China's National Carbon Market - one step forward

In brief 7 min read

Draft legislation revealing the intended coverage and mechanics of China's national emissions trading scheme, which is due to commence operation within a year, has been released for public consultation until 2 May. Partner Jillian Button and Associate Shona Shang report on its key aspects.

Background

In November 2017, China's National Development and Reform Commission (the NDRC) issued the Construction Plan of the National Carbon Emission Trading Scheme (Power Sector) (the Plan). This lays out the foundation of the key aspects and timeline of setting up China's national emissions trading scheme (the national ETS), as reported on in our Client Update: China's National Carbon Market – what to expect.

The Plan, among other things, establishes a three-stage process of forming the national ETS. Stage one is a one-year preliminary consultation period for the development of laws and regulations on the management of the national ETS.

On 3 April 2019, China's environmental protection agency, the Ministry of Ecology and Environment of the People's Republic of China, released a draft Interim Regulation on the Administration of Carbon Emission Trading (the Draft Regulation), which is a key part of stage one.

Key aspects

The administrative bodies

The Draft Regulation provides that the Ministry of Ecology and Environment of the People's Republic of China (the MEE), and its local bureaus at the municipal or provincial level (the local MEEs), will be the administrative bodies responsible for overseeing carbon emission trading activities. The MEE will be in charge of administering and supervising the trading activities nationally, including establishing mechanisms and rules to regulate national trading activities, such as methods and standards of allocating emission quotas; and of determining the key emission entities that are obliged to participate in the national ETS (the key emission entities).¹ The local MEEs are responsible for administering the trading activities of their respective administrative regions, including identifying their key emission entities.²

Who is eligible to participate in the national ETS?

The Plan mentions that entities in the power sector with direct or 'Scope 1' emissions of 26,000 tonnes CO2 equivalent per year or more will be initially designated as the key emission entities to participate in the national ETS.³

The national ETS will operate as a 'cap and trade' scheme. According to the Draft Regulation, each key emission entity will be obliged to comply with the national ETS by surrendering emissions quotas equal to its Scope 1 emissions for the previous year, while other entities and individuals who are eligible may trade quotas voluntarily (voluntary participants).⁴

The Draft Regulation establishes scope for the criteria for determining key emission entities is to be further developed by the MEE.⁵ This appears to provide the mechanism for the emissions threshold of the key emission entities to be gradually lowered, and entities in sectors other than the power sector to ultimately be covered by the national ETS in the future, as foreshadowed by the NRDC in the Plan.⁶

Each local MEE is responsible for identifying the key emission entities of its administrative region, the list of which will then be reviewed and released to the public by the MEE.⁷

The Draft Regulation does not clearly forbid entities and individuals from outside the mainland of China from voluntarily participating in the national ETS. The People's Bank of China, China's central bank regulating monetary policy and financial institutions, issued an official notice on 6 April 2018 allowing entities outside the mainland of China (including entities registered in Hong Kong, Macao and Taiwan) to open a special RMB deposit account to trade carbon emission quotas in RMB in China.⁸

Management and trading of emission quotas

Emission quotas will be capable of being traded by way of agreement or auction.⁹

The key emission entities are responsible for monitoring their emissions each year, and are required to acquit carbon emission quotas equivalent to their emissions of the previous year. Any surplus quotas can be traded in the national carbon emission trading registry (the registry). Any shortfall in quotas must be made up by 31 December each year, by purchasing quotas in the registry.¹⁰

Voluntary participants may trade the quotas voluntarily.

The local MEEs are allowed to pre-allocate to the key emission entities a certain amount of quotas free of charge for the upcoming year.¹¹

Monitoring, reporting and verification of emissions

The amount of emission quotas that should be acquitted by the key emission entity each year is determined by the local MEEs, based on its amount of carbon emissions in the previous year. Every year, a key emission entity must submit to the local MEE a report on its carbon emissions for the previous year, and a verification report prepared by one of the verification agencies listed by MEE. The local MEE will then confirm the amount of quotas that should be acquitted by the key emission entity in the next year, based on the reports submitted, and submit the confirmation to the MEE for approval.¹²

The voluntary participants are not subject to these reporting obligations.

Formats and requirements for the reports are in the draft Technical Guideline on Carbon Emission Trading for Power Generation Enterprises, issued by the National Power Industry Energy Efficiency Standardization Technology Committee, in the form of a national standard, at the end of 2018, for public consultation until 22 February 2019.¹³ Once finalised, liable entities under the national ETS will need to comply with this guideline.

Liabilities

A key emission entity may be fined RMB 50,000 to RMB 200,000 by its local MEE if it fails to submit the above reports on time or they contain false information, and fails to rectify the non-compliance within a certain period of time, as ordered by its local MEE.¹⁴

Similarly, if the key emission entity fails to surrender the amount of quotas equal to its accredited annual emission of the previous year on time, and fails to rectify the non-compliance within the time ordered by its local MEE, it may be fined an amount equal to two to five times the market value of the quotas it fails to surrender.¹⁵

Any violation of the Draft Regulation by key emission entities and voluntary participants will be recorded by the MEEs and local MEEs, and incorporated as part of these entities' credit records.¹⁶

Offsets

The Draft Regulation allows participants to use carbon quotas obtained outside the ETS for the purposes of complying with their obligations under the national ETS. Eligible credits include Certified Emission Reductions generated under the Clean Development Mechanism, and Chinese Certified Emission Reductions (CCERs) generated under China's existing voluntary greenhouse gas emission reduction mechanism.¹⁷

China's various ETS pilot schemes have set varying limitations on the percentage of the annual quotas that can be satisfied using CCERs, at between 5 to 10 per cent. Guidance on the importation of quotas into the national ETS is still outstanding.

What still needs to be addressed?

The Draft Regulation leaves some blanks that we expect will be addressed in detailed regulations in the future. These include:

• mechanisms to manage/limit the fluctuation of carbon prices, regulation of abnormal transactions and fluctuation of carbon prices, and dispute resolution;¹⁸
• deadlines for the key emission entities' obligations, such as for submitting annual reports; and
• rules to guide the transition from the pilot schemes to the national ETS.

It is also worth noting that the national ETS will only cover the power sector initially. As several other sectors are currently being covered in the pilot schemes, existing participants in the pilot schemes that are not in the power sector can't be incorporated in the national ETS and will need to continue to trade in the pilot schemes. Clear rules are needed to guide these entities as to any further steps that need to be taken on transitioning to the national ETS era.

What's next?

The deadline for public submissions on the Draft Regulation is 2 May 2019. It is expected that detailed rules, such as measures for determining the annual emission limits and the allocation of quotas, will be released in due course.

According to the Plan, if it is still on schedule, the national ETS is expected to move into the simulation operation stage by the end of this year, and we will be able to see initial carbon emission trading in the national ETS by the end of this year, or by early 2020.