Rules and Parameters - Amazon S3 › arquivos2.gvces.com.br › epc › ...corporate leaderships to manage GHG emissions and climate risks, and suggest public policies for a low-carbon

BUSINESS FOR CLIMATE PLATFORM

EMISSIONS TRADING SYSTEM SIMULATION

Rules and Parameters

An initiative of: Partnership:

February 2015

Center for Sustainability Studies (GVces)

Business Administration School at Getulio Vargas Foundation (FGV-EAESP)

http://www.fgv.br/ces 2

Table of Contents

GLOSSARY OF TERMS ............................................................................................................................. 3

1. INTRODUCTION ............................................................................................................................... 3

PURPOSE OF EPC ETS SIMULATION .......................................................................................................................................... 3

CAP & TRADE SYSTEM OVERVIEW ............................................................................................................................................ 4

2. EPC ETS GENERAL PRINCIPLES ........................................................................................................ 4

GOALS AND OBJECTIVES OF EPC ETS PLAYERS IN 2015 ........................................................................................................... 5

SCHEDULE OF THE EPC ETS ANNUAL CYCLE ............................................................................................................................ 5

3. ACTORS AND ROLES IN THE ETS IN 2015........................................................................................... 6

4. EPC ETS SIMULATION RULES AND PARAMETERS FOR 2015 ............................................................... 7

INVENTORY FOR THE BASE YEAR AND SUBSEQUENT YEARS.................................................................................................. 7

CHANGES IN THE CORPORATE LIMIT ........................................................................................................................................ 7

GLOBAL ABSOLUTE CAP AND REDUCTION GOAL ................................................................................................................... 8

EMISSIONS SCOPE UNDER CONSIDERATION .......................................................................................................................... 8

MARKETS AND NEGOTIABLE BONDS ....................................................................................................................................... 9

ALLOWANCES ALLOCATION ................................................................................................................................................... 12

INITIAL ALLOCATION OF FICTITIOUS FINANCIAL RESOURCES ............................................................................................... 13

USE OF OFFSETS ...................................................................................................................................................................... 13

BANKING .................................................................................................................................................................................. 14

CONFIDENTIALITY .................................................................................................................................................................... 14

MARKET ANALYSIS .................................................................................................................................................................. 15

PENALTIES ................................................................................................................................................................................ 15

MEMBERSHIP AND WITHDRAWAL ........................................................................................................................................... 16

MARKET STABILITY RESERVE (MSR) ........................................................................................................................................ 16

REFERENCES ......................................................................................................................................... 18

http://www.fgv.br/ces




Glossary of Terms

EPC | Business for Climate Platform

GVces | FGV-EAESP Center for Sustainability Studies

EPC ETS | Business for Climate Platform Emissions Trading System

GHG | Greenhouse Gases

Scope 1 | Calculates GHG emissions that are released or controlled by the organization (GVces and WRI, 2011)

Scope 2 | Calculates GHG emissions from the purchase of electric and thermal power consumed by the

organization (GVces and WRI, 2011)

Scope 3 | Calculates emissions resulting from activities performed by the organization, but that occur in sources

that do not belong to or are not controlled by the organization, i.e.; emissions throughout the value chain

(GVces and WRI, 2011)

MO | Market operator; includes RMO and SMO

RMO | Regulated market operator; it refers to EPC ETS participating companies whose emissions are regulated

by the environmental regulator body

SMO | Special market operator; it includes investment banks and offset traders

MC | Management Committee

AC | Advisory Council

Ec$ | EPcents

EU ETS | European Union Emissions Trading System

1. Introduction

The Business for Climate Platform1 (EPC), an initiative coordinated by the Center for Sustainability Studies (GVces)

at Getulio Vargas Foundation2 was launched in 2009 with the purpose of involving, mobilizing and engaging

corporate leaderships to manage GHG emissions and climate risks, and suggest public policies for a low-carbon

economy. In 2015, EPC counts with the participation of 34 large enterprises from different sectors of the Brazilian

economy. In 2014, the first year of operation of the EPC Emissions Trading System (EPC ETS) simulation, there were

20 participating companies. For more information and to access EPC ETS analytical reports, please visit EPC ETS

webpage.

Purpose of EPC ETS Simulation

Currently, there are a number of multinational, national and subnational initiatives of 'cap & trade' systems, where

'cap' refers to a maximum desired threshold of emissions, and 'trade' refers to emissions trade. The major examples

are the European multinational system (EU ETS), Australia and New Zealand national systems, and subnational

systems in California, China (7 subnational systems: 2 provinces and 5 cities), and Quebec (Canada).

1 For more information, please visit http://www.empresaspeloclima.com.br 2 For more information, go to: http://www.gvces.com.br


http://www.empresaspeloclima.com.br/sistema-de-comercio-de-emissoes-sce?locale=pt-br


http://www.empresaspeloclima.com.br/

http://www.gvces.com.br/




Considering that global agreements on greenhouse gas emissions are expected to become mandatory from year

2020 on, and that Brazil has to meet the emission reduction targets that can no longer be achieved by exclusively

reducing deforestation, there have been discussions on possibilities of implementing a cap and trade system in the

country.

In this context, EPC has developed, along with its member companies, a cap and trade system simulation in order to

allow the private sector to better understand how this economic tool works, as well as to support the Brazilian

Government with suggestions on how to outline and implement a similar system in Brazil, if this is the case in the

future.

