23 July 2010

IETA reply to public consultation1 on a revision of the Market Abuse

Directive (MAD)

1. General remarks2

1.1 IETA is the leading voice of the international business community on the subject of
emissions trading with over 170 member companies from across the carbon cycle. IETA
supports efforts to address the pressing environmental challenge of climate change, and is
dedicated to the establishment of environmentally effective market-based emissions trading
systems that generate reductions at least cost to the community.

1.2 IETA welcomes the core objectives of the revision of Directive 2003/6/EC namely increasing
market integrity and investor protection, strengthening enforcement against market abuse,
harmonizing standards across the EU, reinforcing coordination among national regulators
and improving transparency, supervision, safety and integrity of derivatives market.

1.3 As for every regulatory exercise, care shall be taken to avoid any unnecessary additional
burdens on market participants and to undertake a thorough impact assessment before
implementing changes. This is of particular importance for the carbon market which is the
result of a legal obligation and must remain a tool for cost-effective CO2 emission reductions.

1.4 IETA would also like to stress the importance to avoid any regulatory overlap. IETA would
first like to see evidence from the work commissioned by DG CLIMA on whether the carbon
market is sufficiently protected from insider trading and market manipulation, before any
extension of market protection rules is undertaken.

1.5 The carbon market requires a different treatment from other instruments, as (i) it is a
regulated market, i.e. entities covered have a legal obligation to participate and allowances
are produced and allocated by governments; (ii) it is a young market; (iii) it has many smaller
participants; (iv) and its transactions are mostly traded on exchange or cleared.

1.6 The carbon market shares the strongest similarities with other commodity markets, e.g.
energy, power and gas. Therefore, we do believe carbon market oversight measures should
be co-ordinated with other commodity markets, including energy markets.

1
http://ec.europa.eu/internal_market/consultations/2010/mad_en.htm
2
See also IETA’s position paper of May 2010 on transparency and oversight in the EU’s carbon market at
http://www.ieta.org/ieta/www/pages/download.php?docID=3477
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 IETA reply MAD Consultation
July 23, 2010

2. Extension of the scope of MAD:

2.1 (Q1) Should the definition of inside information for commodity derivatives be expanded in
order to be aligned with the general definition of inside information and thus better protect
investors?

“In relation to derivatives on commodities, "inside information" could mean information of a

precise nature which has not been made public, relating, directly or indirectly, to one or
more such derivatives and which if it were made public, would be likely to have a significant
effect on the prices of such derivatives or affect the price of the underlying asset. This would
include notably information which is required to be disclosed in accordance with legal or
regulatory provisions at EU or national level, market rules, contracts or customs on the
relevant underlying commodity market or commodity derivatives market.” (p. 5 Consultation)

The expansion of the definition for insider information used for equity to commodity
derivatives is highly problematic. In global commodity markets, it is much harder to define
the market arena, e.g. who releases which information from where is not so easily
identifiable. Moreover, the price sensitivity can vary across global markets. This makes it
very dangerous to expand the ‘price sensitivity’ definition under MAD to commodity markets.
As a result, effective hedging could be inhibited which would drive up prices.

This might be a smaller issue in the carbon market, which remains a regional rather than
global market (at this stage), where one can identify the market more easily. However, the
usefulness of the definition is questioned for the carbon market where price sensitive
information is mainly related to fundamental data (e.g. regulatory modalities set for the EU
ETS, emissions from installations covered by the EU ETS).

Market participants want to be confident that if they comply with transparency requirements
in underlying markets, they are not in breach with insider information rules. Disclosure of
sector-specific information should be considered within sector-specific regulation which
should result in an exhaustive list of mandatory disclosure requirements.

Among others, this list should contain a comprehensive definition of relevant fundamental
data, define who has the duty of publication, set out the manner and timing of such
publication to ensure consistency with the timeframe for commercial and operational
decisions. This should allow all market participants to have simultaneous access to the
relevant information needed for any trading decisions.

2.2 (Q2) Should MAD be extended to cover attempts to manipulate the market?

IETA welcomes this step but considers it difficult to prove ‘intent’ in practice. If this hinges on
an attempt that is unsuccessful, it will be hard to proceed in the prosecution. However the
extension of the prohibition of market manipulation to attempts to manipulate the market
would be acceptable as long as the definitions of attempts are precisely defined and the
burden of proof regarding such "attempts" lies with the regulator. In other words, regulators
will still have to prove that the behaviour was intended to manipulate market outcomes.

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2.3 (Q4) Should MAD cover all financial instruments (including derivatives) admitted to trading
on a MTF, but not traded on a regulated market? To what extent?

IETA supports the expansion of MAD to cover instruments admitted to trading on a MTF but
there should remain a clear distinction between regulated and non-regulated markets. The
extension of MAD must not bring with it any requirements on entities trading on MTFs to
become regulated entities under MiFID.

2.4 Alignment of the definition for financial instruments (and others) between MAD/MiFID?

IETA welcomes the alignment of definitions between MAD/MiFID. We would like to emphasize
however, that carbon allowances should not be treated as financial instruments. Only carbon
derivatives that are cash-settled or have the option for cash-settlement are listed as financial
instrument under MiFID (Annex I, Section C(10)). MiFID mentions derivative contracts relating
to "emission allowances", but it is unclear whether this only relates to EUAs, or to other
carbon credits as well (CERs, ERUs, or even VERs). There seems no reason why EUA
derivative contracts would be treated differently from derivatives relating to other tradable
carbon credits, but regulatory clarification on this issue would be appreciated.

3. Enforcement Powers and Sanctions

3.1 IETA will respond to the forthcoming MiFID review but would like to already give a view on
the risks of introducing position limits. Position limits can hinder the ability of
producers/manufacturers to hedge effectively or expose these firms to a detrimental
regulatory risk (risk that regulators will set position limits) and commercial risk (carbon price
risk). Moreover, in the absence of forward allowance sales by Governments ahead of 2013,
position limits could unnaturally limit the ability of market participants to close the
“speculative gap” (which is driven by real hedging needs and not by speculative aims) built
between advanced hedging demand for allowances from 2010 onwards and the subsequent
spot sales of allowances several years hence from 2012 at the earliest.

3.2 (Q8) Do you agree with the sanctions proposed?

IETA welcomes the proposal to introduce more harmonized sanction standards. There is
clearly a need for more effective enforcement in certain EU Member States. At the same
time, the regulator has to be able to reduce the fine in exchange of cooperative action (‘plea-
bargaining’) to encourage any assistance in the detection of market abuse.

3.3 (Q9/10) What coordination role should ESMA play in the relations among EU competent
authorities for enforcement purposes?

ESMA should play a key role in coordinating relations among EU competent authorities with
regard to carbon derivatives falling under MiFID/MAD. Moreover, a close cooperation with
related sectoral authorities is essential to gain a full overview of the carbon market as ESMA
will have no traction capacity for non-financial transactions in the carbon market and might
lack the relevant sectoral expertise.

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