Introduction

The rapid development of Chinese economy has resulted in soaring energy consumption and greenhouse gas emissions (Han et al. 2015; Chen et al. 2017). Chinese CO2 emissions accounted for one-quarter of the global total in 2011 and for 80% of the world’s rise since 2008 (Liu et al. 2013b). Facing international pressures to curb its CO2 emissions and severe domestic air pollution from both point and nonpoint sources (Chen et al. 2011), China has made great efforts to address climate change, such as the nationwide goal for energy intensity (a reduction of 15% from 2015 levels) in the 13th 5-year plan (FYP) (2016–2020), China’s Copenhagen pledge of a 40–45% CO2 intensity reduction from 2005 levels by 2020, and China’s Paris pledge of achieving peak CO2 emissions by 2030 (Yang et al. 2017; Zhou et al. 2019). Various environmental policies and measures, such as command-and-control regulation, market-based instrument, voluntary participation, have been initiated to achieve these targets (Wang et al. 2019). The cap-and-trade scheme has become one of the most important market-based instruments in China’s mitigation of climate change (Jiang et al. 2016a).

In October 2010, China first announced the plan to establish a cap-and-trade emission trading scheme (ETS). Following the State Council’s decision in November 2011 to “gradually promote the establishment of a carbon emissions trading market” (Munnings et al. 2016, p. 1), the National Development and Reform Commission (NDRC) of China selected five cities (Beijing, Chongqing, Shanghai, Shenzhen, and Tianjin) and two provinces (Guangdong and Hubei) with different economic structures and development levels as regional pilots to introduce ETS (NDRC 2011). Seven ETS pilots have been launched since 2013. So far, they have covered 743 million tons of emissions emitted from more than 2000 firms (Jiang et al. 2016a) and gone through five compliance periods from June 2013 to August 2018, during which the total transaction of emission allowances was approximately 154 million tons, with a value of more than 31 billion RMB (China’s currency unit),Footnote 1 second only to the European Union (EU) ETS. These ETS pilots were authorized to accumulate experience for informing the design of a national ETS that is expected to cover approximately 7000 firms and to double the share of the global greenhouse gases covered by ETS when fully implemented (Goulder et al. 2017). In the wake of the evolution from regional pilots to a national scheme, China’s ETS is expected to play increasingly significant roles not only in domestic climate policies, but also in global carbon market development.

However, China’s nationwide ETS, which was started in December 2017, currently covers only the electricity sector (NDRC 2017) and remains in its infancy, still very far away from being a mature carbon market (Jotzo et al. 2018). In particular, ETS is a market-based instrument that originates from developed economies. Yet, China is a transition economy with a political–economic–institutional context that is distinct from those in developed countries. Challenges are inevitable if an effective ETS is to be operated in China (Jotzo and Löschel 2014). The seven ETS pilots have gone through five compliance periods and accumulated a great deal of experience that will make it easier to achieve a smooth start-up of China’s national-level ETS (Jiang et al. 2017). The existing literature on China’s nationwide ETS establishment has focused mainly on two aspects. Early research paid utmost attention to the design of its mechanism, in terms of cap setting, allowance allocation, etc., based on either the descriptive comparison of specific designs between the seven ETS pilots or empirical models (Zhang et al. 2014; Zhang 2015; Chen et al. 2010).Footnote 2 Alongside the progress of China’s seven ETS pilots, more recent studies have turned to the carbon market performance in China by examining empirically real trading data (both carbon price and trading volume) (Fan and Todorova 2017; Cong and Lo 2017; Song et al. 2018). To our knowledge, no literature has discussed the implications for China’s national-level ETS through analyzing comprehensively both the key features of the pilot ETS design and the market performance of the seven ETS pilots based on publicly available trading data. Therefore, this study intends to contribute to the literature through providing a clear and systematic analysis of the current progress of the seven ETS pilots and then giving insights into policy proposals for the development of China’s nationwide ETS. This study focuses on four key issues: (1) the characteristics and disparities of ETS design in seven pilots; (2) the in-depth evaluation of market performance in the seven ETS pilots according to publicly available trading data; (3) the achievements and deficiencies of the pilots; and (4) challenges and suggestions for the evolution of the ETS pilots into a nationwide ETS during the process of mitigating climate change.

