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Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) and Rule 19b-4 thereunder, notice is hereby given that, on August 19, 2024, NYSE Arca, Inc. (“NYSE Arca” or “Exchange”) filed with the Securities and Exchange Commission (“Commission”) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by the self-regulatory organization. The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change
The Exchange proposes to list and trade shares of the COtwo Advisors Physical European Carbon Allowance Trust under NYSE Arca Rule 8.201-E (Commodity-Based Trust Shares). The proposed rule change is available on the Exchange's website at www.nyse.com, at the principal office of the Exchange, and at the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the self-regulatory organization included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of those statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in sections A, B, and C below, of the most significant parts of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and the Statutory Basis for, the Proposed Rule Change
1. Purpose
The Exchange proposes to list and trade shares (“Shares”) of the COtwo Advisors Physical European Carbon Allowance Trust (the “Trust”), under NYSE Arca Rule 8.201-E, which governs the listing and trading of Commodity-Based Trust Shares.
Commodity-Based Trust Shares are securities issued by a trust that represent investors' discrete identifiable and undivided beneficial ownership interest in the commodities deposited into the trust.
The Trust was formed as a Delaware statutory trust on January 12, 2023. The Trust has no fixed termination date. The Trust will not be registered as an investment company under the Investment Company Act of 1940, as amended, and is not required to register under such act. The Trust is not a commodity pool for purposes of the Commodity Exchange Act, as amended.
On May 12, 2023, the Trust filed with the Commission a registration statement on Form S-1, as amended on January 16, 2024 and April 4, 2024 (File No. 333-271910) (the “Registration Statement”) under the Securities Act of 1933 (15 U.S.C. 77a) (the “Securities Act”). The description of the operation of the Trust herein is based, in part, on the Registration Statement. The Registration Statement in not yet effective and the Shares will not trade on the Exchange until such time that the Registration Statement is effective.
17 U.S.C. 1.
The sponsor of the Trust is COtwo Advisors LLC, a Delaware limited liability company (“Sponsor”). State Street Bank and Trust Company serves as the Trust's administrator (the “Administrator”) to perform various administrative, accounting and recordkeeping functions on behalf of the Trust. Wilmington Trust serves as trustee of the Trust (the “Trustee”). State Street Bank and Trust Company serves as the Trust's transfer agent (the “Transfer Agent”) and as custodian of the Trust's cash, if any (“Cash Custodian”).
The Cash Custodian is responsible for holding the Trust's cash as well as receiving and dispensing cash on behalf of the Trust. Deposits of cash held by the Cash Custodian will be used in connection with the purchase of an applicable amount of EUAs for creations and redemptions of Creation Units and in connection with the payment of Trust expenses.
The Exchange represents that the Shares will satisfy the requirements of NYSE Arca Rule 8.201-E and thereby will qualify for listing on the Exchange.
Operation of the Trust
The description of the operation of the Trust, the Shares, and the carbon credit industry contained herein are based, in part, on the Registration Statement. See note 5, supra.
The investment objective of the Trust will be for the Shares to reflect the performance of the price of EU Carbon Emission Allowances for stationary installations (“EUAs”), less the Trust's expenses. The Trust intends to achieve its objective by investing all of its assets in EUAs on a non-discretionary basis ( i.e., without regard to whether the value of EUAs is rising or falling over any particular period). Shares of the Trust will represent units of fractional undivided beneficial interest in and ownership of the Trust. The Trust's only ordinary recurring expense will be the Sponsor's annual fee. The Trust will not hold any assets other than EUAs and cash. The Trust may purchase or sell EUAs in connection with the creation or redemption of Creation Units by Authorized Participants, as described below. In addition to selling EUAs to distribute cash to Authorized Participants redeeming Shares, the Trust may sell EUAs to pay the Sponsor's annual fee. All EUAs will be held in the Union Registry (defined below).
The Trust will not invest in futures, options, options on futures, or swap contracts. The Trust will not hold or trade in commodity futures contracts, “commodity interests,” or any other instruments regulated by the Commodity Exchange Act.
