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  • Writer's pictureAlessandro Vitelli

Brussels gets twitchy

I have edited and updated this blog to add some thoughts on Article 29a, and to include some information from Carbon Pulse, who repost these blogs and often improve them.

FURTHER EDIT (1532 GMT): ESMA has said: “We are currently not aware of any initiative by the Commission to impose additional position limits on EUAs,” a spokesperson for ESMA said.

“However, we continue to closely monitor developments in Brussels and will act in accordance with any tasks assigned to ESMA by the co-legislators.”

Carbon endured a boisterous day’s trading on Thursday, first reaching a new record high of €40.12 and then plunging more than 3% in the last 20 minutes of the day after Bloomberg published a story claiming that the European Commission was considering limiting speculative positions in the market.

Friday morning saw the market continue to dive from the opening; prices reached a low of €37.06, for a total fall of 6.6% in 21 minutes of trading.

To be clear, prices have since recovered significantly – perhaps the market has had some time to reflect – and EUAs are at €38.70.

It’s not the first time the Commission or member states have reacted to price volatility in the market, and I’m sure it won’t be the last. But something doesn’t quite add up here.

Firstly, the article suggests the Commission was looking to put a limit on how many EUAs can be held in registry accounts.

Which is fine, in and of itself. But if you’re a speculative investor, the last thing you want is to hold physical EUAs. You want to be nimble, you want to be able to react instantly to developments, and, if you’re a fund using an algorithm, you don’t have time to go through all the security and administration to release some spot EUAs.

I can’t say I know this for a fact, but it seems logical.

So, Bloomberg’s suggestion that the Commission is thinking about setting limits on registry holdings doesn’t affect speculative investors. In fact, it would probably hurt compliance players more, since they are the participants that need to accumulate large holdings of EUAs in the registry.

And not just compliance companies either. What about the banks that serve them? If a bank is running the compliance function for a utility client(s), then that bank will be holding large physical positions in the registry, and any limit would impact the bank’s ability to serve its clients.

(EDIT This from Carbon Pulse's version of the blog): NOTE: In California’s carbon market, restrictions on physical allowance holdings are enforced to prevent price manipulation, with the annual limit for market participants based in part on the annual emissions cap. Emitters receive an exception to their quotas limit based on their unmet CO2 obligations, while speculators do not. However, the restrictions do not include futures or options, meaning participants can accumulate larger positions but then must liquidate them ahead of delivery in order to avoid going over the limit. In Switzerland, which is linked to the EU ETS and where the market’s annual emissions cap is only around 6 Mt, non-compliance entities cannot hold more than 1 Mt of allowances in their registry account.)

So, this leaves us with position limits in financial derivatives. Would the Commission ask ESMA to put additional limits on futures and options positions?

At this point I’m reminded of RWE’s statements back in 2018 that it had hedged itself financially as far out as…2025? 2030? Surely that much financial hedging would represent a far larger futures or options position than any hedge fund has accumulated so far, unless I’ve misunderstood what RWE has done.

Rock, meet hard place.

It seems to me that the Commission’s intention is purely to curb speculation, rather than compliance trading, and so I’d have to assume that whatever restrictions it comes up with would have to be surgically targeted at those participants who are neither compliance buyers, nor the entities that serve them.

That sounds problematic since the law of averages suggests that there will always be an innocent victim.

EDIT: Some people have been asking me about Article 29a of the Emissions Trading Directive, which sets out a trigger mechanism for possible intervention in the market.

It's true that this mechanism is set to trigger a meeting of the regulator to decide whether further action is warranted.

However, the "trigger" is a long, long way from being reached. Poland did argue in late 2018 that the trigger point had been reached when current prices rose by more than 3 times above the average price over the previous two calendar years:

But no meeting was convened at that time, and the chart shows, we are nowhere near the required multiplier today.

On this basis, the EU would need to find an entirely new and different justification for intervening in the market to adjust holding or position limits. Let's see what ESMA has to say.

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