Carbon trading needs to be further promoted

[CAI MENG/CHINA DAILY]

Since the rollout of the national carbon trading system on July 16, 2021, the basic structure of the carbon market has been shaped in China, helping enterprises reduce greenhouse gas emissions, accelerate their green transformation and to provide a benchmark for carbon pricing.

China’s first carbon market compliance cycle, which covered the calendar year 2021, included 2,162 power companies and covered 4.5 billion metric tons of carbon dioxide emissions. The emission allowances (ECA) were traded on June 28, with a total trading value approaching 8.5 billion yuan ($1.3 billion).

The CEA price closed at 59 yuan per ton on June 28, up 22.9% from the first trading day. Although this price is still lower than most markets in the European Union, the national carbon trading mechanism has served its pricing function as such trading has been attempted in most parts of China.

Systematic arrangements have been made, with carbon trading management regulations published at the end of December 2020 and carbon emission calculation, verification and settlement methods introduced.

To enrich the financial characteristics of carbon trading, the China Securities Regulatory Commission issued industry standards for carbon-related financial products in mid-April. More and more banks have set up carbon pledge loans and financial products linked to the carbon market have started to emerge.

But it should be noted that China’s carbon trading is at a very early stage compared to other mature markets. Business activity was weaker during cycles of non-compliance, which was not widely observed in the EU.

One of the main reasons is the relatively small number of participants. Currently, only power companies with emissions control targets are allowed to engage in carbon trading. Individual or institutional investors cannot access this trade. Therefore, compliance is the most important factor that drives power companies to trade allowances. Higher transaction activity during compliance periods is therefore plausible.

A second cause is the currently unclear market expectations. Instead of a long-term plan for ACEs or amendments, carbon emission allowances are now published on a yearly basis on the Chinese carbon market. Therefore, power companies cannot benefit from clear market forecasts.

Meanwhile, unused carbon emission allowances can be carried over to later trading periods in China. Therefore, electricity companies subject to compliance obligations may tend to keep unused allowances rather than trading them in order to be able to cope with future uncertainties. It has also led to a decline in commercial willingness.

But in the EU, long-term targets have been clearly set to reduce carbon emissions over a maximum period of 10 years. Market entities can thus be well prepared and have clearer plans for the future.

The limited supply of commercial products has also led to a drop in commercial activity. There are not enough risk management tools provided in the market today.

Based on EU experiences, carbon-related financial derivatives, in particular futures and futures, play an important role in stimulating carbon trading during periods of non-compliance. The volume of transactions in the futures market far exceeds that of the spot market. Derivatives can also help market entities better hedge price risk and manage risk exposure in carbon trading.

Only spot trading of carbon allowances is done in China, which undermines companies’ willingness to more actively manage their carbon allowance assets.

Financial institutions cannot participate directly in carbon trading at this time. The supply of innovative financial products linked to carbon trading is limited.

In this sense, laws and regulations regarding carbon trading should be completed in the first place to stabilize market expectations.

In the meantime, a clear carbon emissions target and a dynamic adjustment mechanism should be established. These are the foundations of a stable and efficient carbon spot market.

Concerted efforts should be made by different parties to promote the development of the carbon market. Carbon futures should be deployed first, through which larger-scale innovation of carbon-related financial derivatives can be made possible. The Ministry of Ecology and the Environment and financial regulators should therefore come together to regulate the carbon financial market and reduce risks.

Carbon trading thresholds should be moderately lowered. Commercial banks should be encouraged to participate in carbon trading. The participation of financial institutions will provide more liquidity, strengthen the market function of price discovery and control price volatility. More importantly, the various innovative products and services that will be developed by these institutions will lead to a diversified development of the Chinese carbon market.

According to the Framework Plan for the Development of China’s Carbon Market, released by the National Development and Reform Commission in December 2017, eight industries are expected to be included in carbon trading. After electricity companies, suppliers of building materials and non-ferrous metal companies are expected to be the second group to participate in carbon trading.

On the one hand, the above two industries have unified techniques and rich data sources, which are more visible in cement and electrolytic aluminum enterprises. On the other hand, a basic quota allocation plan was initially drawn up for the two industries when preparations for a national carbon trading system began in 2017.

The second compliance cycle, which started on March 15, is crucial for getting the carbon market on the right track. During this period, the trading mechanism should be further optimized and more market entities should be included in carbon trading.

Supervision and management mechanisms need to be completed.

More industries should be included in carbon trading. Individual and institutional investors should be allowed to participate in carbon trading, where appropriate.

The author is chief economist at the Industrial Bank and a member of the China Chief Economist Forum.

Opinions do not necessarily reflect those of China Daily.

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