From April 2010, the Carbon Reduction Commitment Energy Efficiency Scheme (CRC) - a new mandatory cap and trade scheme for carbon dioxide (CO2) emissions - will come into force in the UK. The new scheme essentially imposes a tax on the CO2 emissions of UK properties in both the commercial and public sectors. It is essential that developers, owners and occupiers of property and lenders taking possession over secured property are aware of whether they will need to participate in the CRC. With poor compliance potentially resulting in increased costs, bad publicity and even criminal prosecution, this imminent legal development should not be ignored.

What is the Carbon Reduction Commitment Energy Efficiency Scheme (CRC)?

The CRC is a mandatory emissions trading scheme for the UK, designed to cut energy use and encourage investment in new technology aimed at reducing CO2 emissions. Emissions falling outside of the CRC include emissions from transport, domestic consumption, consumption outside the UK and activities covered by the EU Emissions Trading Scheme and/or climate change agreements (subject to certain thresholds).

From when will it apply and for how long - phases and compliance years

The CRC is due to commence in April 2010 and will run for set time periods known as “phases”. The first phase (known as the “introductory phase”) will run for three years and subsequent phases will each last for seven years. Each year in a phase (known as a “compliance year”) will run from 1 April to 31 March. (As explained below, financial obligations under the CRC will not commence until the second compliance year (starting in April 2011)).

Who is the CRC Administrator?

The CRC will be administered by the Environment Agency (EA) in England and Wales, the Scottish Environment Protection Agency (SEPA), and the Northern Ireland Environment Agency (NIEA) (collectively referred to in this briefing as the “CRC Administrator”).

Who is required to participate?

Qualification criteria

Public sector organisations will always be required to participate in the CRC (irrespective of whether the qualification criteria (set out below) are met).

Commercial organisations will be required to participate in the CRC where, during the “qualification period” (i.e. the 2008 calendar year for the introductory phase, and the financial year (April-March) prior to the first compliance year for subsequent phases), their UK operations (including all of their UK properties):

(a) consumed at least 6,000 mega-watt hours of electricity (equal to approximately £50,000 of electricity bills / annum); and

(b) had at least one “half hourly electricity meter” (a meter which records total energy consumption every half hour and automatically transfers this information to the energy supplier).

Commercial organisations participating in the CRC may include UK and non-UK incorporated companies, partnerships and other unincorporated associations which operate (and therefore use electricity) in the UK.

Non-qualifying organisations

An organisation which has a half hourly electricity meter but does not meet the electricity consumption threshold set out in the qualification criteria may still need to submit an information disclosure to the CRC Administrator. Information disclosed will include how much electricity the organisation has consumed through all half hourly electricity meters.

Group company participation

For the purposes of qualification, group companies will be treated as a single entity under the CRC and the group’s total UK electricity consumption (over all of its properties) will be aggregated. Groups may disaggregate Significant Group Undertakings (SGUs) (i.e. group members which would be capable of meeting the CRC qualification criteria in their own right) where the remaining group still qualifies for CRC participation. Following disaggregation, the group and the SGU will participate separately in the CRC.

Where a group company, meeting the qualification criteria, has a UK-based parent company, that parent company will, by default, act as the group’s “primary member” (i.e. the organisation held to be responsible for complying with the CRC on the group’s behalf). However, the group may choose to nominate another UK-based group member (such as the highest placed group company in the corporate structure) to act as its primary member. This nomination will be particularly relevant where a group’s parent company is based overseas.

Landlord and tenant participation

In relation to leasehold property, the party having responsibility for the provision of energy consumption to the building (i.e. as counterparty to the electricity bill) will have responsibility for CRC compliance (should the qualification criteria be met).

In practical terms:

  • Where a whole building is fully let to a tenant, the tenant will usually be responsible for purchasing the energy used by the building. Therefore, the tenant (or its parent organisation) will be the CRC participant.
  • In multi-let premises where the landlord has responsibility for the energy used in the whole building, the landlord (or its parent organisation) will be required to participate in the CRC. This applies even if the landlord can claim the costs back from tenants by way of a service charge.
  • In multi-let premises where the landlord pays for the energy used in common parts and individual tenants are responsible for purchasing energy used in their own units, both the landlord and the tenant (or their parent organisations) may be required to participate in the CRC.

Where responsibility for CRC compliance rests with the landlord, the tenant will be legally required to “co-operate” for the purpose of complying with the CRC (e.g. by providing the landlord with data related to its energy supplies). (It should be noted that a property industry working party has consulted on whether a cross-industry consensus can be reached in relation to how CRC complicance costs (and obligations) should be apportioned between landlords and tenants under new leases. The consultation closed in February 2010).

Secured lenders’ participation

A lender which takes possession of property (following a borrower’s loan default) will have responsibility for CRC compliance in relation to the building (should the qualification criteria be met and assuming that the building is not leased or, if it is leased, that the lender in possession is responsible for the energy consumption).

What will CRC participation involve?

Registration: CRC participants will need to register with the CRC Administrator for participation in each phase of the CRC. The registration period runs from April to September during the first compliance year of each phase.