Cap & Trade System Overview

By determining a target for GHG emissions reduction when compared to a base year, the body actually establishes

an expected cap for emissions. In order to have the lowest possible costs to meet that reduction target, the body

creates, associated with the reduction target, an emissions trading system (market), and makes it available to the

system players, through auctions or direct allocation (either free or charged), an amount of emission allowances

equivalent to the cap. In this system, organizations purchase the allowances needed to compensate for their

emissions. Purchases can be made through auctions (primary market) or directly from other players (secondary

market).

In order to make the cap still more flexible, the body can allow participating companies to buy compensation bonds

from projects of reduction or removal of emission sources not covered by cap & trade, widely known as carbon

credits (offsets).

At the end of the year, all participating companies shall submit to the authority the amount of bonds (allowances

and offsets) equivalent to their actual emissions for the period. Those who were not able to get the amount in bonds

equivalent to their emissions will be penalized.

Thus, the emissions trading system allows companies with higher costs to reduce emissions to buy bonds from

other companies that have lower costs to reduce emissions. Ant it is through this cost balance that the total lowest

cost is achieved for the global emission reduction target established by the authority.

Businesses should always take into account the costs involved and assess which option is more beneficial for them:

reduce emissions or buy the equivalent in bonds available in the carbon market. This decision may vary according to

the market current prices. As bond offer is determined by the cap, the higher the demand, the higher the prices.

And, if market bond prices rise a lot, bond purchase may be less attractive than investments on reductions in

company operations, which can lead to higher investments on technology innovation related to GHG emission

reduction.

In order to keep bond prices within a certain interval, the regulating body can use some mechanisms, such as

establishing a minimum value, purchase and sale of bonds in the market, market stability reserve, or even act as an

operating agent.

2. EPC ETS General Principles

All companies participating in the EPC ETS simulation shall submit to the Management Committee (MC) the

amount of bonds (emission allowances or offsets)3 equivalent to their actual emissions for the period, by the end of

the trading period for the current year4.

3 Rules for using offsets can be found in item Use of Offsets, and those bond characteristics and the limits of their use are part of Offsets

Normative Ruling.





Goals and Objectives of EPC ETS Players in 2015

The objective of companies participating in this simulation is to balance emission reduction actions with the

purchase of emission allowances in the EPC ETS, in order to get the lowest economic cost for their GHG emissions

management in each cycle. The economic cost of GHG emission management will consider the sum of expenses

related to reduction activities plus expenses with EPC ETS.

Each player has the following goals in the EPC ETS:

1. Cover each CO2e ton released during the year of the current cycle (projections for each company) with bonds

available in the EPC ETS5.

2. Obtain the lowest cost per ton of CO2e handed over to the MC in the form of bonds traded in EPC ETS, at the

end of the trading period for the current year. At the end of the trading period, the cost of buying the bonds

handed to the MC shall be calculated, as well as incomes from the sale of bonds that were not handed to the

MC, occasional penalties due to emissions not covered by bonds, and the financial result of speculation

operations (purchase and sale of the same bonds with the purpose of having financial gains).

Schedule of the EPC ETS Annual Cycle

EPC ETS has annual cycles; operations occur from March to November, when the secondary market remains open

everyday, 24x7. There are two fixed bond auctions that are held in every cycle: when the market opens and when it

closes. Other auctions can be included by the MC in the specific schedule for each cycle. The auction painted gray, in

the illustration above, indicates such possibility.

4 Bonds are handed to the MC upon completion of operations, at the end of each year. However, final conciliation is performed in August of

the subsequent year, when GHG emission inventories are published. 5 Actual accomplishment of the target will only be confirmed once GHG inventory for the current year is published.





Before the market opens, between February and March, there is a training to teach how to operate in the EPC ETS,

in which we give a brief overview of the key concepts, present the rules and parameters that will be followed in the

current cycle and the online trading platform, where secondary market transactions and auctions occur.

The EPC ETS monitoring is translated into two major reports, a half-year and an annual analytical report, plus

quarterly operational reports targeted at participating companies. Communication becomes more regular, through

fortnightly newsletters sent by e-mail to EPC ETS participating companies summarizing the transactions for the

period, ad hoc news and normative rulings, defining specificities or detailing the rules and parameters presented

here.

3. Actors and Roles in the ETS in 2015

Management Committee (MC): Composed by GVces’ team, it is responsible for regulation (through normative

rulings), communication (creation of reports, newsletters and the like) and operation (physical delivery and financial

settlement of the operations, auctions, etc.). It will act in such a way to avoid and fix market distortions, and will

follow up EPC ETS performance data, which will be part of the analytical reports.

Advisory Council (AC): Composed by national and international experts on carbon market, the Advisory Council has

the purpose of contributing to strategic decisions when it comes to creating and managing the EPC ETS. Whenever

needed, the Council will be consulted about the best way to solve potential conflicts or situations that were not

anticipated in EPC ETS rules. To get to know the AC members, please visit EPC ETS webpage.

Regulated market operators (RMO): Companies that are part of the EPC ETS and are qualified to trade bonds in

the market. They are the 'regulated operators', meaning their GHG emissions are regulated and shall be conciliated

with market bonds at the end of the cycle. All companies that are EPC members and all companies that are

members of Brazil GHG Protocol Program with Scope 1 emissions equal to or greater than 10,000 tCO2e are eligible

to participate in the EPC ETS. They are required to have their GHG emission inventories available to the public from

2013 on.

