CLASSIFICATION
Progressing NZ ETS market governance - Approval
to lodge Cabinet paper
Context
1. The purpose of this paper is to seek your feedback on the attached Cabinet paper on the
NZ ETS market governance work programme.
2. By way of background, in June 2023 the previous Government agreed to:
i
amend legislation to enable the NZ ETS Register, which is administered by the
Environmental Protection Authority (as applicable) to publish or share certain market
information already collected and require account holders to provide more
information when NZUs (New Zealand Unit) are traded;
ii
establish an education campaign for all people interacting with the NZU market; and
iii
treat NZUs as a financial product for the purposes of Part 2 of the Financial Markets
Conduct Act (FMCA) and add regulation-making power to the FMCA [DEV-23-MIN-
0135 refers].
3. They also agreed:
in principle that a centralised exchange should be compulsory and directed officials
to begin a Request for Proposal process with a report back to Cabinet, to procure a
centralised exchange.
4. In February 2024, you directed officials to make changes to the market governance
work. These included taking a phased approach that prioritises options that are the most
effective, at the least financial cost, and with the lowest compliance burden on
participants. You also decided not to progress the procurement of a centralised
exchange and clearinghouse at this time, focusing instead on more targeted measures
to improve the collection and reporting of trading information and enhanced oversight of
the NZU market [BRF-4290 refers].
5. The attached Cabinet paper is an updated version of the draft provided to you on 24
April [BRF-4609 refers] and reflects the refreshed market governance work programme,
which comprises:
i
improving how the Government collects and reports NZU transaction information;
ii
options to undertake market monitoring and consideration of associated risks;
iii
proposals to ensure basic market integrity rules for the NZU market; and
iv
developing an information initiative for the NZU market.
It also notes your decision not to progress procurement of an exchange at this time. We
have updated the paper to include more detail on the background of market governance
and the options being considered.
BRF-4994
2
CLASSIFICATION
CLASSIFICATION
6. We propose to return to Cabinet before the end of the year for policy decisions.
Therefore, the timing of the next steps will be important to meet this deadline.
7. Given the Government’s interest in the NZ ETS and the NZU market, we propose that
ministerial consultation is undertaken as soon as possible to allow enough time for the
Cabinet paper to be agreed before the proposed lodging date of 25 July 2024 for
consideration at Cabinet Economic Policy Committee on 31 July 2024, and Cabinet on 5
August 2024. The Department of the Prime Minister and Cabinet, Ministry of Business,
Innovation and Employment, Ministry for Primary Industries, Treasury, Environmental
Protection Authority and Financial Markets Authority were consulted on the Cabinet
paper, and their feedback was incorporated.
Recommendations
We recommend that you:
a.
agree to provide feedback on changes to the draft Cabinet paper (Appendix 1) to officials
by 15 July.
Yes | No
b.
agree to aim for Cabinet consideration of the paper on 5 August 2024. Note the following
steps to lodging the Cabinet paper for Economic Policy Committee and Cabinet
consideration:
18 to 24 July: Ministerial consultation;
25 July: Cabinet paper lodgement;
31 July: Economic Policy Committee; and
5 August: Cabinet consideration.
Yes | No
Signatures
Mark Vink
General Manager, Markets
Climate Change Mitigation and Resource Efficiency
10/07/2024
BRF-4994
3
CLASSIFICATION
CLASSIFICATION
Hon Simon WATTS
Minister of Climate Change
/07/2024
BRF-4994
4
CLASSIFICATION
CLASSIFICATION
Appendix 1: Cabinet paper
BRF-4994
5
CLASSIFICATION
CLASSIFICATION
Policy and Privacy
CLASSIFICATION
Office of the Minister of Climate Change
ECO - Cabinet Economic Policy Committee
Progressing NZ ETS market governance
Proposal
1
This paper outlines my proposed work programme to improve the market governance
of the New Zealand Emissions Trading Scheme (NZ ETS), with a particular focus on
the secondary market (NZU market). I am seeking to inform Cabinet of the market
governance work programme, after which I intend to make a public announcement on
these updates.