The remainder of this study consists of two main parts. Section “China’s ETS pilots” is the first part, a systematic review of the seven ETS pilots in China is presented in this part. More specifically, the design of key elements—cap setting and coverage, allowance allocation, a monitoring/reporting/verification (MRV) and compliance system, and an offset and risk control system—is compared among the ETS pilots. Next, the performance of the ETS pilots is evaluated on the basis of publicly available secondary market data. To offer an in-depth assessment, this study, referring to the research of Tan and Wang (2017), focuses on both internal and external performance. The external performance is reflected in compliance rate, market price, and market scale (trading volume and value), whereas the indicators of internal performance, referring to the financial trading market, are market liquidity, market fragmentation, and effective trading day (Tan and Wang 2017; Zaghini 2016; Rannou and Barneto 2016). Following these, a conclusion of achievements and deficiencies of the seven ETS pilots is summarized, providing potential reference values and implications for China’s national ETS. Based upon the systematic review and commentary on the ETS pilots, coupled with international experience, “Discussion and suggestions for the national ETS” section constitutes the second part of the paper, shedding light on the challenges for the current time and then navigating policy proposals for the establishment of China’s national ETS. The overall framework of this paper is illustrated in Fig. 1.

Fig. 1
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Research framework

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China’s ETS pilots

In October 2011, the NDRC formally approved implementing pilot ETSs in four municipalities (Beijing, Shanghai, Tianjin, and Chongqing), two provinces (Hubei and Guangdong), and one Special Economic Zone (SEZ, Shenzhen) by 2013. The seven regions cover more than 480,000 sq. km, accounting for 5% of the country,Footnote 3 from north (Beijing) to south (Guangdong) and east (Shanghai) to west (Chongqing), which covers different stages of economic and social development. The richest parts of China lie in regions along the eastern coast, whereas the inland lags behind in economic development. The underdeveloped inland regions are represented by Hubei and Chongqing. Guangdong is the largest province, with the highest GDP and population. Shenzhen is the most prosperous region and has the highest per capita GDP compared to the other six regions. Among the four municipalities, Tianjin’s per capita GDP is the highest. The GDP and populations from all seven regions account for approximately 27.4% and 19.26%,Footnote 4 respectively.

The characteristics and disparities of ETS design in seven pilots

China’s ETS pilots have confirmed great divergence in market design including cap setting, sectoral coverage, allowance allocation, MRV and compliance, offset and risk control (Zhou et al. 2016), which results from the great differences of economic development, industrial structure, energy consumption patterns, and emissions intensity in the seven regions.

Cap setting

It is prerequisite to set a reasonable emission cap for a cap-and-trade-based carbon market. China’s seven ETS pilots adopted the regional carbon intensity reduction targets issued by the central government to determine the regional annual emission levels (Table 1). Specifically, Shenzhen combines top-down and bottom-up designs to impose dual caps. In addition to the overall cap on carbon intensity and absolute carbon emissions for the whole pilot period, Shenzhen assigns carbon intensity targets to each entity covered (Munnings et al. 2016). From a cap setting perspective, China’s ETS pilots are not pure cap-and-trade, because they indicate uncertainty about the absolute emission reduction. This intensity-based cap setting is adopted according to the reality that each local economy will grow rapidly in the future, whereas an absolute cap may restrain their development (Kuik and Mulder 2004; Ellerman and Wing 2003).

Table 1 Cap setting details in China’s ETS pilots (Zhang et al. 2014; Council 2011)
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Coverage

The sectoral coverage of the seven pilots differs based on different thresholds that are decided by the unique industrial structure and emission intensity of each pilot, but the most emission-intensive industries are all included. Hubei has a heavy industry domination, and its market threshold of 120,000 ton CO2 emissions per year is the highest, while the Shenzhen ETS pilot has the lowest market threshold of 3000 ton annual CO2 emissions to cover a substantial portion of the total emissions because of its limited heavy industry (Zhang et al. 2017). In addition, the initial list of industrial firms covered by the Shenzhen ETS pilot is determined by the firm’s value added and energy consumption data (Tables 2 and 3). The Beijing ETS pilot decreased its threshold from 10,000 to 5000 tons annual CO2 emissions and expanded its sector coverage in January 2016. The shares of emissions covered range from 33% (Hubei) to 60% (Tianjin).

