Improving market governance of the New Zealand Emissions Trading Scheme

9 Dec 22

The Government has recently released a public discussion document relating to the governance framework of the Emission Trading Scheme.

The Government has identified that the New Zealand Emissions Trading Scheme (NZ ETS) lacks a market governance framework that efficiently deals with several risks within the New Zealand Unit (NZU) market. It is believed that if these risks are left unaddressed, they could impact the ability to reach domestic emissions budgets and undermine the robustness of the NZ ETS internationally.

Based on previous consultations, the Government has now released the “Market Governance of the New Zealand Emissions Trading Scheme” discussion document. It outlines and seeks feedback on the final elements of the proposal to improve governance of the NZU market.

The Government previously identified seven market risks that fall within three overarching themes:

Theme A: Governance of advice

  • Risk 1: Inadequate, false or misleading advice being provided relating to NZUs.
  • Risk 2: Conflicts of interest involving the New Zealand Emissions Trading Register (NZETR).

Theme B: Governance of trading

  • Risk 3: Potential lack of transparency, oversight and monitoring of trades in the secondary NZU market.
  • Risk 4: Credit and counterparty risks.

Theme C: Governance of market conduct

  • Risk 5: Insider trading and information asymmetry.
  • Risk 6: Manipulation of NZU prices.
  • Risk 7: Money laundering and financing of terrorism in the NZU market.

The consultation suggests four topics that work together to address the above risks and achieve the following overall policy objectives:

  • Increase integrity and efficiency of the NZU market.
  • Promote confidence in NZU market trading.
  • Reduce the risk of misconduct.

Under each topic, the Government has provided several options for consideration and feedback.

Topic 1: Regulating the market based on financial legislation

This topic aims to ensure that the NZU market trades with integrity, functions efficiently, promotes confidence and addresses the risks of misconduct.

Summary of options:

  • Status quo: Crimes Act 1961 (CA).

Currently, there are key protections under the CA with penalties applying for crimes. However, the CA insider trading provisions are limited and there would be no prohibition on market manipulation in the NZU market.

  • Financial Markets Conduct Act 2013 (FMC Act) with suitable modifications.

This would involve applying market manipulation prohibitions and offences like those in the FMC Act to the NZU market. Additionally, in principle, an optional centralized exchange has been agreed to. Finally, market operators would be required to hold a license and comply with obligations.

  • CA and market manipulation prohibitions.

This would use key protections in the CA while prohibiting market manipulation with similar FMC Act provisions. This option would not require a market operator to monitor for insider trading or market manipulation.

Government preference: Option 2

What this proposal would mean in practice:

  • A person cannot trade NZUs if they have material non-public information about government policy. Market manipulation would also be prohibited.
  • Monitoring and surveillance would be conducted by a frontline monitor who gathers information from over-the-counter trades and trades that occur on the proposed centralized exchange. If misconduct is detected, it will be forwarded to the Financial Market Authority (FMA) as the potential regulator for investigation and enforcement.
  • Facilities for trading NZUs would require licensing if they meet the definition of a financial product market. This may affect existing facilities that allow or facilitate NZUs to be bought or sold.
  • It may have flow-on costs for users trading on those facilities, in the form of fees to use the market along with the burden of complying with market rules.

Topic 2: Regulating NZU financial advice, transactional and/or custodial services

The Government’s objective under this topic is to ensure all persons who engage with the NZU market have access to quality advice about trading NZUs. They also want to ensure that services relating to NZUs are provided with appropriate care, diligence and skill.

Summary of options:

  • Status quo: Existing legislation.

Currently the NZU market is partially covered by four Acts, including the Fair Trading Act 1986, Forests Act 1949, FMC Act and Financial Service Providers Act 2008, which together create a complex framework for regulating advice. Additionally, private remedies exist independently from legislation, such as a claim for a breach of contract.

  • Regulating NZU financial advice, transactional and/or custodial services.

Under this option persons who make recommendations or give opinions about the trade of NZUs would be regulated similarly to the provision of financial advice under the FMCA. Advice providers would be obligated to comply with a code of conduct, meet standards of competence, operate under a license from the FMA and belong to a dispute-resolution scheme. Additionally, fees and levies would be payable.

  • FMC Act wholesale client settings.

This option assumes that a larger proportion of those receiving NZU financial advice would have a higher degree of experience than clients who receive advice about other financial products. Therefore, this option proposes that wholesale client settings apply for all NZU market users. This involves registration and compliance with some statutory duties but does not require licensing.

Government preference: Option 2

What this proposal would mean in practice:

  • Greater oversight for government agencies, the regulator and the public as to who provides financial advice relating to NZUs, and greater ability to monitor compliance with existing laws.
  • Greater oversight and additional protections for smaller NZU market users – in particular, increased access to redress for clients of NZU advisers if something goes wrong.
  • Increased confidence for those receiving advice from NZU advisers, as the advisers would be required to act ethically and competently in relation to NZUs and would be subject to FMA oversight.
  • NZU advisers would be subject to internal and external compliance costs (such as licensing fees, Financial Service Provider Register fees, FMA levies, and dispute-resolution scheme fees) – which may be passed on to clients.

Topic 3: Improved transaction reporting

The Government’s objective here is to increase transparency in the market and address the information asymmetry that is currently evident in the NZU market.

Summary of options:

  • Status quo: current reporting obligations.

The NZETR collects certain information about transactions which is reported to the Environmental Protection Authority. However, currently price and value information are not collected. If made visible this information could be useful for market efficiency and investigating market conduct.

  • Improved transaction reporting.

This would involve the implementation of additional reporting fields on the price or the total value of the transaction, whether the trade is between more than one person and the primary reason is for the trade/holding an account. This additional collection would provide greater access to useful data.

  • Full transaction reporting.

This would involve adding additional reporting fields that replicate many of the prescribed wire transaction reporting obligations of the Anti-Money Laundering and Counter-Terrorism Financing Act 2009 (AM/CFT Act).

Government preference: Option 2

What this proposal would mean in practice:

  • All NZU secondary market users would be required to report additional transaction details which would assist the regulator in detecting fraudulent activity or price manipulation.
  • Improved price discovery for the wider NZU market.
  • Over-the-counter trades would require manual submission to the NZETR.
  • Individual and commercially sensitive information collected would remain non-public and subject to the NZ ETS confidentiality obligations for regulators.

Topic 4: Applying the AML/CFT Act Framework

No further AML/CFT obligations will apply to the NZU market beyond what already applies. The Government did not consider other options to the status quo but put forward this topic as a reminder of the current AML/CFT obligations.

Overall, the Government’s preferred approach in each topic involves leveraging existing financial market frameworks to address the identified risks within the NZU market.

Submissions on these proposals are due 24 December 2022, with final decisions to be made in early 2023.

Want to know more?

Click here for a copy of the discussion document and for information about how to make a submission. Please contact our Carbon Trading Team if you have any further questions about the NZ ETS.

PDF version: here.

This article is included in our latest edition of Rural.

For more information contact:

Josh Williams