The CRC Energy Efficiency Scheme Order 2010 enters into force today. The CRC is a mandatory emissions trading scheme that will apply to a wide range of organisations in the public and private sectors, many of whom have had no prior experience of emissions trading.

The main requirement is for businesses to purchase sufficient carbon allowances to cover carbon dioxide emissions resulting from their consumption of electricity, gas and other fuels. A key part of the scheme is the annual publication of a league table highlighting good and bad performance.

The scheme will apply on a group wide basis to most organisations which spend more than around £700,000 per annum on electricity in the UK (consuming more than 6,000 MWh), and includes reporting requirements for any organisation which has at least one half-hourly settled meter.

5,000 organisations including retailers, large offices and banks are expected to be full participants, with an additional 15,000 organisations subject to the reporting requirements.

Organisations that are required to participate in the scheme must complete registration for the first phase by 30 September 2010 or, if they wish to disaggregate Significant Group Undertakings (SGUs) from the wider organisation, by 30 June 2010.

The Environment Agency has already warned that registrations will need to be submitted in advance of these deadlines because the checking and approval of registrations will take "some weeks". This leaves little time for organisations to finalise their preparations for registration, particularly if they wish to disaggregate SGUs, something which many large groups and private equity funds should consider.

This e-bulletin considers the main changes to the CRC Energy Efficiency Scheme (the new official name of the CRC) and main policy decisions taken by Government since the publication of our e-bulletin on the draft Order.

No allowances required during first compliance year

It was originally proposed that a 'double' sale of CRC allowances by Government would be held in April 2011 for participants to purchase allowances to cover their emissions during the first compliance year (April 2010-March 2011) and second compliance year (April 2011-March 2012).

The first compliance year will now be a reporting-only year with no requirement to purchase and surrender allowances. The first sale in April 2011 will be for allowances to cover emissions during the second compliance year only. This change was made following concerns over the potential cash flow implications of a double sale and to help participants adjust to the monitoring and reporting obligations of the CRC before having to purchase and surrender allowances.

Organisations – "parent undertakings" and "subsidiary undertakings"

The CRC Order draws on the definitions of "subsidiary undertaking" and "parent undertaking" in the Companies Act 2006 to define a participating organisation.

An undertaking includes unincorporated associations such as partnerships. Businesses will need to examine the holding and control of voting rights, rights to exercise a dominant influence, rights to appoint directors, and whether undertakings are managed on a unified basis. Regard will therefore need to be had to arrangements under relevant shareholder/joint venture/partnership agreements and constitutional documents.

A previous Herbert Smith e-bulletin discussed the difficult application of these definitions to private equity and other fund structures. By confirming its approach, Government has rejected calls from the private equity sector that UK GAAP or another accounting standard be used to define a CRC organisation. However, the burden on private equity and other funds may be eased to some extent by the ability to disaggregate SGUs (see below).

Disaggregation

An SGU (formerly referred to as a 'principal subsidiary') is a subsidiary undertaking that together with its own subsidiaries would qualify for participation in the CRC in its own right because it meets the 6,000 MWh of electricity consumed per annum qualification threshold.

Organisations will be allowed to disaggregate SGUs from the wider organisation during the registration process for each phase of the CRC provided that the remaining parts of the organisation do not then fall below the qualification threshold. In order to disaggregate for the first phase of the scheme, the wider organisation registration must be submitted and approved by 30 June 2010. The registrations for the disaggregated SGUs must then be submitted and accepted by 30 September 2010.

A disaggregated SGU will be a separate participant and will not be jointly and severally liable with the remaining organisation for compliance. It will be responsible for surrendering allowances and be identified in terms of performance in its own right, thereby providing the ability to ringfence certain better or worse performers in the group if so desired. The ability to, and merits of, disaggregation will need to be carefully considered.

Responsibility for energy supply

It was originally proposed that responsibility for energy consumption would rest with the counterparty to the relevant energy supply contract. This has been replaced with a new but similar rule by which an organisation will be responsible under the CRC for a supply of energy if:

  1. it is a party to the supply agreement,
  2. the energy is supplied pursuant to the agreement,
  3. in the case of electricity and gas, the energy is measured and charged for by reference to a meter, and
  4. the organisation consumes the energy for its own use.

The purpose of the new rule is to prevent those that contract for energy on behalf of the consumer from bearing responsibility under the CRC. However, the new rule expressly prevents a landlord from relying on 4. to disclaim responsibility for any energy supplied to it but which is consumed by its tenant.

Landlord and tenant

The treatment of landlords and tenants has remained largely unchanged despite industry concerns. Where the tenant is responsible for its energy supply, the tenant organisation will be responsible for those emissions covered by CRC. However, where a landlord is responsible for the supply according to the new supply principles above, the landlord organisation will be responsible for associated emissions even though the energy is primarily consumed by the tenant.