Table 2 Coverage details in the ETS pilots
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Table 3 Quotas allocation methods and management systems details in the ETS pilots
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Allowance allocation

The seven pilots use different approaches to allocating allowances, leading partially to their following different market performances (Jiang et al. 2016b; Wang et al. 2018b). In general, the ETS pilots distribute allowances for free, except for the Guangdong ETS pilot which auctions a small share of allowances. Grandfathered allowances cannot be used to either trade or pay in the Guangdong ETS pilot unless the number of allowances obtained via auction reaches a certain value. Allowances are usually distributed on an annual basis, but Shanghai allocated all allowances for the pilot period 2013–2015 at one time and updated its allowances again within each compliance period (Zhang et al. 2017). As for free allocation, there are two approaches: grandfathering and benchmarking. Chongqing only uses grandfathering for free allocation, while other ETS pilots use both. Beijing uses grandfathering for existing entities and benchmarking for new entrants. The allocation in other ETS pilots relies on the sectors covered, and benchmarking usually applies to the power sector. It is worth noting that Shenzhen employs a game theory approach to distribute allowances for its industrial firms, considering serious information asymmetry for future output of manufacturing. The government declares a sector-wide cap, provides historical carbon intensity benchmarks, and sets corresponding targets for each sector. Firms then submit emissions’ demand and predicted output to compete with others for free allowances. This game is repeated, and with every round each firm has a chance to either accept or reject its proposed allocation and exit the game. Such exits are deducted from the total amount of allowance and, therefore, decrease the cap for the next round that will be played out by the remaining firms (Munnings et al. 2016; Jiang et al. 2014).

MRV and compliance

Each pilot has established a system of MRV to assure that trading is based on credible emission reductions. The MRV protocols across all ETS pilots are similar, with some slight technical differences. The threshold determining which entity should be covered is higher than is the threshold for reporting emissions. Monitoring and reporting of emissions are self-conducted by the covered firms. A third-party verifier then provides verification for the self-conducted reports. In some regions, like Shanghai, there is also a fourth party to double-check the verification report to guarantee its authenticity. The local governments undertake the cost of verification in most ETS pilots. Only Beijing (since 2015) and Shenzhen require firms to pay for it. Local governments will designate the verifier if they pay for the verification. All ETS pilots have established a variety of penalties, including financial and non-financial penalties, to ensure compliance. Some pilots levy 3–5 times the market value of the excess CO2 emissions, whereas others levy a predetermined fine. Apart from financial penalties, the excess emissions are deducted from the allocated allowances for non-compliant firms in the following year in the Beijing, Shanghai, and Guangdong ETS pilots. The deduction could be up to twice the excess emissions. Other non-financial penalties include recording the failure to comply in the business credit report system, repealing the qualification for government support in the areas of energy, environment and climate change, as well as recording non-compliance in the performance appraisal system of state-owned enterprises (SOEs). Additionally, SOEs are subject to periodic performance appraisals conducted by the central government. A record of non-compliance affects negatively the remuneration of SOE executives and the probability of promotion (Zhang et al. 2017).

Offset and risk control

Each ETS pilot allows for the use of offset credits that are composed mainly of Chinese Certified Emissions Reductions (CCERs), but with a restriction on their ratios that lies in the range from 5 to 10% (Table 4). All the pilots, except for the Shanghai ETS pilot, have a region or project prohibition for CCERs used to meet firms’ abatement obligations. Restricting the market volatility of carbon price is the main approach for all pilots to control the market risk. Usually, ETS pilots employ allowance auctions, buyback measures, price rise-fall limits, and information disclosure to stabilize carbon prices. Specifically, the Shanghai ETS pilot undertakes urgent measures like stopping market transactions temporarily to control the market price. Besides, banking is allowed in all ETS pilots except for Hubei. The allowance expiration date in Hubei is the last working day in June of each year, which suggests that covered firms must sell surplus allowances every year; otherwise, those allowances will be canceled.

