Response to Cluster Group A Recommendations

1. All emitters with a point of obligation under the ETS should be required to provide to the market compliance (demand and supply positions) information on a quarterly basis.

Officials believe that providing information on a quarterly basis may not have a significant impact as prices will be set internationally and New Zealand will be a price taker.

At a practical level, it would be difficult to apply meaningfully to all sectors, especially forestry, and would impose additional compliance costs on participants.

2. Audited information need only be released on an annual basis.

The current model proposed in the Bill is one of self-assessment in a similar manner to GST and income tax provisions where the onus is on the individual to provide accurate information.  There is currently no general requirement for emissions return information to be audited prior to submission. Once this information is received by the regulator, there will be some level of general verification based on risk factors, but this will not constitute an audit.

However, the Bill permits regulations being made requiring a participant to have a verifier "verify" their data and/or their return prior to submission.  Similarly, after the emissions return information is received, the Chief Executive may elect to conduct an investigation to check the information. This would not be more frequent than annually.

3. Each entity can meet any government annual reporting compliance requirements off audited or non-audited information, thus ensuring that each entity can tie their carbon audit into their annual financial audit process.

(a) There is no requirement in the Bill for emissions returns to be based on audited information.  However, entitlements and liabilities for NZUs included in participants’ balance sheets would be subject to their own external audit where required.  This will add a level of confidence about the completeness and accuracy of information provided.

(b) If different emissions return cycles were allowed based on organisations balance dates, it would be extremely difficult to get a view of the emissions for a common period. Given that Kyoto reporting requirements follow an annual reporting cycle, having New Zealand participants’ emissions being reported on a differing cycle could present NZU and Kyoto reporting challenges.   However, the Registry system is being designed to accommodate differing annual emissions returns cycles should this be a requirement in future.

4. All entities should be required to release their information to government and the broader market via an accredited information provider that can ensure that such information is available globally on a real-time basis. This is important to reduce search costs for global players (i.e., they have it delivered to them, rather than having to search a specific New Zealand database or access it by request).

Officials assume this recommendation refers to compliance information provided to government (noting there is no requirement for third party audit).  The Emissions Unit Register will only record the number of emissions units transferred, not the unit price.

The Bill already provides for significant information to be accessible and searchable under sections 18, 26, 27, 28 and 79.  These sections provide, amongst other things, for total (aggregated) information to be available about the total quantities of units held at the beginning of a calendar year, total units issued, total units transferred to other registries, and total units cancelled, surrendered, and converted, etc during the year.  They also provide for the publishing in relation to each activity of the total number of participants, total number and type of activities, number and type of units surrendered, total NZUs transferred for removal activities, allocated free of charge and sold by public tender.

Any trading provider or platform would have easy access to this information.

However, at a practical compliance level, compliance information received and disseminated to the market (including government) via approved information providers would be analogous to Inland Revenue receiving information on corporate taxpayers’ obligations via quarterly release of financial results to an entity such as the stock exchange or an information service.  This compliance information is required for meeting statutory obligations which generally generate a liability for the entity and it would not be appropriate for that information to be provided to government through public channels.

1. The legislation should require that all trades in NZUs by (or on behalf of) entities with an NZETS compliance obligation, or by financial intermediaries regulated in New Zealand, be reported to an accredited market information provider.
2. The specific information reported should comprise the volume traded and the price per unit traded. This information should not be bundled (e.g., if an entity trades 20 tonnes at $20 per tonne, and 10 tonnes at $18 per tonne, each of those trades should be reported separately, as to bundle them would not allow a true market supply and demand curve to be constructed, or to track price movements (e.g., 30 tonnes at $19.30 is a very different information set).
3. This post-trade information should be required to be reported immediately to the information provider.
4. To ensure the authenticity of price and volume information released to the market, accredited information providers should receive, but not release, information as to the identity of the entities transacting.
5. The requirements to become an accredited market information provider should be managed in regulation not legislation.

