Time of the Essence for Connecting Schemes to Reduce Emissions

A post by Justin Macinante (Edinburgh Law School)

Tradable permit schemes, such as for emissions trading, have been an innovative addition to climate change policymakers’ repertoire. Yet, to date, emissions trading schemes (ETSs) have failed to live up to their potential. Connecting ETSs could engender deeper, broader, more liquid markets at a greater scale, less susceptible to manipulation and that price carbon more effectively. Connected markets could generate a more globally consistent price, reducing volatility and the risk of carbon leakage. Given these advantages, then, it is surprising that there haven’t been more linking connections.

Or perhaps it isn’t. Connecting by linking is the status quo, however, linking can be difficult and time-consuming. For instance, linking requires the participating jurisdictions to adapt to each other, to harmonise in certain respects. At the very least, the respective ETSs need to be compatible. More than this, however, linking might involve not just alignment of schemes, but also policies, laws, processes and so on. This can give rise to political issues, stemming from the perceived impact on sovereignty of participating jurisdictions, as well as legal and practical issues, and potential inflexibility. For example, design features from one scheme – type and stringency of cap, offset crediting provisions, commitment periods, price management mechanisms – might extend to the other(s); the administrator of one scheme may have more influence or control than the other(s); or distribution of costs may have competitiveness implications for one or more of the parties.

Resolving matters such as these takes time. Ten years until implementation, in the case of the EU and Switzerland. Time is, however, a commodity in short supply for the purpose of addressing GHG emissions mitigation. Furthermore, having resolved all these questions sufficiently to sign up to a linking agreement does not mean the parties’ economies and emissions profiles become static: over time, imbalances and changes in balances will need to be managed as an on-going issue. It might be expected that in these and any other negotiations between the parties, the economically larger party will have the advantage, potentially requiring more time to reconcile concerns.

Rather than linking, a more time and resource efficient way to connect ETSs would be to network them. Networking carbon markets can provide an alternative, faster track for scaling up emissions trading globally, at the same time reducing inherent risk from the issue of imbalance in parties’ negotiating positions. A networked market might be viewed not as a single market, as with linking, but rather as a connection facilitating transactions between individual, separate markets, each of which continues as an autonomous operation in its own jurisdiction, while participating in the network created by the connection.

In practical terms, this means that rather than converging ETSs so that traded units (i.e., allowances) from one are able to be treated the same as units from the other(s) (in other words, fungible), instead a common metric would be derived so that differences in the units of respective schemes could be valued. This might be called the ‘mitigation value’ (MV) of the unit. Then, units of MV would be traded on a trading platform owned and operated by the participating jurisdictions (self-regulatory market operation). MV would be assessed under an independent, objective technical process overseen by a regulatory body (as the provider of independent market information). The self-regulatory market operation and the independent market information would constitute two of the three interacting, functional pillars of the governance framework for the networked market. The third functional pillar is the supervisory/regulatory pillar, which might be constituted by two overriding supervisory bodies, one from a climate change perspective (e.g., UNFCCC subsidiary body), and one from a global financial perspective (e.g., an IOSCO committee), acting conjointly.

Connecting ETSs, whether by linking or networking, necessarily involves reconciling differences between the schemes. The essential point of difference is the extent of mitigation brought about by the respective schemes. The networking structure proposed separates this climate element from the more administrative and mechanistic elements. On the other hand, linking requires harmonisation of these administrative and mechanistic elements as part of the process of reconciling differences in the climate element. Thus, by focusing just on the climate element, networking holds out potential for a more practical, flexible, efficient approach to scaling up carbon markets globally.

This blog post is based on the book:

The views and opinions expressed in this post are solely those of the author(s) and do not reflect those of the editors of the blog of the project LIFE DICET.