Relation to Government priorities
2
Ensuring that the market governance of the NZ ETS is robust and fit for purpose is
important for delivering a number of Government priorities, including:
2.1
the Prime Minister’s ninth public service target - New Zealand is on track to
meet its 2050 net zero climate change targets, with total net emissions of no
more than 290 megatonnes from 2022 to 2025 and 305 megatonnes from 2026
to 2030;
2.2
the Climate Change Strategy endorsed by Cabinet on 3 June, which identifies
credible markets to support the climate transition as a priority [ECO-24-MIN-
0097, CAB-24-MIN-0195 refers];
2.3
the discussion document for the second emissions reduction plan identifies a
credible NZ ETS as crucial and that an action to support this is strengthening
market governance.
Executive summary
3
This paper informs Cabinet of my proposed work programme to improve the market
governance of the NZ ETS. Some aspects of this work were started under the previous
administration. I am refreshing the work programme to align with this Government’s
priorities. This work will enhance the credibility of the NZ ETS by addressing
weaknesses in the governance and oversight of the NZU market and by improving the
availability of market information to participants.
4
Overall, the regulatory framework for the NZU market is unclear and not well suited to
address unacceptable market behaviour. There is limited market information available
to participants. This impacts the effectiveness of the NZ ETS and means that its market
governance arrangements are out of step with international norms. Stakeholders have
told me that market governance arrangements need to be improved.
5
There is no evidence that misconduct is currently happening in the NZU market, but
there is also no system in place to detect such misconduct. Current settings therefore
2
CLASSIFICATION
CLASSIFICATION
make us vulnerable. Should misconduct, such as price manipulation, occur, it could
severely impair confidence in the market and therefore significantly impact the
effectiveness of the NZ ETS.
6
The work programme will take a phased approach and will focus on options that are
the most effective, involving least financial cost, and with the lowest compliance burden
on NZU market participants. It will include:
6.1
Improvements to the NZU transaction information that the Government collects
and reports to ensure adequate price transparency. This could include
requiring participants to provide key trading information, such as trade price
and trade settlement date, and capturing administrative transfers when
recording a transfer of NZUs in the NZ ETS Register;
6.2
Proposals to ensure adequate market integrity rules are in place for the NZU
market, such as prohibiting market manipulation and the provision of false or
misleading advice, as well as disclosure requirements for conflicts of interest;
6.3
Options to undertake market monitoring so misconduct can be detected; and
6.4
Developing an information initiative for the NZU market to improve participant
understanding and market efficiency.
7
In 2023, the previous Government agreed, among other things, to begin procurement
of a government-funded exchange and clearinghouse for trading NZUs. I have decided
not to progress this procurement further at this time as I consider the most immediate
improvements to the market governance of the NZU market are best delivered through
the targeted measures discussed above.
8
Following Cabinet consideration of this paper, I propose to publicly announce the
refreshed work programme for market governance, including the decision to not
progress the procurement of a government-funded exchange and clearinghouse for
the NZU market.
9
I intend to report back to Cabinet on the market governance project later this year. That
paper will seek Cabinet decisions on specific initiatives.
Background
10
The NZ ETS is the best tool the Government has to reduce net emissions at least cost;
however, its effectiveness depends on its credibility. The NZU market is significant –
the total value of NZUs on issue is over $7.5 billion.1 The market governance work
programme will enhance NZ ETS credibility by addressing weaknesses in the
governance and oversight of the NZU market and by improving the availability of
market information for participants and the Government.
11
Improving market governance is about strengthening the policies and rules applied to
manage risks of misconduct in the NZU market and to ensure there is sufficient
transparency of activity in the market. Ensuring market participants are adequately
informed and protected against misconduct assists in building a robust, efficient, and
credible emissions trading scheme.
1 Source: https://www.epa.govt.nz/industry-areas/emissions-trading-scheme/market-
information/privately-held-units/, 30 June 2024; and https://www.commtrade.co.nz/.
