Improving market governance of the New Zealand Emissions Trading Scheme

Closes 27 Feb 2023

About this consultation

Executive Summary

Overview

A poorly governed New Zealand Emissions Trading Scheme (NZ ETS) could impact our ability to meet our domestic emissions budgets and undermine the robustness of the NZ ETS and its reputation internationally. Through this consultation, we want to better understand the impact of leveraging existing financial market frameworks to address the key risks in the NZ ETS market when trading New Zealand Units (NZUs) (referred to here as the ‘NZU market’).*

*There is a distinction between the use of the terms ‘NZ ETS’ and ‘NZU market’ in this document. The NZ ETS refers, more broadly, to the scheme, which has an underlying purpose to reduce emissions. The NZU market refers to governance – that is, the rules and oversight of different types of conduct in the NZ ETS market where NZUs are traded. This distinction is to differentiate the purpose of market governance reform from the wider purpose of the NZ ETS as an emissions reduction scheme. This includes conduct that overlaps within the primary and secondary market of the NZ ETS. The term NZU market is used intentionally in this document to refer to the parts of the NZ ETS where there are risks in trading NZUs, which the proposals in this document are intended to regulate. Refer to Glossary for full definitions of both terms.

Aotearoa New Zealand lacks a robust NZU market governance framework

Setting up a comprehensive NZU market governance framework and appointing a regulator is important to ensure integrity, efficiency and confidence in the market.

Seven market governance risks

The Government has identified seven market governance risks, set out in three themes.

  • Theme A: Governance of advice  
    • Risk 1: Inadequate, false or misleading advice 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 

Prior consultations informed policy options

In the 2021 market governance consultation, stakeholders identified their preferred policy options to address the risk themes. With stakeholder feedback in mind, the tools chosen to progress the market governance package are listed below for each theme:

  • Governance of advice: Code of conduct, licensing and registration of NZU financial advisers
  • Governance of trading: Optional centralised exchange platform for NZU trades
  • Governance of conduct: Improved transaction reporting

Stakeholders also favoured appointing a skilled regulator with market design and market compliance powers to oversee the NZU market.

We want your feedback

We want your feedback on the impact of the market governance proposal.

This document presents four market governance topics, informed by the themes and tools we have previously consulted on. Table 1 outlines each topic below:

Table 1: Market governance options

Topic 1: Regulating the market based on financial legislation

  • Option one: Crimes Act 1961 (status quo). Continue to use the Crimes Act to manage insider-trading risks. No provisions against market manipulation in the NZU market. Market operators would not be licensed.
  • Option two: Financial Markets Conduct Act 2013 (FMC Act) with suitable modifications. Apply market manipulation prohibitions and offences to the NZU market like those in the FMC Act. Licensing requirements would apply to any facility for the trading of NZUs that met the definition of a financial product market (a licensed NZU exchange).
  • Option three: Crimes Act 1961 and market manipulation prohibitions. Use the Crimes Act to manage insider trading risks. Market manipulation would be addressed using prohibitions like those in the FMC Act. There would be no licensed market operators.

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

  • Option one: Relying on existing legislation (status quo). Advice relating to NZUs is partially covered by four Acts, including the Fair Trading Act 1986 (FTA), Forests Act 1949, FMC Act and Financial Service Providers (Registration and Dispute Resolution) Act 2008, which together create a complex framework for regulation advice.
  • Option two: Regulating NZU financial advice, transactional and/or custodial services. Require persons that provide a financial advice service to comply with FMC Act fair-dealing rules, certain statutory financial advice duties, and additional statutory duties if they provide a service to retail clients. Those who have retail clients would also be required to hold or operate under a licence and belong to a mandatory dispute-resolution scheme. Fees and levies would be payable.
  • Option three: Applying FMC Act wholesale client settings. Implement a code of conduct that outlines the expectations of a person providing NZU financial advice. A person providing NZU financial advice would be required to be registered and comply with some statutory duties. No licensing would be required.

