Ontario wades into cap-and-trade

As Ontario prepares to implement a cap-and-trade system to curb greenhouse gas emissions, businesses have expressed concern about lingering uncertainties related to the new regime. One particular question involves how these carbon credits will be categorized.

“What are the legal characteristics of that thing that I’m buying and selling?” asks Jason Kroft, a lawyer at Stikeman Elliott LLP in Toronto. “Is it a security? Is it a commodity? Is it a derivative instrument? How is it regulated?”

Under the cap-and-trade system adopted by the province on April 13, companies must hold credits equivalent to their emissions. Carbon credits can be purchased on the secondary market by companies that emit more than a particular threshold (10,000 metric tons in Québec). Companies that emit less, meanwhile, can sell their extra credits and reap a profit. Credits can also be purchased from the government in auctions, or in Québec’s case, given free to certain industries.

The secondary market acts like a securities exchange, where both emitters and non-emitters can participate, but these credits are not considered securities. As such, the carbon market will run separately from any regular exchange, such as the TSX. In Québec, the products contained within this new parallel market are considered by some to be “intangible commodities.”

Jean Piette, a lawyer at Norton Rose Fulbright Canada LLP in Montréal, says the regulatory body in Québec made sure of this differentiation. “They’re not securities within the meaning of Canadian securities laws, and this has been checked with the Autorité Des Marchés Financiers in Québec, which is the regulatory body. So both organizations are in contact because they want to make sure that there’s full understanding of the nature of these units.”

Ontario’s decision to go cap-and-trade rather than the carbon tax route, as BC has done, will mean it will work closely with two other cap-and-trade jurisdictions, Québec and California. Ontario already had the basic legislative framework for a cap-and-trade system when it passed Bill 185, the Environmental Protection Amendment Act, but it was never supplemented by regulation. Québec’s system is regulated under its Environment Quality Act.

André Turmel, a lawyer at Fasken Martineau DuMoulin LLP in Montréal, says he recalls similar questions about carbon credits in the early days of Québec’s cap-and-trade system.

“One of the main issues was … if you are somebody who wants to trade or sell, you have to cope with the methodology that is being agreed upon by either the California or Québec system. So that means a lot of monitoring.” He adds that understanding the new system, as opposed to complying with it, was the initial challenge.

To be sure, defining carbon credits was essential for Québec to avoid the kinds of violations that could be committed under regular securities trading conditions. With an already highly regulated securities industry in place, the secondary carbon market borrowed some of those concepts.

“We’ve seen references to them being described as sui generis, or a parallel system that uses language and concepts similar to those that are found under derivatives or securities legislation, but fall out of that,” says Anne Drost, a lawyer at Blake, Cassels & Graydon LLP in Montréal. “They can be considered an intangible commodity or, very roughly … consider the emission allowances being a quota or a permit.”

Michael Bantey, an M&A lawyer also at Blakes in Montréal, adds that the government used regulations in the securities industry to stem practices deemed harmful to this new market.

“I guess having the benefit of the securities and derivatives regimes, which themselves are highly regulated, the government has thought, ‘Well, wait a minute, here are some issues ... and we have the benefit of what we’ve regulated as securities and derivatives. ... They’re not those things, but let’s make sure that, like those, [we] avoid the same kinds of issues that could arise.’”

Drost adds that there are references in the regulation to Québec’s Derivatives Act, alluding perhaps to the possibility that Ontario will also borrow from its own securities regulations.

In spite of these possible hurdles, Ontario and its industries stand to benefit from the fact that Québec and California have already done much of the legwork, according to Drost.

“Perhaps the good news for Ontario is that California and Québec have already started, so a lot of the difficulty has been overcome. It took quite a lot of time to iron out the regulations. The ramping up was about two years in the making, so I think that it will be easier for Ontario to join.”