3
CLASSIFICATION
CLASSIFICATION
12
The Climate Change Response Act (CCRA) establishes the NZ ETS and provides its
legal framework. However, the CCRA does not have provisions regulating NZU market
conduct. In addition, financial market regulations (such as those contained in the
Financial Markets Conduct Act) do not apply to NZUs as they are not considered to be
financial products. Market conduct for NZUs is primarily governed under general
competition and consumer laws, mainly the Fair Trading Act.2
13
This means action to prevent or respond to NZU market misconduct, such as price
manipulation, would need to be taken by the Commerce Commission, or directly by
market participants, under the Fair Trading Act. This would prove challenging as it is
not the type of misconduct that Act is primarily concerned with, and the Commerce
Commission does not have suitable regulatory tools or expertise to respond to market
misconduct. These general competition and consumer laws only set out what
constitutes unacceptable behaviour in a broad sense; it is not clear how these general
laws should apply specifically to the NZU market and there is no guidance on what
constitutes acceptable market behaviour.
14
In addition, no Government department or agency is currently charged with monitoring
NZU market activity for misconduct.
15
There is also weak transparency to both the Government and the market of key NZU
trading information, such as price and volume. Platforms that enable trading of NZUs
do publish some information, but it is not complete. In addition, a large volume of
trades occur directly between participants (so called “Over the Counter”, or OTC,
trades) and there is no price or volume visibility of these.
16
Overall, the regulatory framework for the NZU market is unclear and not well suited to
address unacceptable market behaviour, and there is limited market information
available to participants. This impacts the effectiveness of the NZ ETS. For markets to
function effectively and efficiently, good market information must be available, and
markets need to operate within robust frameworks that clearly define acceptable and
unacceptable conduct. The market governance programme seeks to address these
issues.
17
There is no evidence that misconduct is currently happening in the NZU market, but
also there is no system in place to detect this misconduct. Current settings therefore
make us vulnerable. Should misconduct, such as price manipulation, occur, it could
severely impact confidence in the market and therefore significantly impact the
effectiveness of the NZ ETS. Feedback through previous consultation voiced support
for a regulatory regime that mitigates the risks of misconduct and harm in the market
and that progresses an efficient and transparent NZU market.
18
Market governance arrangements for the NZ ETS are also out of step with the
international trend. In other jurisdictions, carbon market trading is generally regulated
under regimes designed for financial products, there is monitoring of trading, and
mechanisms are in place to provide transparency of key trading information.
19
There are unique aspects to the NZ ETS, such as its relative size and the inclusion of
forestry, which will mean that the specific regulatory approaches in other jurisdictions
are not necessarily well suited in the New Zealand context. Nevertheless, our lack of
2 Anti-competitive behaviour, such as colluding on bids in NZU auctions, is prohibited under the
Commerce Act, and the corrupt use or disclosure of official information by officials, such as insider
trading by officials, is covered by the Crimes Act.
4
CLASSIFICATION
CLASSIFICATION
consistency with other jurisdictions highlights the need to review our market
governance arrangements to ensure they are appropriate.
Decisions of the previous Government
20
In 2023, the previous Government progressed decisions to improve NZU market
governance [DEV-23-MIN-0135, CAB-23-MIN-0280 refers].
21
I note the following key decisions from this time:
21.1
Directing officials to begin a procurement process to procure a centrally
cleared, exchange for trading NZUs, with an associated fiscal cost of an initial
$10 million and ongoing costs of $5 million per annum;
21.2
Agreeing to make necessary amendments to the CCRA and other relevant
legislation, such as the Financial Markets Conduct Act 2013 (FMCA) to enable
the collection of better information and enhanced oversight of the market;
21.3
Agreeing to progress an ‘education campaign’ for all people interacting with the
NZU market.
Proposed Market Governance work programme
22
I propose to take a phased approach to improving market governance, initially focusing
on options that are the most effective and with the lowest compliance burden on
participants. Some aspects of the work that the previous administration started can
usefully be continued as part of a refreshed work programme, while others are less
aligned with this Government’s priorities and are not part of my proposed approach.
