As the global focus on combating climate change intensifies, emission trading systems have emerged as a mechanism for incentivising and regulating greenhouse gas emissions. The European carbon market has grown substantially since its inception in 2005, and is likely to continue its growth following EU's decision to include maritime transportation in the EU Emissions Trading System ("EU ETS"), while also deciding to annually reduce the overall number of emission allowances in the market by 4%.
The Norwegian Emission Trading Act (Klimakvoteloven) entered into force in 2005, and Norway joined the EU ETS in 2008. This means that Norwegian industries to which the system applies, are subject to the same rules on emissions trading as those within the EU. The EU ETS is a legislative scheme based on a 'cap and trade-principle', where EU sets a limit on total greenhouse gases ("GHGs") that can be emitted yearly by certain industries. This cap is reduced year by year so that the emission target for sectors covered by the system shall be met by the end of the period.
Under the EU ETS, emitters of GHGs subject to a cap are required to monitor and report their emissions, as well as surrendering emission allowances to offset their GHG emissions. One emission allowance permits the emission of one tonne of CO2 equivalent, and emitters must surrender sufficient allowances to cover their verified emissions from the previous year.
In this newsletter, we will provide an overview of key legal issues concerning trading of emission allowances in Norway, such as the allocation and distribution of emission allowances, the obligations and responsibilities of market participants pursuant to the applicable financial regulatory laws and regulations, the tax/VAT treatment of emission allowances, as well as the role of the Norwegian Environment Agency as the operator of the Norwegian emissions trading registry (Klimakvoteregisteret).
Allocation and distribution of Emission Allowances
Emission allowances are currently allocated free of charge or may be purchased in auctions.
A certain amount of the emission allowances allocated free of charge are currently granted to high emitters in sectors vulnerable to carbon leakage, such as a certain parts of the petroleum sector to which the EU ETS applies. However, emission allowances granted free of charge will gradually be phased out with the gradual introduction of EU's Carbon Border Adjustment Mechanism, which will apply in its final form from 2026.[1] There are no free emission allowances granted to the shipping industry.
The primary method for acquiring emission allowances is by auctions arranged by the European Energy Exchange (the "EEX"). The EEX is a regulated exchange that enables trading of emission allowances and operates the spot and futures markets for trading emission allowances under the EU ETS (the "EUA spot market"). On the EUA spot market, market participants can trade allowances for the current compliance period, which runs from 1 January to 31 December each year. On the EEX futures market, market participants may trade emission allowances for future compliance periods. The contracts on the aforementioned EEX markets are physically settled, meaning that emission allowances are delivered at the time of settlement against the exchange of cash.
The futures contracts on the EEX market are standardised with set delivery dates, allowing market participants to hedge against future price fluctuations in emission allowances and to plan for future compliance. If market participants wish to have less standardised contracts, they may trade in the OTC market for emission allowances, where transactions are concluded on a bilateral basis.
Transactions in the OTC market are typically physically settled spot or forward transactions on emission allowances. However, there is also a substantial OTC market for financially settled derivatives with emission allowances as underlyings, i.e. transactions where only the cash value of the emission allowances are delivered at the time of settlement, and not the emission allowance itself. Transactions in the OTC market are typically agreed on terms materially based on the 1992 or 2002 ISDA Master Agreement incorporating the 2005 Commodity Definitions with an Emissions Annex, or an EFET General Agreement with a Power/Gas Allowance Appendix.
Participation in the EU ETS and the Norwegian Emissions Trading Registry (Klimakvoteregisteret)
In order to purchase allowances and participate in the EU ETS market, market participants must open an account with an administering authority in an EEA Member State. In Norway, the Norwegian Environment Agency (Miljødirektoratet) administers the Norwegian Emissions Trading Registry (Klimakvoteregisteret), aligning with the EU ETS.
There are different types of accounts. A Trading Account is the account type that is most suitable for purchasing, transferring and selling emission allowances. However, emitters of GHGs that are encompassed by the EU ETS and therefore obliged to surrender emission allowances for their emissions, also need to open a (Maritime) Operator Holding Account.
Any company may open a Trading Account, irrespective of their duty to surrender allowances under the EU ETS. There are certain requirements for opening a Trading Account, which vary between the different EEA Member States. Many states require some form of connection to the state. In Norway, a company that wish to apply for a Trading Account must, inter alia, have a Norwegian company registration number in the Norwegian Register of Business Enterprises and be registered for VAT in the Norwegian VAT Register.
Market participants with a Trading Account may purchase allowances on the EEX (minimum 500 allowances) or in the OTC market.
Guidance on how to open a trading account (and (maritime) operator holding accounts) is available here.
Financial Market Regulation of Emission Allowances in Norway
Emission allowances, as well as derivatives thereof, are treated and regulated as "financial instruments" following an amendment in 2019 of the Norwegian Securities Trading Act (the "NSTA"). Trading of emission allowances and other investment services and/or investment activities related to emission allowances will therefore – as a starting point – be subject to a licensing requirement. This because any provision of investment services and/or investment activities related to "financial instruments" in Norway requires a license.
