In addition to coming to grips with Australia’s proposed carbon price mechanism, a number of compensation packages, new carbon regulators and an independent advisory body, carbon traders (and others) will need to comply with Australia’s financial services regulations.

Traders already in the financial services industry are currently subject to Australia’s complex financial services regulations and should be well placed to comply with the proposed changes to those regulations.  Traders that are not subject to the financial services regulations will need to make significant investments to  comply with the financial services regime.  The proposed start dates will be a challenge for traders and other participants as well as regulators.

Not 1, not 2 but 3 new financial products

The Carbon Farming Initiative and the Clean Energy legislative packages were introduced by the Federal Government in 2011.  “Australian carbon credit units” (ACCUs), “eligible international emissions units” and “carbon units” will each become a financial product for the purposes of the Corporations Act and the Australian Securities and Investments Commission (ASIC) Act.  This will result in  activities relating to those units becoming subject to Australia’s complex financial services regulations including market misconduct or other conduct rules, potential licensing, disclosure rules as well as regulation by ASIC and the Australian Transaction Reports and Analysis Centre (AUSTRAC).

A short selling ban will stymie a forwards market

A controversial feature of the Government’s 2009 scheme  (the Carbon Pollution Reduction Scheme) was to subject the 2009 scheme’s eligible emissions units to the short selling prohibition of the Corporations Act.  Only a few types of financial products are subject to the prohibition (i.e. shares, interests in managed investment schemes, governments bonds and derivatives ).  Generally the prohibition prevents a person from offering to sell (or purporting to sell) an affected financial product if the person does not have a presently exercisable and unconditional right to vest the product in the buyer. 

It is not clear whether the Government proposes to do the same again.  It is possible that it will do so by regulations as with the 2009 scheme. 

For share and bonds, the short selling prohibition doesn’t inhibit forward contract trading because the seller can own or borrow the products at the time of entering into the forward contract.  A key difference is that at least before the commencement of the first phase of the scheme and the issue of the first carbon units or ACCUs, there will be no carbon units issued nor ACCUs issued and so it will not be possible for any person to have presently exercisable and unconditional right to vest the units in the buyer. 

If the regulations cover units, they would effectively prevent operators of emissions-intensive trade exposed (EITE) facilities offering to sell forward ACCUs (or eligible international emissions units such as Certified Emissions Reductions under the Kyoto Protocol) based upon their free emission allocations until those allocations were actually issued by the Regulator (because their allocation from year to year is conditional on their production from year to year).  For similar reasons, the regulations would also prevent EITEs promising to deliver those free emission allocations in consideration of other services (eg in return for the provision of electric power at a carbon-exclusive price). Regulations might prevent forestry operators and land owners (under the Carbon Farming Initiative) from pre-selling credits based upon their expectation of earning CFI credits from eligible activities under the CFI. Forestry operators might have expected to raise the funds required for planting forests by pre-selling their anticipated sequestration benefits, but these pre-sales would be prohibited by the restriction (because the entitlement to the CFI credits would be conditional on achieving the required sequestration).

The Government has recognised the desirability of developing forward price signals to help promote certainty about future carbon prices. However, if the units are subject to the prohibition, a physically settled forward market will not be able to commence in the relevant units until the units are first issued (eg by public auction or otherwise).   Further, because the units will be issued in vintages, subjecting those units to the short selling prohibition would prevent physically settled forwards that are vintage specific being entered until the first auction of the relevant vintage.

Other market misconduct rules will apply even to non-licensees

ACCUs, eligible international emissions units and carbon units will be subject to a number of other rules including:

  • insider trading prohibitions and so traders will need to consider putting in place information barriers;
  • unsolicited offering prohibitions; and
  • rules relating to dishonest, misleading and deceptive conduct.

Will you need an Australian financial services licence?

A person who carries on a business of providing financial services in relation to ACCUs, eligible international emissions units or carbon units in Australia will need to hold an Australian financial services (AFS) licence covering the provision of the financial services or satisfy a licensing exemption.   Financial services include dealing in financial products, providing financial product advice, making a market in financial products and providing custodial or depository services in relation to financial products.