Topic 3: Improved transaction reporting

  • Option one: Current reporting obligations (status quo). Under the status quo, the NZETR collects the following information about transactions:  
    • the parties involved in the trade
    • the number of units in the trade
    • the time and date of transaction
    • who set up the transaction
    • who authorised it and how they got their transaction authorisation code.
  • Option two: Improved transaction reporting. Implement new reporting requirements for parties to NZU trades, including: 
    • the price at which the NZUs were bought or sold, or otherwise the total value of the unit block
    • whether the trade is with someone else or between the transactor’s own accounts in the NZETR
    • the transactor’s primary reason for holding an account.
  • Option three: Full transaction reporting. Replicate the prescribed wire transaction reporting obligations in the Anti-Money Laundering and Countering Financing of Terrorism (Prescribed Transactions Reporting) Regulations 2016 [New Zealand Legislation website] (AML/CFT Regulations). This would apply to transaction and customer details.

Topic 4: Applying the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (AML/CFT Act) framework

  • Proposal: (status quo). No further AML/CFT Act [New Zealand Legislation website] obligations would apply to the NZU market beyond what already applies today. This highlights how the AML/CFT Act already captures activities of interest within the NZU market to deter money laundering and financing of terrorism.
About this engagement

Overview

This engagement is a follow-up to the 2018* and 2021** consultations on market risks, options and governance scenarios.

The intended audience is those who already interact with the NZU market or who have previously engaged or followed the market governance consultations. The information collected from this engagement will help inform the Cabinet decision-making process on the final market governance project.

We are considering addressing the identified risks of treating NZUs as a financial product*** in the NZU market.**** This means that the discussion document outlines the key aspects of, and regulatory concepts in, financial markets legislation that are intended to apply to NZUs in a manner broadly equivalent to financial products.

We seek your feedback on the impacts of treating NZUs as a financial product, as well as feedback on alternative options. Your feedback is a key part of improving the NZ ETS. We want to hear your views on how these options may affect you and the NZU market.

While the term ‘financial product’ is a defined term in section 7 of the FMC Act [New Zealand Legislation website], and it is one option to treat NZUs as if they were a financial product, the shape and form of legislative design of any ETS market governance reform package will be decided at a later stage. These proposals should not be treated as consulting on the use of any particular regulatory framework or design.

Note the distinction drawn between the NZ ETS and the NZU market, as outlined at n 1 above, and in the definitions of each term provided in the Glossary. 

 

*Read the Improvements to the New Zealand Emissions Trading Scheme: Consultation document. Ministry for the Environment [PDF, 2.2MB].

**Read the Designing a governance framework for the New Zealand Emissions Trading Scheme: Consultation document. Ministry for the Environment [PDF, 1,473 KB].

***While the term ‘financial product’ is a defined term in section 7 of the FMC Ac [New Zealand Legislation website], and it is one option to treat NZUs as if they were a financial product, the shape and form of legislative design of any ETS market governance reform package will be decided at a later stage. These proposals should not be treated as consulting on the use of any particular regulatory framework or design.

****Note the distinction drawn between the NZ ETS and the NZU market, as outlined at n 1 above, and in the definitions of each term provided in the Glossary. 

Scope of this engagement

Limitations and constraints

The scope of options in this discussion document has been limited by earlier market governance consultations, stakeholder feedback, and Cabinet decisions.

Between 2015 and 2021, the Ministry for the Environment (the Ministry) conducted multiple consultations on the prevalence of risks in the NZU market, the appropriate policy tools to address these risks, and potential market governance scenarios. Between 2018 and 2022, Cabinet agreed to various improvements to the governance of the NZ ETS and NZU market.

A review of the NZ ETS in 2015 found room for improvement. The review identified that the current market governance framework in the NZ ETS is not fit for purpose.

In 2018, the Government consulted on improving the NZU market and identified seven key risks in relation to market governance.* Stakeholder feedback to the consultation indicated that the risks in the NZU market existed and would likely continue to exist.

In 2018, Cabinet agreed in principle to:

  • prohibit insider trading and market manipulation in the NZU market and, as much is practical and appropriate, approach these two risks in the same manner as they are treated in the FMC Act
  • as much as is practical and appropriate, provide penalties and offences for insider trading and market manipulation in the NZ ETS that mirror the equivalent penalties and offences in the FMC Act.