Calculating emissions: The number of allowances to be purchased under the CRC is governed by a calculation of an organisation’s CO2 emissions from its energy use (i.e. consumption of electricity, gas and any other types of fuel such as coal, LPG and diesel) minus exempt emissions (e.g. emissions relating to energy used for transport or onward supply). A CRC participant’s CO2 emissions will determine the number of allowances that it will be required to purchase (and surrender) to comply with the CRC scheme.

Purchasing allowances: For each compliance year, CRC participants will need to purchase sufficient allowances to cover their annual CO2 emissions. One allowance will be the equivalent of 1 tonne of CO2.

There are two markets for purchasing allowances:

  • Primary market - CRC participants will be able to purchase allowances from the CRC Administrator during the first month of each compliance year. During the introductory phase (i.e. the first three compliance years), allowances will be sold for the second and third compliance years at a fixed price of £12/tonne CO2. However, from April 2013, the total pool of allowances will be capped and subject to auction.
  • Secondary market - Following the initial sale of allowances on the primary market, CRC participants may buy and sell allowances on the secondary market.

To protect against the price of allowances becoming too high on the secondary market, the CRC has a built in “safety valve” through which CRC participants can ask the CRC Administrator to issue extra allowances throughout the year. Allowances purchased under the safety valve will be more expensive than £12/tonne CO2 but cheaper than allowances sold on the EU ETS market.

Organisations holding more allowances than they need may bank allowances for future use. The only exception to this is that in the final year of the introductory phase, all remaining allowances will be cancelled.

Emissions management: CRC participants will be encouraged to develop systems to manage their CO2 emissions and to improve their energy efficiency. CRC participants using more energy than they originally predicted will need to purchase additional allowances to fulfil their CRC obligations with obvious cost consequences.

Footprint report: CRC participants will be required to submit a footprint report at the end of the first compliance year of each phase (i.e. one report is submitted per phase). The footprint report will include information on a participant’s energy supplies and sources to be included in the CRC for that phase (minus exempt sources).

Annual report: CRC participants will be required to submit an annual report to the CRC Administrator detailing their emissions in addition to information required to assess each participant’s performance (by comparison to previous compliance years). Annual reports must be submitted by the last working day of July following the relevant compliance year (e.g. July 2011 for the first compliance year of the introductory phase (2010/11)).

Performance Commitment: At the end of each compliance year, CRC participants will be required to surrender allowances corresponding to their total CO2 emissions.

League table: Following annual reporting, the CRC Administrator will publish a league table showing how all participants have performed under the CRC scheme. Participants will be ranked in the league table according to how they have performed against three metrics - (1) early action (i.e. fitting automatic meter-reading equipment and/or meeting Carbon Trust (or equivalent) standards prior to CRC participation; (2) absolute growth of emissions (i.e. percentage change in emissions); and (3) relative growth in emissions (i.e. carbon intensity of any growth or decline in turnover). Whilst the league table will be weighted in favour of the early action metric in the first compliance year of the Introductory Phase (i.e. April 2010-March 2011), early action will not be considered from April 2013 onwards and the league table will be largely calculated with reference the absolute growth in emissions.

Opportunities

Recycled payments: Based on ranking in the league table, revenues received from the sale of allowances will be recycled back to participants. In essence, this means that high performance (and therefore league table position) will be rewarded by bonuses in the form of “recycled payments” (predicted to equate to up to 150 percent of the original outlay for allowances by 2020) in addition to good publicity.

Cost savings: Compliance with the CRC has the potential to make CRC participants more energy efficient which could facilitate cost savings.

Onsite renewables: Whilst electricity from renewable sources consumed onsite by a CRC participant is not deemed to be carbon neutral under the CRC scheme (unless government incentives under the Renewables Obligation and Feed in Tariffs are not claimed), details of a CRC participant’s onsite renewable energy generation will be published alongside (but separate to) the league table resulting in good publicity (but no financial rewards at this stage).

Risks

League table ranking: Participants who fail to perform under the CRC will be “named and shamed” by the publicity of the league table, and will in effect bear extra costs (because they will not benefit from recycled payments).

League table metrics: Participants seeking to expand their UK operations (or number of portfolio properties) may be penalised by the league table ranking system which (following the introductory phase) largely considers a participant’s absolute growth in emissions which would naturally increase with an expansion in business operations/growth.

Cost: The CRC is likely to significantly increase the cost of using energy in the UK as participants will need to purchase allowances in proportion their energy consumption. In addition, participants will be required to meet the administrative costs of scheme participation (e.g. relating to forecasting, monitoring and complying with reporting obligations).

Civil liability: In the event of non-compliance with the requirements of the CRC scheme, the CRC Administrator may impose civil penalties and may publicise the non-compliance. For example, in the event of failure to register under the scheme deadlines or for failure to submit an annual report, a fixed penalty of £5,000 (and daily fines thereafter) may be levied. In the event of failure to carry out the performance commitment, a fine of £40/tonne of CO2 may be levied in respect of each allowance that should have been obtained.

