March 24, 2016


Ministry of the Environment and Climate Change
Climate Change and Environmental Policy Division
Air Policy Instruments and Programs Design Branch
77 Wellesley Street West
Floor 10
Ferguson Block
Toronto, OntarioM7A 2T5

Attention:        Melissa Ollevier
                        Senior Policy Advisor

RE:       EBR Registry Number 012-6844

Dear Sirs/Mesdames:

The following letter sets out the submissions of the University of Toronto’s Environmental Finance Advisory Committee (“EFAC”) on the proposed Bill 172 “Climate Change, Mitigation and Low-Carbon Economy Act, 2016” (“Bill 172” or “CCMLEA”) and the proposed regulation to be made under Bill 172 (“Proposed Regulation”).

By way of background, EFAC serves as a forum for the exchange of innovative ideas in environmental finance between the University of Toronto and the commercial sector, thereby providing professional development and networking opportunities. The Committee operates through the contributions of insight, time, and effort from experts and advisors who represent the intended audience of business and industry leaders, as well as academics and students.

At the outset, EFAC supports “putting a price on carbon” to help reduce greenhouse gas (“GHG”) emissions. We believe that a key advantage of the pricing system chosen by Ontario, cap and trade, ‎is its promise to achieve the same volume of emission reductions at a lower cost to the economy than other systems, including a carbon tax. At its root, this promise is based on the ability of entities able to make GHG emission reductions at the lowest possible cost to do so and be rewarded by the ability to trade those reductions or the instruments (allowances and offsets) that enable or represent them to others which could make equivalent reductions at a higher cost. The market is designed to operate efficiently so that GHG emission reductions can be achieved at the least cost. “An efficient market means that allowance and offset credit prices reflect supply and demand, and accurately reveal the value of allowances and offset credits.”[1]

Consequently the ability to efficiently trade instruments related to those emission reductions, whether allowances or credits, as defined in CCMLEA, is a critical factor in achieving a liquid, well financed, balanced and transparent carbon market.

Our comments on Bill 172 and the Proposed Regulation are set out below. In this regard, we have endeavored, as much as practicable, to match our comments to the section order set out first, in Bill 172, and then in the Proposed Regulation.

1.              Definitional Matters – Legal Characterization of Allowances/Credits

Section 1 of Bill 172 sets out definitions for “credit”, “emissions allowance”, “Ontario credit” and “Ontario emissions allowance” which avoid reference to the legal characterization of these new assets.

In our view, it is fundamental to the healthy development of an emissions trading market for those who are permitted to acquire, hold, trade and surrender credits and allowances (including those created in Ontario) to have certainty with respect to their precise legal nature. It is only with that clear understanding that they can evaluate holding and trading risks and develop risk mitigation strategies. For capped emitters themselves, and for those who develop and operate projects intended to generate offset credits, it is also fundamental in understanding the nature of these assets for purposes such as their valuation and treatment for accounting purposes, and their potential use as credit enhancement or financing tools.

In Ontario, where definitive legal characterization is not found in a statute, parties looking for certainty can only look to common law jurisprudence. While it is arguable that credits and allowances (including those created in Ontario) may be capable of being found to constitute property, there can be no certainty of whether they would be found to be characterized as such for important purposes such as personal property security legislation or insolvency legislation. In our view, the needed certainty under applicable Ontario law could be provided by making it explicit in the legislation and regulation that credits and allowances (including those created in Ontario) constitute personal property. This, indeed, is an approach which has also been explicitly adopted in many jurisdictions, including certain member countries of the EU ETS, New Zealand and certain US states. This approach, we believe, will promote confidence and integrity in the development of a market, while at the same time reducing uncertainty for holders of credits and allowances.

We are aware, as you will be, that California did not adopt this approach in structuring its enabling cap and trade legislation. We understand, however, that there was a valid, uniquely US law concern, which motivated that choice. As you will know, California’s system permits the regulator to void, revoke or invalidate credits in certain circumstances, and, under California law, a government which ‘takes’ personal property is required to do so by making or providing just compensation to the affected party. California did not wish to invoke that legal requirement to compensate in those circumstances. That principle of California law is not, however, and has never been, the law of Ontario. In our province, instead, it is well settled law that no such principle with respect to personal property rights or licenses exists independently of a statute – and that if a statute specifically empowers a revocation, termination or forfeiture, it can do so on any basis which the legislature determines. Accordingly, we believe that the Government of Ontario should not regard California’s choice as determinative – particularly when there are clear benefits to Ontarians of making it clear that credits and allowances are personal property rights.