The Trust is not a proxy for investing in EUAs. Rather, the Shares are intended to provide a cost-effective means of obtaining investment exposure through the securities markets that is similar to an investment in EUAs. Specifically, the Shares are intended to constitute a simple and cost-efficient means of gaining investment benefits similar to those of holding EUAs directly, by providing investors an opportunity to participate in the EUA market through an investment in the Shares, instead of the traditional means of purchasing and storing EUAs. Trust shareholders will be exposed to the risks of investing in EUAs, as well as to additional risks that are unrelated to EUAs. For example, the public trading price at which an investor buys or sells Shares during the day from their broker may be different from the value of the Trust's holdings. Price differences may relate primarily to supply and demand forces at work in the secondary trading market for the Trust's Shares that are closely related to, but not identical to, the same forces influencing the prices of EUAs, cash and cash equivalents that constitute the Trust's assets. In addition, EUAs will have to be sold to pay Trust expenses that would not be associated with an investment in EUAs. Additional risks related to the Trust's structure, the Sponsor's management of the Trust, and the tax treatment of an investment in Shares are further in the Registration Statement.
EUAs and the EUA Industry
Description of EU Emissions Trading Scheme
According to the Registration Statement, the European Union Emissions Trading System (“EU ETS”) is a “cap and trade” system that caps the total volume of greenhouse gas (“GHG”) emissions from installations and aircraft operators responsible for around 40% of European Union (“EU”) GHG emissions. The EU ETS is the largest cap and trade system in the world and covers more than 11,000 power stations and industrial plants in 31 countries, and flights between airports of participating countries. The EU ETS is administered by the EU Commission, which issues a predefined amount of EUAs through auctions or free allocation. An EUA represents the right to emit one metric ton of carbon dioxide equivalent into the atmosphere by operators of stationary installations (“Covered Entities”). By the end of April each year, all Covered Entities are required to surrender EUAs equal to the total volume of actual emissions from their installation for the last calendar year. EU ETS operators can buy or sell EUAs to achieve EU ETS compliance.
There are two types of EU emissions allowance: (i) general allowances for stationary installations, or EUA; and (ii) allowances for the aviation sector (“EUAA”). The Trust will hold EUAs only.
In 2012, EU ETS operations were centralized into a single EU registry operated by the EU Commission (the “Union Registry”), which covers all countries participating in the EU ETS. According to the Registration Statement, the Union Registry is an online database that holds accounts for all entities covered by the EU ETS as well as for participants (such as the Trust) not covered under the EU ETS. The Union Registry can be accessed online in a similar manner to online banking systems. An account must be opened in the Union Registry by a legal or natural person before being able to participate in the EU ETS and transact in EUAs. The European Union Transaction Log (“EUTL”) checks, records and authorizes all transactions that take place between accounts in the Union Registry to ensure that transfers are in accordance with the EU ETS rules. The Union Registry is at all times responsible for holding the EUAs. All EUAs are held in the Union Registry.
The EUTL is a central transaction log that checks and records all transactions taking place within the EU ETS. It is run by the European Commission and provides an easy access to emission trading data contained in the EUTL. See https://www.eea.europa.eu/data-and-maps/dashboards/emissions-trading-viewer-1.
Major Holders and Allowance Use Cases
According to the Registration Statement, while there is limited publicly available data on individuals or individual organizations' holdings in physical carbon allowances, carbon allowances are primarily held for three different use cases:
(a) Complying with the EU ETS: Companies that need to surrender allowances under the EU ETS hold allowances to surrender them annually. These positions are typically built over time and ultimately surrendered at time of compliance. Therefore, the largest emitters in the EU ETS hold a significant amount of allowances, which include entities such as large utilities with a substantial share of fossil fuel fired power plants, cement companies, steel producers, chemical producers, oil and gas majors and airlines.
(b) Providing financial services for hedging purposes or speculation, such as clearing houses for the European Energy Exchange or the Intercontinental Exchange, or banks holding allowances for their clients.
(c) Trading on and speculating around price moves, using physical emission allowances. This can take many forms, including “yield trades”, which includes holding a physical allowance and selling an EUA future at a premium to gain the yield in the forward curve; or outright positions for short term or long term speculation.