To encourage tenants to work with landlords, Government has included a provision in the final legislation to require tenants to provide assistance to landlords in relation to CRC compliance. Whether landlords will seek to pass compliance costs on to tenants remains to be seen. The wording of existing leases may not permit cost pass through, so this may only be an option for new leases. Certainly this will require detailed consideration and we are advising several major property holding clients on how to devise and implement their CRC strategy.

Overseas entities

The CRC operates on a group wide basis and so the UK electricity consumption of all subsidiaries of an overseas parent must be aggregated to determine if the group is caught. The highest overseas parent company will then need to nominate a group member with a UK presence to act as the primary participant for the group.

Other changes

Renewable Energy

Despite strong campaigning, the overall approach to reporting and accounting for renewable electricity in the CRC remains unchanged. There is no credit for receiving a supply under a 'green' tariff, nor for on-site renewable generation (unless Renewables Obligation Certificate (ROCs) or feed-in tariffs (FIT) are not claimed). However, in order to give some recognition to renewable energy, DECC has announced that it will publish data concerning onsite renewable energy generation by CRC participants alongside the league tables.

Transport

There have been some important revisions to the exemption from the CRC for energy used for transport. The exemption will now cover energy used to power a licensed road vehicle, a vessel, an aircraft, or a train and related network services (as defined by the Railways Act 1993). The exemption will cover not only energy used for propulsion but also energy used for other purposes (such as heating and lighting). Organisations will not be required to include any transport electricity within their total electricity consumption when determining whether they meet the 6,000 MWh qualification threshold.

Early action

The early action metric, which will apply during the introductory phase of the CRC (April 2010 to March 2013), gives recognition in the form of enhanced CRC league table performance to those organisations that take voluntary action to monitor emissions with a view to reduction.

Automatic metering and accreditation to the Carbon Trust Standard will remain the qualifying measures under this metric. However, accreditation under schemes that are alternative but equivalent to the Carbon Trust Standard will now also qualify. There are strict criteria which have been listed in the consultation response as to what will be regarded as equivalent to the Carbon Trust Standard.

The early action metric, in terms of calculating overall CRC league table performance, will be given an increased level of weighting during the second compliance year to give credit to organisations taking qualifying early action measures. The new early action weighting will be 100% in the first compliance year, 40% in the second and 20% in the third.

Franchises

As originally proposed, franchisors will be responsible for the energy supplies of their franchisees. However, some changes to the definition of a franchise have been made which restrict the application of this principle to more limited circumstances. For the franchise provisions to apply:

  • an agreement must be in place between two organisations for the sale or distribution of goods, or the provision of services;
  • the franchisee carries out business using the name provided by the franchisor;
  • the premises where the franchisee operates are used exclusively for the franchisor’s business; and
  • the presentation of the premises which customers can access must have an internal or external appearance agreed by the franchisor similar to other premises operating the franchise business.

There will be a new obligation on the franchisee to provide its franchisor with reasonable assistance to comply with the CRC.

Action required

Organisations that need to participate in the CRC should already have been contacted by the Environment Agency. There is still concern however that some entities remain unaware of the requirements of the CRC. Companies will need to ensure that appropriate steps are being taken at a group level:

  • any organisation with at least one half hourly settlement meter will need to provide electricity consumption information;
  • an organisation using over 6,000 MWh of electricity in the UK in 2008 (taken across the entire group, including on-supplies to any tenants and electricity used by franchisees), is likely to be required to register as a participant, and (from April 2011) purchase allowances;
  • registration is open from 1 April 2010 to 30 September 2010; this is a multi-stage process which must be completed in full by the closing date and which will take several weeks; the registering entity will need to have all required information from across the group;
  • prompt action is required for parent companies wishing to disaggregate. This has an earlier cut off date of 30 June 2010 to allow sufficient time for the disaggregated entity to submit its own registration application;
  • in addition to information on electricity meters and consumption during 2008, organisations will need to know which group entities were responsible for the consumption, whether they are eligible for any exemptions (such as where a Climate Change Agreement applies to emissions) and to nominate a senior officer who is able to act on behalf of the entire group for CRC compliance purposes; and
  • an evidence pack must be maintained for compliance purposes; 20% of participants are expected to be audited on an ongoing basis and money laundering checks will take place as part of the registration process.

In addition to greater focus on energy management and investment in energy efficiency, preparation for the CRC is already leading to detailed consideration by landlords of the arrangements in place with their tenants as regards energy supplies and cost pass through arrangements, the potential for asset divestment where the ownership of energy intensive assets is not essential for business operations, and the restructuring of investment portfolios to optimise performance under the league tables and reduce compliance costs.

Organisations that have energy management and efficiency schemes in place will still need to consider the wider corporate governance issues that arise from the “whole organisation” approach required for the CRC – the sharing of information, costs, repayments and liability under the scheme will need to be addressed for group companies, and also for their tenants and franchisees. This raises particular issues for groups with overseas parents, and will also become one of the necessary due diligence issues for future M&A activity involving UK subsidiaries.