forwards", "Steams" and "Options" which the Consultation Paper envisages when it draws a distinction between transfers, where the legal ownership of an allowance changes ownership, and trades, where in effect the equitable title or rights in such an allowance are passed. As the Consultation Paper points out, such mechanisms will develop as a means of managing risk. To allow these mechanisms to develop fully it is important that the legal nature of these allowances should be established, either by Government or if need be by the market.

10) Some technical issues

If targets are to represent real reductions in emissions it will be necessary to establish a business’s actual emissions over a given period (its "baseline"). Once this has been done, a target can be set for future emissions which represents, if achieved, real emissions reductions.

The Consultation Paper proposes that, for entrants to the ETS in 2001, the baseline should be average annual emissions for the three years up to and including 2000. However, entrants may be allowed to use a shorter period if they can satisfy external verifiers (see below) that they do not have access to sufficient information for all three years. One likely issue of equal concern to initial entrants and those who enter at a later date is that the Consultation Paper does not indicate how baselines will be calculated for future entrants into the current ETS. It simply states, unhelpfully, that the baseline for future entrants shall be decided at some future time. The only guidance given is that "any decision will be governed by the principle that early entrants should not be penalised for their early commitment to the ETS", this principle is often referred to as "baseline protection". It seems that Government has suggested in some quarters that if there is to be a mandatory scheme in future, then the baseline under such a mandatory scheme will not be based on a period later than 2000/2001, so providing some level of baseline protection to current Participants.

As the ETS is to be applied to energy users rather than energy producers (a downstream scheme) it will cover both direct and indirect emissions. Targets will be based on CO2 emissions only or, subject to their being verifiable, on all six GHG actually emitted. It is thought that if Participants were able to choose between the GHGs they would "cherry pick" the easiest to reduce, ignoring the others.

Electricity used by an entity will constitute an indirect emission for which conversion factors have been developed to convert the amount of electricity used into CO2 equivalent emissions. Whatever the energy usage by an entity, be it direct, indirect or a mixture of both, reliable and verifiable protocols are needed for monitoring these emissions, so that entities can provide reliable reports on obligated GHG emissions. Protocols for CO2 emissions have now been developed. These will, where practicable, also be used for the CCLAs so as to minimise administrative burdens on Participants. Similar protocols for the other five GHGs are still being developed and are promised for April 2001.

If the ETS is to be credible and deliver the real emissions reductions needed to meet the UK's national emissions reduction targets, robust verification of the emissions data reported by Participants will be essential. The proposed method for achieving this is through external accredited verifiers. There would then be fuller checks carried out periodically. Such fuller checks would presumably be made by the ETA but this is not made clear. This approach largely follows that used to verify the performance of those companies which have joined externally verified environmental management systems such as ISO 14001. Those companies wishing to offer verification services will need to be appropriately certified. Discussions are under way with the United Kingdom Accreditation Service to determine how this will be done.

11) Governance

Initially there is to be no new legislation to set up the ETS; the scheme is to be brought into being using the Government's existing administrative powers. The Participants will each be required to enter into agreements with the Government; these agreements (drafts of which have yet to be circulated) will probably be similar to the CCLAs. Like the CCLAs these ETS agreements will probably not be contractually binding. Draft agreements are currently being prepared by the DETR.

As Government will have the key role in setting up the ETS, it is proposed that initially it will have the key role in administering the ETS. This it is proposing to do through a pseudo Emissions Trading Authority ("ETA") which will, in reality, be simply a function within Central Government, probably based at the DETR or possibly at the DTI. This is largely because there will be no legislation to give the ETA its own existence and powers. The Consultation Paper expressly states that in the longer term the ETA will be established as a statutory independent body. This will almost certainly require primary legislation, so it is unlikely to happen for at least two years or probably longer.

The ETA is likely to have responsibility for:

(a) approval of the monitoring and reporting protocols;
(b) approval of the accreditation process for verifiers;
(c) enforcing the ETS rules;
(d) operating the registry of allowance holdings;
(e) approving emissions reductions projects.

However, some of these functions such as operating the registry may well be contracted out to a private firm. It is also suggested that the ETA will be responsible for enforcing penalties on those in non-compliance. However, apart from advising Government to withhold payment of the incentive or possibly expelling a Participant from the ETS, it is difficult to see what other practical penalties exist for the ETA to enforce. Even if there are other penalties, for example under the criminal law (discussed in Section 12), it is not clear what powers the ETA would have to investigate and enforce these.

12) Penalties

The Consultation Paper makes it very clear that in the early stages of the ETS, there will be no express statutory sanctions for breaches of the rules other than withholding the incentive or expelling a participant. Is this a problem? In some cases it is possible that the cost for a Participant of compliance with its target may easily exceed the value of the incentive. This raises the possibility that there may not, to begin with, be an effective deterrent against non-compliance with the ETS.

It is rather optimistically suggested in the Consultation Paper that reliance could be placed on general criminal law. The example given is that of obtaining property by deception (s.15 Theft Act 1968) presumably the property meant is the incentive payment. Another option may be the offence of evasion of liability by deception. This could occur where a party to a CCLA falsifies emissions data to make it appear that it was in compliance with its target, thus evading the liability to pay the full CCL. Another more realistic offence would be that of the fraud of false accounting. This is very likely to be an applicable offence, as an element of accounting for permits and emissions will need to be introduced. It is also not clear who, in the absence of new legislation would have jurisdiction to investigate and enforce penalties for such offences. Without legislation the ETA may not have the power to do so.