In addition to holding physical allowances, there is a liquid secondary futures and options market that is primarily used for hedging future emissions or speculating.
Trading Location
According to the Registration Statement, the EU ETS is linked to small emissions trading systems in Europe (Norway, Switzerland, Iceland and Liechtenstein), but not to any other major cap and trade markets. Therefore, allowances handed out in the EU ETS are not transferable to any registry outside of the EU ETS and cannot be used for compliance in any other cap and trade market.
There are a number of other trading systems globally, and like the EU ETS, no allowances of any of these systems can be used in any other system:
(a) Western Climate Initiative (WCI): The State of California and the Canadian province Quebec created a linked cap and trade market, that covers >80% of emissions.
(b) Regional Greenhouse Gas Initiative (RGGI): a group of US east coast states created a linked market that covers power generators only.
(c) The China National ETS: Technically not a cap and trade scheme (as the amount of allowances is not fixed but calculated according to historic production of units).
(d) South Korea ETS: A comprehensive market covering the majority of Korean emissions.
Pricing of Allowances and Trading Volume
According to the Registration Statement, there are currently two primary avenues for trading EUAs: a primary market and a secondary market. The primary market involves participation in a regularly scheduled auction. The secondary market involves transactions between buyers and sellers on regulated markets. The contracts offered for trading are the following (1) instruments with a daily expiry, including spot EUAs and the Daily EUA Future (as defined below), (2) futures contracts with various maturities; and (3) options on futures contracts. There are also over-the-counter transactions, but they comprise a negligible percentage of transactions.
The spot and futures markets for EUAs have existed since 2005 after the formal launch of the EU ETS on January 1, 2005. Spot EUA contracts are traded exclusively on the European Energy Exchange AG (“EEX”), and futures contracts and options on futures contracts are traded on EEX, ICE Endex Markets B.V. (“ICE Endex”) and Nasdaq Oslo, although the latter's market share is marginal.
EEX is an exchange under the German Exchange Act and a Regulated Market (“RM”), as defined in the Markets in Financial Instruments Directive (Directive 2014/65/EC) (“MIFID II”). As a RM for spot and derivatives transactions, EEX is supervised by the Saxon State Ministry for Economic Affairs, Labour and Transport (the “Exchange Supervisory Authority”). The Exchange Supervisory Authority is in charge of the legal supervision of EEX and of market supervision of the trading participants according to the German Exchange Act. The members of EEX are supervised by the Federal Financial Supervisory Authority (BaFin). All trading participants are required to comply with the market behavior at the spot and derivatives markets of all exchange participants is supervised on a daily basis by the Market Surveillance Office, an independent body of the exchange according to Section 7 of the German Exchange Act. See https://www.esma.europa.eu/sites/default/files/EEX_1.pdf. See also Rules and Regulations at https://www.eex.com/en/markets/trading-ressources/rules-and-regulations.
ICE Endex is regulated in the Netherlands by the Dutch Authority for the Financial Markets (“AFM”) as a RM, as defined in MIFID II, which is implemented in Dutch Act on Financial Supervision (“DFSA”). The license as a RM is obtained under Section 5:26(1) of the DFSA, resulting in an authorization by the Minister of Dutch Ministry of Finance to operate a RM and supervised by the AFM. In the UK, ICE Endex is a Recognized Overseas Investment Exchange by the Financial Conduct Authority. See https://www.ice.com/endex/regulation#:~:text=The%20Dutch%20Authority%20for%20Consumers,energy%20industry%20and%20wholesale%20trading. ICE Endex is also recognized by the CFTC as an authorized Foreign Board of Trade. See https://www.cftc.gov/sites/default/files/idc/groups/public/@otherif/documents/ifdocs/orgiceeregorder170110.pdf.
