Abstract: China had made tremendous efforts in mitigating climate change before seven regions officially launched their ETS by July 2014. The newly launched ETS in China had a lot of achievements, covering strictly formulated local regulations and market monitoring rules, wide coverage of mandatory participants, innovative and comprehensive allocation mechanism of allowance, flexible mechanism for compliance. However, there are still various challenges that we have to face in the future, concerning transparency requirement, accuracy and reliability of reporting data, practicability of compliance and enforcement, possibility of linkage with other cap-and-trade systems. As to the ETS in China, we absolutely need adequate patience by adhering to ‘practicing and progressing’.

Keywords: China  Emission Trading System  Carbon Market  Emission Allowance

1 Introduction

Climate change stands out as the quintessential global-scale collective action problem with implications that require carefully managed policy coordination problem and multi-level governance. Although the emissions are global in scope, the polluting activities often require local, state/provincial, or national monitoring and control. [1]In short words, every stakeholder’s effort in multi-level (e.g. nation, state/province, city, individuals), along with transnational cooperation, is undoubtedly essential in mitigating climate change. Fortunately, despite the long-lasting but depressed international negotiation for climate change, recent developments made by giant partners in addressing this global issue has shown some encouraging signals for reducing greenhouse gases(GHG) emission. A remarkable achievement undoubtedly lies on China’s ambition and action to reduce emission of GHG in recent years, especially exemplified by emerging sub-national or regional carbon emission trading schemes (ETS) .

Surely, China has showed its strong desire and aggressiveness to mitigate climate change and GHG emission in that by July 2014, seven regions in China (i.e. Shenzhen, Shanghai, Beijing, Guangdong, Tianjin, Hubei and Chongqing sequentially) officially initiated regional ETS. ETS in Chongqing is under construction and scheduled to start in 2014.  Regional ETS was widely acknowledged as a market-oriented and cost-effectively measure for reducing GHG emission in China and a substantially progressive way to promote the international cooperation for climate change. It was primarily proposed that a nationwide ETS should be established before 2020.

This paper aims to illustrate China’s regional ETS pragmatically, focusing on some important issues in stead of giving a whole picture about this. The paper will be structured as follows besides section 1. Section 2 simply describes the most important measures taken by China up to now for emission reduction. Section 3 analyses current achievements of seven regional ETS, mainly based on the released regulation, working programs and actual practices. Some interesting comparisons will be made among six provinces/cities. Section 4 explores the challenges ahead or problems which are still waiting to be resolved. Section 5 makes simple conclusions.

2 Background of ETS: Substantial measures in mitigating climate change during 2010-2013

It has been widely acknowledged that China is one of the largest emitters of GHG currently. As a result, China plays as a key player in international efforts to secure a global climate change agreement by 2015 which is expected to come into force in 2020. China’s emission abatement policies and practices have undoubtedly received worldwide attentions and produced much impact on international agenda in combating climate change.

Mandatory allowance-based ETS led by government [2]has been more widely applied than the carbon tax, ranging from national (e.g. EU Member States, Australia), regional (e.g.RGGI, California) to local(e.g.Tokyo) level, mainly in that this ‘cap-and-trade’ mechanism can minimize the possible reduction cost by exchanging emission permits in the open market and trigger the investment into low-carbon economy and technical innovation by way of price signal of emission permits. ETS puts a price on carbon and can produce much more economic incentives to remitters than command-and-control measures. [3]China currently is the new entrant of ‘ETS club’ and highly expected to produce new incentives into international climate change negotiation.

During Copenhagen Climate Change Conference in 2009, China committed that it will reduce the carbon intensity per unit of GDP by 40-45 percent compared to 2005 levels by 2020. This commitment has been reinforced in 12^th Five Year Plan(FYP) which stated that China will reduce the carbon emission of per unit of GDP by 17% compared to 2005 levels by 2015. The main reason why China set the carbon-intensity reduction target instead of capping the emission is that, due to rapid industrialization and urbanization, absolute emissions of China will definitely climb and the emission peaking is expected to come in 2025 or 2030.Although carbon-intensity target has aroused debates, [4] it is undeniable that this project is more feasible and acceptable than absolute emission target nowadays. Furthermore, pursuant to the national carbon-intensity reduction requirement, the importance of cap setting was reiterated in all the newly launched regional ETS.