Table 4 Offset and risk control details in the ETS pilots
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Evaluation of the seven pilots

The secondary carbon market is the primary place for the trading of emission allowances and related financial instruments. This research studies the performances of the secondary market utilizing the daily online trading data in seven Chinese carbon markets. China’s secondary market includes online and over-the-counter transactions, but we only have access to the detailed information about online trading. Hence, these data represent the main information used to evaluate the performance of the seven carbon markets. These online trading data offer the spot market historical information, including prices (opening, high, low, deal, and closing), trading volumes, and trading values.Footnote 5 The time span is from June 2013 to July 2018, varying in different ETS pilots. Figures 2, 3, and 4 show the basic graphical illustrations and summary statistics. By July 27, 2018, the seven pilots have traded 153.76 million tons of emission allowances, valued at 31.47 billion RMB. The carbon prices in most markets went up in the early stage of trading and then fell gradually. Specifically, the price of Shenzhen fluctuated at 30–60 RMB at most time points except for jumping up above 120 RMB at the beginning of the market. The Beijing and Hubei ETS pilots stabled their market price at 40–60 RMB for most of the time. The price in Shanghai experienced a small rise at first and then a continuous fall to approximately 5 RMB, then after which they began to rise and finally stabilized at 30–40 RMB. The prices of Guangdong and Tianjin declined continuously to 20 RMB after these two markets started and were then sustained at 10–20 RMB. The price trend of Chongqing was not clear because of the short trading time and lack of trading activity. Most transactions occurred 1–2 months prior to the compliance deadline, after when the trading volumes decreased rapidly, which is known as the “compliance effect” (Tan and Wang 2017). The market scales of Hubei, Guangdong, and Shenzhen were much greater than were those of Beijing, Shanghai, Tianjin, and Chongqing, indicating that the former three pilots had lower market fragmentation and, therefore, less fragmented trading (Chao et al. 2017). Both internal [including compliance rate, market price, and market scale (trading volume and value)] and external (including market liquidity, market fragmentation, and effective trading days) market performance are analyzed in depth in three phases: 2013–2015, 2016–2017, and post–2017.Footnote 6

Fig. 2
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Data source: http://k.tanjiaoyi.com/

The carbon price trend of seven pilot ETSs between June 19, 2013 and July 27, 2018.

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Fig. 3
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Data source: http://k.tanjiaoyi.com/

The carbon price and trading volumes of the ETS pilots between 2013 and 2017.

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Fig. 4
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Data source: http://k.tanjiaoyi.com/

The percentage of trading volume and trading value.

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Phase 1: 2013–2015

Since China’s first carbon market was launched in Shenzhen on June 18, 2013, China put combating with climate change through market instruments into practice, and the trials of the other six ETS pilots started gradually. This was the preparation phase between 2013 and 2015. During this phase, the seven ETS pilots completed two to three compliance obligations.Footnote 7 Table 5 shows the final official compliance results for seven pilot ETSs. In general, the compliance rates are relatively high and increase steadily with time. The Shanghai ETS pilot was the only one that completed its commitment on time during the three compliance periods, while the other pilots failed to fulfill their obligation within the specific time. Beijing, Guangdong, Hubei, and Tianjin achieved a 100% compliance rate in some years under the circumstance of postponing their initial compliance deadlines. In particular, the number of firms covered in the Beijing ETS pilot was expanded to 954 in 2015, nearly twice as much as that in 2014, and then its compliance rate reduced from 100% in 2014–99% in 2015. The compliance rate of Chongqing was relatively low, only 70% in 2014, and the information about its compliance in 2015 is missing.

Table 5 Compliance details for pilot ETSs
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During 2013 and 2015, Shenzhen, as the first carbon market in China, experienced a high price level (up to 130 RMB) at the start of market opening, but it declined sharply after 2014. A similar trend was found in the Guangdong, Shanghai, and Tianjin ETS pilots. As a result, the price of these ETS pilots shocks severely. By contrast, the carbon price of Beijing ETS pilot remained relatively stable and high, fluctuating between 40 and 60 RMB. The Hubei ETS pilot also had a stable but low price, fluctuating between 20 and 25 RMB. Based on the above price distributions, the average price of the Beijing ETS pilot was the highest, at approximately 51 RMB, during 2013–2015, even though the price of the Shenzhen pilot once reached an average of approximately 71 RMB in the first compliance period (Table 6). The Shanghai, Guangdong, and Tianjin pilots maintained an average price of less than 20 RMB between 2013 and 2015. In 2015, the average price of the Shanghai and Tianjin pilots fell to less than 10 RMB.