2.              Certain Mandatory Participants – Obligation to Cover Natural Gas and Fuel ‎GHG Emissions

Under Bill 172 and the Proposed Regulation, GHG emissions from the combustion of natural gas and petroleum products will largely need to be covered‎ (i.e. matched by emission allowances and or credits acquired and surrendered to the Ontario government) like GHG emissions emitted by large facilities. In both the case of natural gas and the case of petroleum products (e.g. gasoline, diesel and propane), the emissions are diffuse, occurring in the course of heating individual homes or driving cars, trucks and other vehicles. For practical reasons, the Proposed Regulation allocates that responsibility to the distributors of natural gas and petroleum products, providing these entities with the ability to drive the demand for allowances/credits and to control or at least significantly influence the market. This is compounded by the fact that the Proposed Regulation contemplates that industrial facilities in Ontario (but not natural gas distributors) will receive free allowances for the first compliance period (2017 to 2020). We believe that demand and therefore the carbon market in Ontario will likely be driven by the needs of natural gas and petroleum products distributors.

We note that, in comparison, the cap and trade systems of Quebec and California, with which Ontario hopes and expects to link, create a different result within their respective jurisdictions. We note that Quebec has very little gas-fired generation while Ontario has very significant gas-fired generation. In Ontario, under the Proposed Regulation, gas-fired generators, except for those connected to interprovincial or international pipelines, will have their emissions covered by the upstream natural gas distributor. As a result, natural gas distributors in Ontario can be expected to drive a much bigger portion of the demand relative to Quebec, and certainly relative to California, where the gas generators have their own compliance obligation. We believe that Ontario should examine this issue with a view to reducing the potential market influence of the large natural gas distributors on the carbon markets in Ontario, which, we believe, in turn will create a more rational market for allowances and credits in Ontario.

3.              Cap and Trade Accounts and Transactions – Separation of Beneficial and Registered Ownership of Allowances and Credits

Section 27(2) of the CCMLEA provides, in effect that, except as otherwise permitted by regulation, “No registered participant shall hold in the participant’s cap and trade account an emission allowance or credit that is owned, directly or indirectly, by another registered participant” (“Beneficial Interest Prohibition”).

In our view, the Beneficial Interest Prohibition, which ‎we presume is designed to prevent undisclosed ownership relationships from existing and to protect the markets from abusive arrangements that concentrate market power or facilitate fraud, is arguably not necessary. The carbon markets are commodity markets not unlike the energy markets in which commodities, securities and derivatives are trading on a spot and forward basis. No similar ‎prohibition exists in those markets and it is unclear to us why such a prohibition is necessary for the carbon markets.

We note that the efficient operation of a market benefits from, and cannot be achieved without, market participants deepening liquidity and arbitraging inappropriate price differentials using an almost unlimited range of strategies and arrangements. Where these efforts result in undesirable market behaviors in other commodity markets, regulators step in to limit or prohibit those activities under broad powers relating to the prevention of market manipulation (which we believe is also contained in Sections 28(1) and (2) of Bill 172). Moreover it is frequently the case that disclosure of activities is a sufficient deterrent rather than a market-constraining prohibition. We suggest that this approach which is used in the non-carbon markets be adopted and the Beneficial Interest Prohibition be eliminated.

We also draw to your attention that this approach has not been adopted in other carbon markets such as the EU ETS or the rules relating to the creation and trading of Kyoto credits. One of the arrangements that has proven to be very helpful for participants in the Kyoto Protocol and EU carbon markets has been the use of custodians and escrow agents for carbon allowances and credits. For example, when a large purchase and sale of such Kyoto credits is to be effected, the buyer will be unwilling to transfer the funds until the carbon credits are transferred to avoid the “fail to transfer b‎ut keep the money” risk. Financers of the buyer’s purchase will be even more adverse to this risk. Sellers will not be prepared to transfer the credits to the buyer until there is certainty of payment, i.e. “the money is in the bank”. Placing the credits with a depositary or escrow agent which is well capitalized and familiar with this type of transaction is the preferred approach. But this requires the registered interest in the credits (which needs to be with the depository or escrow agent) to be separated from the beneficial interest (which needs to be with the seller until consideration is paid and then must be moved to the buyer).

