The Kyoto Protocol & Beyond: A Legal Perspective Registries & Contracts in the EU ETS

1. The Kyoto Protocol & Beyond: A Legal PerspectiveRegistries & Contracts in the EU ETS Anthony Hobley General Counsel to the Fund Director Legal/Policy ahobley@c-c-capital.com +44 (0) 20 7290 9893 10thJune 2006

2. Introduction to Climate Change Capital • Climate Change Capital is a specialist merchant-banking group focused on companies and financial institutions affected by the policy and capital market responses to climate change. • Founded in 2003, 70+ professionals • UK headquartered, offices in Madrid, Paris and Washington, evolving relationships beyond • Focus onClean Power, Clean Fuels, Clean Technology and Carbon Finance • Policy expertise in climate change and energy security at its core • Three distinct but complementary groups: • Advisory – providing corporate finance, M&A, financial and policy advisory services • Asset Management – investing in companies that facilitate the transition to a low carbon economy: Ventus I (£15mn UK windpower fund), launching Ventus II and III and a €150mn pan-European clean energy/clean tech VC fund • Carbon Markets – investing in projects and companies that generate carbon emission credits under the flexible mechanisms of the Kyoto Protocol: 105M$ managed under C4F andlaunching C4F-2

3. Market Size: Recent Statistics • According to the US Council on Foreign Policy, the eventual size of the CO2 trading market is $2.5 trillion to $3 trillion. • Total traded volumes: 1,500 Mt (799 Mt in 2005, and 94 Mt in 2004) across EU ETS, CDM and JI • Volumes: • Total volumes in EU ETS: 874 Mt (362 Mt in 2004) • Total volumes CDM: 620 Mt (397 Mt) • Total volumes JI: 70 Mt (28 Mt) • Value: • Total value of market : €27.1 billion (€9.4 bn) • Total value of ETS: €22.7 billion at current prices (€7.2 bn) • Total value of CDM: €3.8 billion at an implied average price of €6.13 (€1.9 bn) • Total value of JI: €335 million (€96 m) • China had a market share of around 70% in CDM. India was distant second with around 11%. • HFC projects constituted 66% of volumes.  Coal Mine Methane was second with 7%. • Funds bought 43% of CERs/ERUs, corporate compliance buyers 42%, and governments 3%. 2 billion tonnes of CERs forecast up to 2012 Source: Point Carbon

4. Who will trade? • Compliance v trading • Banks, Funds and commodity traders • speculative • risk management • Operators of installations • compliance and price risk • Related opportunities : regulatory arbitrage, CDM/JI • First mover advantage

5. Registries Regulation • Each Member State shall establish a registry • Standardised Secure Electronic database (not a trading platform) • Accurate recording of issue, holding, transfer, acquisition, surrender, cancellation and replacement of allowances • Assessment of compliance – reconciliation between allowances and verified emissions • Any person may hold allowances • Consolidated system with Community independent transaction log (EU Registries to be integrated with Kyoto Registries – therefore only one national GHG Registry for each member state) • Functional and technical specifications

6. Registries Regulation • Not necessary to have an account in a country in order to trade with it • EU ETS Directive and Registries Regulation guarantee right to make transfers which comply with the requirements of the EU ETS both inter and intra National Registries

7. Proposed Numbering of EU Allowances Party of origin (ISO 3166 standard) Unit type 1=AAU, 3=ERU, 5=CER Force Majeure JI or CDM project identifier Unique consecutive #. For non JI or CDM=0000 FR - 00 – 0 - 00 - 0000 - 000000000001 - 000000001000 - 00 - 097 End block Issuance commitment period Pre-Kyoto # are 00, period from 2008-2012 will be 01, etc. LULUCF activity This field is relevant to RMUs, for all other instruments = 00 Unique number 12 consecutive number enables identification of instruments by block (Start) EU tag (ISO 31661 standard) Shows that an AAU/ERU/CER has been converted into an EU allowance

8. Registries vs. transaction logs • Registries are places where carbon assets sit. These are: • CDM Registry: where CERs are born • National Registries • Transaction logs are checking and clearing mechanisms. These are: • International Transaction Log (ITL) • Community Independent Transaction Log (CITL)

9. National Registries (Annex B only) • Legal basis: Marrakesh Accords, EU ETS Directive and Registries Regulation • Function: Ensure accurate accounting of the issuance, holding, transfer, acquisition, cancellation, retirement, and banking of EUAs/ERUs/CERs/AAUs/RMUs • Run by: Designated registry administrator (e.g. for UK, the Environment Agency)

10. CDM Registry • Function: issues and transfers CERs in accordance with MOP decisions and CDM EB decisions • Run by: the CDM EB • Status: • Built and ready to go operational subject to agreed administrative protocols to be established by the CDM EB

