The Climate Department of China’s National Development and Reform Commission (NDRC) recently published an article entitled “Regarding the Fundamental Conditions and Operational Thinking Behind the Promotion and Establishment of the National Carbon Emissions Rights Trading Market” (National Market Plan).1 This is significant as it addresses some basic questions that many observers have been asking about China’s anticipated national carbon trading market, and lays out a roadmap of how China plans to develop this market over the coming years. At this moment, much remains to be done in terms of liquidity and efficiency for this market to achieve its real potential.
Background Last November, China announced its aim for the country’s overall carbon emissions to peak and then start to decline by 2030.2 The development of its domestic carbon trading market is a major component of China’s strategy to reduce carbon emissions. To this end, China has launched seven regional emissions trading schemes, the first of which opened in Shenzhen in June 2013. The schemes are pilots for a proposed national market which was at one stage expected to come into operation in 2015.
All seven pilot schemes are now operational and have developed systems for (1) setting carbon emissions caps for relevant emitters; (2) allocating emissions allowances; (3) monitoring, reporting, and verifying emissions; (4) offsetting allowances with carbon credits; and (5) registering and trading the allowances and offsets. However, they suffer from illiquidity to varying degrees due to limitations of scale, rigid participation requirements and product limitations (for example, spot trading only).3
In December, the NDRC published the Provisional Measures for the Administration of Carbon Emission Rights Trading(the Provisional Measures).4 These set out the basic regulations that will govern the nationwide emissions trading scheme that is now expected to be launched in 2016. The new national registry created by the Provisional Measures allows carbon offsets, Chinese Certified Emissions Reductions (CCERs), to be purchased through spot trading on the seven regional exchanges for the first time.
Significantly, foreign entities are not allowed to open a CCER account. This means that if a foreign entity wants to participate in trading CCERs in China, it needs to set up a Chinese subsidiary to do so (discussed in more detail below). Furthermore, CCER trading is still a work in progress, and much work needs to be done to facilitate efficient trading.
Although the relevant exchange under each pilot scheme is linked to the national CCER registry, the exchanges are not linked to one another. A CCER must be transferred to a local exchange before it can be traded; if someone wants to trade a CCER on the Shanghai exchange, but that CCER is currently listed on the Beijing exchange, the CCER must first be delisted from the Beijing exchange and then relisted on the Shanghai exchange. This is inefficient, but it is hoped such inefficiencies will be eliminated after the national exchange has been established.
The Timeline The NDRC’s roadmap for the development of this national exchange is found in the National Market Plan. It divides the development of China’s carbon markets into three periods; it tells us where the market is now and predicts how it will develop:
- The preparatory phase (2014-2015) During 2015, the most important task will be for the State Council to issue State Council level regulations as quickly as possible. As those who trade CCERs on the local exchanges already know, the seven pilot schemes are governed by varying levels of local regulations. The carbon markets of the pilot schemes therefore operate quite differently from the anticipated national market. The national market should be subject to a national level of regulation, which would be expected to be uniform and more readily enforceable. A national market will also be welcomed by foreign participants, as CCER trading on the current seven exchanges requires considerable duplication of effort.
During 2015, the NDRC plans to: (1) issue supporting details and technical standards; (2) determine greenhouse gas accounting methods and standards for all regulated industries and enterprises; (3) define the total quota, allocation methods and standards for national carbon emissions; and (4) improve the registration system to prepare for the commencement of trading.
- The operational improvement phase (2016-2020) 2016 through 2020 will be a period of trial operations. The most important tasks will include: (1) gradually incorporating China’s 31 provinces and other regions into the scope of the national carbon trading rights system (it is not yet clear how the transition from the seven pilots to the national exchange will be effected); (2) distributing the first allocation of allowances; and (3) commencing market operations. For the remaining years of this phase, the National Market Plan emphasises: (1) fully implementing the carbon rights trading system; (2) adjusting and perfecting the trading system; and (3) achieving stable market operations.
- The stabilisation and maturation phase (after 2020) The National Market Plan’s most important tasks after 2020 will include: (1) increasing the number of product categories traded; (2) developing diverse trading modes; (3) gradually forming stable, healthy, active trading markets; (4) further upgrading market capacity; and (5) exploring the feasibility of linking with other international carbon markets.
The NDRC also says that, for the time being, trading will be limited to spot trading, and that futures will be introduced when “conditions permit”.