In July 2019, Cabinet also decided to establish a market governance work programme to address all seven market governance risks.**

In July 2021, the Ministry for the Environment consulted on the seven market governance risks. The consultation included a range of proposed regulatory and non-regulatory options, and possible market governance regulatory scenarios. Stakeholder feedback:

  • agreed that the NZU market needed market governance amendments to be implemented
  • supported the use of existing frameworks to regulate the NZ ETS
  • supported a code of conduct, licensing and registration of NZU market users
  • supported an optional centralised exchange for greater transparency
  • supported appointment of an appropriately skilled regulator to improve trust, efficiency and confidence in the NZ ETS.

This 2022 targeted engagement continues the consultation process. Some stakeholders suggested, in response to an earlier consultation, that we should consider leveraging the existing financial market framework and policy tools. For this reason, we are seeking your feedback on:

  • treating NZUs as a financial product
  • treating financial advice relating to NZUs as a financial advice service
  • treating market risks in the NZU market as financial risks
  • including the NZU market under existing financial frameworks legislation
  • appointing the Financial Markets Authority (FMA) to oversee and regulate the NZU market.

We also seek your feedback on other matters, such as the financial and administrative impacts of leveraging policy tools from the FMC Act and the AML/CFT Act, and what alternative market governance proposals we should consider to mitigate the seven identified risks.

While we have in this document expressed a preference for particular options, we are open to feedback on what may and may not work in practice and how effective the options are likely to be.

 

*Above, n 2.

**Above, n 3.

Context

Overview

The NZ ETS is critical to meeting emissions reduction targets in Aotearoa New Zealand. The Government is committed to responding to climate change by transitioning to a climate-resilient economy in a manner that is fair to all New Zealanders.

The Climate Change Response Act 2002 [New Zealand Legislation website] (CCRA) established the NZ ETS in 2008 as an important tool for meeting our international and domestic emissions targets. The NZ ETS puts a price on greenhouse gas emissions by requiring people and businesses covered by the scheme (NZ ETS participants) to purchase and surrender NZUs to the Government for their emissions.

In the NZ ETS, the primary market includes the supply of NZUs from the Government to NZ ETS participants. The secondary market is where previously issued NZUs are bought and sold. The Government sets the number of units supplied into the scheme. This number reduces over time, limiting the total amount that people and businesses can emit, in line with Aotearoa New Zealand’s emissions reduction targets.

A review of the NZ ETS in 2015/16* found that the framework is incomplete and could be improved. The review resulted in proposals to improve the NZ ETS so it supports the climate-resilient transition more effectively. The review acknowledged a need for good governance, to ensure consistency and alignment to improve operational efficiencies.

‘Market governance’ refers to the rules and oversight of different types of conduct in the NZ ETS market where NZUs are traded. This includes conduct that overlaps within the primary and secondary market of the NZ ETS. We refer to this as the NZU market, to differentiate the purpose of market governance reform within the wider purpose of the NZ ETS as an emissions reduction scheme.

The risks to the NZ ETS scheme due to insufficient market governance have been noted by the Ministry for the Environment,** the Climate Change Commission,*** the Productivity Commission,**** and the Government.*****

At present, the NZU market lacks an integrated legislative framework to address misconduct. A comprehensive framework facilitates a well-functioning market and protects the integrity of the scheme. A robust framework could also facilitate links with international emissions trading schemes.

Improving the NZU market can contribute to Aotearoa New Zealand reaching international and domestic emissions reduction targets and make a just and inclusive transition to a low-emission economy.

The NZ ETS is unique among international emissions trading schemes

The NZ ETS is different to most international emissions trading schemes in that it has a forestry sector that generates NZUs, which can be made available to other NZU market users.

However, there is a higher level of regulation apparent in other international emissions trading schemes, when compared to the NZ ETS and the NZU market.

International emissions trading schemes use a range of approaches and tools to regulate and monitor trading and conduct in their schemes. In the NZU market, conduct between participants lacks this level of regulation.

Despite these differences, comparative review can provide important lessons for market governance in the NZU market. Many international emissions trading schemes include emissions allowances as a financial instrument under their own definitions, with regulation by their respective financial market authorities. Table 2 summarises the various approaches to market risks taken by international emissions trading schemes.

Table 2: Treatment of market risks in international carbon markets

View a landscape version of Table 2 within the discussion document [PDF, 2.4MB] or a picture version [PNG, 221 KB].

