Overview Countries must rapidly reduce greenhouse gas (GHG) emissions to satisfy their nationally determined contributions (NDCs) under the Paris Agreement. An emissions trading system can help them achieve climate goals. Emissions trading is a proven tool to curb GHG emissions by leveraging market forces through the sale of carbon credits (e.g., emission reduction unit). This mechanism aims to decrease investment in high-emission activities and increase investment in clean energy technology. In an emissions trading system, participants face real costs to reduce emissions and are rewarded when they introduce efficiencies. However, developing an emissions trading system can be complicated. There are several considerations that require careful analysis. A toolkit was developed by the Asian Development Bank (ADB), which provides member countries in Asia and the Pacific with customized policy analysis support. It explains what an emissions trading system is and how to develop a national system. Summary As countries work to achieve their NDCs, they should consider emissions trading as a strategy that brings positive economic benefits. But before proceeding, a country should assess whether it is an appropriate approach to GHG emissions reductions, given its economic, political, and social situation. Once that hurdle is passed, it must establish the legal framework, set clear objectives, decide the level of formalization and centralization, define core institutional functions, and determine key milestones and timelines. With the framework in place, a country can design and initiate the emissions trading system. ADB, the International Carbon Action Partnership, and the World Bank all offer resources to support countries’ ambitions around emissions trading, including detailed step-by-step guides. Although they can be iterative and the order may vary, there are 10 key actions in designing and operating an emissions trading system: Prepare. Develop baseline data to determine the key sectors and emission sources that should be included in the system and to design appropriate reduction strategies. Decide the scope. Considerations in prioritizing and adding sectors include mitigation potential and regulatory costs and requirements. Engage stakeholders, communicate, and build capacity. Meaningful stakeholder engagement helps secure public approval and continued support. Set the cap and the compliance period. The cap is the total amount of emissions—expressed in tonnes of carbon dioxide equivalent (tCO2e) with each ton referred to as an allowance unit—that will be allowed over a given period, called the compliance period. Distribute allowances. Each covered entity is allowed to release a fixed amount of emissions in a compliance period. Allowances are distributed among covered entities through either free allocation or auctioning at the start of each compliance period. Promote a robust market. Like all free market systems, an emissions trading system should be well-regulated to avoid price volatility and promote transparency. Ensure compliance and oversight. Compliance can be ensured by managing emission reporting through approved methods, monitoring and approving verifiers and plans, establishing rules and methodologies for market and registry operation, managing approval and verification processes, and designing and enforcing penalties. Incorporate flexibilities. Flexibility allows a higher participation rate by lowering barriers to entry. Flexible mechanisms—offsets, banking, and borrowing—enable a covered entity to meet its allowance requirement. Consider linking. Linking emissions trading systems creates a large carbon market by permitting allowances from one system to be used in another. Implement, evaluate, and improve. Policy evaluation metrics are recommended to promote regular progress through the development of the emissions trading system. The record shows that emissions trading offers real advantages for countries. Benefits include: (a) generating revenue; (b) expanding trade connections by linking to emissions trading systems in other countries; (c) complementing other carbon pricing instruments; (d) supporting phased emissions reductions goals flexibly; and (e) giving options to tune coverage (national, subnational, or sectoral) to the goals. As with most complex economic tools, there is no one-size-fits-all solution. Policymakers should consider their country’s unique circumstances and needs when weighing the alternatives. Nor is emissions trading a silver bullet. Upon implementation, economic, political, and capacity challenges will arise, requiring constant reevaluation to ensure a successful emissions trading system. Resources Asian Development Bank. 2023. Carbon Pricing and Fossil Fuel Subsidy Rationalization Tool Kit. Manila. Ask the Experts Rachael Jonassen Director, Environmental and Energy Management Institute, George Washington University Rachael Jonassen directs the climate and greenhouse gas management program in the Environmental and Energy Management Institute at George Washington University, where she holds joint appointments in engineering and urban sustainability. She has worked on climate change issues for over 4 decades, ranging from high-level nuclear waste disposal to hydroelectric vulnerability, urban adaptation, and mitigation to energy system risks. She holds a doctor of philosophy and master of science degrees in Geoscience with a research focus on computer simulation. Asian Development Bank (ADB) The Asian Development Bank is committed to achieving a prosperous, inclusive, resilient, and sustainable Asia and the Pacific, while sustaining its efforts to eradicate extreme poverty. Established in 1966, it is owned by 69 members—49 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. Follow Asian Development Bank (ADB) on Leave your question or comment in the section below: View the discussion thread.