Markets View – December 2023

Welcome to Christmas Markets View! For our final outing of the year, in keeping with the pervading yuletide spirit of nostalgia, we take a look back at some of the key items we covered earlier this year and see how they’ve come along – plus throw in a few other treats along the way.

Rockin' around the EMIR active accounts obligation

In our September issue we mentioned that, as part of its EMIR 3 proposals, the Commission has controversial plans to require FCs & NFC+s who are subject to the clearing obligation to hold active accounts at EU CCPs. September saw several trade associations chime in with a Joint Statement seeking deletion of that requirement. However, the most recent developments have swung the other way: on 05 December the EU Parliament's ECON Committee issued a Report endorsing the proposal, and the very next day the Council also expressed its support in a Press Release (although, when it comes to the detail, that doesn't mean they're singing from the same hymn sheet). For now, we'll have to wait for the EU bodies to mull over the issue in trilogue negotiations, which we expect to start in January.

Walking in a REMIT wonderland

Back in July we flagged that a sneaky change to some reporting rules was bringing certain firms who trade energy derivatives within scope of the EU's Regulation on Wholesale Energy Market Integrity and Transparency (REMIT). We've had a constant stream of queries on this over the autumn, so clearly it's something a lot of firms are still grappling with.

We also mentioned that there's a Commission Proposal in the works seeking to amend REMIT. This is worth taking a deeper look at, as it has come on quite a bit in recent months. The proposal itself contains a whole raft of changes, but here we focus on a few key ones:

• New requirement for third country market participants to 'declare an office' in a Member State (Article 9): this simple phrase had a lot of third country firms concerned that they might have to establish a new EU office and move principal trading operations there. However, there are good tidings: the Parliament and Council announced in a November Press Release that they've fixed on a less burdensome interpretation whereby third country firms will only need to 'designate a representative' in an EU member state.

• New regulations to cover algorithmic trading (Article 5a): there's a whole set of these, including new systems and risk controls, testing, monitoring and continuity arrangements and notification requirements. There are several aspects that are unclear and have had a frosty reception in the industry (voiced by the FIA & ISDA in a Letter in May). However, the proposals look to have the approval of the Parliament and Council, so we do expect them to come in in some form.

• Permanent extension of LNG data reporting: one for the LNG traders, this relates to a reporting requirement that's currently found in an emergency Regulation that followed last year's gas market crisis, but which is set to expire this month. If it's inserted into REMIT, LNG market participants will need to address this additional reporting requirement on a permanent basis (on top of the standard Art 8(1) reports).

• Harmonisation of the rules on penalties: the existing rules are a patchwork implemented at the member state level. (We're aware that firms are especially sensitive to REMIT enforcement issues since a large investment bank recently got fined £5m+ by Ofgem, albeit this was a matter of UK enforcement rules).

EU ETS is coming to town

We previously signposted a raft of changes that are set to upgrade the EU ETS in the coming years. Two of these are now fast approaching.

The first is the extension of EU ETS to cover maritime transport activities from 01 January 2024. This applies to 50% of emissions from large commercial vessels (both cargo and passenger) voyaging to and from an EU port, and 100% of emissions for voyages between EU ports. This is a world-first for an emissions trading system, representing a big change for the shipping industry (globally, given that coverage extends to all ships voyaging to EU ports) and an opportunity for firms who can source EUAs for their shipping industry clients. There are a few headline points to flag:

• Phase in: 2024 is just the start of a phase-in period: shipping companies will only need to surrender allowances for 40% of their verified emissions for 2024. That figure will then leap up to 70% and 100% in the two subsequent years. 30 September 2025 is the deadline for shipping companies to surrender their first EUAs, in respect of their 2024 reported emissions.

• New accounts: every shipping company will be associated with the administering authority of one member state, where they will need to open a 'Maritime Operator Holding Account' and surrender their EUAs. For non-EU companies, there's a formula to work out who the relevant authority is. By 01 February 2024, the Commission is due to publish a list detailing where each company must register.