 

European Union

California

Quebec

United Kingdom

Australia

Switzerland

Aotearoa New Zealand

Governance of advice

Code of conduct

Unknown

Can suspend trades based on poor advice

Unknown

Australian Financial Services licences for carbon units

Swiss securities regulation does not apply to OTC emission allowances trading on secondary markets

Fair Trading Act 1986

Crimes Act 1961

Governance of trading

Licensed platforms, disclosure of ‘know-your-consumer’ (KYC) information

Centralised allowance-tracking system

Ministry-approved registration of market participants, disclosure of KYC information

Managed through the UK Emissions Trading Registry (records on allowances held, movement of allowances for UK). Also serves as the UK Kyoto Protocol Registry

Requires Australian market licence

Managed through the National Emissions Trading Registry

KYC obligations via AML/CFT Act 2009

Governance of conduct

Market abuse regulation

Market abuse regulation, purchase and holding limits

Market abuse regulation, purchase and holding limits

Market abuse regulation, position and purchase limits

Market integrity regulation for market operators and participants

Federal Act on Financial Market Infrastructures and Market Conduct in Securities and Derivatives Trading

Crimes Act 1961

Appointing a regulator

European Securities and Markets Authority

California Air Resources Board

Ministry of the Environment and the Fight Against Climate Change works with financial market regulatory agency

Financial Conduct Authority (with regulators ensuring compliance)

Australian Securities and Investments Commission

Swiss Financial Market Supervisory Authority

Department of Internal Affairs and FMA for parts of the NZU market

Treatment of units and market risks

Financial instrument

Non-financial******

Non-financial******

Financial instrument

Financial product

Non-financial

Non-financial

 

**Above, n 2.

*****Read the Transitioning to a low-emissions future – the Government response to the Productivity Commission's Low Emissions Economy report. 2019. Ministry for the Environment [PDF, 302 KB].

******The circumstances under which the Western Climate Initiative (WCI) was established differ to those which gave rise to the NZ ETS. The WCI represents a carbon market designed, developed and operated exclusively by subnational governments in different countries and under different legislation. A regional allowance market is created by the partner jurisdictions recognising one another’s allowances for compliance, regardless of unit definition.

What has happened so far

2018 consultation sought to better understand the impacts and prioritisation of the seven risks for stakeholders

In 2018, the Government identified and consulted on seven market governance risks* relating to bad advice, transparency issues with trading, and misconduct in the NZU market. Table 3 outlines the seven identified market governance risks and their corresponding themes.

Table 3: Market governance risks and themes

Theme

Risk

Theme A:

Governance of advice 

Risk 1: Inadequate, false or misleading advice relating to NZUs

Risk 2: Conflicts of interest involving the 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

In general, submitters were more concerned about future misconduct than current behaviour.

One submitter noted, “As the market becomes more mature and the volume and value of trading increases, it will become important for units to take on some of the features that ordinary financial products have, as well as a more sophisticated compliance monitoring and enforcement regime”.

Some commented that initiatives to address risks and improve governance could have unintended consequences for engagement in the NZU market, or lead to higher compliance costs,** especially for smaller participants. They therefore recommended carefully considering any change, ensuring any proposed regulation is proportionate to the risks and not too onerous.

2018 Cabinet in-principle decisions

In 2018, alongside the decisions to introduce auctioning in 2020 and subject to the wider market governance decisions, Cabinet agreed in principle to address the risks of insider trading and market manipulation as a priority, because of the increased likelihood of misconduct.***

Cabinet agreed in principle that insider trading and market manipulation should, as much as practicable and appropriate, be treated in the same manner as in the FMC Act and have offences and penalties that mirror those in that Act.

Cabinet noted that Ministry for the Environment officials will do further work to determine the most appropriate regulator to enforce this conduct, including careful consideration of which regulator could be adequately resourced to deal with this conduct.****

2021 consultation informed policy options

In July 2021, the Ministry for the Environment consulted on options to address the seven identified market governance risks.***** The full range of options considered is provided in Appendix A.

The consultation adopted a first-principles approach. The first-principles approach allowed the Ministry to establish the prevalence of market governance risks and consider the most appropriate regulatory and non-regulatory tools to address these risks, without being restricted to the types of tools that already existed in the market, the legislation or any prior policy assumptions.

