Authors: Beilei Hou, Zi Ling, Corporate & Commercial Group, King & Wood Mallesons
- The legal framework of the national ETS has a three-level structure; the two ETS exchanges are in Shanghai and Hubei
- The CCER trading centre in Beijing and the Guangzhou Futures Exchange in Guangzhou have been established as a supplement to the national ETS
- Market participants and trading products will be limited on the national ETS at the initial stage
- The National ETS will be gradually opened to foreign investors; GBA market and futures market will also bring opportunities to foreign investors
China has just launched its national carbon emissions trading scheme (ETS) . Building a national carbon market involves a large amount of preparation and challenges are different from those faced by the regional pilot markets. China has a strong will to establish a centralized ETS system, and the national ETS has long been regarded as a key policy instrument to accomplish the country’s ambitious pledge for reaching carbon neutrality by 2060.
Under the current legal framework of the national ETS, foreign participants are not covered by the scheme at the initial stage and trading products remain limited. However, it is expected that China will gradually open its ETS markets to foreign investors in the long term.
The Legal Framework at a Glance
Currently, the Ministry for Ecology and Environment (MEE) is the prime competent authority for regulating carbon emissions in China.
The legal framework for the national ETS has a three-level structure:
A high-level law titled the Tentative Regulations for the Administration of Trading of Carbon Emissions Rights (Revised Draft) (the New ETS Regulations) (碳排放权交易管理暂行条例 (草案修改稿). Although the MEE released the draft of the New ETS Regulations for public comment on March 31, 2021, the law has not yet been approved and promulgated by the PRC State Council. However, once in force, the New ETS Regulations will become the primary overarching legislation for China’s national ETS.
A secondary set of rules titled the Measures for the Administration of Trading of Carbon Emissions Rights (Trial Implementation) (the Trial Measures)（碳排放权交易管理办法 (试行)） have been promulgated by the MEE and came into force on Feb. 1, 2021. Before the New ETS Regulations are promulgated, the Trial Measures (together with the three sets of implementing rules issued by the MEE in May 2021 regulating the registration, trading and settlement of carbon emissions rights in China’s ETS) will be the de facto legislative framework for operating the ETS.
There are two ETS Exchanges in China that form the lower level of China’s ETS operation: in Hubei Province (the national registry system) and Shanghai (the trading system). It is expected that these Exchanges will release detailed handling and operating guidelines relating to the registry and trading of carbon emissions rights. On June 22, 2021, the Shanghai Environment and Energy Exchange issued a public announcement (the Announcement on Matters Relevant to National Trading of Carbon Emissions Rights (关于全国碳排放权交易相关事项的公告)) clarifying matters relating to the Exchange, trading methods, account opening system and other matters relevant to the national trading of carbon emissions. The registry system in Hubei has not yet issued any rules or guidelines.
Initially, the national ETS only includes the power sector, comprising 2,225 coal-and gas-fired power plants
Market participants and other key features
The national ETS is at a very early stage, and there are a number of key features worth noting:
- Initially, the national ETS only includes the power sector, comprising 2,225 coal- and gas-fired power plants. In the long term, other emission-intensive industries will be covered by the national ETS scheme, although this will take place on a gradual basis.
- Foreign investors or individual investors are unlikely to be allowed to participate in the national ETS at the initial stage.
- Trading is limited to spot transactions; over-the-counter transactions are not yet covered.
- Trading products only include carbon emission allowances (CEAs). China Certified Emissions Reduction (CCERs) are not included in the first iteration of the system.
- Other products, such as futures and derivatives, are subject to approval by the State Council before being traded on the national ETS.
Market participants and trading products will be limited at the initial stage. This is likely because there is uncertainty surrounding the legal attributes of carbon emissions rights (i.e. CEAs) under the existing legal regime. It is unclear, for example, if they are to be regarded as a new property right or something else. It is reasonable to anticipate that policymakers will firstly deal with legal attributes of the carbon emissions rights and then put forward a legal regime to regulate the trading of such rights. After that, the relevant trading products can be designed to be traded on the national ETS.
It is clear that the regional pilot scheme is undergoing a transition and will be gradually phased out of the carbon markets
Key Dimensions of the Market
As noted earlier, the national ETS is structured to feature two centres: a national registration and clearing platform located in Hubei Province, and a centralized trading platform operated in Shanghai.
It is noteworthy that there are two other markets established or to be established along with the national ETS.
The first is the CCER market. On March 10, 2021, the General Office of CPC Beijing Committee and General Office of Beijing People’s Government jointly issued the Beijing Municipality, Implementing Plan on Building a Modern Environmental Governance System (北京市关于构建现代环境治理体系的实施方案) which provides that Beijing will lead the establishment of a national CCER trading centre). The national ETS allows 5% of verified emissions to be offset through the surrender of CCERs. The remaining CCERs after the offset (if any) can be traded on the CCER trading platform in Beijing.
The other is the carbon futures market, which is to be centred on the Guangzhou Futures Exchange. The China Securities Regulatory Commission (CSRC) stated in a press briefing on April 16, 2021 that it plans to formulate a carbon emissions future market as a supplement to the national ETS, and will provide guidance to the Guangzhou Futures Exchange to accelerate the launching of carbon futures. However, it appears that carbon futures may only start to trade after the formal launch of spot transactions on the national ETS.
