An emissions trading scheme is a market-based policy instrument that caps the total quantity of greenhouse gases that regulated entities may emit and allows them to trade emission allowances. By placing a price on carbon through tradable permits it incentivises reductions where they are cheapest to achieve. Schemes such as the EU ETS and the UK ETS operate on a cap-and-trade basis and form a central pillar of climate policy and carbon markets.
- An emissions trading scheme is a market-based policy instrument that caps the total greenhouse gases regulated entities may emit and lets them trade emission allowances.
- By pricing carbon through tradable permits it drives reductions where they are cheapest, a mechanism distinct from a flat Carbon Tax.
- It is a central segment of regulated Carbon Markets.
- It complements voluntary action by attaching a compliance price to emissions.
Overview
- Under cap-and-trade, a regulator sets an overall emissions cap and issues a corresponding number of allowances, each permitting the emission of one tonne of carbon dioxide equivalent.
- Entities that reduce emissions below their holdings can sell surplus allowances, while those exceeding their permits must buy more, establishing a market price for carbon.
- The cap is tightened over time to deliver progressive decarbonisation in line with climate targets such as the Paris Agreement.
- The EU ETS, launched in 2005, is the largest and longest-running scheme; the UK ETS, China’s national scheme and several regional North American programmes follow comparable designs.
Key aspects
- An overall emissions cap that declines over time.
- Tradable allowances denominated in tonnes of CO2 equivalent.
- Auctioning and free allocation of allowances.
- Market stability mechanisms to manage price volatility.
- Monitoring, reporting and verification of emissions.
Mechanisms
- Cap-setting aligned with national and international climate commitments.
- Primary auctions and secondary market trading of allowances.
- Surrender of allowances to cover verified emissions each compliance period.
- Linkage between schemes to deepen liquidity and harmonise prices.
Applications
- Compliance obligations for power, industry and aviation sectors.
- Carbon price signals informing investment and abatement decisions.
- Revenue generation for governments through allowance auctions.
- Inputs to corporate carbon accounting and sustainability reporting.