Table 6 Second market overview I.
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As for trading volume, the “compliance effect,” which refers to the transactions occurring mainly before the compliance deadline, emerged in all ETS pilots except for Hubei during 2013–2015. The trading activities in the Hubei ETS pilot were distributed evenly in every month after the carbon market opened (Fig. 3). The trading volume of the Beijing and Shenzhen ETS pilots achieved continuous growth in the three compliance periods (Table 6). The relative active transactions in the Shanghai carbon market were concentrated in the second compliance period (August 2014–July 2015), while Guangdong carbon market witnessed its most trading activities in the third compliance period (August 2015–July 2016) (Fig. 3). The phenomenon of “having price but no deal” existed in the Chongqing and Tianjin ETS pilots between 2013 and 2015. In 2013, when the Hubei and Chongqing ETS pilots had not start, Shenzhen had the largest share of total trading value (nearly 40%), due to its highest average carbon price, whereas Tianjin had the lowest share of total trading value (less than 7%), although the share of total trading volume in Tianjin was similar to that in Beijing, Shanghai, Guangdong, and Shenzhen (Fig. 4). After Hubei started the carbon market in 2014, it had the largest market size in terms of either trading volume or trading value, which accounted for over 60%, but its market size dropped by half in 2015. The shares of trading value for Beijing and Shenzhen were higher than were their shares of trading volume owing to their relative high market price, whereas the shares of trading value in Shanghai and Guangdong were lower than were the shares of trading volume, especially so in the Shanghai carbon market in 2015, which accounted for less than 3%.

The carbon market, which is constituted by CO2 emission allowances—a new type of financial asset (Zeng et al. 2016)—usually has attributes similar to financial markets. Market liquidity and market fragmentation are two major attributes reflecting second market performance (Zaghini 2016; Rannou and Barneto 2016; Garcia-de-Andoain et al. 2014). Accordingly, this paper measures market fragmentation of the seven ETS pilots based on the studies of Chao et al. (2017) and Chang et al. (2018):

$${\text{MF}}_{it} = 1 - \frac{{{\text{Vol}}_{it} }}{{\sum\nolimits_{i = 1}^{7} {{\text{Vol}}_{it} } }}$$
(1)

where \({\text{MF}}_{it}\) refers to the yearly market fragmentation of the ith ETS pilot at time t; \({\text{Vol}}_{it}\) represents the trading volume of the ith ETS pilot at the time t; i denotes China’s seven ETS pilots; and t denotes the compliance periods from 2013 to 2017. The higher the \({\text{MF}}_{it}\), the higher the degree of market fragmentation of an ETS pilot.

Market liquidity, according to previous studies (Munnings et al. 2016; Zhang et al. 2017), is proxied by turnover rate which is calculated as follows:

$${\text{ML}}_{it} = \frac{{{\text{Vol}}_{it} }}{{{\text{TotAll}}_{it} }}$$
(2)

where \({\text{ML}}_{it}\) refers to the yearly market liquidity of the ith ETS pilot at time t; \({\text{Vol}}_{it}\) represents the trading volume of the ith ETS pilot at the time t; \({\text{TotAll}}_{it}\) is the total number of allocated allowances in the ith ETS pilot at time t; i denotes China’s seven ETS pilots; and t denotes the compliance periods from 2013 to 2017.

Results are shown in Table 7. During 2013–2015, the market fragmentation of the Hubei ETS pilot accounted for less than 60%, much lower than any other pilots, indicating a lowest degree of market fragmentation. Shenzhen and Guangdong ranked second and third in terms of low degree of market fragmentation, with market fragmentation of 79.65% and 80.31%, respectively. These three ETS pilots were the first echelon. The second echelon was Shanghai and Beijing, with market fragmentation of 90.99 and 93.99%, respectively. Tianjin and Chongqing had the highest level of market fragmentation. Furthermore, the trading volumes of the seven ETS pilots all constitute a small fraction of the total number of available allowances in the first three compliance periods, the largest of which is less than 0.2% (Shenzhen ETS pilot). The Beijing, Shanghai, Guangdong, and Hubei ETS pilots exhibited the second highest level of market liquidity, and the Tianjin and Chongqing ETS pilots showed the lowest market liquidity. Market liquidity in Beijing, Shanghai, Guangdong, and Shenzhen improved greatly during 2013–2015, especially from 2014 to 2015.

