Security measures brought in to protect the EU ETS have helped protect the market from abuse, but more improvements are needed to increase confidence amongst participants and investors, and to safeguard billions of euros in trade, EU auditors said.

The European Court of Auditors on Thursday published a report examining the integrity and implementation of the EU ETS, days before the European Commission (EC) is due to release its recommendations on to improve the 10-year old market in a reform process that is expected to take several years.

EU lawmakers brought sweeping changes for the current third trading phase (2013-2020) following multiple incidents of theft, the re-use of retired carbon credits, and VAT fraud which alone cost governments over €5 billion in lost revenues.

Focusing mainly on the ETS’ second phase (2008-2012), the auditors found that while the improvements have bolstered security considerably, regulatory and supervisory risks remain in the world’s largest carbon market, which is viewed as a model for other countries currently designing their own schemes.

The auditors also found that additional improvements could be made, for example to improve the scheme’s MRV system, increase cooperation between the EC and member states, enhance transparency, and ensure a more level playing field for participants.

The Commission accepted most of the reccomendations.

Below are the main findings of the European Court of Auditors’ report:

• Management of the scheme was not adequate during Phase 2 and several weaknesses were identified, including:
  • EU-wide MRV system was not well implemented or harmonised;
  • Competent authorities did not adequately check emissions verifiers, nor were sufficient on-the-spot checks made at installations;
  • Gaps existed in the EC’s guidance and monitoring of member states’ implementation of the ETS;
  • Assessment of countries’ emissions plans – so-called National Allocation Plans (NAPs) – was not sufficiently transparent;
  • Some member states did not submit all of the required reports on the operation of the ETS, and EC did not publish the annual implementation report required under the ETS Directive;
  • Consultation and coordination between EC and governments was limited due to low participation of member states;
  • EC’s role in ensuring harmonisation of key implementation controls has been limited;
  • In addition to the €100/tonne non-compliance fine faced by operators, there is a patchwork of penalties levied by various member states for other infringements, which vary widely and adversely affect the “level playing field” for participants;

• Improvements have been made in Phase 3 (2013-2020) including beefing up security in the Union Registry and regulating the spot market under MiFID by classifying the units as financial instruments.
• However, a number of issues still exist and should be addressed to provide better regulation and supervision, and to increase investor confidence.

• The report directed the following recommendations at the EC:
  • Enhance the regulation and oversight of compliance traders, smaller market participants, and bilateral over-the-counter (OTC) spot transactions, for example by strengthening regulatory cooperation between the EC and member states;
  • Clarify the legal definition of emissions allowances order to support market liquidity;
  • Clarify the legal status of allowances to improve the market’s stability and the confidence of participants. This includes analysing the benefits of treating allowances as property rights and whether they can be used to support so-called security interests, or the legal claim on collateral. If so, a registration mechanism for such activities should be developed;
  • Consider how effective cross-border transaction monitoring in the Union Registry can be developed and coordinated at EU-level to mitigate abuse and fraud;
  • Enhance controls and promote best practices for member states on the opening of registry accounts, and ensure these are implemented across the EU;
  • Consider whether further amendments to the MRV system are needed, and require competent authorities to improve related enforcement practices;
  • Ensure member states keep up-to-date information on the application of all types of ETS-related penalties, and increase their transparency among relevant bodies;

• The report made the following recommendations to member states:
  • Improve cooperation and the exchange of information between authorities, including financial intelligence units, law enforcement and agencies responsible for administering the Union Registry on a national level;
  • Ensure representatives from competent authorities regularly attend meetings and participate in exchange of information, experience and knowledge on EU ETS implementation issues;
  • Implement coherent, effective control frameworks including MRV inspections;
  • Submit to the EC in a timely fashion the annual reports required by the ETS Directive;
  • Regularly publish reports on the implementation and results of the EU ETS to encourage transparency amongst participants;
  • Consistently apply any EU and national ETS-related penalties, and keep up-to-date and accurate information on their application.

• Of the recommendations made to the EC, the bloc’s executive accepted most, adding in the report’s annex that it will:
  • Analyse the benefits of clarifying the legal status of allowances and consider whether and how a mechanism for security interests could be provided;
  • More rigorously monitor member state implementation of the ETS in Phase 3;
  • Examine in detail the information it receives through EU ETS compliance review studies and the annual reports submitted by member states, and take action where appropriate.

The full report can be download here.

By Mike Szabo and Ben Garside – mike@carbon-pulse.com

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