Mainland China is making strides towards achieving its goal of net-zero emissions over the next four decades, with the introduction of the ambitious national emissions trading system (ETS).
However, there are already questions over how the scheme will work in practice, how it will lead to a unified pricing structure and whether it will effectively create a market with enough depth to be effective.
Long road
Since the introduction of an ETS for power sector companies earlier this year, the ETS now covers more than 2,225 power plant operators. Yet, a lot of work remains to be done. Financial institutions do not currently participate in the ETS, and mainland China has yet to introduce a carbon tax. The way the system works, carbon credits are allocated to participating companies, which can buy, sell or trade them on an exchange.
‘A well-designed carbon market should drive up carbon prices and provide economic incentives for companies to cut emissions’
‘The impact of China’s ETS is going to be huge, but I hope that somewhere down the line, recycling can be incorporated to bring it down to individuals,’ says Andy Ho, CEO at Carbon World Limited.
‘It will be a long road to Rome, but the journey begins with the first step.’
Analysts from the Fitch Ratings sustainable finance research team note that ‘the aim is to gradually expand the ETS to seven other major emitting sectors within the next few years’.
Wider push
The drive for a more effective ETS is part of a wider push in mainland China to lower emissions. Speaking during the virtual Climate Ambition Summit in December 2020, President Xi Jinping pledged to achieve a 65% reduction in carbon intensity per unit of GDP by 2030 and reach net-zero emissions by 2060.
However, efforts towards a nationwide ETS began long before President Xi made his public pledge.
‘While the system has yet to ramp up and become the most used carbon instrument in the nation, this countrywide ETS platform builds upon a decade of operational experience from provincial and city-level ETS pilots,’ according to CLSA, an institutional brokerage and investment group.
Mainland China has already launched eight regional ETS pilots, expected to run parallel to the national ETS. Beijing, Fujian, Guangdong and Tianjin have already issued their 2020 allowances, while Shanghai and Shenyang, the two remaining cities with pilot programmes, will be covered by the national ETS. The power sector will be regulated by the national ETS this year.
‘Carbon trading platforms in Beijing and Guangzhou have seen voluntary participation from numerous sectors such as cement and power generators. These have tested different design options, pricing levels, industry scope and monitoring, reporting, and verification approaches, all of which inform China’s national ETS,’ states the World Bank’s State and Trends of Carbon Pricing 2021 report.
Accounting for ETS
The introduction of mainland China’s national emissions trading system (ETS) this year will have an impact on work performed by accountants, including:
- Accounting for and monitoring emissions outputs so that the ETS works effectively
- Verifying solutions that claim to effectively reduce emissions so as to encourage innovation in clean technology
- Ensuring that accounting standards consistently measure carbon mitigation levels across different projects.
‘The accounting industry will also likely see the concerted inclusion of “non-financial” measurements to provide better visibility into carbon contributions of various business segments at the company or group level,’ says CLSA, an institutional brokerage and investment group.
Pricing and market size also remain as challenges, not just in mainland China but globally.
‘Currently, there is not enough depth, or trading volume, on ETS systems to give a full and compelling price for these instruments,’ says Ross O’Brien, managing director at Intercedent Asia, a consulting and research provider. ‘There just isn’t enough of a market, which is a fundamental challenge globally and not just in China.’
Incentivise efficiency
The biggest draw of the ETS is that it incentivises companies and creates a clear path for companies to reduce their carbon emissions. According to CLSA, the mechanism ‘provides a clear price signal to participants, who can choose when and where to reduce emissions.
‘This system incentivises efficiency, or less carbon-intensive energy generation. In the coming years, this instrument will likely promote the deployment and innovation of low-carbon technology.’
The sustainable finance research team at Fitch agree that the ETS mechanism will incentivise companies to reduce emissions.
‘A well-designed carbon market should drive up carbon prices and provide economic incentives for companies to cut emissions,’ the team says.
Challenges remain
Despite the positive impact it is likely to have, the ETS scheme has room for improvement, starting with its design.
For instance, market limits on the volumes of carbon dioxide that companies can release must be set carefully. If caps are too lenient and there is an oversupply of carbon allowances, companies will have more opportunity to wiggle out of paying financial penalties. This, in turn, would disincentivise them from reducing emissions, one of the programme’s advantages.
‘Regulators must also accurately measure emissions from factories and plants, to catch and deter data manipulation. Furthermore, there are worries that the current scope of power companies only is not ambitious enough.
The initial impact of the ETS is also likely to be limited, as compliance obligations are capped at 20% of verified emissions above the free allowance. However, the Fitch team expects the rules to become stricter and for obligations to increase as it becomes fully functional and the government steps up efforts to meet its emissions pledges.
Another challenge is that the ETS uses multiple carbon-intensity benchmarks, unlike the absolute emission caps used by the European Union’s version.
However, the Fitch team notes that ‘this design tends to improve plant efficiency rather than substitution across fuel source, and we expect a shift to a single benchmark, as well as the introduction of absolute emission constraints, over time’.
More information
Find out more about the vital role accountants must play in ensuring every financial decision takes climate change into account at ACCA’s annual virtual conference Accounting for the Future on 23–25 November.