• Who pays for the EUAs? The shipping company has to surrender them, but that doesn't mean they'll necessarily bear the cost. In practice, what we've seen is that the industry has developed standard language, the broad principle of which is that whoever pays for the fuel pays for the allowances.

The second change is that 2024 will see the first of two one-off reductions in the total number of allowances (the other being in 2026), to align with enhanced emission reduction targets. The overall cap goes down every year anyway, but this change means we'll see a much stronger-than-usual tightening of the ratchet (although confusingly, because maritime is getting added in, the effect won't look so stark on paper).

I'm dreaming of high-integrity voluntary carbon markets

Back in July we talked about the scaling up of the voluntary carbon markets, and the challenges of doing so. Well, those challenges certainly haven't gone away, and we have continued to see news reports about credits not living up to their carbon-cutting claims. However, the story is more complicated than that. Three interesting themes stand out, and point to a lot of work that's going on behind the scenes in these markets:

• Multiple industry reports have indicated that buyers are shifting their purchases towards higher-integrity credits backed up by newer methodologies - notwithstanding the additional expense. This is pushing up average prices, even while trading volumes go down.

• At present, the bulk of credits consist of 'nature-based solutions' (such as planting trees, or stopping them being cut down); now, however, we're seeing a surge of investment in 'technology-based solutions' such as direct air capture (DAC), particularly in the US off the back of the IRA. These projects have the potential to produce more measurable and permanent results, so there's a lot of potential interest once they come to market.  

• In terms of markets themselves, it's non-stop! We commented already on the launch of CIX exchange in Singapore. October saw the Johannesburg Stock Exchange and Xpansiv collaborate to launch a new market in South Africa. The same month, ACX Abu Dhabi went live with the world's first fully regulated carbon credit exchange and clearing house (because the ADGM is the first jurisdiction to regulate carbon credits as financial instruments).

Of course, at this point we have to mention the latest from COP28, where discussion around voluntary carbon markets featured strongly on the Finance and Trade day. For now, what we're seeing is a collective effort to boost the drive to quality mentioned above, with key international players (who signed a joint statement) and standards setters (who've penned a collaboration agreement) getting together to see how they can learn from each other and improve what they do. Notably, IOSCO also announced a new consultation paper, which is packed full of interesting proposals based around a set of "Good Practices" intended to give the VCMs a stronger foundation (open for comments until 03 March 2024). However, we've yet to see significant progress on the big prize - negotiation on Article 6 of the Paris Agreement.

Special mention: the LME Nickel market case

Finally, we have to mention the recent judgment (handed down on 29 November) in favour of the London Metal Exchange, in the case brought against it by Elliott Associates and Jane Street Global Trading for alleged losses resulting from the LME's handling of the nickel crisis in March 2022.

For those seeking a refresher: the basic outline of events was that, following unprecedented price rises after Russia's invasion of Ukraine, the LME decided to suspend Nickel trading on 08 March 2022 through to 15 March 2022, and retrospectively to cancel all trades done on 08 March prior to the suspension, on the basis that the market was 'disorderly'. The market reopened on 16 March but continued to experience disruption before stabilising in late March. Unsurprisingly, this had a huge (and in many some highly detrimental) impact on lots of LME members and their clients. This crisis was the big story of early 2022 in the commodity markets, and many of you will recall we tracked it day-in, day-out.

The key message we take from the case is that, while aspects of trading on exchanges may be highly regulated, ultimately the operator-member/client relationship is a contractual one - and generally the terms are weighted heavily in the operator's favour. In the present case, the LME's rulebook gave it significant powers, including to cancel, vary or correct trades if it considered it appropriate. We have reviewed hundreds of rulebooks and member agreements in compiling and maintaining our Trading Venue Reviewer tool, and we come across these sorts of provisions all of the time - indeed we specifically red-flag unduly burdensome or ambiguous provisions that we think members should be aware of.

Thank you all for reading Markets View this year, we look forward to sharing more updates and insights with you in 2024. And if there's anything we can help you with in the meantime, let us know, let us know, let us know.