In the consultation document, the Ministry:

  • investigated the prevalence of the market governance risks and whether they still existed under the status quo
  • presented a range of regulatory and non-regulatory options that would address the market governance risks (these options were not mutually exclusive)
  • presented different combinations of options (market governance scenarios) which could apply in the NZU market (including low-regulatory, balanced, and high-risk-mitigation scenarios, to show a range of possible intervention levels)
  • did not consult on the appropriate legislation to implement the changes, or on whether NZUs should be regulated as financial products (either under an existing or new framework).

The approach allowed stakeholders to express their opinion on their preferred direction and the types of tools that would be useful for addressing market governance risks, and it helped the Government gather a range of perspectives before making policy decisions.

Stakeholder feedback from the 2021 consultation confirmed the existence of the seven identified market governance risks to the NZU market, under the status quo, and informed our consideration of several options to address those risks. The market governance options below, for addressing misconduct, are modified versions of what was consulted on but are actively being considered based on stakeholder preference.

The following were identified as the appropriate types of tools to address the market governance risks, grouped by their risk themes (advice, trading, conduct):

  • Governance of advice: education campaign, code of conduct, licensing and registration of NZU advisers
  • Governance of trading: optional centralised exchange platform for NZU trades (modified from the mandatory centralised exchange proposed in 2021)
  • Governance of conduct: Improved transaction reporting (modified from full transaction reporting proposed in 2021)

The 2021 consultation also showed stakeholders favouring the appointment of a skilled regulator, with market design and market compliance powers, to oversee the NZU market.

 

*Above, n 2.

**Compliance cost refers to all the expenses that a firm incurs to adhere to industry regulations. Compliance costs are difficult to estimate as they depend on the extent to which a company complies or exceeds the current rules.

****Above, n 16, at [61].

*****Above, n 3.

Market governance framework

Objectives

Overall market governance objectives

The Government has identified market governance risks relating to poor advice, transparency, and misconduct in the NZU market. Currently there is a lack of cohesive legislation to address these risks.

A poorly governed NZU market could have implications for meeting domestic emissions budgets. Through this consultation, we want to better understand the impact of leveraging existing financial market frameworks to address key risks in the NZU market.

As the NZU market matures, the value of NZUs continues to rise. Additional NZU market users are joining the scheme and there is potential to open the NZU market to international participants.

The overall policy objective of market governance is to address the seven identified market governance risks in order to:

  • increase the integrity and efficiency of the NZU market
  • promote confidence in NZU market trading, and
  • reduce the risk of misconduct for NZU trades.

Topic objectives and risks addressed

There are four topics included in this engagement that are derived from previous stakeholder feedback. Table 4 outlines those topics and their objectives. Table 5 sets out the risks covered by each topic chapter.

Table 4: Summary of market governance topic objectives

Theme

Risk

Topic 1:

Regulating the NZU market based on financial legislation

To ensure the NZU market trades with integrity, functions efficiently, promotes confidence and addresses the risks of misconduct. To ensure all NZU market users have the same material information relating to NZUs. 

Topic 2:

Regulating NZU financial advice, transactional and/or custodial services

To ensure all persons who interacts with the markets where NZUs are traded has access to quality advice about buying and selling NZUs. To ensure services relating to NZUs are provided with appropriate levels of care, diligence and skill.

Topic 3:

Improved transaction reporting

To increase transparency in the NZU market and address information asymmetry currently seen in the market.

Topic 4:

AML/CFT Act framework

To better communicate how the AML/CFT Act captures activities of interest within the NZU market to deter money laundering and financing of terrorism.

Table 5: How each topic addresses market governance risks

 

Topic 1:

Regulating the market based on financial legislation

Topic 2:

Regulating NZU
financial advice, transactional and/or custodial services

Topic 3:

Improved transaction reporting

Topic 4:

AML/CFT Act framework

Risk 1:
Inadequate, false or misleading advice relating to NZUs

 

 

 

Risk 2:
Conflicts of interest involving the NZETR

 

 

 

Risk 3:
Potential lack of transparency, oversight, and monitoring of trades in the secondary NZU market

 

 

Risk 4:
Credit and counterparty risks

 

 

 

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

 

 

 

Topics are not mutually exclusive

Proposals given in topics 1–4 work together to achieve the overall policy objective. Some topics perform different functions – for example, regulating NZU financial advice performs a different function to the AML/CFT Act framework.