China’s substantial endeavors for climate change mitigation can be traced back to July 2010 when China’s National Development and Reform Commission (NDRC) announced to establish pilot low-carbon zones, including five provinces (Guangdong, Liaoning, Hubei, Shanxi and Yunnan) and eight cities(Tianjin, Chongqing, Shenzhen, Xiamen, Nanchang, Guiyang, Baoding and Hangzhou) . [5]In that notice, it was required that every province or city should completed the regulatory system for GHG emission, including data collection and accounting, capacity building and institution establishment, which can be easily understood as preparatory works for ETS. Further, In October 2011, NDRC decided to launch pilot emission trading system (ETS) in two provinces (Guangdong and Hubei) and five cities(Beijing, Tianjin, Shanghai, Chongqing and Shenzhen) in order to accumulate experience and hope to establish a nationwide carbon market some time before 2020. [6]It was hoped that the seven regional ETS can begin their integration process by 2015.But there are still many difficult technical issues which has to be addressed for integration before a national platform can be built.

It was witnessed in 2012 that dramatic developments had been made in order to  initiate China’s ETS as soon as possible. On June 2012, NDRC issued the Interim Regulation for Management of Voluntary Emission Trading of GHG which invited any foreign and domestic institution, enterprises and individuals to take part in and encouraged project-based voluntary GHG emission trading. In November, NDRC made public China’s Policies and Actions for Addressing Climate Change(2012) which reiterated the significance of pilot ETS programs in seven regions and shortly concluded the updated progresses. Besides, some regions announced the ETS legislation by local people’s congress (e.g. Shenzhen) or working programs by local governments (e.g. Beijing, Shanghai, Guangdong) in 2012, defining the overall concept, objects, key tasks and project schedules. They had calculated the overall cap about GHG emission in their regions mainly depending on energy consumption (e.g. in terms of quantity of standard coal) and formulated plans for distributing emission reduction targets by considering the regional economic development level, industrial structure and energy consumption. Relevant institutions, i.e. emission exchange, were set up promptly.

Due to various reasons, e.g. lack of sufficiently reliable data for GHG emission, absence of well experienced human resources, resistance of big remitters(e.g. cement manufacturer, iron and steel producer), fearing for slowing down the economic growth, little progresses had been achieved during the first half of 2013. However, on 18 June 2013, Shenzhen firstly launch an experimental permits trading among seven Chinese regions. It was reported by Shenzhen Carbon Emission Exchange that on the first trading date, the prices ranged from 28 to 32 RMB per ton and total trading volume and value even amounted to more than 21 thousand tons of CO2 equivalents and 610 thousand RMB respectively. [7]This icebreaking event was applauded by World Bank’s president Jim Yong Kim as an “encouraging” sign for the currently depressed international climate change negotiation and global carbon market.[8] After that, Shanghai( on 26 November 2013), Beijing(on 28 November 2013 ), Guangdong(on 19 December 2013) , Tianjin(on 26 December 2013) ,Hubei(on 2 April 2014) and Chongqing (on 19 June 2014)officially launched their emission trading in sequence.

 China’s surprisingly hard works and ambitiousness to initiate pilot ETS should be carefully watched and cautiously commented. Exactly speaking, what has been achieved up to now and what remained as challenges ahead or unresolved problems deserved our deep discussion.

3 Main Achievements about China’s Regional ETS

3.1 Strictly formulated local regulations and market monitoring rules

According to the principle of rule of law in China, every ETS should be governed by local legislation or regulation. Up to now, all six province/cities had met this requirement of legality in varying degrees. The governments of Shanghai, Guangdong and Tianjin had officially released the regulation, e.g. Shanghai Pilot Measures of Management of Carbon Emission, Guangdong Pilot Measures of Management of Carbon Emission. Alternatively, the remaining governments, i.e. Shenzhen and Beijing, chose to formulate detailed working programs under the authorization of local people’s congress respectively in stead of making local regulations directly.

A common feature of those regulations or working programs is that they covered almost all the important issues of ETS, mainly including “cap-and-trade” principle, allowance management, MRV system (Measurement, Reporting and Verification), trading system, market supervision, compliance and enforcement mechanism. Another common feature is that during the process of formulation, regulation drafts were released on official website and public comments were widely invited. So to a large extent, the working process highly respected the principle of transparency. The public, ranging from enterprises, intermediary organs and experts, showed keen interests on this new issue. Many suggestions were responded to but not all of them were adopted.

Besides, potential market risks and market misconducts in ETS were carefully examined and detailed market monitoring rules had been formulated in order to ensure a safe and efficient trading platform and to strengthen the confidence in the market. Carbon market exchanges in seven regions had been set up promptly and they released various rules covering patterns of trading, settlement and delivery, risk management and information disclosure, etc. For example, under the authorization of government, exchanges are able to set the margin about price fluctuation every day, to impose reporting requirement on eligible participants and to deposit risk reserves. It was evident that carbon market monitoring rules in China were somewhat comparable to those of securities market, which well illustrated the cautiousness of formulators.

