The first auction of New Zealand units (NZUs) will take place this Wednesday 17 March 2021. Auctioning has been introduced as part of the reforms to New Zealand's emissions trading scheme (ETS) made by the Climate Change Response (Emissions Trading Reform) Amendment Act 2020 and related regulations. Auctioning aims to more closely align the supply of NZUs in the ETS with New Zealand's emission reduction targets.
In this update we look at what the auction will entail, how the ETS fits within the current New Zealand financial services landscape, and the potential for market governance reforms ahead.
What is happening in the auction?
The auctions will have a sealed bid, single-round, uniformly priced format, and will be operated by NZX on a platform developed by NZX and the European Energy Exchange.
The Government expects to make 19.0 million NZUs available for auction in 2021, with 4.75 million NZUs available at each of the four auctions scheduled. Up to 7 million additional NZUs may be made available in 2021 if the auction price reaches $50 (the cost containment reserve). The cost containment reserve will replace the current fixed price option as the mechanism for capping the price of NZUs, although the fixed price option will remain in place until 31 May 2021.
A floor price of $20 has been set for 2021, but, following the passing of the Climate Change Response (Auction Price) Amendment Act 2021 last week, the Government may set a confidential reserve price that is higher than this in order to prevent NZUs from being auctioned for significantly less than their secondary market price. Any NZUs that remain unsold at the end of an auction will be rolled forward to be sold at the next auction in the same calendar year.
How does the ETS framework fit within the current NZ financial regulation landscape?
There is currently no overarching market governance framework for the ETS, and the Government has decided that further work is required in this area. NZUs are treated as commodities rather than securities in New Zealand, so financial market regulations such as the Financial Markets Conduct Act 2013 (including the financial advice regime) and the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 do not generally apply to the ETS (though do apply to related derivatives and certain related activities). While existing competition and consumer laws generally apply to the ETS, some forms of potential market misconduct are not currently regulated under the ETS.
Market governance reforms
While currently not subject to any overarching governance framework, the Government has recognised that if market misconduct were to occur, it could distort the price of NZUs and reduce confidence in the ETS, potentially undermining the effectiveness of the ETS.
Specifically, the Government has identified seven particular areas of concern:
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insider trading;
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market manipulation of the NZU price;
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inadequate, false or misleading advice provided to participants;
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lack of transparency, monitoring and oversight of trades in the secondary market;
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money laundering and the financing of terrorism;
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credit and counterparty risks; and
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conflicts of interest.
The Government has agreed in principle that insider trading and market manipulation, in particular, should be prohibited in the ETS. The Government has established a market governance work programme to address these risks and this will be a space to watch over the next few years.
Changes to the ETS, of course, are one aspect only over wide-scale law and policy reform underway to respond to climate change. See links to our earlier updates here on the Climate Change Commission report, climate-related financial disclosures and the outlook for 2021.