Table 7 Second market overview II.
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In addition, the effective trading days of a carbon market also reflect the market efficiency. Table 7 shows shares of the number of effective trading daysFootnote 8 in the seven ETS pilots to the total number of trading days during 2013–2015. In general, the Hubei ETS pilot demonstrated the highest ratio of its effective trading days, especially in 2015 (over 95%). Shenzhen and Guangdong exhibited a growing ratio of their effective trading days from 2013 to 2015, and, in particular, the ratio of effective trading days in the Shenzhen ETS pilot exceeded 90% in 2015. The ratio of the effective trading days in the Beijing pilot showed subtle changes around 50%, whereas the ratio of effective trading day in the Shanghai ETS pilot dropped rapidly in the period from 2013 to 2015. The ratio of effective trading days in the Tianjin ETS pilot shocked severely, and Chongqing had the lowest ratio, at less than 10%.

All three indicators showed that the carbon markets in Hubei, Guangdong, and Shenzhen ETS pilots were, relatively, the most efficient among the seven pilots, with the highest level of market liquidity, the lowest degree of market fragmentation, and the largest share of effective trading days. The performance of the carbon markets in Beijing and Shanghai ETS pilots ranked in the second level, with a higher level of market liquidity, a lower degree of market fragmentation, and a larger share of effective trading days. By contrast, there was a huge gap existed between the development of these five pilots and the development of both the Tianjin and the Chongqing ETS pilots, which displayed inactive market activity and the lowest pricing efficiency (Chang et al. 2018).

Phase 2: 2016–2017

After the first three compliance periods for preparation (2013–2015), China’s seven ETS pilots advanced into a quickly growing phase from 2016 to 2017 and completed two compliance obligations. Table 8 shows the final official compliance results, except for the missing information on the compliance of the Chongqing ETS pilot in 2016 and 2017 and the Beijing, Shanghai, and Hubei ETS pilots in 2017. Firms in the Shanghai, Guangdong, and Shenzhen ETS pilots completed their commitment on time in both 2016 and 2017, whereas others postponed their initial compliance deadlines in 2016 or 2017. Guangdong had a 100 percent compliance rate in 2016, but one firm out of 246 failed to comply by the deadline in 2017. Several firms in both the Shanghai and the Shenzhen ETS pilots failed to fulfill their obligation by the initial deadline in 2016 and 2017. Tianjin achieved a 100 percent compliance rate after postponing its initial compliance deadline by 1 month in both 2016 and 2017, whereas in the Beijing ETS pilot, 22 firms failed to comply, although the initial deadline was postponed by 10 days in 2016 and two and a half months in 2017. Hubei finished its compliance period of 2016 with a 100 percent compliance rate on time but lacked information on the compliance rate even though it postponed the deadline of its compliance period of 2017.

Table 8 Compliance details for pilot ETSs
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During 2016 and 2017, the carbon price in China’s ETS pilots remained much more stable compared to the period from 2013 to 2015, except for Shanghai and Chongqing (Fig. 2). The Beijing and Shenzhen ETS pilots sustained their market prices at 40–60 RMB and 20–50 RMB, respectively, while the Hubei, Guangdong, and Tianjin ETS pilots stabilized their price at a low level (10–20 RMB) with an average price of approximately 15 RMB (Table 9). The price in the Shanghai ETS pilot made a huge leap during 2016–2017, from the lowest level of less than 10 RMB at the beginning of the compliance period of 2016. The price in the Chongqing ETS pilot rose to 40 RMB only before the compliance deadline, while it stayed around 1 RMB in other months, which resulted in the lowest average price of less than 5 RMB in 2016 and 2017 (Fig. 2, Table 9).