According to the Registration Statement, the EUA markets are generally liquid. The classifications for market participants include five basic categories—(1) investment firms or credit institutions, (2) investment funds, (3) other financial institutions, (4) operators with compliance obligations and (5) commercial undertakings which are non-financial firms without compliance obligations. According to the European Union Transaction Log, there are over 18,773 registry accounts. The number of participants in the market have a direct bearing on the quality of trading. An Oxera report indicates that as the number of participants trading EUA futures has increased consistently since January 2017, relative spreads, calculated as the average quoted spread divided by the closing price, have decreased significantly—from just under 0.4% in January 2017 to roughly 0.06% in October 2021. In a February 2023 publication, Refinitiv estimated that approximately 9.27 billion EUAs were traded across all markets in 2022, amounting to approximately €751 billion. Out of the total EUA market, approximately 487 million EUAs (amounting to €38.5 billion) were attributable to the EUA primary (auction) market, 8.45 billion EUAs (€685.3 billion) were attributable to the EUA secondary market and 335 million EUAs (€27.3 billion) were attributable to over-the-counter (“OTC”) transactions. In this context, the secondary market includes (1) the EEX spot EUA market, (2) the Daily EUA Futures market, (3) the markets for other EUA futures contracts (together with Daily EUA Futures, “EUA Futures”), and (4) options contracts on EUA Futures. Data regarding each of the trading of each of these instruments is provided below. As of January 2023, the secondary market had average daily trading volume of €2 billion, with the majority of the liquidity in the daily futures market as described in more detail below. EUA auctions are held on a near-daily basis throughout the year, other than between mid-December to mid-January, when auctions are paused. Twenty-eight countries (25 EU member states plus Liechtenstein, Norway, and Iceland) have agreed to use EEX to conduct their regularly scheduled auctions. Germany and Poland have opted out of the common auction but also utilize the EEX for auctions. Hence, EUA auctions take place exclusively on EEX. These auctions take place on a regularly scheduled basis; the number of allowances being auctioned is disclosed on a schedule prior to auction. Prices achieved in these auctions are published on various publicly-accessible websites, including the European Commission's primary website.
See esma70-445-38_final_report_on_emission_allowances_and_associated_derivatives.pdf ( europa.eu).
Carbon trading in the European Union: An economic assessment of market functioning in 2021, Oxera, p. 42 (February 15, 2022); available at https://www.oxera.com/wp-content/uploads/2022/02/Oxera-EU-carbon-trading-report-3.pdf.
See “Review of Carbon Markets in 2022” (February 2023): available at https://www.refinitiv.com/content/dam/marketing/en_us/documents/gated/reports/carbon-market-year-in-review-2022.pdf. The report presents Refinitiv's assessment of the world's major carbon markets in 2022 and the total EUA market size includes spot, auctions and futures.
Below is a discussion of the secondary markets for EUAs and associated derivatives. The Trust will only hold EUAs, and will not hold any of the related derivatives.
Instruments With a Daily Expiry
Instruments with daily expiry include spot EUAs traded on the EEX and the Daily EUA Future traded on ICE Endex. The Exchange notes that the settlement and economic outcome for a spot purchase on the EEX and a same day futures purchase on the ICE Endex are identical (as further detailed below). In fact, the European Securities Markets Authority (“ESMA”), in its “Final Report: Emission Allowances and Associated Derivatives,” uses the term “spot” EUAs to include both spot EUAs traded on EEX and the Daily EUA Future traded on ICE Endex.
See esma70-445-38_final_report_on_emission_allowances_and_associated_derivatives.pdf ( europa.eu).
Spot EUA Market
As noted above, spot EUA contracts are traded exclusively on the EEX. The current value (spot price) for a EUA is greatly influenced by a number of factors, including regulatory changes, world events and general levels of economic activity. The trading hours for spot EUAs on EEX are 8:00 a.m. to 6:00 p.m. Central European Time (“C.E.T.”), and trade registrations are possible until 6:45 p.m. C.E.T. Trades concluded before 4:00 p.m. C.E.T. are settled on the next business day, or T+1, while trades after 4:00 p.m. C.E.T. are settled on the day after the first business day, or T+2. In the twelve-month period ended July 15, 2024, the average daily, monthly and annual trading volumes of spot EUAs on the EEX was 156, 3,247 and 38,968 round lots of 1000 EUAs, respectively. Over the same period, spot EUAs traded in the secondary market on EEX at their highest volume of 5,010 round lots of EUAs on December 1, 2023, and their lowest volume of 0 EUAs on four different occasions. The EEX calculates and publishes each trading day an index (the “EUA End of Day Index”) reflecting the end of day price of EUAs traded in the secondary market on EEX.