Special Market Operators (SMO)

Offsets traders : Agents qualified to act in EPC ETS as offset traders, but not qualified to trade emission

allowances. They join EPC ETS with their own offset portfolio and financial resources, and trade directly with players

in the secondary market only. They are exempt from emission control regulation. The role of offset trader will be

played by two GVces members who are part of teams in different programs.

Investment banks: Agents qualified to operate in EPC ETS as traders. They will trade directly with players, and can

buy or sell any bond available in the secondary market – although they are not eligible to participate in auctions.

They are exempt from emission control regulation. They will enter the market without their own bond portfolio, but

with many financial resources. The role of offset trader will be played by two GVces members who are part of teams

in different programs.






4. EPC ETS Simulation Rules and Parameters for 2015

Inventory for the Base Year and Subsequent Years

EPC ETS simulation base year is 2013.

Since EPC ETS is based on real emissions data, engaged companies must therefore prepare and publish their

corporate GHG inventories according to the method defined in GHG Protocol, from base year (2013) and the

subsequent years companies participate in EPC ETS.

By using the method defined in GHG Protocol, we mean adopting one of the following documents: GHG Protocol

Corporate Standard (WRI, 2004); or Brazil GHG Protocol Program Specifications (GVces and WRI, 2011); or,

eventually, ISO 14064-1 (ABNT, 2007). Using other methods for calculating and reporting emissions can generate

distortions during the comparison with calculations of emissions made by other participating companies.

By publishing inventories we mean making the company's GHG emission data related to Scope 1 and Scope 2

(separately), at least, available to public consultation through Sustainability Reports, corporate website, or

platforms such as the Public Emissions Registry, among other examples.

Changes in the Corporate Limit

Whenever there is any change in the company's organizational limit compared to the base year (such as mergers,

acquisitions/building of new facilities or divestment), it will be necessary to make adjustments in the emission

calculation related to the current year and to past years. Recalculation of emissions aims at ensuring consistency

and ability to compare the company's emissions throughout the years, which includes establishing inventory

(organizational and operational) limits6.

Adjustments in inventories shall be made using emission estimates or actual data, and primary data shall be priority.

Should emission data not be available, organizations can use secondary data as an anticipation of annual production

and corresponding retroactive estimates, leveraging carbon intensity indicators from their own company; or, still,

when this piece of information is not available, they can use industry benchmarks in Brazil.

There are many cases of changes in the organizational limit, and they may or may not require inventory recalculation, as follows:

Purchase or building of new facilities: Organizations shall estimate emissions from the facility since

the beginning of its operation, and regularly account for it in their inventories. Organizations will receive

in emission allowances the free initial allocation quota corresponding to the new facilities, applying the

same percentage set in the benchmark rule, as established in the free initial allocation in the beginning

of the EPC ETS cycle. As the facility did not exist yet in the base year, there are actually no emissions to

be included in the base year and, therefore, there is no point in calculating it.

Purchase of existing facilities: The inventory shall be recalculated, summing up emissions of all

purchased facilities, from the base year up to the current year (or to the last inventory published by the

organization). In that case, the 'environmental liability' concept shall be applied, meaning the

organization that bought the facility is accountable for its total emissions, including past emissions.

Organizations will receive in emission allowances the free initial allocation quota corresponding to the

purchased facilities, applying the same percentage set in the benchmark rule, as established in the free

initial allocation in the beginning of the EPC ETS cycle.

6 You can refer to organizational limits in Brazil GHG Protocol Program Specifications, Chapter 4.


https://s3-sa-east-1.amazonaws.com/arquivos.gvces.com.br/arquivos_ghg/152/especificacoes_pb_ghgprotocol.pdf




Mergers: The inventory shall be recalculated, summing up emissions from all facilities in the merged

companies. If applicable, the industry in which the organization operates shall be adjusted, applying the

corresponding intra-industry indicator(s) to recalculate the benchmark and initial free allocation of

emission allowances.

Divestments or sale of facilities: The inventory shall be recalculated, subtracting emissions of all sold

facilities, from the base year up to the current year (or to the last inventory published by the

organization). The organization will deduct the free initial allocation quota in emission allowances

corresponding to the facilities sold.

In any case, participating organizations are responsible for updating the data and communicating the MC every

year, in August, during their emission conciliation with the previous cycle, about the change in their organizational

limit. Emission estimates shall be calculated and normalized for the whole operational year, i.e.; for all 12 months of

the year, except for building or purchase of new facilities (those that did not exist yet in the base year). For existing

facilities, mergers or acquisitions, the base year shall be recalculated, applying the same organizational limit of the

current year.

Global Absolute Cap and Reduction Goal

EPC ETS has adopted a global absolute cap. Thus, the total emission allowances (cap) made available by the MC at

each cycle is determined according to the global reduction goal applied to total emissions for the same RMO group

in the base year, 2013.

In order to determine a relative cap, we would need to have information that is not currently available on reduction

history, marginal costs of deduction for the industries involved and/or establish an intensity indicator that could be

applied to different industries. We should also take into account the fact that most emission markets operating

worldwide started their operations with an absolute cap, and EPC ETS is still going through its second cycle.

