PBoC Outlines Shortcomings in China's Carbon Trading Scheme

(ATF) China is setting up a national carbon trading scheme, described as a cap-and-trade system with market mechanisms and ‘bottom up’ architecture. The aim is to create an international market through exchanges where allowances are traded and emissions are monitored and reported. But it is still in its infancy and currently half the size of the European Union’s trading market.

Researchers from the People’s Bank of China have been watching developments in Europe, but the EU’s Emissions Trading System was disrupted by the coronavirus last year. The price put on carbon fell to about 15 euros ($18+) per tonne in March 2020, a drop of more than 30% from before the pandemic, which was a record low since November 2018. The Swiss postponed their compliance by four months, while auction results in March and June were declared invalid, so connections with the EU-ETS were delayed.

On June 30, 2020, the International Civil Aviation Organization agreed to only use 2019 emissions as a benchmark for the first three years of the Carbon Offset and Reduction Program for International Aviation (CORSIA).

Subsequently, countries and regions represented by the European Union launched a series of epidemic recovery plans highlighting green development. Under this incentive, global carbon prices have gradually recovered, and mainstream carbon market prices have returned to pre-epidemic levels. Recently, European carbon prices reached new highs.

With the US set to get a new President next week – a leader who has made the fight against global warming one of his top priorities, China appears to be laying more of its cards on the table or perhaps is ramping up publicity about its efforts (very sluggish its critics say) to meet its global commitments in regard to the Paris Agreement to counter climate change.

A policy study by a team from the Central Bank Research Bureau has voiced reservations about the current global carbon market, saying it faces four main “contradictions” – market segmentation, uncertainties (or risks), low carbon prices, and insufficient capacity for carbon finance innovation, according to a report in The Paper, a Chinese news outlet.

The researchers said the three mechanisms stipulated in the Kyoto Protocol all involve business relationships between different countries and markets, and different markets have diverse laws and regulations, quota allocation methods, and trading mechanisms.

“Complicated application of laws and geographical jurisdiction increase the risks of market entities, and there are significant obstacles and higher costs in the approval and certification of transnational projects,” the report said.

Uncertainty and risk was also highlighted, noting that the United States had withdrawn from the Paris Agreement and some countries had considered levying carbon ‘border adjustment taxes’.

The third problem that bothered the researchers was low carbon prices. According to the ‘State and Trends of Carbon Pricing 2020’ put out by the World Bank, although global carbon prices continue to rise, they are still below the price required to achieve the goals of the Paris Agreement.

At the end of March 2020, nearly half of global carbon prices were less than US$10 a tonne, and less than 5% of the carbon price was consistent with the goal of achieving the Paris Agreement.

The PBoC also felt that there was insufficient capacity for innovation in the carbon finance system – it lagged behind demand, and the reasons for this included a lack of carbon finance professionals, while some governments had not fully liberalised their carbon markets, so the development and innovation in carbon finance products was relatively cautious.

Low-Standard Carbon market

China’s carbon market has a solid foundation and huge potential to be an important market-oriented emission reduction tool, the report said. However, the study also noted that since a unified national carbon market has just started, it needs to put find effective solutions to outstanding problems such as an imperfect policy framework, insufficient degree of financialization, and the “inadequate” role of the carbon market.

The overall policy framework of China’s carbon market is incomplete and its international status is low.

As of the end of 2019, the cumulative trading volume of pilot carbon market quotas in the seven provinces and cities of Beijing, Tianjin, Shanghai, Chongqing, Guangdong, Hubei, and Shenzhen was 356 million tonnes, with an amount exceeding 7.3 billion yuan ($1.13 billion). But, affected by the epidemic, the compliance date for some pilot projects had to be postponed. However, the carbon price had not fluctuated significantly.

The degree of financialization in China’s carbon market is generally low. Although pilot regions and financial institutions have developed products such as carbon bonds, carbon futures, carbon options, and carbon funds, carbon finance is still in a sporadic pilot state. Regional development is uneven, and there is a lack of a systematic and complete carbon finance market, so it “could not meet control requirements”.

Companies producing carbon emissions did not have the management capacity to manage carbon trading in areas such where ‘Belt and Road’ projects were undertaken. Professional investors were ‘underdeveloped’, while the carbon finance sector lacked long-term financial support.

So, China’s carbon market was not working. The research team noted that international practice had shown that a carbon finance market is highly dependent on intense carbon emission controls and mature carbon emission rights with a spot trading market. Unlike Europe and the US, where financial functions are built into the carbon market, carbon finance is a more subordinate market tool for carbon emission reduction, it said. This was an important reason for the insufficient outcome.

How Can China’s Carbon Finance Market Develop Better?

The PBOC research team said China needed to consolidate its industrial foundation and its spot market, while improving its carbon finance system. The researchers said raising awareness, strengthening constraints, and striving to achieve the 2030 peak goal in advance would help. The country would bolster local governments, which had the main responsibility to make the process work, and continue to try to restrict carbon emissions.

There needed to be more publicity, education and policy incentives, and greater determination and action by local governments and market entities to implement the emission control target, as well as exploring and promoting advanced regions to take the lead in achieving carbon neutral goals. Officials need to study the establishment of a total carbon emission control system, to subdivide the control targets in various industries and regions, and strengthen assessments.

The PBOC researchers said it was vital for a nationally unified carbon emission rights market to be set up, and for formal trading to be promoted as soon as possible. They needed to determine the total amount of carbon allowances to ensure a reasonable carbon price.

In terms of trading methods, trading institutions should be given greater flexibility to study and explore carbon emission trading venues to carry out continuous trading and call auctions under the premise of strict supervision.

They also needed to introduce a central counter-party mechanism, to set up a carbon pricing centre, establish a carbon allowance reservation mechanism and a carbon market stabilization fund, as well as improving price control.

The report encouraged the cultivation of green and low-carbon industries and increased demand for carbon finance. Focusing on cultivating green and low-carbon industries with global competitive advantages, developing low-carbon technologies such as carbon capture and storage, could make up for the negative impacts on economic growth and employment that come with the end of high-polluting and high-energy industries.

The goal should be to make the real economy ‘greener,’ including carbon finance market demand. Leaders should integrate green development in the post-epidemic economic recovery plan, to increase investment in green projects as much as possible, and attaching “emission reduction and efficiency improvement” conditions on the rescue plan.

China would also need to improve laws and regulations, and to clarify the attributes of carbon emission rights legally. The research team suggested that in the process of implementing the Civil Code, the legal attributes and quality of environmental rights should clarify carbon emission rights.

Departmental regulations should formulate carbon finance market supervision and transaction management policies, and unify market supervision, transaction systems, legal responsibilities, incentive and restraint mechanisms, accounting and tax treatment and other related content.

Lastly, the report said the pricing authority and transaction efficiency of the carbon market needed to be improved. Officials should appropriately relax access and encourage relevant financial institutions and carbon asset management companies to participate in market transactions and innovate product tools.

One option was to explore the establishment of a self-disciplinary mechanism for the carbon market. The government would need to cultivate intermediary agencies and markets, and encourage the development of financing, investment, security, and information consulting service agencies.

In-depth integration of digital technology and carbon finance, and the use of advanced technologies such as big data, blockchain, and “robo-advisors” could help with customer screening, investment decision-making, transaction pricing, post-investment and loan management, information disclosure, investor education, and other aspects.

In other words, it’s time to get serious.