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China Prepares to Launch National Carbon Trading Scheme
by Gloria Luo
02 Aug 2017

The stage is set for China to become a global leader in climate action, as it prepares to launch the world’s biggest carbon market. The market will be unprecedented in its scale and complexity. China, the world’s largest emitter of greenhouse gases (GHG), will reportedly institute its national carbon trading scheme (“the scheme”) in November 2017 at the earliest, and likely only cover three industries, including power, cement and aluminum, at the initial stage given the availability of their emissions data.

An emissions trading scheme, or a cap-and-trade system, is a market-based policy instrument that provides emitters with market incentives to reduce GHG emissions. The government sets the cap on emissions and distributes allowances to companies who can only emit set amounts. Companies that reduce their emissions can sell their allowances to companies that emit more, creating a market where emissions reduction and innovation are encouraged and rewarded. The underlying economic rationale is that emitters are forced to internalise the costs of emissions generated by their business operations, ultimately driving efficient resource allocation and the development of more carbon-efficient industries. Compared to a carbon tax or command-and-control regulation, the “trading” element of the scheme allows businesses in China greater flexibility in emissions reduction as an attempt to meet the national commitment to peak emissions by 2030.

To pave the way for the scheme’s nationwide implementation, the Chinese government has been experimenting since 2013 with seven pilot markets in Beijing, Chongqing, Guangdong, Hubei, Shanghai, Shenzhen and Tianjin, which together account for around 25% of the nation’s annual GDP and represent various economic conditions within the country. These pilot markets have a certain leeway to design, implement and enforce their own schemes, contributing to their varying features from sectors and entities covered and allocation of allowances, to standards for monitoring, reporting and verification, to rules of compliance. Now in their fourth year, these markets show different performance results and have accumulated practical experience in carbon trading.

Building on these pilot markets, the national scheme is expected to facilitate China’s ambitious transition towards a low-carbon economy and exert a profound influence on its economic growth in the long term. In particular, Dr Richard Sandor, named the “father of carbon trading” by Time Magazine, encouraged Hong Kong, as an international finance centre, to contribute its part in China’s low-carbon development:

“If you marry environmental objectives with its well-developed financial system, I am very optimistic that [Hong Kong] will, can and should be a laboratory for all of China.”

However, it remains to be seen how the pilot markets can be integrated into a nationwide regime considering their varying features and performance results. It is also questionable whether the scheme can enable active participation of businesses in carbon trading, mature into a fully functional national carbon market and may even connect to mature markets in the developed regions, like the European Union and California, both of which have shown interest in collaborating with the scheme in China.

In reality, significant challenges still lie ahead, one of which is the proper measurement, reporting and verification of all the emissions data. Reliable and comparable data will be the key to an integrated, well-functioning national carbon market and the government may keep on enforcing strict regulations. For businesses in China, it is critical to understand the potential risks and opportunities of the scheme brought by the increase in compliance-related costs and cost-cutting potential. Covered entities should also assess their carbon footprint, management and reporting to ensure accuracy, timeliness and transparency.

The Chinese leadership has shown strong political will in the country’s transition to a low-carbon economy. In a foreseeable future, the national carbon trading scheme will continue to be one of the key pillars of China’s climate policy. It will pose not only challenges for businesses in China, but also opportunities for them to proactively use carbon trading to their advantage and thrive in a more sustainable world.

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