As a guideline to determine the cap for each cycle, we established an incremental annual emission reduction

target of 2%, based on the target set in 2014, which was a 10% reduction compared to global emissions in the

base year. The incremental target of 2%7 does not prevent organizations that were penalized for not conciliating

their emissions in a given cycle from establishing feasible strategies for conciliation in the subsequent year.

Although a reasonable path to establish the reduction target could be through the national target of emission

reduction for 2020, as this target will likely be met based on deforestation reduction, the industry will not have to

significantly contribute to accomplish it. As we still do not know the target that will be established after 2020, EPC

ETS keeps the adopted model, inspired by UE ETS.

Emissions Scope under Consideration

Only Scope 1 emissions from the participating companies’ emissions inventories are considered in the EPC ETS. For

calculating the global cap, the items considered are the following: base year emissions, carbon intensity indicators,

industry benchmark, performance metrics, and the volume of bonds for conciliation.

Scope 1 consists of GHG direct emissions, which are released by sources that belong to or are controlled by the organization8.

7 The incremental target is close to the rate annually applied in the EU ETS (European Union), which is 1.74% per year (European Commission

website). 8 Source: Brazil GHG Protocol Program Specifications.


http://ec.europa.eu/clima/policies/ets/index_en.htm


http://www.ghgprotocolbrasil.com.br/especificacoes-do-programa-brasileiro-ghg-protocol?locale=pt-br




Markets and Negotiable Bonds

EPC ETS works as a spot market (cash) and as a futures market, and operates in two different modalities: auctions

(primary market) and stock market (secondary market).

a. The Spot Market

Spot market consists of immediate delivery of business (except for the time needed for bureaucratic procedures). In

this market, two different types of fictitious carbon bonds are transacted: emission allowances and offsets. Each

allowance or offset represents 1 ton of CO2 equivalent (tCO2e).

Offset characteristics are regulated through the Offsets Normative Ruling issued by the MC9.

Transactions in the spot market are immediately physically delivered and financially settled. Meaning: financial

resources committed by the bidder in the deal are transferred to the seller (financial settlement), and the seller

bonds are transferred to the bidder (physical delivery) as soon as the deal is closed.

It is through the spot market that RMOs, companies regulated by the market, build their position concerning the

physical and financial targets they should meet (presented under 'Goals and Objectives of EPC ETS Players in 2015',

on page 5). RMOs and SMOs (investment banks and offset trader) operate in this market.

b. The Futures Market

The futures market is characterized by an agreement to sell or buy an asset at a given time in the future, at a

previously settled price (Hull, 2009). Such agreements, with predefined specifications, are expressed in standard

contracts, and that is why bonds traded in futures markets are contracts. Futures contracts are, thus, considered

derivatives, since their goal is an asset traded in another market.

As for EPC ETS, futures contracts are derivative of the emission allowances traded in EPC ETS spot market10. RMOs

and SMOs participate in this market.

Futures contracts are both physically delivered and financially settled.

Physical delivery occurs at the contract maturity. The seller hands in emission allowances to the bidder, who, in its

turn, pays for the corresponding futures contract, at the price settled.

Financial settlement can occur at any time before the contract expires, and it is performed by reversing the position,

i.e.: in order to settle a long position (when investors buy bonds) in 10 futures contracts, they must sell the same

amount of the same type of contract, whereas to settle a short position (when investors sell bonds) in 10 futures

contracts, they must buy the same amount of the same type of contract.

Since in this market the settlement occurs sometime in the future, there is risk of default, should any party lose their

financial ability to honor the agreement before it is due. In order to mitigate such risk, the futures market relies on

two peculiar mechanisms: periodic adjustments and performance bond margins.

9 Normative Rulings can be changed by the MC anytime, but they will only be effective after they are communicated to the players of the

simulation at least one week in advance. All Normative Rulings effective in EPC ETS can be accessed at EPC website. 10

Important note: this futures market does not create emission allowances. Emission allowances are created by the cap established by the

EPC ETS and managed by the MC, which distributes them to the market through direct free allocation or auctions.


http://www.empresaspeloclima.com.br/simulacao-de-comercio-de-emissoes-da-plataforma-empresas-pelo-clima-sce-epc?locale=pt-br




Periodic Adjustments

The parties with open positions in the futures market (which bought or sold futures contracts) will have the values of

their positions periodically and compulsorily adjusted by the MC on predefined dates, based on a settlement price to

be calculated by the MC until the maturity of the contract. The adjustment consists of:

In the period when the deal is closed: Pay or get paid for the difference between the emission allowance future

price, according to the long or short position in the futures contract (price of the closed deal), and the adjusted price.

In subsequent periods, until maturity of the contract or reversing the position: Pay or get paid for the difference

between the adjusted price for the previous period and the adjusted price in the current period.

In summary, whoever is in long position (bought futures contracts) shall pay for the difference if the adjusted price is

lower than the futures price that was contracted (price of the deal), and shall receive the difference in case the

opposite situation occurs. Following the same rationale, whoever is in short position (sold futures contracts) shall

get paid for the difference if the average price of the futures is lower than the futures price that was contracted, and

shall receive the difference in case the opposite situation occurs.

Performance Bond Margins

While periodical adjustments minimize the likelihood of default, since they avoid the growth of a potential debt due

to variation of futures prices along time, performance bond margins are a tool to ensure an assets reserve that can

be used to honor the settlement of futures contracts if bidders or sellers run short of resources to honor the

adjustments or the physical delivery of their position at the maturity of the contract.