Considering that these offences were not drafted with emissions trading in mind, and bearing in mind the difficulties already experienced in prosecuting complicated financial fraud cases or environmental offences in ordinary courts, the criminal law is unlikely to be an effective enforcement mechanism. It may, however, work for a time as a deterrent so long as it does not actually have to be used in practice. But it will probably work only for clear and deliberate wrong-doing e.g. falsifying emission returns. It will not apply where a company simply fails to meet its target, for example because it fails to invest in the necessary equipment or to purchase sufficient allowances.

The other suggestion made is that the Participants might themselves agree to a self-imposed regime of penalties for breaches of the ETS rules. Such a regime would almost certainly have to rely on some form of contractual arrangement between the Participants. If the ETS agreements with Government are, like the CCLAs, administrative only and so not contractually binding, thus additional binding agreements would be needed between all Participants. The Participants would also need to appoint a body or set up a company to be a party to these agreements and enforce them. Case law suggests, however, that such contractual penalties may not actually be enforced by the Courts and therefore such a scheme will rely very much on the goodwill of the Participants in accepting any penalties imposed. As soon as a party chooses to challenge these contractual penalties, that could jeopardise such an enforcement scheme. Such schemes work in some areas, such as sports. However, if a football club refused to pay a penalty imposed upon it by the FA, it could be expelled and so could in effect be prevented from playing competitive football. The benefits derived from membership are central to a football club's existence, so it is unlikely to risk expulsion. This is unlikely to be the case for an ETS member.

13 Liability

The Government was at one point looking to sidestep the whole issue of penalties and compliance by favouring a "buyer liability" as opposed to a "seller liability" basis for the ETS. A buyer liability approach would mean that the buyer of any allowances took a risk that all or some of those allowances purchased would subsequently be revoked if the entity to whom such allowances had originally been issued failed to comply with its emissions targets. However, sources within Government have indicated that it has now dropped any serious consideration of the buyer liability model in favour of seller liability. Under the seller liability approach, allowances in the ETS will have a guaranteed value once they have been sold.

In the absence of clear statutory penalties for non-compliance, buyer liability may have reduced the risk of failure to comply, but it would probably also have reduced substantially the number of allowances traded, so undermining the whole purpose of the ETS. Complicated contractual provisions would have been needed to protect the buyer, and buyers would presumably have wished to carry out a certain amount of due diligence on the seller's progress towards meeting its targets. Therefore, the transaction costs associated with any buyer liability based trading which actually took place would tend to be relatively high.

14 Will it work?

If one views the ETS as essentially a pilot programme developed jointly by business & Government so that both may "learn by doing" it is then a reasonable assumption that the ETS will work in the short term. Many of its objectives are to learn so making the UK a centre of expertise in this new market. It is not expected that it will be perfect. Many of the companies taking part are likely to be enthusiastic. Therefore they will also probably believe that making early emissions reductions and learning how to trade emissions will give them a commercial advantage over their competitors. On this basis the Scheme will probably work in the short term, but there are two caveats. First, the rules protecting early entrants against being penalised for early emissions reductions need to be set out now, and secondly the legal nature of allowances, including rights of ownership, needs to be specified.

However, the ETS will not be a "pilot scheme" indefinitely: in the medium to longer term it will probably only survive if it is put on a full statutory footing with clear statutory penalties for non-compliance. There are many reasons why such a future statutory scheme could well be a mandatory one.

It will be a difficult decision for those companies that are not already parties to CCLAs or that have emissions outside their CCLA to decide whether or not to bid into the ETS in the early autumn. However, companies should now be weighing up the pros and cons of so doing. If the timetable envisaged is maintained there is in fact very little time to make this decision and prepare a bid for the incentive.

While many of the detailed rules of the proposed ETS have been outlined in the Consultation Paper, many have only been set out in the most rudimentary terms. These include the rules governing baselines for new and late entrants, the legal status of allowances, credits from JI and CDM projects and the precise bidding mechanism. Some issues, such as how the incentive and profits from trading are to be taxed have not even been touched on in the Consultation Paper. If these issues and others cannot be settled before companies must submit their bids for the incentive in the early autumn, companies will find it extremely difficult to make an informed commercial decision over whether they should join the ETS at the start of the scheme or perhaps join as a late entrant. This article should have given those of you who may be party to such decisions a brief overview of the position and an idea of some of the complex issues which you will need to address as part of such a decision.

Any article seeking to provide such an introduction to a topic such as this may raise as many questions as it answers. If you have any further questions on this topic or require clarification on any of the points raised please feel free to e-mail the author at [email protected], who will endeavour to respond to any enquiries which you may have.

The author, Anthony Hobley, is a senior solicitor in the Environment Law Group. He is secretary to the UK Environmental Law Association, Working Group on Climate Change, Chairs the ETG legal liaison sub-group on compliance and governance and has advised both a major trade association and a number of clients in connection with the CCLAs.

For further information, please contact Anthony Hobley at [email protected] or on +44 (0)20 7367 2795.


Footnote 1 Carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulphur hexafluoride.

Footnote 2 Economic incentives for Environmental Protection: Opportunities and Obstacles; Richard Stewar; Environment Law, The Economy & Sustainable Development, Cambridge University Press, 2000.

Footnote 3 www.unfccc.de,http://cop6.unfccc.int

Footnote 4 www.etg.com

Footnote 5 www.detr.gov.uk

Footnote 6 The only way in which an entity which is party to a CCLA could gain entry to the ETS as a voluntary Participant is on the basis of any part of its facility or other facilities not covered by a CCLA, or on the basis of emissions of the other five GHGs.

Footnote 7 Section 30 and Schedules 6 and 7 of Finance Act 2000

Footnote 8 Official Journal of the European Communities (OJ) L257, 10.10.96; This approach is used because it was not possible to develop a workable definition of a heavy energy user. Note the limitations and thresholds in those A1 and A2 process descriptions do not apply for the purpose of eligibility.

Footnote 9 These proposals are outlined in the Consultation Paper, Section 6.