11. Moving carbon: pre-ITL CDM Registry EU Annex I Pending account Italian National Registry UK National Registry CCC interim account EU Community Independent Transaction Log (CITL) CCC UK account Russian National Registry Polish National Registry German National Registry Greek National Registry French National Registry Spanish National Registry Czech National Registry Cyprus National Registry CER EUA

12. Registries snapshot Post ITL CDM Registry EU Annex I Pending account Italian National Registry UK National Registry EU Community Independent Transaction Log (CITL) UN International Transaction Log (ITL) CCC UK account Russian National Registry Polish National Registry German National Registry Greek National Registry  JI SC French National Registry Spanish National Registry Czech National Registry Cyprus National Registry CER ERU EUA

13. Moving EUAs from our account • Just like internet banking • Log on to national registry account with username/password • Fill out transfer order specifying quantity of EUAs to send, and the receiving national registry and account. Click OK. • CITL makes checks through 7 message sequence and the transfer is made • But, starting in 2008 (ITL operational), transfer order goes through ITL first for Kyoto checks and then CITL for EU ETS specific checks. When the transfer goes through, the sending/receiving country’s AAU balances change. • ITL sees only AAUs; CITL sees only EUAs • CITL can stop the transaction if it violates Commitment Period Reserve Rules • Can’t move an EUA out of the EU registry system unless mutual recognition agreement with e.g. Japan or Canada • In other words, can’t sell EUAs to Japanese gov’t as AAUs

14. Legal Title & Delivery • Depends on what is being transferred e.g. include provisional CER? • May need to define nature of title & associated rights • Mechanism for delivery exists (eg. a Registry); • Quantity – Minimum or Maximum? • Point at which legal title passes must be specified: • delivery of annual verification report; or • delivery into buyer’s account; or • upon payment. • Buyers Account – Specified National Registry • Sale should be unencumbered

15. Annual Trading Cycle Year 2 Year 1 1 calendar year Jan Dec 28 Feb New Allowances for Year 2 31 March Input verified emissions – if not, account of operator frozen 30 April Surrender Allowances • May “borrow” forward across years, not phases • No vintage but EUAs have a phase

16. Phase I leading into Phase II Phase II Phase I 2009 2005 1 January 2008 1 January 28 February Issue Phase II EUAs 30 April (end of Phase I) Surrender Phase I EUAs • May “borrow” forward across years, not phases • No vintage but EUAs have a phase • CERs can be carried over into Phase II

17. Emissions Trading (ET) Contracts • Development of standard form trading contracts: • IETA (International Emissions Trading Association) • ISDA (International Swaps and Derivatives Association) • EFET (European Federation of Energy Traders) • Allocation of Risk • Credit Risk • Delivery Risk • Sale and Purchase of Allowances/Sale and Purchase of CERs/ERUs • Purchase of generic emissions reductions so called VERs?

18. EUA Contracts Developing A European Standard Document PROMOTING MARKET LIQUIDITY PROMOTE CERTAINTY OF TRADING TERMS REDUCE TRANSACTION COST AND TIME

19. Issues for Contracts • The holding account of an operator shall be blocked if an installation’s annual verified emissions for the previous year have not been entered by 31 March • Holdings in accounts, price information and trades are confidential • If there are discrepancies in processes (e.g. transfers), the registry administrator shall terminate the processes • EU ETS Directive and Registries Regulation guarantee right to make transfers which comply with the rules of the scheme

20. IETA/EFET/ISDA Contract Comparison • Excess Emissions Penalty provisions • Differences in basic mechanics e.g. payment and delivery dates • Differences in the force majeure / settlement disruption/ failure to deliver provisions and consequences e.g. compensation payable • Differences in the calculation of any termination payments • Differences in termination proceedings e.g. some or all Transactions? • Payment netting and close-out netting enforceability • Effect of changes to scheme

21. CASE STUDY - SUMMARY 1992 ISDA ½ million EUAs EFET 1million EUAs POWER GENERATOR BANK A BANK B France Germany Luxembourg IETA ½ million EUAs 2002 ISDA ½ million EUAs OIL & GAS Co UK

22. CER issuance process diagram CCC Project CCC UK account contract info UK National Registry Verifier  verification report CDM EB CDM Registry Pending account CITL CCC interim account (pre-ITL) ITL Pending CERs CERs

23. Licensing/Regulatory Political Risk appraisal(PDD) registration(CDM Exec Bd) regulatory change regulatory change tax change tax change certification verification host country approval host country approval monitoring Financial crediting period currency Technology Cost/Delay price ERPACounterparty compliance cost completion delay CDM Project Risks (some…) performance credit

24. Anthony Hobley General Counsel to the Fund Director Legal Policy Climate Change Capital Limited ahobley@c-c-capital.com +44 (0) 20 7290 9893 The Kyoto Protocol & Beyond: A Legal PerspectiveRegistries & Contracts in the EU ETS10th June 2006