3.2 Wide coverage of mandatory participants

All the governments had established the baseline for the mandatory participation of remitters, mainly based on historically average annual emission of CO2. The baseline for compulsory participation varies to large extent mainly owing to the regional economic structure and development level. For example, In regard to Beijing, the baseline for these participants is that their average annual direct or indirect carbon dioxide emissions exceeded 10 thousands tons during 2009-2011. However, the counterpart in Tianjin and Shenzhen was raised to 20 thousands tons and reduced to   5 thousands tons respectively. It was the common practices that when calculating the historical emission, the energy inputs, namely standard coals, are used as measurement unit.

The most innovative and ambitious aspect of some regional ETS which should be stressed is that not only all eligible energy-intensive manufacturing but also certain eligible service sectors had to take part in emission trading. For example, as required by Shanghai government, any important manufacturing enterprises which remitted directly or indirectly more than 20 thousands tons of carbon dioxide in 2010 or 2011 will be compulsorily covered in ETS, including steel, petrifaction, non-ferrous metals, papermaking, power generation, textiles, etc. ETS also extended to any eligible services sectors, including airport, airline, shopping mall, hotel, harbor, banking and railways, which remitted directly or indirectly more than 10 thousands tons of carbon dioxide in 2010 or 2011. It was noteworthy that by initiating ETS, China also aims to enhance the energy saving policy since shopping mall, hotel and banking are all big energy consumers and consequently have huge indirect emission.

Among the first batch of 197 pilot enterprises in Shanghai, Eastern Airlines, Shanghai Airline, Jixiang Airline and Chunqiu Airline were covered. [9]This paper deems it an amazing achievement since, as we know, China had severely questioned the legality and reasonableness of extra-jurisdiction of EU’s aviation ETS and as a result serious conflicts occurred in 2013. In this regard, we can understand that China had showed an encouraging signal to respond to or coordinate with EU’s aviation ETS in that theoretically emission allowance obtained in China carbon market can be used by China’s airlines to meet the requirement of EU aviation regulation. How to realized this implicit policy goal and how to link the two carbon market still remained to be seen.

3.3 Innovative and comprehensive allocation mechanism of allowance

It was admitted that grandfathering mechanism is the most feasible allocation method in pilot phase but the less efficient one in cutting emission when comparing to benchmarking or other mechanism. The disadvantage and weakness of grandfathering had been confirmed during the first and second trading periods of EU ETS since it was partly responsible for the over-allocation of permits and slumping down of carbon market. In this regard, China’s local governments chose to adopt more innovative and comprehensive techniques for allowance distribution. It means that the allocation methodology was not solely dependent on historical emission of specific remitter. Instead, the average emission of certain industry and targeted reduction ratio should be taken into account by the regulators. Besides, “dynamic cap” or adjustable cap for enterprises was applied in some regions. In a word, when respecting the historical emission in order to ensure feasibility, China also considered to strongly encourage and reward innovative reducing measures made both in prior and future stages.

For example, according to Shanghai’s implementing project, grandfathering was primarily used for manufacturing sectors but the amount of energy saving which was previously approved by government would be considered in the total mount of permits. That is to say, the eligible enterprise will be rewarded extra allowances according to its previous performance of energy saving. The exact calculation program is: rewarding allowance amount=30%X2.23 ton-CO2 per ton of standard coal. Furthermore, Benchmarking was applied to power generation, airline, airport and harbors in Shanghai.

In Shenzhen, the so-called “dynamic cap” was imposed to enterprises. Only after the end of each compliance year, can actual emission and industrial output be calculated, reported and verified. Allowance will be determined ultimately by following formula:

Actual allowance= A X B X C                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

A- reduction target (percentage)

B- actual industrial output (measurement is made in RMB)

C-Carbon-intensity for different grouping of enterprises (tons of CO2/ 10 thousands of RMB)[10]

According to above program, Both A and C indicators are unchangeable for the first stage of 2013-2015. But B index is changeable absolutely. Exactly speaking, actual amount of allowance will only be determined after the end of each year when the actual economic output can be confirmed. The so called ‘dynamic cap’ was designed to resolve the problem of information asymmetry in order to avoid imprecise distribution made by false reporting of enterprises. It is also aimed to maintain the stability of carbon price and consequently avoid the unexpected fluctuation of price because of shortage or oversupply of allowance in that allowance is adjustable depending on the economic performance of enterprises in 2013-2015.