In addition, the regional pilot scheme will continue to function in parallel, although those entities covered in the regional pilot scheme will be unconditionally integrated into the national ETS if they are covered by the latter scheme. It is clear that the regional pilot scheme is undergoing a transition and will be gradually phased out of the carbon markets.
Widespread attention has been devoted to market access into China’s national ETS for foreign investors. It may disappoint some investors that the current regulations fail to provide definite guidance as to how they can participate in the national market. However, it is likely that opening access to what is the world’s largest green-field carbon market to foreign participants is being considered. Potential pathways available for foreign participants include:
- National ETS: Though foreign investors are not covered by the national ETS scheme at the initial stage, the New ETS Regulations actually allow qualified institutions and individuals to participate in the national ETS. However, it remains unclear as to what eligibility criteria will apply in determining these “qualified institutions and individuals”. Cross-border foreign exchange and settlement for trading by foreign investors on the spot market will be another issue to be tackled. If these questions and issues can be resolved, it is only a matter of time before market access will be opened to foreign investors.
- GBA market: Notably, on May 14, 2020, the Guangdong-Hong Kong-Macau Greater Bay Area (“GBA”) adopted new special measures for further developing the GBA (these were issued jointly by the People’s Bank of China, China Banking and Insurance Regulatory Commission, China Securities Regulatory Commission (CSRC) and State Administration of Foreign Exchange). These measures support the establishment of an environmental rights trading and financial service platform in the GBA as well as the foreign exchange pilot for carbon emissions trading. Qualified foreign institutional or individual investors can participate in carbon trading, by using foreign currencies or RMB for trading within the GBA market. Green finance, possibly including carbon finance, is being developed in the GBA, and this will bring opportunities to financial institutions.
The Chinese government aims to turn the GBA into a world-class city cluster that houses an international innovation, science and technology hub and a series of interconnected financial markets
The GBA market can be considered as independent. The Chinese government aims to turn the GBA into a world-class city cluster that houses an international innovation, science and technology hub and a series of interconnected financial markets. The government will therefore grant special policies to the GBA for further development and opening up of the market.
Given the national ETS has yet to launch and further expansion to include foreign participants may take some time, the GBA market could be an option for foreign investors entering into the China carbon market before participating in the national ETS market.
Carbon futures market: Future markets are subject to oversight by the CSRC, not by the MEE. As discussed earlier, the Guangzhou Futures Exchange is currently looking into carbon futures under the guidance of the CSRC. This raises questions as to whether foreign investors can participate in the trading of carbon futures and, more specifically, whether they can invest in the carbon futures market under the so-called QFII/RQFII scheme (as per the Measures for the Administration of the Investment in Domestic Securities and Futures by Qualified Foreign Institutional Investors and Renminbi Qualified Foreign Institutional Investors (the QFII/RFQII Scheme) (合格境外机构投资者和人民币合格境外机构投资者境内证券期货投资管理办法) for further opening the capital market to qualified foreign investors, released on Sept. 25, 2020).
Whether or not carbon futures are defined as “commodity futures contracts” under the QFII/RQFII Scheme is subject to determination by the CSRC
Under the QFII/RFQII Scheme, qualified foreign investors are eligible to trade, among others, commodity futures contracts listed and traded on futures exchanges approved by the CSRC, or options listed and traded on futures exchanges approved by the State Council or CSRC.
Whether or not carbon futures are defined as “commodity futures contracts” under the QFII/RQFII Scheme is subject to determination by the CSRC.
However, when discussing the legal nature of carbon futures, this will lead back to the same question of the legal attributes of the underlying carbon emissions rights. If carbon futures are approved to be traded as a commodity futures contract by the Guangzhou Futures Exchange, foreign investors should be allowed to invest through the QFII/RQFII Scheme.
Nevertheless, the current futures market allows foreign investment through the QFII/RQFII Scheme in a limited number of commodity futures, including iron ore futures, crude oil futures/options, copper futures, and palm oil futures/options. It is likely that the carbon futures market may firstly open to domestic investors and later expand to include foreign investors.
Legal and regulatory developments should be expedited to provide much needed clarity and guidance to existing and potential market participants, and to adequately address the risks that may arise
After a decade of attempts and efforts, China’s national ETS is finally set to come into reality. China is bound to face teething problems in its early implementation of such a huge market scheme.
Legal and regulatory developments should be expedited to provide much-needed clarity and guidance to existing and potential market participants, and to adequately address the risks that may arise. It is worth mentioning that China’s ETS is unlikely to allow for much speculative trading. Under the current legal framework, the MEE will prevent excessive speculation in order to maintain a healthy development of the carbon market. It may also take measures to restrict trading in case of a violation.
Looking further ahead, China may look to increase the liquidity and robustness of the market by way of introducing various market participants, adopting diverse derivatives products, and exploring opportunities for international connections to other carbon markets.
This article was first published on China Law & Practice, www.chinalawandpractice.com.