Thus, operators who open a position in the futures market (buy or sell EPC ETS emission allowance futures

contracts) must, necessarily, hand in to the MC, until the traded futures contracts mature, a certain amount of

assets in order to warrant the operations they have in the futures market. When the futures contract is mature, or

when the position is settled in advance, those assets are returned to the operator, except for the amount necessary

to cover occasional financial losses from that operator when the position is closed. The MC will take as collaterals:

emission allowances, verified offsets and financial resources.

Should the MO fail to honor periodical adjustments or physical delivery by the futures contract maturity date, the

MC will necessarily settle that MO's assets until the debt is paid. In case the MO's balance of assets is not enough to

honor the debt, the MC will cover the difference between the balance and the debt, and the MO will pay the total

amount plus interests in the following cycle. The interest rate is determined by the Futures Market Normative

Ruling that regulates this market, issued by the MC (available at EPC website).

The MC is entitled to block operations and settle assets of any MO in case it deems the RMO does not have enough

assets to honor the physical delivery or financial settlement of their open positions in the futures market, even

though deposited collaterals are taken into account.

Futures Contracts Specifications, Collaterals and The Like

Futures contracts characteristics, such as their expiration series, periodicity of adjustments, the method used to

calculate performance bond margins, and the hierarchy of the collateral types the MC will request from the

operators, among other aspects related to the futures market, are regulated through the Future Markets Normative

Ruling (available at EPC website).

It is not mandatory that RMOs, the companies regulated by the market, operate in the futures market in order

to build their positions concerning the physical and financial targets they should meet (presented under 'Goals

and Objectives of EPC ETS Players in 2015', on page 5). For such, all they need to do is operate in the spot market.







However, the futures market, a financial instrument for itself, may be critical for better performance in goal #2,

which is related to the lowest possible financial cost for the position.

Auctions (Primary Market)

For each EPC ETS cycle, there are two auctions: one for opening, and one for closing the cycle. The other auctions,

held throughout the operation cycle, are determined and promoted by the MC following a specific schedule,

according to market performance.

Auctions make up the primary market and will be promoted by the MC, representing a channel for entrance of

emission allowances and a possible channel for entrance of offset credits in the EPC ETS.

Opening prices for emission allowance auctions will be calculated by the MC using the following equation:

PLEPCd = 0.5 X (PEPCd-1) + 0.5 X (PEUd-1) PLEPC

d = Price for EPC market auction at day d

PEPCd-1

= Average price in EPC secondary market at day d-1

PEUd-1

= Average price in the European spot market at day d-1 or the day before, should values not be available at d-111

.

Notes:

- If there is no price reference in EPC ETS secondary market, the weight assigned to this market shall be 0 (zero), and the

European spot market will be the sole reference.

- If there is no transaction in EPC ETS secondary market at d-1, the price to be adopted shall be the price applied at the previous

closest date and when at least one transaction was made. The same will apply to prices in the European market.

- The MC, who is responsible for the auctions, may, at its sole discretion, add up to 10% of premium or apply a discount in

PLEPC in order to encourage liquidity in the market.

- The European spot market price will be communicated by the MC to the players prior to the auction.

- The European spot market price will be converted into Brazilian Reais (BRL), and then into EPCents (1BRL=1Ec$)

Auctions are scheduled in advance by the MC; the trading platform is open for bids from 11 AM to 6 PM on the date

set. Bid prices are submitted through digital means, anonymously. After closing, the system automatically checks

the winners. Physical delivery (transfer of bonds to the auction winners) and financial settlement (transfer of the

corresponding amount of EPCents from the auction winners to the MC) of the transactions occur at d+1 (on the day

following the order execution). Criteria for asset settlement in the auction follow the rule (i) the highest price

offered (Ec$/tCO2e); (ii) the oldest offer.

Secondary Market

Players can make offers to buy or sell bonds, through the online platform of the secondary market, daily, 24x7,

during the period EPC ETS operates in each cycle. The system does not disclose bidders, so, if the deal is closed, the

parties involved will not know who their competitors were. The system shows updated information on the open

offers, as well as on closed deals, so players can assess EPC ETS activity level, in addition to the prices offered, and

the prices of the deals closed up to that moment.

Deals are automatically closed by the system, as long as there are compatible bid prices and ask prices. When the

quantities are not compatible, the deal is closed using the amount corresponding to the lowest offer. In the event

there is more than one bid with the same price desired by the other party, the system will prioritize the bid entered

11

Please refer to prices on the website www.theice.com. European market: Products > All products > insert the contract code: ECP(ICE EUA

Phase 3 Daily) > data > last.


http://www.theice.com/

https://webmail.fgv.br/owa/redir.aspx?C=PPLYudzkgUmmlzXysu1we6IhACTGGNEIWkq6nAiHLIFG0k6q_GjPgtyWxJ1vOuHl4mAaNNNtQZU.&URL=https%3a%2f%2fwww.theice.com%2fproductguide%2fSearch.shtml%3fproductGuide%3d%26markets%3dICE%2520Futures%2520U.S.%26markets%3dICE%2520Futures%2520Europe%26markets%3dICE%2520Futures%2520Canada




earlier in the system. The system immediately communicates the player whose deal was closed, and automatically

transfers the resources (bonds sold to the bidder, and the equivalent EPCents amount to the seller).

Allowances Allocation

Part of the emission allowances issued is freely allocated to players at the beginning of each cycle. The

remaining allowances enter the market through auctions.