23
As part of my proposed changes, I have decided not to progress the procurement of a
government-funded exchange and clearinghouse for the NZU market. I consider that
the most immediate improvements to market governance arrangements would be best
delivered through lower cost, targeted measures to improve the collection and
reporting of trading information, and enhanced oversight of the NZU market.
24
The details of the work programme are set out below. The refreshed work programme
will progress in consultation with the Minister of Commerce and Consumer Affairs, and
the Minister of Forestry.
25
I intend to report to Cabinet on the progress of the market governance project later this
year. This report-back will include comprehensive supporting details, including an
options analysis, and will seek Cabinet approval on specific initiatives.
26
I note that fully implementing some options will have some associated cost, for
example to adjust the NZ ETS Register. The costs associated with different options,
and how these could be managed including phased implementation, will be included
in the Cabinet report-back.
Decision to adopt stronger transaction reporting
27
A key component of the market governance programme is considering how to improve
the transparency of trading information in the NZU market. The weak transparency of
market information in the NZU market affects both the ability for participants to make
informed trading decisions and for the Government to detect market misconduct.
5
CLASSIFICATION
CLASSIFICATION
28
Options will be investigated to capture information about all trades relating to NZUs.
This could include requiring participants to provide key trading information, such as
trade price and trade settlement date, and to capture administrative transfers when
recording a transfer of NZUs in the NZ ETS Register. This is similar to the approach
taken in the Californian emissions trading scheme to capture key market information
about trades. Officials will test these proposals with key stakeholders through targeted
engagement before Cabinet decisions are sought.
29
I will also consider options for publishing this trading information. Greater access to
such market information will allow market participants to make more informed trading
decisions.
Decision to develop enhanced standards and oversight of the NZU market
30
As noted above, the regulatory framework for the NZU market is unclear and not well
suited to address unacceptable market behaviour. Combined with the lack of market
oversight, this makes it difficult to determine whether misconduct is taking place, and
to respond if it were discovered. I have instructed officials to advise on options to
ensure clear, adequate market integrity rules for the NZU market, such as prohibiting
market manipulation and the provision of false or misleading advice, as well as
disclosure requirements for conflicts of interest.
31
This could include bringing NZUs into the scope of specific sections of the Financial
Markets Conduct Act, so conduct in the market is governed by that Act rather than the
Fair Trading Act, and enabling the Financial Markets Authority to enforce these rules.
32
Officials will explore opportunities with trading platform operators and potentially other
market participants about what can be achieved voluntarily.
33
I have also asked officials to consider measures and provide advice on options for
market monitoring, utilising the proposed transaction reporting data. The market
monitor could then refer suspected misconduct to the responsible agency for
enforcement.
Decision to develop an information initiative
34
The NZ ETS and the NZU market are complex and unique. Some current and
prospective participants in the market may not fully comprehend how the market
operates or the extent of risk they are exposed to when transacting. Stakeholders have
also expressed that well-coordinated market-related information would assist
participants’ decision making and help them gain insight into the market. Accordingly,
I have instructed officials to progress with an information initiative. This will be
progressed in phases.
35
The first phase, an external calendar, will provide clearer and more consolidated
information for NZU market participants and the wider public about the NZU market
and Government decisions that could affect it. Stakeholders have asked me to provide
this calendar. It is in the final design stages and will be implemented shortly.
36
Officials are progressing a second phase, which will provide clear information on how
the NZU market operates and what risks are involved. Future phases will be
progressed as needs are identified. The information initiative is a cost-effective way to
improve market efficiency and participant understanding.
6
CLASSIFICATION
CLASSIFICATION
Decision to not procure a government-funded exchange and clearinghouse for the NZU
market
37
Previous Cabinet decisions to begin the procurement of an exchange and
clearinghouse were intended to improve transparency and oversight, alongside
assisting the general development of the NZU market.
38
Ministry for the Environment officials initiated the procurement process, beginning with
a Request for Information. Seven responses were received. The procurement process
has not progressed past this stage.