CCERs: Trading Begins China’s partial progress on its path to a national exchange is visible in the way that CCER trading is developing on the seven exchanges.
First, the procedures for opening, closing, and changing accounts to trade CCERs are governed by one set of rules and standard forms promulgated by the NDRC: the Provisional Procedures for Opening an Account in the National CCER Registration System (CCER Registration).5
Applying for a Trading Account As foreign entities are not allowed to open a CCER account, if a foreign entity wishes to participate in the trading of CCERs, it must establish a Chinese subsidiary. This is not currently the case for trading in allowances in certain of the pilots (such as Shenzhen and Guangdong), which allow direct access to trading for foreign entities.
How a Foreign Entity Establishes a Chinese Subsidiary To set up a Chinese subsidiary, a foreign entity needs to establish a foreign-invested enterprise (FIE) in China in accordance with Chinese law. The FIE could be either a wholly-owned subsidiary or a joint venture with a Chinese partner. To establish an FIE, the foreign investor normally needs to: (i) obtain the approval of, or complete a filing with, the local bureau of commerce (BOC), (ii) register with the administration for industry and commerce (AIC); and (iii) complete post-registration formalities, including tax and foreign exchange registrations.
The exposure to PRC taxation, such as enterprise income tax on trading profits and withholding tax on dividends remitted overseas, as well as administrative and other compliance costs, will need to be weighed up, as well as the location of the FIE. For example, establishment in the Shanghai Free Trade Zone could be advantageous, although this will depend on the particular circumstances of the entity.
The pilot exchanges do not currently require trading participants to have a specific business scope; a general business scope that includes trading, investment or consulting is therefore sufficient to become a member of an exchange and to participate directly in trading. Some pilot exchanges, however, require that trading members have been in operation for a certain number of years, have a particular level of registered capital, and so forth. However, if a company (including an FIE) fails to satisfy these requirements, it is nevertheless still able to participate indirectly in trading through a brokerage firm.
Trading on the Exchanges Since CCER trading does not occur between the local exchanges, and because national trading has not yet been enabled, those who want to trade CCERs on a particular exchange have to open an account on that exchange. Those who wish to trade on all seven exchanges will have to open seven separate accounts. In most cases, one must open both trading and funds accounts in order to trade CCERs.
It appears that it is not possible for traders to exchange CCERs except through the local exchanges. The private exchange of a CCER is not possible, as there is no provision for notifying the national register of the transfer of a CCER except through an exchange, and, of course, one must be a member of an exchange in order to trade on it.
Local Criteria for CCER Use One aspect of CCER trading of particular note is that the local exchanges are free to reject CCERs that do not meet local criteria. For example, the Beijing and Shanghai exchanges do not allow CCERs generated before 1 January 2013 to fulfil compliance obligations.6 This means that of the nearly 14 million CCERs that have been approved by the NDRC to date, merely 68,000 can be used for compliance purposes on those exchanges.
Furthermore, CCERs that the Shanghai and Beijing exchanges do recognise can be used to offset no more than 5 percent of an entity’s compliance obligations. The Beijing exchange also requires that half of the compliance obligations that a CCER may offset must have been generated in the Beijing area.7 Some CCERs will, therefore, be worth less than other CCERs. It is not known how this issue will be resolved by the national scheme, as the National Market Plan does not address it.
Conclusion China’s carbon markets are developing rapidly. The process of trading CCERs is cumbersome, and the rules vary from exchange to exchange. As the National Market Plan notes, one of the top priorities is to formulate one set of rules and to adjust and improve the trading system for a stable market that will also improve trading efficiency.
As has been frequently noted, one of the most serious weaknesses of the pilot exchanges is the lack of liquidity; the anticipated availability of futures and derivatives in due course on the national exchange ought to provide a significant boost in that respect.
However, while the National Market Plan refers to the development of futures, it provides little detail. As the CSRC will continue to oversee the financial products and trading practices of the exchanges, how the NDRC and CSRC work together will, to a large extent, influence how China’s carbon markets develop and how trading will be conducted on the exchanges.
Further, it seems unlikely that futures trading on the carbon market would precede futures trading on domestic equity markets, for which a clear timetable is still awaited. Although with stock options trading just launched on 9 February 2015, this might be nearer than recently anticipated. China’s regulators no doubt want to see the young carbon market walking well before it tries running.