Considered in Grand Committee
My Lords, I beg to move that the regulations, which were laid before the House on 8 March in draft, be approved. This statutory instrument, laid under the European Union (Withdrawal) Act 2018, makes consequential amendments to financial services law and related matters to provide for the safe and effective operation of the market in UK emission allowances as part of the establishment of a UK Emissions Trading Scheme.
At the end of the transition period, the UK ceased to be part of the EU ETS. As of the start of this year the UK has established its own ETS, which has been designed to ensure a consistent price for carbon. This SI was preceded by legislation laid last year under the Climate Change Act 2008 which legally established the UK ETS. In implementing the UK ETS, the Government have drawn on the best of the EU system, which the UK was instrumental in developing. At the same time, however, we are making improvements where needed to ensure greater flexibility, so that this scheme is properly designed for the UK. The new scheme allows for a smooth transition for businesses while reducing our contribution to carbon emissions from day one. Reducing emissions while supporting UK industry is central to the Government’s mission to deliver our world-leading net-zero target. The UK ETS is key to achieving that target.
Emissions trading schemes work on the cap and trade principle. This is where a cap is set on the total amount of certain greenhouse gases that can be emitted by installations and aircraft covered by the scheme. Within the cap, participants receive or buy emission allowances which they can trade with one another as needed. This cap is reduced over time, so that overall carbon emissions fall. Participants are required to monitor their emissions during a calendar year and surrender one emissions allowance for every tonne of carbon dioxide equivalent—CO2e—that they have emitted at the end of each reporting year. Thus the ETS is underpinned by the creation of a market for emission allowances. The auctioning and trading of allowances leads to the discovery of a market price for greenhouse gas emissions and will in turn drive cost-effective emissions reductions across our intensive industries, power generation and aviation sectors.
This statutory instrument amends existing financial services legislation so that it works in the context of the creation of a UK ETS. In doing so, it ensures that the Financial Conduct Authority can oversee the auctioning and trading of emission allowances and ensure the soundness and integrity of the market. This instrument is being introduced now so that it is in force in time for the first auctioning of UK emission allowances in May. In particular, this SI establishes the activity of bidding in an emission allowance auction as a “regulated activity” and establishes UK emission allowances as “financial instruments”. This means that the FCA has oversight of bidding in allowance auctions and ensures that the allowances themselves are subject to the appropriate regulatory treatment with regard to issues such as market abuse. The instrument also amends financial promotion legislation so that the promotion of investments in UK emission allowances can be undertaken only by persons with the correct permissions.
To properly empower the FCA to oversee the regime, the SI updates rules around the disclosure of confidential information so that the FCA can correctly discharge its functions with regard to the disclosure of information relating to the UK ETS and emissions allowance holdings. It ensures that the FCA has the investigation and enforcement powers to fulfil its duties with regard to preventing financial misconduct in the context of the auctioning and trading of emission allowances.
Finally, this SI amends the UK market abuse regulation so that it covers the primary and secondary market trading of UK emission allowances, and the secondary market trading of EU emission allowances where these activities are within the territorial scope of UK MAR.
This instrument will ensure the integrity of the UK carbon emission allowance market to facilitate ETS carbon pricing policy in the UK. This is integral to the Government’s ambitions to encourage cost-effective emissions reductions and, ultimately, achieve our goal of net zero.
My Lords, I thank my noble friend for that very clear introduction. I recognise his expertise—probably more particularly on the financial side rather than the climate change side—and I have several questions which I hope he will be able to answer but, if he is unable to bring to bear the relevant expertise, I am quite happy for him to write to me.
I support these regulations; their intention seems quite unexceptional. The Government have established a domestic emissions trading scheme based on our previous expertise and experience in Europe to replace the EU Emissions Trading Scheme—that is the background to this. On Monday, we were discussing accounting obligations placed on the United Kingdom in relation to the existing scheme—or I should perhaps say, in our case, the previously existing scheme—which will of course go on for some time. Although there are remaining accounting obligations, we have clearly left the EU trading system and are now entering into a new system, although some of the furniture of the scheme is clearly familiar from the previous EU scheme.
The approach of the Government, as exemplified by these regulations, is to pursue a domestic ETS rather than a carbon tax, and I applaud that. I welcome the clear emphasis on decarbonisation and towards renewables at the centre of the Government’s policy, and that they are favourable towards nuclear too. As I say, these regulations are part of our domestic emissions trading scheme and are clearly designed to provide a smooth transition for effective carbon pricing in the United Kingdom.
