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EU emissions trading serves as a central instrument of the European Union to reduce greenhouse gas emissions (such as CO2) in a sustainable and economically favourable way. From a legal point of view, trading in emission allowances entails some risks. In particular, the authenticity and acquisition of ownership of EU CO2 certificates remain a fundamental problem due to non-harmonised standards within the member states. This is where blockchain could come in as a solution and make the certificates eligible for authentication.

1. What is EU ETS?

The EU Emissions Trading Scheme (EU ETS) was established in 2005 to implement the Kyoto international climate change agreement. Members are the 27 EU member states, Norway, Iceland, Lichtenstein, and later the UK. The Swiss emissions trading system has also been linked since 2020. The EU ETS covers emissions from around 11,000 installations in the energy sector and energy-intensive industries across Europe, which together account for around 40% of greenhouse gas emissions in Europe. Intra-European air transport is also included in the EU ETS.

The EU ETS works according to the principle of so-called “cap & trade”. A cap determines how many greenhouse gas emissions may be emitted in total. The Member States issue a corresponding amount of emission allowances to installations – partly free of charge, partly through auctions. One allowance permits the emission of one tonne of carbon dioxide equivalent – CO2-eq. The emission allowances can be freely traded on the market (trade). This creates a price for the emission of greenhouse gases. This price creates incentives for the companies involved to reduce their greenhouse gas emissions.

2. How does trading work?

The auction platforms are organised on a national basis. Every member of the EU ETS has access. This includes companies, joint ventures, public institutions and investment firms authorised under EU law. The most important European CO2 exchanges are ECX (USA), Bluenext (France), EEX (Germany) and Nordpool (Norway, Denmark, Sweden, Finland). Admission is granted to those who have a registered account, through which trading and emission levels are recorded and the certificates are stored.

The trading of emission certificates takes place on the one hand via electronic exchanges as wholesale trading platforms and on the other hand via the privatised, unregulated over-the-counter market (OTC market). Trading via the exchange offers the advantage that access to the trading market is guaranteed for a large number of participants without major effort and serves as a suitable instrument for ensuring an efficient allocation of resources. In addition, trading and price determination on the exchange take place according to comprehensible, state-supervised processes and are therefore much more transparent than the OTC market. This is because data from the OTC market is not published – in contrast to standard exchange practice.

3. The (fraud) risks

Since its introduction, CO2 allowance trading has suffered many losses in terms of trust due to fraud, such as VAT tax fraud, recycling of allowances and theft through phishing attacks. At EU level, countermeasures are being taken with registration obligations and serial numbers. A centralised Union register and a special mechanism also ensure that once used, certificates cannot be reused. However, there is sometimes no EU-level oversight of the emissions market. Insufficient regulation and compliance of registry systems, as well as differences in data collection, make the EU ETS a vulnerable target for tax fraud and theft. The most prominent weaknesses include: insufficient account security, the possibility for almost anyone to open an account, the almost instantaneous transfer of allowances on the spot market, the lack of harmonised standards to deal with stolen allowances, and sanctioning options or uniform penalty amounts.

To make matters worse, the legal nature of ETS allowances is not clearly defined. The Member States audited take different approaches to the legal status and nature of CO2 allowances. In Germany, they take on a hybrid function. They have elements of both administrative rights and tradable private property rights. Due to the legal differences, the risk increases when they are acquired at the international level. In Germany, for example, a bona fide acquisition of property is possible, but not in the UK. If the bona fide acquisition of a non-legitimised certificate is not possible, the acquirer does not obtain ownership and thus cannot obtain sales proceeds, and additionally bears the risk of criminal law consequences.

So far, solutions have always been found for cases of fraud or theft. The tracing and authentication of certificates nevertheless remains a problem. This could be avoided if there were a secure way to prove the origin and authenticity of a certificate.

4. Application of blockchain

This is where blockchain can come into play. When a certificate is issued via blockchain-based models, the data is digitised and a digital identity is assigned to each. All certificates are marked and are traceable. Originals are stored securely on the network of computers in the blockchain. Blockchain enables transparent data exchange and ensures that certificates are recorded in an immutable and tamper-proof audit trail, creating a resilient proof of authenticity. Through measurable transactions and standardised, readily available data, a trusted, traceable and secure link would be established between all participants in a supply chain of CO2 allowances, protecting against transnational multiple sales and fraud.

However, the mere issuance of a token via a CO2 allowance does not, by its very nature, confer any legal rights to the underlying credit or impact that the token purports to represent. In fact, most standards contain legal provisions that explicitly prohibit this. Without two-way communication with the issuing standard, there is a risk that tokens will become meaningless. Instead, the issuer of the standard determines the status. This means that there is no absolute protection of ownership through this either. Rather, any secondary market, blockchain-based or otherwise, must comply with the terms and conditions of the issuing standard to ensure legal ownership of the credit and the right to claim it. It is therefore important that a token marketed as a CO2 allowance is professionally and independently verified.

The enormous power consumption of the blockchain, has also often been criticised in the past. However, this does not apply to Corda or Fabric, which are most commonly used for private corporate applications. Compared to public blockchains such as Bitcoin or Ethereum, these are low-energy. This is mainly due to the different way these protocols validate transactions. In the case of Corda or Fabric, through the so-called consensus method using digital signatures, as opposed to mining in the case of Bitcoin and Ethereum.

Isolated pilot projects by Mercedes and Microsoft or “Carbonfuture” – a start-up in Freiburg – already offer CO2 reduction by means of blockchain.

5. Outlook

The topic of EU emissions trading will occupy us in many ways in the future. Harmonised global registers and a transparent exchange of data as well as networked market structures are indispensable in order to achieve the goal of reducing greenhouse gas emissions in the sense of the upcoming climate protection measures.

Due to the planned diversification of emissions markets, it is becoming increasingly important to be able to trace the authenticity of certificates. Although the use of blockchain does not exempt from detailed verification of the content, it does offer conventional trading platforms security against forgery, public accessibility and uniform quality standards. Companies in the sector should think about a blockchain-based solution in order to comprehensively secure themselves through transparent business transactions and the ability to authenticate certificates.

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