It is important for the market to have reliable, timely information available to it regarding price and volumes of trades by participants.  However, officials question whether the reporting of all trades would improve liquidity when additional liquidity is provided through international transactions.  The design of the NZ ETS deliberately enables international trade because of the low volumes and liquidity risks within such a small market.  As such, New Zealand will be a price taker and market participants will have access to international price and volume information.

Trading intermediaries could voluntarily provide information to the market about the aggregated volumes and prices of trades they have facilitated.

There are some markets overseas that have such reporting requirements e.g. the Corporate and Municipal bond market in the US is required to report transaction information to Financial Industry Regulatory Authority (formerly known as NASD (National Association of Security Dealers)) within 15 minutes of a trade.

Careful consideration would need to be given to:

• the type of entity that could be an accredited information provider to avoid potential conflicts of interest arising from any other commercial activities an information provider may be involved in, particularly given the commercial sensitivity of the information they would be collecting;
• the need for additional regulation and monitoring of the information provider(s);
• additional compliance and cost burden on Participants;
• a de minimis threshold where transactions under this threshold were not required to be reported, thereby reducing compliance costs for smaller Participants, particularly the potentially large number of smaller forestry players who are Participants in the NZ ETS; and
• concerns by potential NZ ETS Participants that requirements for disclosure of transaction and account holder information within the register are already too broad.

Given these considerations, officials would like to better understand the mechanics, including compliance measures, of how post trade information would be provided and whether this would allow private individuals to undertake direct bilateral agreements or require all trades to be transacted through a trading platform.

Officals are also concerned that, if such a requirement was introduced, it could have broader implications for other financial markets and, in light of this, would need to be considered in the context of broader financial markets, rather than just emissions trading.   As such, this would need wider work which is outside the scope of the Bill.

1. The regulatory approach for anyone who wants to trade on licensed markets (as opposed to OTC), or participate directly in any part of the market infrastructure (e.g., exchange platforms, clearing houses, registry), should be based on the European “passport” model.  Under this approach, if a participant is approved in their home market to undertake certain activities, they should be allowed to undertake identical activities in New Zealand on the basis of being supervised by their home regulator – thus eliminating any duplicative compliance requirements.
2. The New Zealand Government should actively encourage participation in the New Zealand market by seeking mutual recognition for this market and its infrastructure overseas.

Currently, for an overseas entity to have an account in the New Zealand Emissions Unit Register, they must be registered with the Companies Office as an Overseas Company.

The European Passport model currently works across the EC because there is:

• No trading of EUA’s outside of the EC
• Other legislation covering issues such as anti money laundering and combating terrorist financing.

This will not be the case for New Zealand, but consideration is currently being given to allowing Australian companies’ direct access as there is already joint Companies Office filing between New Zealand and Australia.  The Bill does not preclude bilateral agreements with other countries to enable direct access in the future, which would be facilitated through an amendment to the Unit Register Regulations.

Officials would like to better understand further options for models where overseas entities are able to participate in organised exchanges as licensed brokers, etc, with the proviso that this potentially has far broader implications than just emissions trading exchanges and therefore would need to be considered in this broader context.  As such, this would need wider work which is outside the scope of the Bill.

The development of a futures market is important, and regulation should support the development of a futures market in NZUs in New Zealand.

Further work is being undertaken by the Ministry of Economic Development and provisions have been included in the draft Emissions Units Settlement Systems and Futures Bill released for consultation on 11 February 2008.

1. An electronic interface from the New Zealand Government Registry should be provided to other systems, such as those operated by participants, banks, exchanges, clearing houses, depositories and other financial institutions, using the international standard messaging protocol (the SWIFT standard 15022) and/or Web services (such as that used to communicate with ITL).

Discussions with TZ1 in the last two months indicate a solution which effectively allows them to offer DvP⁴ without an elaborate interface with the register.