In EPC ETS operation, free allocation is differentiated intra-industries in order to acknowledge different levels of

efficiency among companies of each sector. At each cycle, the price floor and the ceiling (band) are determined for

free allocation, represented by a percentage applied to the total amount of Scope 1 emissions for the company in

the base year, after having deducted the percentage equivalent to the global reduction target for the same base

year. Those values are determined and registered by the MC in the Parameters Normative Ruling (available at EPC

website).

Taking this band (between the price floor and the ceiling) as reference, the exact percentage each RMO receives in

emission allowances is established based on their relative carbon efficiency position (using a carbon intensity

indicator – CII), in y-2 (current year minus two) compared to the industry benchmark.

The stages to determine free initial allocation are as follows:

(i) Grouping players into industries adapted by CNAE – the Brazilian National Classification of Economic

Activities, linked to IBGE (Brazilian Institute of Geography and Statistics)

(ii) Determining carbon intensity indicators (CII) that will be used in each industry - CIIs are established at the

beginning of each cycle along with representatives of participating companies from each industry (sector

working groups). To find out about the CIIs adopted in previous cycles, please refer to the analytical reports on

the EPC ETS webpage.

(iii) Determining benchmark sector values based on a nationwide research - – for those industries whose market

value was not determined, the best result among the participating companies was assumed as the benchmark

value, and, in cases where no market value was determined and there is only one company representing the

industry at EPC ETS, the average band value is assigned.

(iv) Ranking companies within the band: between the price floor (%) and the ceiling (%) with normalized

distribution, standardizing distances from final indicators of players when compared to benchmarks. The

company whose indicator value is equal to the industry benchmark receives allowances corresponding to the

ceiling (maximum % for its Scope 1 emissions at the base year, discounting the global reduction target

percentage for the cycle). The company with the worst indicator receives the price floor, and the others are

proportionally distributed according to their distance to the benchmark, using the following formulas:

(Ip – Ix)* (0.6-0.4) = Premium (Ip – B)

Premium + 0.4= Quantity of allowances for free allocation of Company X (%)

Where:

Ip = Final indicator with the worst performance among the final indicators of companies belonging to a certain

industry

Ix = Final indicator for the company being assessed

B = Indicator used as the benchmark value.








Illustrative sample for determining allowance allocation among four companies of a given industry with band for

allocation defined as from 40 to 60%:

Industry 1 benchmark: as a benchmark value was not found for the industry, the best indicator was selected among

the companies in the industry. In this specific example, it was 0.0514.

Businesses Final Indicator Premium Allocation

A (Benchmark) 0.0514 0.2000 60.00%

B 0.0730 0.1921 59.21%

C 0.0780 0.1903 59.03%

D 0.6000 0.0000 40.00%

Industry 2 Benchmark: External benchmark, meaning it was an indicator found for the industry. In this case, it is

2.0000.

Businesses Final Indicator Premium Allocation

Benchmark 2.0 0.2000 60.00%

E 2.4 0.1742 57.42%

F 3.0 0.1355 53.55%

J 5.1 0.0000 40.00%

Initial Allocation of Fictitious Financial Resources

Fictitious financial resources allocation will be the equivalent to 150% of the allowances quantity that would have

to be bought in the market by each company in order to conciliate their estimated Scope 1 emissions for the base

year, taking as reference the estimated opening price in the first current cycle auction.

Such percentage (150%) was determined after consultation with the Council and discussions with the companies.

Care was taken in this decision in order to make enough resources available so that it will not pose a restriction to

transactions, while avoiding that excessive quantities lead to currency devaluation.

EPC ETS fictitious currency is called EPCents (Ec$), and the name was selected according to suggestions and an

election made with the companies.

Use of Offsets

Offsets are an additional mechanism to ensure market liquidity and foster trades. At the completion of the EPC ETS

trading period, each company can surrender a certain amount of offsets as compensation for the emissions they

were not able to reduce. Such amount is determined by the MC and communicated through the Parameters

Normative Ruling (available at EPC website). The remaining emissions that cannot be conciliated with offsets shall

be covered with allowances.

Offsets in EPC ETS transactions are fictitious bonds, based either on real offsets or not. Those bonds that are not

based on real offsets are created by the MC for SMOs that are offset traders. Occasionally, the MC itself can offer

this type of offset. As for bonds based on real offsets, they need to be validated, and, if possible, checked by the

RMO along with the MC, which, by acknowledging the bonds, will make the corresponding fictitious offset credit in

the RMO account.






Fictitious offsets based on real offsets are offered by the RMO in the secondary market. EPC ETS accepts offsets

generated by projects developed in Brazil and validated.12. Both types shall follow one of these standards: Gold

Standard or Verified Carbon Standard (VCS), adopting project accounting methods approved by UNFCCC under the

Clean Development Mechanism (CDM) project.

Other types of offset can be created by the MC from different credit generator projects presented by RMOs. Offset

types that can be transacted at EPC ETS, their characteristics and risks, as well as the process and deadlines for

RMOs to submit verification proof to the MC are topics regulated by the Offsets Normative Ruling (available at EPC

website), the same ruling the establishes the maximum amount of that bond to be used in emission conciliation at

the end of each cycle.

Banking

At the end of each EPC ETS cycle, RMOs can save for the next cycle a certain amount of emission allowances that might not have been used in the conciliation of their current cycle emissions. Such mechanism of transferring excess resources to the subsequent period is called banking.

