As a market-based policy tool for energy conservation and emissions reduction, the carbon emissions trading system follows the cap-and-trade principle, with the government setting a cap on the carbon emissions for one or more industries. For every ton of greenhouse gas emitted by an enterprise that is included in the carbon trading system, one unit of carbon emission allowance is required. Enterprises can buy these allowances or trade them with other companies.
In October 2011, the central government launched local pilot schemes for carbon emissions trading in Beijing, Tianjin, Shanghai, Chongqing, Hubei, Guangdong and Shenzhen. Ten years later, in July of this year, the national carbon market went online. However, due to such factors as the late start, uncertain policy expectations, lack of transparency in the carbon allowance allocation mechanism and an immature basic data system, trading has been lacklustre and prices are on the low side.
Still, energy saving and emissions reduction have become such inexorable trends that it makes sense for companies to view reductions as an opportunity and strengthen their carbon trading and carbon asset management capabilities so as to enhance their green and low-carbon competitiveness.
Trading entities. Under the Measures for the Administration of Carbon Emissions Trading (for Trial Implementation), “key emitters” as well as organisations and individuals that satisfy relevant state trading rules can trade on the national carbon market.
The term “key emitter” means an enterprise that is in an industry covered by the national carbon emissions trading market, and the annual greenhouse gas emissions of which reach at least 26,000 tons of carbon dioxide equivalent. At present, only the power industry is included in the trading system, with a total of 2,225 enterprises nationwide named as key emitters.
Setting of cap and allocation. The carbon emissions trading system limits the total available allowances during a specified period of time, thereby controlling the total emissions released by emitters and thus promoting the achievement of the carbon reduction targets.
Similar to the planned phased development of the EU Emission Trading Scheme, China’s national carbon market has, due to being in its early stages, provisionally adopted a bottom-up cap setting method, i.e. the allowances of each enterprise are determined based on its actual output in 2019-2020 and the total allowances of each provincial-level administrative region are then added together to derive the national emissions cap. It seems likely that the top-down cap requirement will be gradually brought in so as to dovetail with the policy objective of reaching peak carbon.
It is widely believed that as emissions reduction work progresses, the allowances flowing into the carbon market and made available for trading will decrease and that the competent authorities will maintain carbon price stability by closely and actively controlling allowances.
The first batch of allowances was allocated free of charge to relevant enterprises, with the performance term running from 1 January to 31 December 2021. In future, with the gradual maturing of the market, paid allowances may be introduced.
Trading mechanisms. Following an announcement from the Shanghai Environment and Energy Exchange, trading mechanisms include transfer by agreement, one-way bidding, or other methods complying with the regulations. Transfer by agreement is divided into listed trading by agreement and bulk trading by agreement.
The maximum submission for any one transaction through listed trading by agreement is required to be less than 100,000 tons of carbon dioxide equivalent. A trading entity makes a submission and completes a trade by viewing real-time listing quotations and, based on the price priority principle, selects from the counterparty’s five most favourable real-time prices as the transaction price. The transaction price under this method is determined at plus or minus 10% of the closing price on the previous trading day.
The minimum submission for any one transaction through bulk trading by agreement must also be not less than 100,000 tons of carbon dioxide equivalent. A trading entity may initiate a trade submission, or conduct dialogue and bargain on the price with a counterparty that has initiated a submission, or reach a deal directly with the counterparty.
A deal is confirmed once the parties reach a consensus through negotiations on such elements as the transaction price, transaction quantity, etc. The transaction price under this method is determined at plus or minus 30% of the closing price on the previous trading day.
China’s carbon trading system only provides a one-way bidding function, i.e. a trading entity submits a sell application to the trading institution, the trading institution issues a bid announcement, the eligible prospective transferees submit their quotes in accordance with regulations and the deal is concluded through the trading system by the specified time.
Trading requirements. Each trading entity may open only one trading account and may apply for multiple operators and a corresponding account operation authority. A trading product that has been bought may not be sold again on the same day. The clearing and settlement of carbon emission allowances are handled by the registration institution in accordance with regulations based on the transaction results provided by the trading institution. The original documents relating to a transaction and relevant documents and information are required to be kept for not less than 20 years.
It should be noted that the carbon trading market is a policy instrument and the market is naturally subject to the intervention and regulation of government authorities. When abnormal fluctuations in trading prices trigger the regulation and protection mechanism, the Ministry of Ecology and Environment may take such measures as open market manipulation, adjusting the use of national certified voluntary emission reductions, etc., to promote the sound development of the market.
Against a background of macro policy, companies should rapidly get to work establishing a carbon asset management framework and systematically develop their carbon asset management capabilities, including integrated management of carbon business, unified accounting of carbon emissions, orderly development of carbon assets and establishment of a compliance system so as to effectively avoid final settlement and performance risks.
Financial institutions have also moved from pilot projects to intensive participation, with the central bank rolling out a carbon emission reduction support tool on 8 November 2021. The scale of green credit continues to increase, and several banks have launched national carbon emissions rights loans. Zhongrong Trust has offered the first carbon trading China Certified Emission Reduction investment trust and allowance buybacks.
Allowance pledges and forwards, as well as carbon funds, trusts and bonds are continuously being developed and rolled out by various financial institutions. All of which signals that the carbon market is gradually becoming an increasingly important component of the green financial system.