Other topics, however, reinforce each other. For example, the optional centralised exchange is reinforced by improved transaction reporting because, together, they provide a full picture of trading activity.

There are different options given under each topic (and a preferred option put forward) for stakeholders to consider.

The status quo: no unified framework or regulator

Currently, there is no integrated legislative framework for market governance in the NZU market, creating risks to market function, integrity and confidence.

The status quo is that many different pieces of legislation and different regulatory systems provide overarching coverage for aspects of the risks identified in the NZU market, but none is tailored to provide full coverage.

Set out in topics 1–4 of this document is a series of proposals and alternative options for a range of statutory tools and obligations that can be used to build the market governance framework.

Table 6 below provides a detailed description of each topic’s status quo which, put together for the entire NZU market governance framework, provides a patchwork for coverage of the risks identified in 2018.

Table 6: Status quo legislation under each proposal topic

Topic 1: Regulating the market based on financial legislation

  • Crimes Act 1961: Includes punishments and offences for crimes.

The status quo: Crimes Act only. The Crimes Act is used to manage insider trading risks. No provisions against market manipulation in the NZU market. Market operators would not be licensed.

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

  • Forests (Regulation of Log Traders and Forestry Advisers) Amendment Act 2020: Establishes a registration system for log traders and forestry advisers.
  • Fair Trading Act 1986 (FTA): Generally prohibits false and misleading conduct by those in trade.

The status quo: advice relating to NZUs is partially covered by four Acts. The FTA, Forests Act 1949 and the FMC Act and Financial Service Providers (Registration and Dispute Resolution) Act 2008 together create a complex framework for regulating advice.

Topic 3: Improved transaction reporting

  • Climate Change Response Act 2002: Mandates annual emissions reporting to the NZETR.

The status quo: the NZETR collects the same information for transactions. Under the status quo, the NZETR collects the following information about transactions:

  • the parties involved in the trade
  • the number of units in the trade
  • the time and date of transaction
  • who set up the transaction
  • who authorised it and how they got their transaction authorisation code.

Topic 4: Applying the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (AML/CFT Act) framework

  • Anti-Money Laundering and Countering Financing of Terrorism Act 2009: Generally requires businesses to take measures to guard against money laundering and terrorism financing.

The status quo: No further AML/CFT framework obligations would apply to the NZU market beyond what already applies today. This highlights how the AML/CFT Act already captures activities of interest within the NZU market to deter money laundering and financing of terrorism.

Leverage existing financial market frameworks

The Ministry for the Environment considers that there are common risks between the NZU market and financial product markets, regulated by the FMC Act. These risks include poor advice from professional advisers, insider trading and market manipulation. 

It could be beneficial to include the NZU market under existing financial market frameworks to minimise market governance risks in the NZU market. This is because the approach could leverage well-established legislative tools and trusted financial market regulators. Using a financial market framework approach to govern the NZU market could align the NZ ETS to international emissions trading scheme standards and to our own domestic financial markets. This alignment could ensure NZU market integrity, efficiency and confidence.

The Government seeks to better understand the impact of leveraging existing financial market frameworks to address the seven identified risks. The Government acknowledges that there are key differences between NZUs and other more traditional financial products. For example, many parties are required to trade in NZUs because of their surrender obligations – a feature that does not exist in other financial markets, where trading is voluntary. All NZUs represent the same units (volume) of emissions, whereas there are a large range of different financial products.

An important aspect of this engagement will be understanding impacts on NZU market users and other affected parties that could eventuate because of these kinds of differences, the modifications that would be required to financial markets frameworks due to those differences, and how the application of these proposals would affect participants in the NZU market.

Appoint the FMA as a regulator

Aligning the NZU market to financial market frameworks would require a regulator to oversee the market. A fit-for-purpose policy framework that treats NZUs as a financial product would leverage the financial market tools and institutional structures of the FMA as the regulator of financial markets to oversee the identified market governance risks, where appropriate, in the NZU market.

Purpose of engagement

Understand the impacts of treating NZUs as a financial product

The purpose of this engagement is to understand the impacts of leveraging existing financial markets frameworks to address the seven identified risks. The feedback from this engagement will help with considering any modifications that may be required to tailor financial markets frameworks to NZUs and whether alternative options may better achieve overall policy objectives.