The limit of allowances that can be transferred to the subsequent cycle (percentage applied to the current cycle Scope 1 emissions) is determined by the MC in the Parameters Normative Ruling (available at EPC website).

The total allowances kept at the end of each cycle are credited to the account of participating companies in August in the subsequent cycle, once inventories for the year (y) are published. Then those bonds can be used for emission conciliation of y+1 at the end of the cycle, as well as traded in the spot secondary market.

There is banking in regulated markets, such as UE ETS and California, in order to avoid bond price drops at the end of the cycle due to a possible increase in offer, and enable regulated agents to elaborate long-term strategies. In the first phase of UE ETS, there was a limit to transfer bonds between periods, and there could be no transfer from the first to the second phase. From the second to the third phase, positive bond balances were transferred in their totality, and there are no more limits for banking between periods.

It is worth noting that banking in EPC ETS can be applied only to bonds, not to fictitious financial resources (EPc$).

Confidentiality

MOs are identified by aliases in EPC ETS. Therefore, players will not be identified in the trades; only the MC will

know their identity. Aliases are also used in reports when it comes to trades and performances in different stages of

market operation.

Company names will only be disclosed in the initiative general list of players, so as to acknowledge and show EPC

ETS representativeness in the Brazilian private sector. Communications with the external audience are the half-year

and annual reports, whose goal is to publish the knowledge generated, promoting discussions on the topic in Brazil,

but still preserving the identity of the participating companies.

More summarized quarterly reports are shared with participating companies.

Besides the alias assigned to them, each MO has a code to operate in the trading platform. Such code is generated

by the MC following an alphanumeric pattern.

12

Type 1 offsets are risk free; risks associated with type 2 offsets are communicated in Normative Rulings on the subject matter. Both offset

types are subject to usage constraints for emission conciliation, which is also communicated in Normative Rulings.


http://www.cdmgoldstandard.org/

http://www.cdmgoldstandard.org/

http://www.v-c-s.org/







Market Analysis

Once the EPC ETS cycle opens, transactions are performed on the online trading platform, and the MC monitors

performance indicators:

o Players Performance

- Physical indicator: The difference between actual emissions in current cycle published in the subsequent

cycle, and the amount of bonds surrendered to the MC at the end of the trading period as compensation for

actual emissions at the current cycle.

- Financial indicator: Cost per CO2e ton surrendered to the MC in the form of bonds traded in EPC ETS, by

the end of the trading period for the current year. At the end of the trading period, the cost of buying the

bonds surrendered to the MC shall be calculated, as well as incomes from the sale of bonds that were not

surrendered to the MC, and the financial result of speculation operations (purchase and sale of the same

bonds with the purpose of having financial gains).

o Indicators of market activity

1. Absolute liquidity: Number of transactions performed (sum of all transactions performed by players, for

buying and selling allowances and offsets)

2. Specific participation: Number of transactions performed per company

3. Speculation level: Tons of carbon equivalent (tCO2e) traded / cap

o Financial indicators

1. Volatility of allowance prices: Variability in allowance prices

2. Volatility of offset prices: Variability in offset prices

3. Auction premium: Difference between opening and closing price in an auction.

Penalties

As a penalty for players that release above the amount of allowances and offsets they own, the following applies:

o In case the company keeps operating in EPC ETS in the subsequent period (y), it will be assigned a negative

balance of emission allowances (tCO2e) in an amount equal to the excess amount it had by the end of the

previous cycle; and for each excess ton of CO2e released, a fine will be charged, and its value will be

equivalent to the emission allowance (Ec$), according to the average price of that bond at the last day the

market operated in the corresponding year, as long as the financial capacity limit of the company is

observed at the beginning of the current cycle. Thus, there is a price ceiling for the penalty, so as to ensure

the company that did not cover all its emissions in the previous cycle with EPC ETS bonds is capable of

conciliating its emissions at the end of the current cycle.

Financial capacity for each RMO is calculated based on the amount of allowances requested at the

beginning of the cycle to build their position, and on the opening price of allowance in the first auction. So:

M = 100% X (SNeg X PMFPerm), as long as M < CapF

CapF = # PermN X PAPerm

If M > CapF, then it will be adjusted to M = CapF

Where:





M = fine applied in August of y

SNeg = negative balance of bonds requested to conciliate y-1 emissions

PMFPerm = allowance average price at the cycle closing day y-1

CapF = RMO financial capacity in the beginning of y cycle

PermN = allowances needed to build position, in the beginning of the y cycle

PAPerm = allowance opening price in the first auction in y cycle.

o If the company does not join EPC ETS in the subsequent period, its history will be kept and any penalties

will be applied if it ever returns to the initiative.

Penalties will be applied in August, in every cycle, when GHG inventories for Brazil GHG Protocol Program

corresponding to the previous year are published.

Membership and Withdrawal

Membership

New memberships will only be accepted between November and March, after the end of a cycle and before the

beginning of the next cycle. To be eligible to participate, organizations must meet the following requirements: be a

member of EPC or Brazil GHG Protocol Program and, for the latter, have Scope 1 emissions that are equal to or

greater than 10,000 tCO2e, and commit to elaborate and publish the GHG emission inventories according to GHG

Protocol13 method, for the base year (2013), the current year, and all subsequent years, during their participation at

SCE.