Other commodity markets do deal with this issue by allowing the registered interest in the commodity to be separated from the beneficial interest. Transactions in these markets are based on the ability of registered interests to be deposited with the depositary or escrow agent in the name of the seller pending payment of the purchase price and transfer of the beneficial interest is to the buyer.

In addition, we believe that where credits from an offset project are presold to a variety of purchasers, some of whom may have provided finance for the project, it is also essential that there be an ability to split beneficial and legal ownership and deposit the registered ownership with a depository or escrow arrangement. Buyers will want the registered interest to be deposited in escrow and will be unwilling to risk the offset credits being issued to an offset project developer which may be poorly capitalized who has granted security interests in favour of third party creditors.

In our view, allowing these arrangements is essential to the operation of a carbon market. We believe that elimination of the Beneficial Interest Prohibition would be beneficial; the alternative is extensive use of the provisions of the regulation to provide needed exceptions, which we believe would create unneeded complexity.

In this context, we would also point out that California, presumably with the same legislative policy intent as Ontario, has drafted its comparable restriction in a manner which better facilitates commercial transactions.

“95921. Conduct of Trade

(f)        General Prohibitions on Trading.

(1)       An entity may purchase and hold compliance instruments for later transfer to members of a direct corporate association. However, an entity cannot acquire allowances and hold them in its own holding account on behalf of another entity, including the following restrictions:

(A)       An entity may not hold allowances in which a second entity has any ownership interest.

(B)       An entity may not hold allowances pursuant to an agreement that gives a second entity control over the holding or planned disposition of allowances while the instruments reside in the first entity’s accounts or control over the acquisition of allowances by the first entity. Provisions specifying a date to deliver a specified quantity of compliance instruments, or specifying a procedure to determine a quantity of compliance instruments for delivery and/or a delivery date, do not violate the prohibition.” (Emphasis added).

Our comments above lend themselves as well to related comment on the note contained in Section 17 of the Proposed‎ Regulation which contemplates permitting the participation of “clearing houses” to “provide clearing services for transactions between registered participants”. Generally clearing services consist of matching buy and sell orders and often involve settlement as well, with settlement being the acts of transferring the subject matter of the transaction from the buyer to the seller and the transfer of funds from the seller to the buyer.

The Proposed Regulation requires that an entity that wishes to be a clearing house for Ontario cap and trade purposes be registered with the MoECC and “recognized by a regulatory authority responsible for supervising financial markets in Canada” with ongoing oversight by that regulatory authority.

We believe that the inclusion of a ‎proposal for permitting credit clearing houses is a positive and, in fact, a necessary component of a functioning carbon market. However the note to section 31 of the Proposed Regulation significantly undermines the utility of a clearing house by prescribing that allowances/offsets can only be held for five days and restricting transfers between registered participant sellers and buyers.

In our view, these limitations are unnecessarily restrictive, even for specific known-in-advance transactions which often have preconditions and delays that extend the time beyond five days and may require transfers other than to registered buyers, for example, transfers to partnerships, limited partnerships and trusts where undivided interests in the allowances/credits are in fact held directly by the partners or trust unit holders. Other arrangements such as unincorporated arrangements (tenancy in common and unincorporated associations) also employ a principal/agent structure, which would not be accommodated under the Proposed Regulation.

We suggest the traditional services structures in non-carbon commodity markets offered by trust companies and depositaries (regulated under the terms of other legislation) be available to participants in the carbon markets on the same terms.

4.              Trading where undisclosed change; Misleading or untrue statements

Section 28 of Bill 172 contains provisions respecting potential market abuses including insider trading and market manipulation. We generally agree that these provisions are necessary to deal with issues related to the new carbon markets.

An essential component of effective regulation in this area to ensure that market participants have the information necessary to conduct trades. This is critical to the effective functioning of any market. This can be accomplished by requiring that participants (including the Government of Ontario) in the carbon markets make public certain “inside” information in a timely manner. Successful regulation in this area will require a balance between making public, certain information which is needed to participate in the carbon market and restrictions on parties not to trade on information which is not otherwise publicly available and which would provide an unfair advantage to one party leading to manipulative market practices. This concept is set out in the WCI White Paper:

“Transparency in the design and the operation of the allowance and offset credit market builds and retains public confidence.