Criteria used to compare options to the status quo

The criteria used to evaluate the options are the same operational criteria used in the broader NZ ETS improvements package in 2018 and 2019, from which the market governance project was initiated.

Table 7 outlines the five impact criteria. We consider the criteria to remain applicable, given that the overarching intention of the NZ ETS reform is to ensure that the scheme operates to achieve Aotearoa New Zealand’s broader emissions reduction targets.

Table 7: Five impact criteria

Criteria

Description

Integrity

Ensuring that the NZU market operates with integrity at all times, and through all trading markets (primary auctioning market and the secondary trading market).

Minimal complexity and administrative cost

Wherever practicable, the costs to administer the market and for NZU market users to participate in the market are minimised. All rules, regulations and legislation are as simple and clear as possible. In particular, how the NZU market is governed has clear regard for the impacts on market participation and engagement of key intermediaries, NZU traders and other parties.

Consistency and proportionality

Wherever possible, the same solutions are used to apply to both the primary auctioning market and secondary trading market. In addition, the solutions are consistent with similar solutions used in other similar contexts, and they are proportional to the risk.

Clarity and transparency

Ensuring that all relevant market information is clearly presented, at the right time and in a clear format. The risk of collusion due to excessive transparency is also considered. All rules, regulations and legislation are clearly explained so that NZU market users understand their obligations and what type of conduct is expected of them.

Market efficiency

The NZU market is efficient when it achieves allocative efficiency and delivers efficient price discovery. Allocative efficiency is the market’s capacity to channel resources, in this case, NZUs – to their highest value uses. That is, emissions are reduced by those best placed to abate, at the best time. Efficient price discovery means that for NZUs to flow to their highest value uses, the carbon price needs to reflect all available information. Providing relevant market information and predictable policy will help NZU market users to identify and understand the overall supply and demand conditions for NZUs, facilitating efficient price discovery. This will produce a reliable price signal that informs investment decisions, while minimising the cost impact of the carbon price. To ensure this price is maintained, there need to be adequate rules and oversight in place to guard against the risks of manipulation of the price, insider trading and anti-competitive conduct.

Options are assessed for how well they perform for each criterion, against the status quo. Table 8 provides a key of symbols representing the results of the assessment.

Table 8: Key to criteria analysis assessment

Symbol

Meaning

++

much better than doing nothing/the status quo/counterfactual

+

better than doing nothing/the status quo/counterfactual

0

about the same as doing nothing/the status quo/counterfactual

-

worse than doing nothing/the status quo/counterfactual

- -

much worse than doing nothing/the status quo/counterfactual

Initially, all criteria are equally ranked. If two or more options received the same score, the following rankings were applied, in order of importance.

  1. Integrity. The most important of the five criteria, the integrity of the NZU market helps achieve the purposes of the market governance framework.
  2. Minimal complexity and administrative cost. This enables regulations to operate sustainably and without burdensome requirements for NZU market users and regulators.
  3. Consistency and proportionality. We want to ensure that the NZU market is regulated in a manner consistent with financial markets and international carbon markets. We also want to ensure that the regulation is proportional to the seven identified market governance risks.
  4. Clarity and transparency. Clarity helps to ensure that stakeholders have access to the information they need to understand their obligations. Transparency helps the status of the market. We note that not all complexity can be eradicated from legislation.
  5. Market efficiency. The market operates in a way that supports channelling resources to their highest value uses. NZU prices reflect all available information, and the market produces a reliable price signal that informs investment decisions, while minimising the cost impact of the carbon price.

Your views

The Government seeks feedback on incorporating the NZU market into existing financial frameworks legislation, including:

  • treating NZUs as a financial product to bring the NZU market into the financial legislation framework, similar to that observed in financial markets
  • treating advice relating to NZUs as financial advice, similar to that observed in financial markets
  • treating market risks as financial risks, to bring the NZU market into the financial market legislation framework, similar to how risks of misconduct are treated in financial markets
  • appointing the FMA to oversee and regulate the NZU market.

This engagement presents options and analysis and includes questions for you to consider. Your views will help us fill information gaps and measure support for the options.