Table 9 Second market overview I.
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As for trading volume, the “compliance effect” still existed during 2016–2017, but it was weakened greatly compared to that emerged during 2013–2015, especially in the Guangdong ETS pilot, where the daily trading activity was more active between 2016 and 2017 than between 2013 and 2015 (Fig. 3). As a result, its market scale, in terms of both trading value and trading volume, surpassed that of Hubei and became the largest among China’s seven ETS pilots in 2016 and 2017 (Fig. 4). By contrast, the daily trading volume in the Hubei ETS pilot was reduced greatly despite there being transactions nearly every day during 2016–2017. Transactions in the Shanghai and Chongqing carbon markets were concentrated in the period from August 2017 to July 2018, whereas, in the Beijing carbon market, both the trading volume and the trading value were almost the same in 2016 and 2017 (Table 9). Transactions in the Shenzhen ETS pilot decreased a lot during 2016–2017 compared to those from 2013 to 2015. The phenomenon of “having price but no deal” still existed in Tianjin ETS pilots during 2016–2017, and, in particular, there were even zero transactions in the compliance period of 2017 (Figs. 3 and 4). In general, the trading volume of the Hubei and Guangdong ETS pilots together accounted for more than the half of the total volume (66% in 2016 and 52% in 2017). The Beijing and Shenzhen ETS pilots had a larger share of trading value due to their higher average carbon prices, despite their smaller share of trading volume.

Table 10 shows the results in terms of market fragmentation, liquidity, and effective trading days. During 2016–2017, the market fragmentation of the Guangdong ETS pilot accounted for 66.53%, lower than that of the Hubei ETS pilot, indicating the lowest degree of market fragmentation. Hubei and Shenzhen ranked the second and third lowest in terms of degree of market fragmentation, at 73.18% and 87.41%, respectively. These three ETS pilots were the first echelon. The second echelon was composed of Beijing, Shanghai, and Chongqing with a market fragmentation of 93.92%, 90.19%, and 90.29%, respectively. Tianjin had the highest level of market fragmentation. Furthermore, except for the lack of information in the Tianjin and Shenzhen ETS pilots, the trading volumes of the remaining ETS pilots also constituted a small fraction of the total number of available allowances, the largest of which was less than 0.05% (Beijing ETS pilot). Beijing keeps its market liquidity stable at 0.048% in 2016 and 2017. The market liquidity of the Shanghai ETS pilot increased gradually during 2016–2017, while the market liquidity of Guangdong, Hubei, and Chongqing declined. As for effective trading days, China’s seven ETS pilots demonstrated much better performance during 2016–2017 than during 2013–2015 in general, except for Tianjin in 2017. Hubei had the highest ratio of effective trading days, which was over 95% in both 2016 and 2017. Shanghai and Guangdong exhibited a growing ratio of effective trading days from 2016 to 2017. Chongqing showed subtle changes around 50% in the ratio of effective trading days, while the ratio of effective trading days decreased in both Beijing and Shenzhen. The ratio of effective trading days in the Tianjin ETS pilot declined from approximately 80% in 2016 to 0 in 2017.

Table 10 Second market overview II.
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All three indicators showed that the carbon markets in the Hubei, Guangdong, and Shenzhen ETS pilots were, relatively, the most efficient among the seven pilots, which was the same as the efficiency rank during 2013–2015. The second level of the market performance included not only the Beijing and Shanghai ETS pilots which was consistent with that during 2013–2015, but also the Chongqing ETS pilot that was in the third echelon during 2013–2015, indicating a huge improvement of the Chongqing ETS pilot. By contrast, there was a huge gap between the development of these six pilots and the development of the Tianjin ETS pilot, which showed worse market performance from 2016 to 2017.

Phase 3: post-2017

After gaining a great deal of experience from the seven ETS pilots, the central government implemented the national ETS in December 2017, including only the electricity sector of 1700 firms first (NDRC 2017). With the development moving from pilots to a nationwide scheme, China’s seven ETS pilots faced a huge challenge post-2017 that was different from preceding challenges. Neither the current ETS pilots nor the future nationwide ETS should be designed as closed schemes given the overall cost effectiveness (Zhou et al. 2013). Therefore, how to link seven pilot carbon markets not only with each other but also with the national ETS to make China’s ETS mature and efficient has become a critical issue and an urgent need during since 2017 (Jiang et al. 2016a; Zhang et al. 2017). This section discusses mainly the potential issues of the co-existence between regional ETS pilots and the national carbon market post-2017 based on international experiences and the reality in China, as obtained from research literature and public government documents, because China’s ETS pilots only involved a very short time (less than 2 months) after the compliance period of 2017 and lacked related data.

