Whether someone trading, broking and advising in relation to carbon credits needs an AFSL requires careful consideration of their activities.
Many companies now trading, broking and advising in relation to carbon credits in Australia are presently unregulated and unlicensed. However, they may soon be regulated and required to hold a financial services licence if they continue carrying on those businesses. Regulations such as those relating to "inside information" on carbon products will be particularly problematic.
The Carbon Credits (Consequential Amendments) Bill, which is currently before Parliament, amends the Corporations Act 2001 (Cth) so as to designate Australian Carbon Credit Units (ACCUs) created under the Carbon Farming Initiative, and eligible international emission units, as "financial products".
The Clean Energy Future Package released on 10 July proposes to also treat carbon permits created under the Carbon Price Mechanism as financial products.
This raises a number of important regulatory implications for persons looking to carry on a business of providing financial services in relation to such credits and permits. Specifically, if a person carries on a business of:
- providing advice;
- making a market;
- operating a registered scheme; or
- providing a custodial or depository service
in relation to the regulated credits and permits, they will need to be covered by an Australian financial services licence (AFSL) issued by the Australian Securities and Investments Commission (ASIC) unless they are able to rely upon an available exemption.
This means that a service provider will need to not only carefully consider whether its activities fall within the above financial services but also whether they will amount to "carrying on a business". This test is informed by both the Corporations Act and the general law.
A service provider can either seek to obtain its own AFSL or otherwise seek to become the representative of the holder of an appropriate AFSL. As might be expected, the obligations of an AFSL holder are significantly more onerous than those imposed on a representative.
What are the obligations of an AFSL holder?
The key obligations imposed on AFSL holders are these:
"Fairly, efficiently and honestly" – A licensee has an overarching obligation to do all things necessary to ensure that the financial services covered by the AFSL are provided efficiently, honestly and fairly.
AFSL Conditions – A licensee must also comply with any conditions on its AFSL imposed by ASIC.
Comply with the financial services laws – A licensee must comply with (and take all reasonable steps to ensure that its representatives comply with) all financial services laws.
Adequate resources – A licensee must have available adequate resources (including financial, technological and human resources) to provide the financial services covered by the AFSL and to carry out supervisory arrangements.
Competence – A licensee must maintain the competence to provide the financial services covered by the AFSL. A licensee must also ensure that its representatives (including its employees and directors) are adequately trained, and are competent, to provide the financial services.
Risk management – A licensee must have adequate risk management systems.
Financial requirements – Broadly, there are certain base level financial requirements that apply to all licensees. The licensee must have:
- risk management systems that address risk to financial resources;
- positive net assets and be solvent;
- sufficient cash resources to cover the next three months' expenses with adequate cover for contingencies; and
- audit compliance with these requirements annually or when ASIC requests.
Other financial requirements may apply depending on the activities authorised by a particular licence. In addition to meeting the above financial requirements, licensees are also required to submit financial statements to ASIC on an annual basis.
Training requirements – Licensees must ensure that their representatives are adequately trained and are competent to provide financial services. "Representatives" of a licensee will include its authorised representatives (ie. those third parties appointed to provide financial services on behalf of the licensee), its employees and directors (including employees and directors of related bodies corporate) and any other person acting on behalf of the licensee.
Managing conflicts – Licensees must have in place adequate arrangements for the management of conflicts of interest that arise in relation to its is financial service activities.
In addition, if the relevant financial services are provided to "retail clients" (as defined in the Corporations Act), the AFSL holder may also be required to provide particular regulated disclosure documents to the client, including a financial services guide, product disclosure statement or statement of advice depending on the activities engaged in by the AFSL holder.
"Making a market" triggers the obligation to get an AFSL
Companies which are liable entities under the carbon price mechanism will probably not need an AFSL to deal in credits or permits to meet their own compliance obligation (because they will be able to rely upon what is typically referred to as the "dealing on own behalf" licensing exemption) provided that they do not otherwise carry on a business of providing financial services in relation to the credits, for example by "making a market" in relation to the credits and permits.
Broadly speaking, a person will be considered to be "making a market" in relation to the regulated credits:
- where the person regularly states the prices at which it proposes to acquire or dispose of the credits on their own behalf;
- in circumstances where other persons have a reasonable expectation that they will be able to regularly effect transactions at the stated prices.
This will be a question of fact which will need to be carefully considered by the liable entity. Regular trading or offering to trade, even through an exchange or licensed broker, can amount to "market-making".
Inside dealing, market manipulation, and the carbon price mechanism
Whether or not a licence is required, once carbon credits are deemed to be "financial products", the market manipulation and inside information regulations of the Corporations Act are also likely to apply.
The inside information provisions can be problematic, particularly when applied to physical trading in commodities such as carbon credits or permits. This is because, unlike the share market, there is no obligation of continuous disclosure in commodities markets, so other participants do not need to disclose their trading or production behaviours.
However, if a party knows or ought to reasonably know that its intended production behaviour is likely to be price-sensitive for carbon products (for instance, information that it is planning to close its large emitting plant), it will not be able to disclose that information to other parties or trade in carbon products until that information is generally known in the market.