My noble friend said, quite correctly, that the scope of the UK ETS includes presently energy-intensive industries and the power generation and aviation sectors, as it did previously and as the EU scheme does. There is clearly an attraction in that linkage but some respondents in the consultation that we undertook favoured extending the ETS to other sectors, and the Government have indicated that they are not unfavourable to looking at that some time in the future. For example, the Climate Change Committee has suggested agriculture and land use. Could my noble friend indicate the Government’s willingness to look at an expansion of the scheme, and when that will be? What will inform the discussion and the choice some time in the future? Could he also say whether we will want to talk to—I assume we will—our previous EU partners, our partners in Europe and in other countries, and how we will arrive at that decision? That would be most helpful.
The United Kingdom is committed by law to reducing emissions to net zero by 2050 and the UK ETS is clearly vital in that endeavour. Could my noble friend indicate the level of ambition that the United Kingdom will have in setting the cap for allowances for the UK scheme, as opposed to what our ambition would be if constrained by the European scheme? How will we approach that? Will we be more ambitious and, if so, how much more ambitious than within the EU scheme?
I welcome the structure of the first phase of the UK ETS from 2021 to 2030, which matches the EU ETS phase 4 length. Most consultees similarly welcomed that development. Will my noble friend confirm that it is intended that the United Kingdom’s operational approach—I stress “operational approach”—to the ETS will broadly mirror that of the EU scheme, while not precisely, of course? That seems sensible and is the conclusion that I draw from reading around the scheme, but it would be good to have his say-so and expertise on that.
Lastly, I would welcome confirmation from my noble friend, if he is able to give it, that the United Kingdom intends to be a trail-blazer on this area in general. I do not just mean the ETS. I know that the Prime Minister has great ambition in this area, and we are hosting COP 26, obviously. There is a massive opportunity for the United Kingdom here—not just on COP 26, of course, but looking to the future more widely. I mean not just our doing the right thing internationally, although the United Kingdom rightly prides itself on doing so, but in ensuring that we establish a strong green economy with sustainable jobs and prosperity domestically.
My Lords, I am grateful to the Minister for introducing this statutory instrument, and to the noble Lord, Lord Bourne of Aberystwyth, for his contribution to this short debate. While the instrument is not formally labelled as an EU exit document, it nevertheless deals with one of the many issues arising from our withdrawal from the European Union and its various structures and policies. As the Minister outlined, the instrument makes changes to the UK legal provisions to reflect the fact that we are no longer part of the EU Emissions Trading Scheme. It then puts in place other provisions linked to the auction platform of the new UK Emissions Trading Scheme ahead of its first use later this year.
For some time, industry has sought certainty over the direction of travel on carbon pricing. It had not been clear whether the UK Government would operate a stand-alone ETS, some form of linked scheme, or an alternative approach such as a carbon tax. The decision to launch a UK ETS may have come later in the day than we would have liked, but it is one that we support. Maintaining the cap and trade principle will be important as we seek to reduce emissions in a manner consistent with meeting the 2050 net-zero target. It was not clear that alternative options such as a carbon tax would offer the same benefits as an ETS. In addition, while I will shortly turn to questions of how the UK’s scheme will work in practice, I can see that it makes sense to retain an approach that relevant companies are familiar with. However, it is regrettable that the regulations are being brought forward only now. The first auctions may not take place until later this year. It surely would have made more sense for the Government to spell out the detail and establish mechanisms further ahead of time. That would have provided greater clarity and certainty to all involved.
Establishing new markets and trading systems is always difficult, especially if you are to achieve early buy-in from companies, which generally require long lead-in times. I am sure that the Minister will be able to cite examples of engagement with business, but I cannot help observing that last-minute policy-making seems to have become one of the hallmarks of this Administration.
The relative size of the UK ETS when compared with the EU scheme raises a variety of questions. Going it alone also introduces an element of risk. Indeed, I am sure that the Minister is familiar with the concerns of the Committee on Climate Change, which pointed out potentially significant challenges in achieving market stability and liquidity.
Why has the UK set the auction reserve price at the level it has, when the EU scheme has seen prices rising sharply in recent months? We acknowledge that the auction reserve price is higher than the level initially proposed and are mindful of the need for it to be set at a level that creates a robust market and ultimately drives down emissions. With that in mind, how will the Government keep the price level under review? What importance, if any, will they place on price fluctuations within other emissions trading schemes around the world? Can the Minister provide an update on whether the UK is looking to link its scheme with others, as suggested in the White Paper published in December? Another consideration is the sectoral coverage of the UK ETS. Do the Government see a case for expanding the number of sectors covered by the scheme and, if so, when can we expect to hear more about it? If a decision were to be made this summer to include agriculture, for example, what kind of timescale would we be looking at for implementation?
