Hammer time

Welcome to Carbon Risk — helping investors navigate 'The Currency of Decarbonisation'! 🏭.

In April we reported on the latest ETS status report from the International Carbon Action Partnership (ICAP). It revealed that almost 26% of global carbon emissions (equivalent to 14 Gt CO2) are now covered by an emissions trading system, an increase of 3 percentage points compared with last years report.

One of the main conclusions I took from the ICAP report is that while ETSs are covering a greater share of global emissions, they are becoming less uniform in their approach and design: absolute or intensity-based, coverage by industry and share of emissions, revenue allocated to investment or rebate, use of carbon credits, floor and ceiling prices, and so on.

This fragmented approach increases the risk of carbon leakage, and in the long-term serves to undermine the strength of the carbon market signal. As such, it is increasingly important that countries work together, seek to understand what works, and avoid making the same mistakes that earlier schemes experienced (see Join the club).

Now a new report opens up a new front explaining the differences in ETS structure and the impact it can have on price formation. While we've discussed the impact of other market design characteristics, one we haven't broached to any great degree is the method for allocating emission allowances.

As this article will go on to show, financial intermediaries in the EU ETS at least, are playing an increasingly important role in the auction process. Other jurisdictions with an ETS (including those at an earlier stage of development) are also likely to want to encourage greater financial market participation.