Criminal liability: CRC participants may incur criminal liability where, for example, they have failed to comply with an enforcement notice or attempted to deceive or mislead the CRC Administrator. Criminal penalties can include fines of up to £50,000 (on conviction in the Magistrates’ Court), or an unlimited fine (on conviction in the Crown Court). Group companies participating in the CRC as a single entity will be jointly and severally liable.

Directors’ and officers’ liability: Individual directors and officers may be subject to personal liability where an offence is proved to have been committed with their consent, connivance or neglect. In extreme circumstances, they could be subject to imprisonment for a term not exceeding three months on conviction in the Magistrates’ Court, or for a term not exceeding two years on conviction in the Crown Court.

Issues for landlords and tenants

Recouping costs: If a landlord has responsibility for the CRC in a tenanted building, it will need to consider whether to accept the CRC cost burden in full or to seek a financial contribution from tenants (e.g. as agreed under the lease (specifically or implicitly as part of the service charge), or by raising the rent). A tenant having responsibility for CRC compliance will equally have to consider whether a financial contribution may be made by the landlord (e.g. as agreed under the lease or by paying a reduced rent).

Implementation of energy efficiency measures: Both landlords and tenants participating in the CRC will need to consider whether the lease allows for work to be carried out to implement energy efficiency measures. For example, landlords may require access to the leased premises to carry out works, and tenants may require the right to implement measures affecting the building’s structure and design. In practice, new leases may need to be drafted (and, if possible, existing leases amended) to ensure that energy efficiency improvements can be made.

Receiving a share of the recycled payment: Landlord and tenants which are not required to participate in the CRC, but which assist their counterparty to meet requirements (either financially or otherwise), may seek entitlement to a share of the recycled payment (if received) (e.g. under the lease).

The CRC is organisation- based. The CRC operates on an organisation basis and not building by building, which may create difficulties that need to be addressed. For example, a landlord with responsibility for the CRC may assign its reversion to a new landlord that operates the scheme within its own organisation in a very different way to the outgoing landlord.

Steps to become CRC ready

Potential participants can prepare for the imminent implementation of the CRC by taking the following steps.

  1. Assessing qualification: Obtain information on total electricity consumption for 2008 (the proposed base year) on a building by building basis. (Landlords and tenants will need to decide which party has responsibility for a building’s electricity consumption prior to carrying out this exercise.) Eligible organisations may engage with their energy suppliers with regard to collecting necessary data.
  2. Establish organisational responsibility: Appoint a CRC Co-ordinator (preferably a director or senior manager) to be responsible and accountable for CRC participation and supported (as appropriate) by a team of CRC Officers responsible under the CRC to assist in data collection/purchasing of allowances. Where a CRC participant owns a portfolio of properties, it may be necessary to have a CRC Officer in each building.
  3. Budget for compliance: Assess the likely costs of CRC participation (including administrative costs, the costs of purchasing allowances and legal costs (e.g. for re-drafting leases)) and budget ahead to allow for forward planning. Although the cost of purchasing allowances has the potential to be recycled back at a later date, the time lapse between purchasing allowances and receiving any recycled payment (approximately 6 months) will inevitably affect cash flow.
  4. Data capture and reporting: CRC participants may consider implementing new systems such as automated data collection networks (sub-meters) to make the capture of data more efficient, regular and reliable.
  5. Maintain records: Familiarise the designated CRC team (including the CRC Co-ordinator and CRC Officers) with the record keeping requirements under the CRC and plan for ongoing compliance (e.g. data collection and filing). Training programmes may need to be set up for this purpose.
  6. Plan for energy efficiency: For existing buildings, explore ways and plan to reduce CO2 emissions through, for example, retrofitting buildings with energy saving technologies and providing staff training and incentives to reduce energy use. For new developments, consider energy efficiency requirements at the design stage.
  7. Early action: Consider applying to meet the Carbon Trust (or equivalent) standard before 31 March 2011 in order to benefit from the Early Action metric (the metric which league table ranking will be predominantly based on for the first two CRC compliance years).
  8. Consider CRC compliance in corporate transactions: A CRC participant entering into a transaction such as the sale or purchase of another company (particularly an SGU) should have regard to the potential effect of the transaction on its energy use (and therefore use of allowances). Failure to carry out thorough due diligence may subject the CRC participant to risks such as reputational and financial loss (through poor league table positioning).
  9. Consider CRC compliance in property transactions: CRC participants will need to consider whether they are likely to buy and sell property within a CRC compliance year as this may affect the number of allowances that will need to be purchased. In addition, when conducting due diligence exercises prior to purchasing a property, regard should be given to the property’s CRC credentials (e.g. how energy efficient is it? Or how much money will need to be spent to make it energy efficient?). Failure to consider such issues may lead to additional costs and to a loss of position on the league table.
  10. Legal advice for landlords and tenants: For existing leases, legal advice should be sought in relation to the extent to which the lease wording covers the sharing of CRC costs between landlord and tenant (e.g. under the service charge) and implementing energy efficiency measures (e.g. by allowing access to carry out improvements). To the extent not covered, your legal adviser will be able to discuss various options such as lease variation and/or entering into a new lease. For new leases, legal advice should be sought in relation to CRC cost and benefit sharing under the terms of the new lease.