Entities liable to surrender units are likely to deal in (e.g. buy or sell) units and possibly derivatives over units and also make a market in units or derivatives.  Hopefully as with the 2009 scheme, Corporation Regulations will be made to modify the self dealing and hedging licensing exemptions appropriately.  Also hopefully other the exemptions that were proposed for providing financial services in respect of eligible emissions units contained in the draft regulations for 2009 scheme will apply.  That is, the exemptions from needing an AFS licence for:

  • making a market where a person sells a free unit that has been issued to them by a regulator;
  • dealing, providing advice or making a market in derivatives, foreign exchange contracts or units so long as the financial services provider is not in Australia and the services are provided to a professional investor; and
  • participating in an auction of units.

Existing licensees who will provide financial services in relation to units will need vary their licences.  Applicants will need to convince ASIC to vary their AFS licences to cover their activities in relation to units and to put in place compliance measures in relation to those activities. 

Traders and others who do not currently have an AFS licence and require one, will need to apply for one.  This will require the investment of considerable time in preparing a comprehensive licence application and also ongoing financial, compliance and other resources.  This is a well worn path for financial services organisations but might be novel and challenging for other organisations.   Mallesons has a wealth of experience in assisting with AFS licence applications.

Disclosure rules

Being financial products, retail disclosure requirements could apply to ACCUs, eligible international emissions units and carbon units.  Potentially this could mean that an issuer of those units would need to prepare a product disclosure statement.  However the 2009 scheme Corporation Regulations proposed that instead of a PDS, an “emissions unit statement” be given in place of a PDS.  However there were no changes proposed in relation to financial services guides and statements of advice.

If units are limited to the wholesale market, it will not be necessary to prepare the retail disclosure documents.  We expect those dealing in the units will seek contractual comfort from counterparties that the units will not be on sold to retail investors.

Anti-money laundering programmes and compliance also apply to non-licensees

Acquiring or disposing of carbon units, ACCUs or eligible international emissions units as agent for a person will be a “designated service” for the purposes of the Anti-Money Laundering and Counter-Terrorism Financing Act (AML/CTF Act).  If you hold an AFSL, arranging for a person to receive this service will also be a designated service.

Persons engaging in activities in connection with carbon units, ACCUs or eligible international emissions units should be mindful of the extended jurisdictional reach of the AML/CTF Act.  For example, a company that, on behalf of another person, acquires international emissions units in a foreign country will provide a regulated designated service even if the only connection with Australia is that the company is incorporated in Australia or is a subsidiary of a company incorporated in Australia.

Providers of designated services have a range of obligations under the AML/CTF Act including reporting obligations to AUSTRAC and a requirement to have an AML/CTF Program.  In relation to the AML/CTF Program it is important to note that an international or global program may not meet the Australian requirements and should be tailored to specifically address the requirements of the AML/CTF Act.

New Australian Securities and Investments Commission policies

ASIC will need to develop new policies.  For example ASIC will need to:

  • Determine its competence, experience and qualification requirements for services provided in relation to units and also registered managed schemes that invest in units.  It will be interesting to what ASIC requires given it is not possible to have experience in new units that are yet to be created!
  • Consider extending the passporting relief to cover ACCUs, eligible international emissions units and carbon units.  The passporting relief provides foreign financial service providers relief from AFS licensing requirements if they are regulated by one of the UK Financial Services Authority, US Securities and Exchange Commission, US Federal Reserve and Office of the Comptroller of the Currency, the Monetary Authority of Singapore, the Hong Kong Securities and Futures Commission, US Commodity Futures Trading Commission and the German BaFiN.

A lot to do before the start dates

Traders will be subject to Australia’s financial services regulations.  As will a number of other participants including entities liable to surrender units, custodians and others who provide transitional services in relation to units.  Even if an entity does not require an AFS licence, it must comply with other financial services regulations including the AML/CTF Act.  If an entity needs an AFC licence or to vary an existing licence, it might take between 3 to 6 months to obtain the licence or variation.  Entities that will be subject to the AML/CTF Act should also take steps now to either create and implement an AML/CTF Program or amend existing programs.

Legislation to subject ACCUs and eligible international emissions units to financial services regulation as discussed in this article was passed on 23 August 2011 and will commence on a date to be proclaimed (but no later than February 2012). The Government proposes that the Clean Energy legislation (establishing the carbon pricing mechanism) that will subject government-auctioned carbon units to financial services regulation will take effect on 1 July 2012. It is critical that the Corporations Regulations are made at the same time and that ASIC releases the necessary policies soon after. Otherwise potential industry participants will run out of time to comply with the financial services regulation (as well as all the other regulations).