As to the effect of Shenzhen ETS, it can be argued that allowance distribution method meets the essence of traditional benchmark because different static carbon-intensity target has given to the corresponding grouping of industry which amounts to benchmark or baseline for specific grouping. Carbon-intensity target is also helpful for the carbon-amount reduction if the former can keep declining and exceed the economic growing rate in the given period.

Another innovation about emission permits distribution is that auction had been actually used in the pilot phase of Guangdong. According to Guangdong’s First Distribution and Working Project of Carbon Emission Allowance(Pilot) [11], 3% and 10% of allowance should be auctioned during 2013-2014 and 2015 respectively. Under the authorization of government, Guangzhou Carbon Emission Exchange takes charge in auctioning and first bidding took place on 16 December 2013. It was reported that total mount of auctioned allowance on that day was 3 million tons and average price was 60 RMB/ton. [12]

3.4 Flexible mechanism for compliance

Admittedly, flexible mechanism for compliance can ease the heavy burden of enterprises, enhance the ability of compliance and as a result encourage participation in ETS to a large extent. Furthermore, it also helps to maintain the price stability of carbon market. In China, offsetting, saving mechanisms were clearly allowed in regional ETS, along with strictly imposed conditions.

   Concerning offsetting mechanism, it is stipulated in Guangdong that enterprise can use China Certified Emission Reductions approved by NDRC (CCER) to offset no more than 10% of its actual emission in specific year with the condition that at least 70% of CCER should be obtained from Guangdong voluntary emission reduction project. The specified percentages of actual emission that can be offset were 5%, 5%, 10% and 10% in Beijing, Shanghai ,Tianjin and Shenzhen respectively.  This paper argued that 5% was not sufficient to promote the development of project-based emission reduction and trigger the incentives of participants.

   Any surplus of allowance can be saved to the next year of same trading period in six pilot ETS. Besides, up to now there is no provision addressing the issue of banking in China except that banking was expressly prohibited in Shenzhen. This paper argued that prohibition of banking is not only inconsistent with general practices of worldwide ETS but also, learning from EU’s lessons, probably would produce negative impact on fluidity of emission permits and confidence on carbon market.

   Offsetting mechanism aroused keen interests on the value of CCER which can be regarded as an important supplement to the ETS. According to rules of NDRC, emission reduction credit from project such as renewable energy, waste heat utilization and biofuel can be verified and registered as CCER. On 28 November 2013, the first CCER transaction was made between a wind power project and PetroChina in Beijing carbon market. [13]The prosperous CCER market will definitely re-energize the currently depressing market of Clean Development Mechanism project in China mainly due to the weak market demand abroad. It also can be predicted that when the first compliance period expires in June of this year, the market demand and price of CCER will climb substantially.

4 Some Challenges ahead

4.1 Transparency requirement

Needless to stay, sufficient and convenient access to full information is vital to the stable and healthy development of carbon market. Adequate information disclosure will also make carbon market attractive to mandatory enterprises and potential investors who have to make their commercial decisions mainly based on the massive information. Furthermore, to ensure transparency of market data is absolutely helpful to resolve the inherent disadvantages of carbon market , i.e. information-asymmetry and consequently fraudulent behaviors and expensive monitoring costs.

Unfortunately, the newly emerging carbon markets and their regulators are currently undergoing much criticism due to its lack of transparency. For example, the exact amount of emission cap for specific region and exact approaches about how to calculate this cap are not make public up to now. In some cities(e.g. Beijing)and provinces(e.g. Hubei), the mandatory participates and exact amount of their allowance in pilot phase are not disclosed. Besides, the daily average amount and price of carbon transaction are released on regional exchanges but the participants, approaches of trading and formation of price are still kept in secrecy. Lack of transparency had discouraged the participation of potential investors and severely suppressed the confidences of mandatory participants.

4.2 Accuracy and reliability of reporting data

Sufficiently accurate and reliable of emission data is the key element for a healthy and stable carbon market. In China, there is a weak tradition among enterprises to provide the authentic data or figures mainly because of the self-interest motivation and loose penalty. False data will absolutely weaken the efficiency of carbon market. To be worse, governments’ ability to monitor the market and ensure the reliability of data was also severely questioned.

For example, according to the stipulations both in Guangdong and Shanghai, false or fraudulent emission reporting of enterprise will be only fined no more than 30 thousand RMB. To some extent, the weak penalty will predictably indulge the violation of participants. Furthermore, although the third-party verification mechanism for emission reporting was widely introduced in all regional ETS, its effectiveness still remained to be tested in the future.

