Emission Trading Systems (ETS) are market-based instruments that put a cap on total greenhouse gas emissions and allow companies to trade emission allowances. These systems have become a key tool in the global effort to reduce carbon emissions cost-effectively.
How Cap-and-Trade Works
Under an ETS, a government sets a total cap on emissions. Companies receive or purchase allowances for each ton of emissions. Those that reduce emissions below their allocation can sell surplus allowances, creating a financial incentive for emission reductions.
Major ETS Programs Worldwide
The EU ETS remains the largest and most mature carbon market. China launched its national ETS in 2021, covering the power sector. Other notable systems operate in South Korea, California (linked with Quebec), the UK, and New Zealand. Together, these systems cover a significant portion of global emissions.
Market Design Considerations
Effective ETS design requires careful attention to cap setting, allowance allocation methods, price stability mechanisms, and market oversight. Lessons from early implementation phases have led to important reforms that have improved market functioning and environmental effectiveness.
Linking Carbon Markets
Linking different ETS programs can increase market liquidity, reduce compliance costs, and create more uniform carbon pricing across jurisdictions. However, differences in market design, ambition levels, and regulatory frameworks present challenges to linking efforts.