However, there are certain important exemptions from the licensing requirement. The first important exemption is the "dealing on own account exemption", which provides an exemption from the licensing requirement and the rules of MiFID II as implemented into Norwegian law for persons dealing on their own account in emissions allowances or derivatives thereof. Please note that this exemption is not applicable to persons who deal on their own account when executing client orders.
The other important exemption is the "ancillary activity exemption", which provides an exemption from the licensing requirement and the rules of MiFID II when providing investment services, other than dealing on their own account, in emission allowances or derivatives thereof to customers or suppliers of their main business.
Both of the abovementioned exemptions require, inter alia, that the trading of emissions allowances and/or related investment services/activities are "ancillary to their main business". What constitutes an ancillary activity is determined based on a "de-minimis threshold test", where, inter alia, the size of the trading activities relative to the main business of the relevant entity (or the group it forms part of, if applicable) will be an important consideration.
In addition to the rules of MiFID II, as implemented into Norwegian law, emission allowances and related derivatives will also be subject to the rules of the Market Abuse Regulation ("MAR"). Any person trading in emission allowances must therefore comply with the restrictions set out in MAR, including the prohibitions against insider trading and market manipulation. However, we highlight that the obligation to publicly disclose inside information only applies to those entities that – on a group level – exceed an emission threshold of 6 million tonnes of CO2 equivalents.
Emission allowances and related derivatives are also subjected the European Market Infrastructure Regulation ("EMIR") and the Markets in Financial Instruments Regulation ("MiFIR"). An exemption applies to emission allowances traded spot, which are not covered by EMIR. This because the term "derivative contract" as defined in EMIR does not include such products, even though emission allowances themselves are classified by MiFID II as "financial instruments".
The above entails, inter alia, that trading in emission allowance derivatives – except those traded spot – will be subject to the reporting and clearing obligations of EMIR, provided that certain thresholds are exceeded. In addition, the above also entails that trading of emission allowances will be subject to the MiFIR reporting requirements and other mechanisms to ensure orderly trading, in addition to the weekly and daily position reporting obligations of MiFID II. However, please note that emission allowance derivatives fall outside the definition of a "commodity derivative" under MiFID II, and is therefore not subject to position limits and position management control, despite being subject to the aforementioned weekly and daily position reporting obligations.
Tax Regulation of Emission Allowances in Norway
Based on the general tax rules, emission allowances should be classified either as an intangible asset or as a financial asset/instrument for tax purposes. As mentioned above, the NSTA was amended in 2019 to include emission allowances in the definition of "financial instruments". However, with respect to the VAT treatment, trading of emission allowances has not been covered by the exemption for financial instruments. For tax purposes, it will likely not have a significant impact which category the allowances are classified under.
In terms of shipping companies, the tax treatment of allowances will depend on whether the company is subject to ordinary taxation or tonnage taxation:
Ordinary taxation:
If a vessel owner purchases allowances, the cost may be expensed proportionally in accordance with emissions and use of the allowances. When the allowance is surrendered, it can fully be expensed. If allowances are sold, the company will be subject to ordinary capital gain/loss tax calculations.
If allowances are acquired by the charterer and delivered to the vessel owner, it should in our view be considered part of the charter income at fair market value and taxable. The cost base for the vessel owner will be the same fair market value of the allowance. The cost of using the allowances is expensed as described above.
Tonnage taxation:
The Norwegian tonnage tax rules are ring-fenced and there are strict rules regarding the assets that a tonnage taxed company may own. In our view, allowances should be considered as a permitted financial asset. In the Norwegian tonnage tax regime operating income is tax exempt, but financial income is taxable at a rate of 22% (2024). It can be argued that any income or loss deriving from the company's own use of the allowances (as described above) should be considered operating income and not financial income. This is supported by statements from the tax authorities on charter derivatives and hedging derivates of bunkers, where the tax treatment of these financial instruments is seen as closely linked to the operating business.
If allowances are sold to third parties instead of being used by the company, there is arguably a disconnect towards the operations and any gain/loss will likely be treated as financial income and taxable at a rate of 22% (2024).
The only business activity a tonnage taxed company can perform is shipping activity and certain auxiliary shipping activities. If the tonnage taxed company extensively sells allowances, this may be considered a separate activity and result in a breach of the tonnage tax requirements, leading to forced exit from the tonnage tax regime.
Similarly, for other industries with special tax rules, such as the oil and gas exploration and production industries, the ETS allowances will have to be classified according to those rules.
Norwegian VAT implications of trading etc. in Emission Allowances
The sale and transfer of Emission Allowances has historically been regarded as a taxable supply that is subject to Norwegian VAT if made between parties within Norway or to a recipient in Norway, and out of scope or exempt from Norwegian VAT if made between parties or to a recipient outside Norway. This was confirmed in a statement from the Norwegian Ministry of Finance of 15 February 2005 with reference to the same VAT treatment in EU law.
