What will it take to establish the world's largest carbon market successfully?
China has made good progress in building the foundations of its national emissions trading system (ETS)—developing capacity and experience through its seven regional pilots. Now, China's challenge as it designs and implements its nationwide ETS is how best to deal with the disparate arrangements allowed in the regions and the sheer scale and diversity of the country.
Challenge 1: What level of legislation should China adopt?
In the pilots, regions had the critical leeway to issue their own ETS laws or regulations, which reflect both their widely differing local needs and their role as separate testbeds. Some took the form of local government orders and others, in Beijing and Chongqing, were enacted at a much higher level, by the regional People's Congress.
China must now decide whether the state council should issue a national ETS law—the widely predicted outcome—whose legal force would trounce the regional rules and regulations to which participating companies have become accustomed. And, if the council does enact such legislation, the question will be how best to converge pilot regulations and the national law to avoid confusion and non-compliance.
Advisers and local government experts can help the central government develop a smart answer by sharing lessons learned from the different approaches adopted in the ETS pilots.
Challenge 2: How can China best manage the different scope of the pilot and national carbon markets?
When China released its national carbon market development program in 2017, the fact that only the power generation sector would be covered initially was big news. As the pilot markets included most high-carbon intensity industrial sectors, this revelation opened up a can of worms.
When the time comes to transition from pilots to a national carbon market, what is supposed to happen to all the excluded sectors, from steel and chemicals to building and aviation?
“The practices adopted in the regional ETS pilots will give China's national government good references and experience to inform the design of the national ETS, and engaging pilot region experts to help formulate plans is an important way of connecting the two.”
- Shu Wang, Senior Manager, Climate Specialist
Some experts suggest maintaining the broad scope of the pilot markets during the early years of the national market, giving non-power generation sectors the opportunity to continue participating and learning. Whatever solution wins out, it's critical that pilot regions are involved. Mobilizing regional leaders through panel discussions and joint research will be one of the most effective ways for the central government to find out what they think, what's possible, and what’s the best way forward.
Challenge 3: What should happen to allowances already allocated in the pilots?
Each pilot market established its own allowance allocation standards, which local companies are now familiar with. Some firms will already have received allowances, which are a form of legal asset that may be protected by civil law.
So, what will happen to allowances already given out when the central government unifies allocation standards, as it certainly will, for the national ETS? If they are canceled, for example, affected companies will likely protest and create a thorny legal problem for the government. There are other proposals on the table, such as forced clearance, interim suspension, repurchase by the government, and discountable conversion into the national market. But, these all come with risks, including the infringement of corporate property.
Unsurprisingly, the issue of allowances is high on the agenda for research, which should lead to some consensus and common sense recommendations.
Challenge 4: How can China unify the monitoring, reporting, and verification standards of the pilots and national ETS?
The success of any ETS depends on the transparency, accuracy, and consistency of its monitoring, reporting, and verification (MRV) standards. The different technical standards formulated in the pilots shared the same overall structure but had their own specific rules. To complicate matters, companies also had to comply with existing national MRV measures issued and updated by the central government since 2013.
The different requirements of the national and pilot standards forced companies to report two sets of emission data, inevitably impacting perceptions of the rationality and credibility of the whole exercise. Any resulting reluctance in the regions to put faith in and switch over to a new national standard could be hugely damaging.
This state of affairs makes the coherence of MRV rules the essential guarantee for achieving a smooth transition to the national carbon market. The central government is putting itself in a position to rise to this considerable challenge through highly-specialized technical support underpinned by capacity building at the national level and training at the regional level.
Challenge 5: How can China integrate regional trading exchanges and registries into their national counterparts?
All seven regional pilots invested heavily in the development of localized versions of the two basic infrastructures required for the operation and management of carbon markets: trading exchanges and allowance registries. Inevitably, the specter of one unified national exchange and registry sweeping aside their existing platforms is troubling to those currently running a regional ETS.
As a result, some regions have stepped forward and asked to play a role in the development of the national platforms. The central government has been receptive to the idea. It has now developed an inclusive plan inspired by the success of events and study tours dedicated to learning from other countries' experience of running carbon markets and encouraging trading.
The government plans to build upon this approach by capitalizing on the regions' registry expertise. One pilot region has even been asked to take the lead in developing the national registry, which the central government aspires to set up as a joint venture with all the pilot regions.
It certainly appears that the knowledge sharing and openness encouraged during the pilots have positively influenced China's approach to the design of its national ETS. Giving the pilot regions both a voice and tangible roles, and continuing to build internal government capacity, will help China create the best possible conditions for its national ETS to take root.