39
I agree that transparency and oversight of the NZU market must be improved;
however, I consider the most immediate improvements to the market governance of
the NZU market are best delivered through other targeted measures as discussed
above. Accordingly, I have decided not to progress this procurement further.
40
Some market participants may be disappointed with this decision as they see a
government-funded exchange and clearinghouse as a key element in improving the
integrity and transparency of the NZU market. However, the cost to procure, build, and
operate an exchange and clearinghouse would be considerable (estimated to cost an
initial $10 million with ongoing costs of $5 million per annum). Moreover, a voluntary
exchange, which participants can choose not to use, may not address the underlying
issues facing the market. Furthermore, a mandatory exchange would risk disrupting
the existing trading platform providers and those who trade in the market.
41
I believe a staged approach to market governance is prudent and in line with our fiscal
goals. An exchange could be considered at a later stage after the impact of the
targeted measures is evaluated. Officials will engage with key market participants to
inform the report back to Cabinet later this year.
Implications
42
There are no cost-of-living, population, or human rights implications associated with
these decisions regarding the market governance programme.
43
This paper has no financial implications.
44
I will provide detailed advice on the legislative and Treaty implications for this work
when I report back to Cabinet on this work before the end of the year. This report back
will also be accompanied by a Regulatory Impact Statement.
Consultation
45
Public consultation on the direction of market governance took place in 2021 and 2022.
Feedback provided through consultation in 2021 and 2022 indicated broad support for
enhancements to market governance.
46
I do not consider further general consultation to be necessary at this stage. However,
I have asked officials to undertake targeted engagement with key stakeholders to test
the proposals to improve transaction reporting and ensure there are adequate market
integrity rules to inform the Cabinet report-back. Officials will also discuss the role a
centralised exchange could play in the market in the future.
47
The Department of the Prime Minister and Cabinet, Ministry of Business, Innovation
and Employment, Ministry for Primary Industries, Treasury, Environmental Protection
7
CLASSIFICATION
CLASSIFICATION
Authority and Financial Markets Authority were consulted on this paper, and their
feedback was incorporated.
Communications
48
The discussion document on the second emissions reduction plan mentions that the
Government is working to strengthen market governance, but it does not provide any
details on this work. As such, following Cabinet consideration of this paper, I propose
to publicly announce the refreshed work programme for market governance, including
the decision to not progress the procurement of an exchange and clearinghouse for
the NZU market.
49
I propose that the announcement occur via press release, with scheduling set for
outside of market trading hours. Respondents to the previous procurement process for
the exchange and clearinghouse will be contacted.
Proactive Release
50
This paper will be proactively released following the public announcement.
Recommendations
1
Note the market governance programme will improve information transparency, and
the integrity and efficiency of the NZU market. This will foster confident and informed
participation, and ultimately strengthen the NZ ETS as a tool to support the Coalition
Government’s climate change priorities.
2
Note I will not progress work on a procurement of a government-funded exchange and
clearinghouse.
3
Note the refreshed market governance
work programme will include:
3.1
Improving how the Government collects and reports information about trades
related to NZUs;
3.2
Proposals to ensure there are adequate market integrity rules for the NZU
market;
3.3
Options to undertake market monitoring; and
3.4
Developing an information initiative.
4
Note the above work programme will progress in consultation with the Minister of
Commerce and Consumer Affairs, and the Minister of Forestry.
5
Note my intent to make a public announcement via press release on the market
governance work programme. This announcement could impact the market and will be
timed accordingly.
6
Note I have instructed my officials to undertake targeted engagement with key
stakeholders to test the proposals to improve transaction reporting and ensure there
are adequate market integrity rules to inform the Cabinet report-back. Officials will also
discuss the role a centralised exchange could play in the market in the future.
8
CLASSIFICATION
CLASSIFICATION
7
Note I will report back to Cabinet seeking final policy decisions on the issues covered
in this paper before the end of the year.
Hon Simon Watts
Minister of Climate Change
9
CLASSIFICATION