When MiFID II was adopted, the definition of financial instruments in the financial market regulations was changed to include emission allowances. Sale and transfers of financial instruments are generally exempt from VAT pursuant to the exemption for financial services, which shall be interpreted in accordance with financial market legislation and with strong regard to the scope of the same VAT exemption in EU law to ensure a level playing field. Thus, the adoption of MiFID II caused uncertainty related to whether sale and transfer of Emission Allowances had become exempt from VAT. The EU VAT Committee has concluded that Emission Allowances are not covered by the VAT exemption for financial services, and consequently that sale of Emission Allowances is subject to VAT, cf. Document taxud.c.1(2016)2049491 – Working paper No 901.
The current position of the Norwegian Tax Administration, however, is that it is not clarified whether the amended definition of financial instruments in the financial market regulations has an impact on the scope of the VAT exemption for financial services, cf. Merverdiavgiftshåndboken (2024) section 3-6.8.
However, as the Norwegian legislator has stated that the VAT exemption for financial services shall be interpreted and applied with a strong regard to the scope of the same VAT exemption in EU law, the sale and transfer of Emission Allowances will most likely still be regarded as a taxable supply not covered by the VAT exemption for financial services in line with the VAT treatment in EU law.
The same applies to forwards and options connected to emission allowances to the extent they are used (options) and involve an actual transfer of emission allowances. If not, e.g., because they are settled financially, they are regarded as financial services exempt from Norwegian VAT.
A service that merely involves deletion of emission allowances, is in any case exempt from Norwegian VAT.
In the event of a taxable supply, the taxable person is the recipient of the emission allowances if the recipient is a business (reverse charge VAT). If the recipient is not a business, the taxable person is the seller/transferor of the emission allowances, whether resident in Norway or not.
Brief overview of the current status of the inclusion of maritime transport in EU ETS
Phase-in of maritime transport in the EU ETS
From 1 January 2024, CO2 emissions from cargo and passenger vessels of more than 5000 gross tonnes sailing to, from and between EU ports have been included in the EU ETS.
Responsible parties will be required to submit allowances to cover 40% of their reported emissions in 2024, which will be gradually increased to 100% of emissions by 2026.
The system will also include CH4 and N2O emissions (from 2026). In 2027, offshore ships of more than 5000 gross tonnes will be included. By the end of 2026, the EU will also consider whether to include offshore vessels and general cargo vessels of between 400 and 5000 gross tonnes.
Current status
Currently, many parties are working on allocating the formal responsibility between the registered shipowner and the Document of Compliance ("DoC") holder. The registered owner is responsible for compliance with the EU ETS and EU MRV by default, but may allocate responsibility for EU ETS and EU MRV to the DoC holder (the technical manager or a bareboat charterer).
Either way, the registered owner will have to submit a letter that informs the administering authority that the DOC holder has assumed responsibility, or, alternatively, which vessels the registered owner will retain responsibility for. The letter which informs the administering authority of the allocation of responsibility is often referred to as a mandate letter and has certain requirements regarding its content. The letter should be submitted to the administering authority that the shipping company has been allocated to. On 1 February 2024, the EU published a list that allocates existing shipping companies registered in the EU to their respective administering authorities.
If the registered owner allocates the responsibility to, for example, the technical manager, the parties will need to agree on the terms of the allocation. BIMCO has published an EU ETS clause for SHIPMAN, which was included in the recently published BIMCO SHIPMAN 2024 standard ship management agreement. This clause is often used as a basis for negotiations.
Additionally, Owners and Charterers will need to negotiate the financial and practical responsibilities of acquiring the allowances required to be submitted to cover the emissions of 2024 and beyond. Parties that are in the process of selling a vessel also need to consider EU ETS in the sale-purchase agreement.
Parties that will be involved in the trading of allowances should take note of the regulatory and tax implications of such trading, as outlined in this newsletter. There are a number of points to consider when trading a financial instrument such as an EU ETS allowance, which some shipping companies may have limited experience with.
Next steps
This year, we expect many parties will be involved in contractual negotiations with technical managers and owners/charterers, as well as engaging in various correspondence with the administering authorities regarding account applications and allocation of responsibility.
By 1 April 2024, or no later than three months after each ship’s first call in a port under the jurisdiction of a Member State, the responsible party must have submitted a monitoring plan pursuant to the EU MRV Regulation. By 30 June 2024, each shipping company must ensure that all their ships carry on board a document of compliance with the EU MRV. These requirements are not new, however, from 1 January 2024 the registered shipowner became the default responsible party for EU MRV compliance, a change from the previous position involving that the DoC holder was responsible for EU MRV compliance.
In 2025, aggregated emissions data will have to be submitted by 31 March, and will then be verified by the appointed verifier. The deadline for surrendering allowances corresponding to the verified emissions data will be 30 September 2025.