Reporting of relevant information to regulatory authorities and public disclosure of information has important benefits. It enables regulatory authorities to conduct effective oversight and ensure compliance. It also helps to ensure market efficiency, effective oversight, and compliance and enforcement. The release of information can change the decisions of market participants, which impacts the prices of allowances and offset credits. Timely, accurate, coordinated and consistent release of market-relevant information allows all market participants to have equal access to public information.

The reporting and disclosure requirements for compliance verification and enforcement balance these benefits against the need for entities to protect certain sensitive information. The potential to disclose certain information that could be used to manipulate the market is also considered. This balancing is consistent with applicable law relating to the disclosure of information.”

In order for such provisions in Bill 172 to be effective they should apply only to regulated participants (i.e., capped participants and market participants), impose a disclosure obligation on these participants; restrict trading by persons who have a connection or relationship to entities about whom the information relates (through insider lists or establishing relationship categories) and allow persons to acquire the information that they require for rational trading activity.

In our view, certain provisions in Bill 172 have not met these standards and, indeed, have gone too far and may create a situation where informational requirements for rational trading activities cannot be met. In particular, we believe that Sections 28(5) and 28(6) of Bill 172 are too far-reaching and ultimately may be extremely difficult to enforce.

Section 28 appears to be an attempt to emulate certain provisions found in the Securities Act (Ontario) (“OSA”); however, in our view, they diverge materially from the OSA provisions.

Section 28(5) of Bill 172 applies to “any person” whereas the equivalent provisions in section 76(1) of the OSA apply to a person in a “special relationship”[2] with a “reporting issuer” (i.e., a public company). Persons or companies in a special relationship are a prescribed class of individuals. The provisions in the OSA are designed to prohibit individuals who have a preexisting relationship with a reporting issuer from trading using knowledge of “a material fact or material information” with respect to the reporting issuer that has not been generally disclosed. (Definitionally, “material” information and changes are those relating to the issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer.) In contrast, Section 28(5) of Bill 172 imposes this obligation on persons with no preexisting relationship with the owners of the emission allowances or credits and on information of a broad and undefined character, however acquired.

Notably, the OSA provisions apply to “reporting issuers”[3] and not to all issuers in the Ontario markets. Reporting issuers have public disclosure obligations under the OSA; in contrast carbon market participants under Bill 172 are not subject to any such comparable obligations.

The OSA imposes a duty on reporting issuers to disclose “material information” and “material changes”. These provisions are designed to ensure that all participants in the market trade on the same information. There is no duty to disclose information under Bill 172; in fact the opposite appears to be true. See also the provisions prohibiting the disclosure of any information prior to an auction (Sections 31(6) and (7) of Bill 172).

Since there is no similar requirement for disclosure under Bill 172 this means that trading would have to take place in a vacuum with imperfect information.

We note, in addition, that Sections 28(3) and (4) prohibit the making of certain statements; what constitutes a “statement” is not defined (i.e., the medium and context) nor to whom such a statement cannot be made. As well, the prohibition applies to “any person”, no matter how engaged, if at all, in the trading of allowances or credits. In contrast, under the OSA, offences and civil liability for misleading statements are premised on concepts that are tightly defined and rigorous, both for certainty and transparency purposes.

Arguably all of the above provisions would have the effect of undermining the purpose of “market mechanism” and no true market for the emission allowances and credits could develop in Ontario.

We suggest, in the alternative to the approach in Bill 172, an approach to regulation like that set out in section 95921(e) of the California cap and trade system regulations which attempts a more principled and differentially tighter approach to regulation in this area:

“Section 95921 Conduct of Trade (e) General Prohibitions on Trading:

A trade involving, related to, or associated with any of the following are prohibited:

(A)   Any manipulative or deceptive device in violation of this article;

(B)   A corner or an attempt to corner the market for a compliance instrument;

(C)   Fraud, or an attempt to defraud any other entity;

(D)   A false, misleading or inaccurate report concerning information or conditions that affects or tends to affect the price of a compliance instrument;

(E)   An application, report, statement, or document required to be filed pursuant to this article which is false or misleading with respect to a material fact, or which omits to state a material fact necessary to make the contents therein not misleading; or

(F)   Any trick, scheme, or artifice to falsify or conceal a material fact, including use of any false statements or representations, written or oral, or documents made by or provided to an entity on or through which transactions in compliance instruments occur, are settled, or are cleared.

