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26/05/2015

Enforcement of the EU ETS in the Member States: Further improvements needed

By Jonathan Verschuuren (TLS)

Although the EU Emissions Trading Scheme (EU ETS) has been operating now in three trading phases for ten years and has been extensively covered by legal research, there has been remarkably little attention for the enforcement of the ETS. Although, generally, we have seen an increasing centralization of the EU ETS, monitoring and enforcement still are largely in the hands of the emissions authorities in the states in which the EU ETS operates: 28 EU Member States plus Norway, Liechtenstein and Iceland. As part of the EU funded FP7-project ENTRACTE (Economic iNsTRuments to Achieve Climate Targets in Europe), we did an ex-post evaluation of the legal implementation of the EU ETS at Member State level with a focus on compliance. We wanted to know whether the effectiveness of the compliance mechanism of the EU ETS has been improved over the years and what further improvements (if any) are necessary. We reviewed the relevant EU law in each of the three phases, reviewed previous evaluations and relevant research projects, and evaluated the implementation of the EU ETS in selected Member States, both through existing sources and through interviews with key players in the compliance mechanism at Member State level. The Member States that we studied were Germany, the Netherlands, Hungary, Greece, Poland and the UK.

The EU ETS is the largest trading program in the world designed to combat global climate change.  The theory behind emissions trading is that a market mechanism is established in order to mitigate greenhouse gasses. After a cap is set and potential polluting firms have obtained allowances to emit, they can either (1) reduce their emissions and sell their allowances by for example investing in technological innovation; (2) use their allowances in order to cover their emissions; or, (3) increase their emissions by buying additional allowances on the market. The crucial importance of a well-developed and operationalized compliance chain has been neglected in the original design. In fact, a striking paradox of the EU ETS is that while the idea is that the market should be the place to regulate greenhouse gas (hereafter: GHG) emissions, the system only functions if it operates in a highly regulated context. Market participants must have the confidence that the system is transparent and consistent, and that it guarantees a level playing field for all actors in the 31 participating States because every firm complies with the rules. Effective enforcement of the rules is, therefore, crucial.

The EU ETS legislation originally left a considerable amount of discretion to Member States. This particularly included operational elements of emission trading, such as registration, monitoring, verification, reporting and enforcement issues. Only after European law enforcement agencies signalled that in some European countries carbon trading fraudsters may have accounted for up to 90% of all market activity, with criminals pocketing billions, the compliance issue received increased attention. Moreover, different strategies for ensuring compliance among Member States give rise to distortions of the market for greenhouse gas allowances. The effectiveness and reliability of the ETS, therefore, to a significant extent depends on the effort of each of the Member States. Lack of compliance of only a few or even a single Member State can harm the functioning of the ETS in the entire EU.

We, as well as other researchers in the consortium (see the London School of Economic’ report on compliance), found that compliance with the EU ETS is high.  Most infringements are caused by genuine mistakes and lack of knowledge, not by deliberate actions to evade obligations. The majority of offences concerns the operation of an installation without holding the required permit, exceeding the deadline for submitting the emission report or not monitoring in accordance with the monitoring plan. It is also believed that the verification process pays off: many mistakes are discovered by private verifiers and subsequently rectified. Since prices of allowances have been very low, the majority of allowances are surrendered and not traded. Hence, the EU ETS has not been tested to the full yet, and it remains to be seen whether compliance will be as high in a market under stress (with high prices due to limited availability of allowances).

There are many indications that current enforcement activities will not suffice in a market under stress, although there a big variations among countries. The number of staff employed in the national emissions authorities, for example, differs enormously, ranging from 4 to 5 in Greece and Hungary to 150 in Germany, 40-50 of whom are devoted to inspecting compliance by installations, i.e., checking emission reports, monitoring reports etc. No need to explain what this means for effective enforcement. The biggest loophole that we found in our evaluation is the absence of site visits. Site visits are not yet part of the standard enforcement strategy of most Member States we studied. Only the UK and the Netherlands have a well-developed blueprint for conducting regular site visits on the basis of a risk assessment. There is a considerable risk that non-compliant behaviour will remain undetected when inspectors rely on data provided by the “paper work” that goes with the EU ETS in its  automated system. In the UK, the competent authority regularly conducts site visits as part of its enforcement strategy; 5% of the operators are audited each year. Operators receive notice of these audits since their purpose is more to check than to inspect, although formally the regulator could use its power of entry to perform an unannounced inspection. Regulators in England and Wales have developed a common format for reporting the results of site visits, which are entered into an electronic database. The details include a summary of the visit, any instances of non-compliance detected follow-up actions that have been agreed with the operator.  The findings of the site visit may also be shared with other government bodies. Non-compliance is explicitly recorded to create a database of historical performance for future reference. Follow-up varies from a phone call or a visit to slightly more invasive forms such as a warning. By comparison, in Germany inspection was until 2013 mainly an administrative process done behind the desk at the emissions authority.  This is true for most of the EU Member States. Germany has very recently changed its policy and now officers of the ETS authority do joint inspections together with officers responsible for the enforcement of regular environmental permits, thus benefiting from the experience and knowledge on past performance of the individual company that the latter usually has.

There is not enough space here to cover all the elements of the enforcement system in the Member States that can be improved. Overall, we concluded that Member States can learn a lot from each other’s attempts to close loopholes and fix weak spots in the compliance mechanism. Overall, more efforts should be undertaken to harmonize enforcement practices of the national competent authorities responsible for the enforcement of the EU ETS. This is not easily achieved. Our research clearly shows that compliance assistance is regarded as the most important element of the compliance cycle of the EU ETS: helping companies to apply with this complex regulatory instrument. Such compliance assistance is best offered at the national level in the national context. In addition, we think that the EU, with the extensive legislative framework for the EU ETS that was developed over the years, has exhausted its legislative powers in this area. Therefore, other forms of harmonization (e.g., network based peer review) need to be explored.

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