4.3 Practicability of compliance and enforcement

It deserves our close attention that whether enterprises can submit the full amount allowance or CCER equivalent to its emission and whether the penalty is rigorous or tight enough to ensure enforcement when the first compliance period expires in June 2014. In China, there are two ways to penalize the failure to present the full amount of allowance or CCER in due time. The first way is that non-compliance will be fined amounting to 50 (e.g. Guangdong) or 100 thousand (e.g. Shanghai ) of RMB. The another way is that non-compliance will be fined with a sum of money which is calculated by multiplying excessive emission amount and average triple carbon price in previous months (e.g. Shenzhen) . This paper argued that 50 or 100 thousand of RMB constituted a too conservative penalty which will not work well to prevent non-compliance especially when the permits price climbed to a high level. In this regard, a floating penalty depending on the carbon price will be more practical.

4.4 Possibility of linkage among each other or with other systems

It was primarily proposed by NDRC that by the end of 2020, a nationwide carbon market should be constructed. A national carbon market is welcomed by both regulators and enterprise since it will widen the coverage, further stimulate the participation of remitters, resolve the problem of carbon leakage, strengthen the cost-effectiveness of ETS in climate change mitigation while ensuring fair competition and consistency among different regions. In this regard, every regional ETS confessed that enterprises outside the specific territory were allowed to participant and coherence or integration across the regions will be discussed further in the future. This effort was newly evidenced by a cooperative pact signed by several cities or provinces from north China, the most severely air polluted and famously foggy area in this country. [14] 

Generally speaking, to link or integrate different ETS is not an easy task since important policy changes have to be made. For example, although EU-ETS has the most advanced carbon market globally and is eager to link with other cap-and-trade systems after its commencement, there are little achievements up to now. [15] Concerning the China, mainly due to sharp differences about development level, economic structure (e.g. composition of industry, energy consumption), emission feature and social concerns, regional ETS currently applied their own standard to set the cap, formulate the coverage for participants,  distribute the allowance to enterprises from different industries and adopt offsetting mechanism. Technical disparities had resulted in different spot trading price in different carbon markets. During March of 2013, the average prices ranged from 32.6(Tianjin), 39.5(Shanghai), 53.8(Beijing), 60.1(Guangdong) to 84.0(Shenzhen) RMB per ton.[16]We can imagine that participants in Tianjin will undoubtedly and strongly resisting to link with other ETS since after linkage the market price in Tianjin will rise to a comparatively high level.

Admittedly, lack of consistency in carbon market construction will produce some obstacles both in establishing a nationwide carbon market and deter the further plan to link with other cap-and-trade systems(e.g. EU and California) . In next stage, China should make efforts to pursue coherence and coordination for national or transnational linkage,[17] especially to integrate technical standards and registry system. Alternatively, NDRC are currently discussing the possible ways to formulate a single set of principles and rules for a nationwide carbon market, especially concerning cap setting, coverage and allowance distribution. [18] Regarding the “Top-Down” administrative characters in China, this paper deems it a practical and workable way. However, regional imbalances in development level and economic structure will remain to be huge obstacles.

5 Conclusions

China’s regional ETS constitutes an important part of global efforts to mitigate climate change and deserves our warm applauses. It also showed China’s strong and voluntary momentum to fight against air pollution and warming climate even in the absence of a global binding agreement. It will definitely help to make compromise in climate change negotiation and seek to reach a global pact. However, when China currently has a lot of achievements in establishing ETS, there are still various challenges that we have to face in the future.

To a large extent, China took EU-ETS as a model in formulating regional ETS, including definition of terms, principles of trading, allocation techniques of allowance, market monitoring. But it was quite obvious that China deliberately and cautiously prevented itself from carbon price slump which severely hit EU market and global climate change pact. For example, allowance adjustment mechanism, by outlining price ceiling and floor or reserving certain amount of allowance in advance, has been formulated in order to maintain the stability of permits price by regulator’s selling or repurchasing in carbon market. Generally, China’s local governments played more active roles in market managing and monitoring in order to maintain the stability and vigor of market, comparing with EU counterparts.

 When China is running to the ETS, it definitely will meet much difficulty which can not be overcome in short times. Before EU officially initiated ETS in 2005, it had spent almost a decade to make tremendous works. However, hard workings did not prevent EU from encountering unexpected setbacks in first and second stages, such as windfall profits, oversupply of allowance and price slump to the floor. So when we find that how to ensure sufficiency and reliability of reporting data, how to achieve compliance and penalize non-compliance in China carbon market are still unclear and far from satisfaction, we absolutely need adequate patience by adhering to ‘practicing and progressing’.