(G)  A fact is material if it could probably influence a decision by the Executive Officer, the Board, or the Board’s staff.”

5.              Intensity Caps

Section 21 of the Proposed Regulation contemplates a mechanism to deal with an “unexpected production increase that increases emissions by 250k tonnes/yr. or more”, which accommodates increased emissions without an increase in intensity. In our view, a downside adjustment is desirable so a lower cap would apply where production multiplied by a constant (or even slightly declining) intensity produces a lower number than the straight-line reducing cap as is contemplated in the Proposed Regulation.

6.              Trueups

In our view, it is possible that problems may arise with the contemplated 2021 one-time trueup‎. California uses a partial trueup along the way to keep emitters from digging a huge hole over the compliance period that swallows them at the end without making reductions. Another technique for consideration would see 2017 (or even a less attractive alternative of 2017 and 2018) as its own compliance period with very little reduction required to give the emitters “practice with training wheels” and kick start the market while delaying the real compliance pain until 2021 as is currently contemplated.

7.              Offset Markets – Timing of Regulation and Development of Protocols

We encourage the Province of Ontario to move as quickly as possible with the draft offset regulation and protocol development in order to create the missing link for the development of a robust emissions trading market in Ontario and beyond. Much work has been done in this regard, in particular, under the WCI umbrella working groups and by British Columbia, Alberta, California and Quebec, and we urge the Province to take advantage of this work in the ultimate design.

8.              Ensuring Consistency of Legislation across WCI Jurisdictions

We emphasize the need for Ontario to be kept abreast of ‎proposed and pending changes in other jurisdictions including California (and vice versa) and for the Ontario Government to participate directly in consultations in those other jurisdictions and when needed, to institute parallel consultations in Ontario. We note, in particular, that as we submit these comments, California is already well underway in a process that may result in significant amendments to provisions of their cap-and-trade system which are the same or substantially similar to provisions in the CCMLEA and the Proposed Regulation.

On behalf of EFAC, yours very truly,

Barbara Hendrickson
BAX Securities Law
Suite 720, 40 University Avenue
Toronto, OntarioM5J 1T1
T:  416.594.0791 ext. 146

Patricia A. Koval
Torys LLP
79 Wellington Street West
30th Floor
Box 270, TD South Tower
Toronto, OntarioM5K 1N2
T:  416-865-7356

Gray Taylor
Barrister and Solicitor
130 King Street West
Exchange Tower, Suite 3670

Toronto, OntarioM5X 1E2
T:  416 786 5533



[1] Western Climate Initiative Market Oversight White Paper, November 18, 2009 page 3

[2] “person or company in a special relationship with an issuer” means,

(a) a person or company that is an insider, affiliate or associate of (“insider” includes a person or company that would be an insider of an issuer if the issuer were a reporting issuer),

(i) the issuer,

(ii) a person or company that is considering or evaluating whether to make a take-over bid, as defined in Part XX, or that proposes to make a take-over bid, as defined in Part XX, for the securities of the issuer, or

(iii) a person or company that is considering or evaluating whether to become a party, or that proposes to become a party, to a reorganization, amalgamation, merger or arrangement or similar business combination with the issuer or to acquire a substantial portion of its property,

(b) a person or company that is engaging in any business or professional activity, that is considering or evaluating whether to engage in any business or professional activity, or that proposes to engage in any business or professional activity if the business or professional activity is,

(i) with or on behalf of the issuer, or

(ii) with or on behalf of a person or company described in subclause (a) (ii) or (iii),

(c) a person who is a director, officer or employee of,

(i) the issuer,

(ii) a subsidiary of the issuer,

(iii) a person or company that controls, directly or indirectly, the issuer, or

(iv) a person or company described in subclause (a) (ii) or (iii) or clause (b),

(d) a person or company that learned of the material fact or material change with respect to the issuer while the person or company was a person or company described in clause (a), (b) or (c),

(e) a person or company that learns of a material fact or material change with respect to the issuer from any other person or company described in this subsection, including a person or company described in this clause, and knows or ought reasonably to have known that the other person or company is a person or company in such a relationship;

[3] “issuer” means,

(a) a reporting issuer, or

(b) any other issuer whose securities are publicly traded;