However, we are exploring further the possibility of allowing a business-to-business (B2B) type interface which will allow bulk transactions to be transacted with the Registry by a party.  

Given the low volume of units expected to be in the market on 1 July, this functionality will not be available from this date, but will more likely be available in early 2009.

2. Internal registry functionality that supports DvP should be provided. As mentioned above, DvP is now a standard in the settlement of other financial and commodity products and will become a standard in the compliance market (a proxy for DvP has been developed in the European ETS). DvP can be offered for both transactions that take place on an exchange or that take place OTC.

Officials are currently investigating what is provided in European registries.

A cost/benefit analysis will need to be considered for each option.

3. The New Zealand Government enables offshore entities to establish accounts in the New Zealand Kyoto Registry with a view to enabling primary CER issuance into the New Zealand register and therefore the New Zealand and broader Asian market.

See comments on account opening by overseas organisations above.

The Ministry for the Environment are currently working on procedures for issuing Letters of Approval. These are expected to be completed in the second quarter of 2008.

1. The Government should enter standard lending arrangements for certain quantities of its Kyoto bank. The Government should work with the private sector to ensure the right institutions are made aware of this facility. The Crown should also outsource the management of the actual lending arrangements. Due to tax reform undertaken last year, such lending will not be a taxable event for the entity that manages such lending on the Crown's behalf.
2. The Government should assess developing framework which would seed carbon funds, thus increasing both float of NZUs in the market and their turnover. This should be a short-term priority.
3. If the Government deems liquidity provision in the public interest and it believes it is best placed to source Kyoto credits, if it acts in the market, it should do so as a normal market participant, through normal channels. This will have a second order effect of facilitating the development of effective intermediaries.
4. The Government should not run an auction process.

In response, officials note that there are a range of factors to be considered in determining how best to ensure liquidity.  These include the strength and size of international markets, the development of national allocation plans, the timing of allocation of free units, availability of units locally and internationally, transaction costs and an analysis of the costs and benefits of introducing options.

Officials’ advice to date has been that improved liquidity will be best provided through access to international markets and therefore establishing lending agreements or seeding carbon funds would be unnecessary.  However, the initiatives identified by the Working Group can be considered later should additional liquidity measures be required.

The Bill provides for the government to purchase and sell into the market if this is required.

The Bill enables a tender process (clause 43, section 75).  The tender process would be used progressively as free allocation was phased out, and could be used to facilitate domestic liquidity.

The Government should not implement any price controls.

Officials’ advice has been that the Government should not implement any price controls and none are provided in the Bill as introduced.

1. NZETS units must be able to be banked through the 2012 transition period.
2. As the impact of any price volatility in 2012 is most likely to be hardest felt by Agriculture, work should be done on ensuring all proper risk management avenues are explored as an important priority.

The Bill places no restrictions on the banking (carry-over) of NZUs across commitment periods.   Section 16 of the Climate Change Response Act addresses the carry-over of Kyoto units across commitment periods; the Bill clarifies that this section applies to “certain Kyoto units”.

The agriculture sector is planned to enter the NZ ETS in 2013.  By this time, there will be active trading activity for other sector participants in meeting their obligations and an assessment of the extent of price volatility and risks can be made closer to this time as part of the review process.

1. Tax treatment of carbon credits, whether NZUs or other credits held on balance sheet, should be treated in an identical manner to the tax requirements for securities such as shares.
2. NZUs and any other carbon units should be subject to GST at the rate of zero percent.

The tax proposals on which the Working Group has commented were set out in an Inland Revenue officials' paper which was issued in September 2007.  Inland Revenue invited submissions on that paper, and submissions were received from various businesses and business groups, advisers, and their representative bodies.

A number of those submissions made the same points as have been made by the Working Group.  These submissions have been considered carefully, and officials have reported on them to government.  Legislation addressing these matters will appear in a tax bill which is intended to be introduced in June 2008.