The EUA End of Day Index methodology is available at https://www.eex.com/fileadmin/EEX/Downloads/Trading/Specifications/Indeces/DE/20211005_Index_Description_v010.pdf.
Daily EUA Futures
Most liquidity in the secondary market is achieved by trading futures contracts. These contracts have expiration going out as far as 2030. A single day futures contract on EUAs is exclusively traded on the ICE Endex (the “Daily EUA Future”), which settles each day at the close of trading. The Daily EUA Future is a deliverable contract where each person with a position open at cessation of trading is obliged to make or take physical delivery of EUAs upon the expiration of the contract at the end of each trading day. Settlement of the Daily EUA Future does not occur through cash transactions. Each Daily EUA Future represents one lot of 1,000 EUAs, with each EUA providing an entitlement to emit one ton of carbon dioxide equivalent gas. Generally, Daily EUA Futures trade on ICE Endex from approximately 2:00 a.m. Eastern Time (“E.T.”) to approximately 12:00 p.m. E.T. The settlement price is fixed each business day and is published by the exchange at approximately 12:15 E.T. Final cash settlement occurs the first business day following the expiry day. In the twelve-month period ended July 15, 2024, the average daily, monthly and annual trading volumes of Daily EUA Futures was approximately 3,688, 76,842 and 922,094, respectively, which represents trading volumes of 3,688,000, 76,842,000 and 922,094,000 EUAs, respectively. Over the same period, Daily EUA Futures traded at their highest volume of 27,749 on April 17, 2024, representing 27,749,000 EUAs, and their lowest volume of 230 on August 11, 2023, representing 230,000 EUAs.
All references to the “Daily EUA Future” refer to the single day EUA futures contract traded on ICE Endex. NASDAQ Oslo also offers a single day futures contract on EUAs, but the contract is not traded.
Comparison of Spot EUA Market and Daily EUA Futures Market
The daily EUA End of Day Index value can be expected to be substantially identical to the daily settlement price of the Daily EUA Future. The comparison below shows a 99.8% correlation between the movements of the two values over the five years from May 23, 2019 through May 23, 2024.
Additionally, the chart below illustrates how closely the Daily EUA Future, in fact, reflects the EUA spot price during the trading day. This chart shows the prices in continuous trading of EUAs on the EEX and the Daily EUA Futures on ICE Endex, in EUR/tCO2 from January 2018 to January 2022. No major differences can be observed, with an average absolute difference of €0.015 between the daily settlement prices for EUAs on the EEX and ICE Endex.
Other EUA Futures Contracts
EEX offers monthly EUA futures contracts for the current and next two months unless a quarterly or December future expires at that month's maturity date; quarterly futures for the current and next 11 quarters unless a December future expires at that quarter's maturity date; and yearly, or December, futures for the next 8 years which mature in December of each respective year. ICE Endex offers up to seven December futures contracts, nine quarterly futures contracts, three August futures contracts and two monthly futures contracts. Nasdaq Oslo offers a quarterly futures contract over a rolling six year period. There is no material trading volume in EUA Futures on Nasdaq Oslo.
In each market, the predominant futures contracts traded were those expiring in December 2024 and December 2025. For the twelve-month period ended July 24, 2024, the average daily trading volumes and annual volumes of the EUA Futures expiring in December 2024 and December 2025 were as follows:
July 24, 2023 Through July 24, 2024
| ICE Endex | EEX | |||
|---|---|---|---|---|
| Average daily trading volume (each contract represents 1,000 EUAs) | Total trading volume (each contract represents 1,000 EUAs) | Average daily trading volume (each contract represents 1,000 EUAs) | Total trading volume (each contract represents 1,000 EUAs) | |
| December 2024 EUA Future | 31,989 | 4,900,021 | 952 | 244,574 |
| December 2025 EUA Future | 3,463 | 500,792 | 195 | 50,164 |