I realise that many of these questions are better directed at the Department for Business, Energy and Industrial Strategy, so I am happy to wait for an answer in writing. However, in the hope of bringing the focus back to the Treasury, could the Minister comment briefly on the role foreseen for the Financial Conduct Authority? What additional knowledge or resource, if any, does the FCA require to fulfil its new responsibilities? Are the Government confident that this will be in place come the first auction?
I thank both noble Lords for their valuable contributions and questions in this short debate, and for their broad support of carbon pricing and this statutory instrument.
The noble Lord, Lord Tunnicliffe, asked several questions, and I hope to be able to give useful answers. On the timing of the decision to create a UK ETS, it is right that at the moment of leaving the EU and in the transition period we took the time properly to prepare and consider a UK ETS and a carbon tax, given that the chosen mechanism will be crucial to meeting our climate ambitions over the coming decades. There was a full consultation on the structure of the UK ETS; the FCA has already completed a consultation on the rules that it will make, following the legislation being debated today.
On the £22 level of the auction reserve price, I agree with the noble Lord’s desire for a strong carbon price signal. The auction reserve price is not the trading price but a floor price. We need to allow sufficient room in this market for price discovery. The EU system does not have a floor, as we saw when prices were extremely low in the years after the financial crisis. We have cut the UK ETS cap by 5% to start with, and I shall consult on a tighter net-zero consistent cap trajectory this year. We would then expect a steadily reducing cap, visible to all participating businesses, to drive higher prices and so reduce emissions over time.
I note that other emissions trading schemes have experienced price volatility. In years one and two of a UK ETS, the cost containment mechanism will have lower price and time triggers, providing a mechanism by which the UK Government can decide whether to intervene sooner, should very high prices occur. We stand ready to use that mechanism if necessary. The risk of price volatility must be balanced with the risk of policy volatility, whereby excessive market intervention would erode policy certainty for businesses. We remain open to linking internationally, but have not made a decision on preferred linking partners. Clearly, ahead of agreeing any link, we will need to consider whether it is in our interests.
The Government said in the energy White Paper that we would explore expanding the UK ETS into the two-thirds of emissions currently uncovered by the scheme. We will set out any plans resulting from this, including on implementation, in advance of COP 26 —which, as the noble Lord will know, is quite soon.
Finally, the noble Lord asked about the role of the FCA. I can assure him that the FCA does not require any additional knowledge or resource to fulfil its new responsibilities. The FCA will continue to oversee the UK ETS in much the same way it oversaw the market for EU emission allowances in the UK when the UK was part of the EU scheme.
My noble friend Lord Bourne asked about the scope of the ETS. As set out in the energy White Paper, we will consider expanding it, as I mentioned. We have initially cut the cap by 5% compared to the equivalent for the UK within the EU ETS. We have committed to introducing a net-zero-consistent cap trajectory and will consult on this later in the year. On the operation of a UK ETS, I can say that the environmental regulators of the four nations of the UK work in close collaboration with the UK Government and devolved Administrations as part of one UK ETS authority. I am happy to write to set out an answer in more detail on that specific question.
My noble friend is right that we want to blaze a trail on decarbonisation. To drive forward progress towards net zero, last year the Prime Minister announced his 10-point plan, which is also part of our mission to level up across the country and will mobilise £12 billion of government investment to create support for up to 250,000 highly skilled green jobs in the UK and spur more than three times as much private sector investment by 2030. At the centre of his blueprint are the UK’s industrial heartlands, including the north-east, Yorkshire and the Humber, the West Midlands, Scotland and Wales, which will drive forward the green industrial revolution and build green jobs and industries for the future. This will build on our already impressive progress to date, which has seen the UK decarbonise its economy faster than anyone else in the G20 since 2000, including France and Germany.
This statutory instrument, laid under the European Union (Withdrawal) Act 2018, will make amendments to financial services law to provide for the safe and effective operation of the market in UK emission allowances as part of the UK ETS. The ETS will drive cost-effective emissions reductions across our intensive industries and power generation and aviation sectors. As such, this legislation will ensure that the UK has a domestic carbon pricing policy that is fit for the net-zero future that we have led the world in committing to. Launching the UK ETS has allowed us the autonomy to pursue our climate goals in the way that works best for the UK. In some areas, we have already taken the opportunity to make the system work better, such as the immediate reduction in the overall size of the pool.
This instrument will ensure the integrity of the market that will underpin our carbon pricing goals and is vital in ensuring that the ETS can function as planned. I commend these draft regulations to the Committee.
The Grand Committee stands adjourned until 3 pm. I remind Members to sanitise their desks and chairs before leaving the Room.