Withdrawal

Withdrawal may occur at any time, and must be formerly communicated to the MC, which, on its turn, will only

communicate the other EPC ETS players at the end of the cycle, avoiding association of the alias with the RMO. All

bonds owned by the withdrawing party will be surrendered to the MC.

In spite of the withdrawal, the organization will be assessed at the end of the cycle and, if applicable, the

corresponding penalties will be calculated in their records. In the event the organization chooses to return to EPC

ETS in the future, it will be accountable for any previous penalties and fines for the new cycle.

Market Stability Reserve (MSR)

This instrument has the purpose of countering EPC ETS price variation, avoiding sudden bond valuations or

devaluations. The mechanism consists of withholding part of the emission allowances that make up the cap for each

cycle and gradually releasing them when given outstanding bond and price parameters are met.

Withheld bonds make up the market stability reserve (MSR) and their quantity is determined by the following

equation:

MSR = (10% + Lo% + Lb%) x Vtc

13

By using the GHG Protocol method we mean the adoption of one of the following documents to elaborate GHG emissions inventory for the

organization participating in the simulation: GHG Protocol Corporate Standard (WRI, 2004); or Brazil GHG Protocol Program Specifications

(GVces, 2010). Using other methods for calculating and reporting emissions can generate distortions during the comparison with calculations

of emissions made by other participating companies.





and

Vtc = cap + Ormo + Bk – Pmo

Where:

MSR = Market stability reserve

Lo% = limit of offsets that can be used in the emission conciliation in the current cycle, in percentage points

Lb% = Limit of emission allowances that can be transferred to the current year in form of banking, in percentage

points

Vtc = Total volume of outstanding bonds (in tCO2e)

Ormo = Volume of offsets owned by RMOs in the current cycle

Bk = Volume of emission allowances in form of banking in the previous cycle

cap = Volume of emission allowances released in the current cycle

Pmo = Total volume of emission allowances owned by MOs in the current cycle

MSR Estimates

Lo% and Lb% percentages will be informed by the MC through notice, before the opening of the current operational

cycle. The 10% margin in MSR formula represents a safety margin in the event of possible economic slowdown

compared to the previous cycle.

MSR has two components: primary MSR (pMSR) and secondary MSR (sMSR). In other words, MSR = pMSR + sMSR.

Primary MSR comprises 10% of VTc and is controlled by a stock trigger. This means that, when the amount or stock

of bonds offered by the MC in the secondary market becomes lower than a given threshold, the trigger is

automatically enabled and a fraction of pMSR stock is deducted from the pMSR and credited to the MC to be

auctioned.

The secondary MSR comprises the Lo% and Lb% corresponding amounts; it can only be accessed after the primary

MSR is over, and it is controlled by a price trigger. So, when the MC offers less bonds than MOs are willing to buy,

and prices rise above a given threshold, the trigger is enabled and a portion of MSR stocks is deducted from MSRs

and credited to the MC to be auctioned.

You can find more details on how MSR triggers work in the Parameters Normative Ruling (click here to access the

Normative Rulings effective for EPC ETS).





References

European Commission. The EU Emissions Trading System (EU ETS) [Online] // European Commission. - European

Union, September 2014. - http://ec.europa.eu/clima/policies/ets/index_en.htm

GVces, 2014. Regras e parâmetros para 2014 (Rules and Parameters for 2014) . // Simulação de Sistema de Comércio

de Emissões (Emissions Trading Scheme Simulation).

http://www.empresaspeloclima.com.br/arquivos/74/EPC_Regras_e_Parametros_SCE_v2_abril.2014.pdf

GVces, 2014. EPC ETS: Biannual Analytic Report: March-August 2014. http://www.empresaspeloclima.com.br/sce-

epc-relatorio-analitico-semestral-marco-a-agosto-de-2014

GVces and WRI, 2011. Especificações do Programa Brasileiro GHG Protocol: Contabilização, Quantificação e

Publicação de Inventários Corporativos de Emissões de Gases de Efeito Estufa (Brazil GHG Protocol Program

Specifications: Greenhouse Gas Emissions Corporate Inventory Calculation, Quantification and Publishing) – 2nd

Edition [Report]. - Sao Paulo: [s.n.], 2011. - p. 74. -

http://ghgprotocolbrasil.com.br/arquivos/152/especificacoes_pb_ghgprotocol.pdf

Hull, J. C. 2009. Fundamentos dos mercados futuros e de opções (Fundamentals of Futures and Options Markets).

BM&FBovespa

Ice. https://www.theice.com/index

WRI, 2004. GHG Protocol Corporate Standard. http://www.ghgprotocol.org/standards/corporate-standard



http://www.empresaspeloclima.com.br/arquivos/74/EPC_Regras_e_Parametros_SCE_v2_abril.2014.pdf

http://www.empresaspeloclima.com.br/sce-epc-relatorio-analitico-semestral-marco-a-agosto-de-2014

http://www.empresaspeloclima.com.br/sce-epc-relatorio-analitico-semestral-marco-a-agosto-de-2014

http://ghgprotocolbrasil.com.br/arquivos/152/especificacoes_pb_ghgprotocol.pdf

https://www.theice.com/index

http://www.ghgprotocol.org/standards/corporate-standard

Documents

Rules and Parameters - Amazon S3 › arquivos2.gvces.com.br › epc › ...corporate leaderships to manage GHG emissions and climate risks, and suggest public policies for a low-carbon