In fact, it was as early as 2015 when China proposed enlarging the ETS pilots’ geographical coverage of the ETS pilots by either merging non-ETS member regions into the existing schemes or carrying out direct linking between various existing ETSs, such as the Beijing–Tianjin–Hubei and Yangtze River Delta schemes (Chen and Nie 2014; Hu et al. 2017). However, the actual performance of these two cross-regional ETSs is so poor that there has been little progress in substantive cooperation among the three regions so far (Jiang 2015). On the whole, given the divergences in the design of the mechanisms of the seven ETS pilots, and their regional development disparities, China’s seven ETS pilots have been operating in isolation so far, even though they have gone through five compliance periods, let alone aligning ETS pilots with the immature national ETS that started only several months ago and various aspects of which remain vague (Goulder et al. 2017). Post-2017, the electricity sector, covered as it is by both the ETS pilots and the national ETS, is wondering how to deal with their emission allowances allocated by the two different kinds of ETS and how to comply with two different regulations without increasing the compliance cost. Other firms covered only by the ETS pilots worry about the fate of their emission allowances gained from the ETS pilots and thereby hold a “wait and see” attitude toward the ongoing carbon market under the circumstance of lacking definite market linkage, hence resulting in rather inactive trading.

Scholars have paid attention to this urgent issue. Zhang, Wang, and Du (Zhang et al. 2017) pointed out market that linkage may cause leakage if it is impossible to impose the same MRV protocols and enforcement on all markets. Therefore, they held that equity and efficiency should be balanced when linking isolated carbon markets. This point was also underlined by Liu et al. (2013a). Other scholars have suggested procedures to develop the linkage in China’s ETS. For example, Munnings et al. (2016) suggested the pilots needed to begin the process of aligning mechanism designs to prepare for future formal linkage, and either carbon offsets or a second market could be the ideal tool in the first step (Wang and Wang 2015; Jiang et al. 2016a). Besides, international practices could also offer us valuable suggestions for our ETS linkage. The Regional Greenhouse Gas Initiative (RGGI), the European Union (EU) ETS, and Tokyo ETS have applied similar methods to expand their geographical coverage, while the Quebec ETS has been collaborating with the California ETS on linking their schemes (Jiang et al. 2016a).

Conclusions of the seven pilots

Accumulating experience to inform the design of a national ETS is the primary goal to authorize China’s seven ETS pilots (Zhang et al. 2017). Hence, clarifying the achievements and deficiencies of the seven ETS pilots will to a large extent shed light on the future development of the national ETS in China. According to the detailed analysis of ETS design and performance evaluation of the second market in the seven pilots, this section concludes several progresses and defects to inform the formulation of China’s national ETS.

Achievements and reference values of ETS pilots for the national ETS

Scholars have indicated that the success of China’s ETS pilots is mixed (Zhang et al. 2014, 2017). Munnings et al. (2016) suggested that the definition of a successful ETS pilot should be distinguished between the long-term and short-term perspectives. Considering the various obstacles that China’s distinctive socialist market economy imposes on the ETS pilots, the goal of emission reductions at lowest cost through ETS will require long-term efforts. However, the implementation of the ETS pilots is in the course of only a few years. Therefore, this study focuses mainly on the shorter-term success of the seven ETS pilots and concludes with several key points as follows.

The progress of the seven ETS pilots has helped introduce the concept of carbon pricing to China, which offers Chinese firms greater autonomy in emission reduction and gradually reshape their attitude and even their behavior toward ETS when the nationwide market opens (Munnings et al. 2016). Carbon pricing releases a signal that environmental protection is an inevitable trend and worth doing, which might affect investment, production, and innovation. This kind of impact makes firms potential markers of progress and harbor much more for the nationwide carbon constraint.

In terms of a more pragmatic perspective, the success of China’s seven ETS pilots lies in reinforcing China’s capacity to develop a market-based scheme in an economy that still cherishes many non-market endowments (Zhou et al. 2018). After five compliance periods, firms covered in the ETS pilots have understood the related rules progressively and learned to hunt for trading opportunities at wholesome prices and volumes, leading to their better and better trading performance of the second market. A notable phenomenon is that the “compliance effect” has weakened greatly over time in most of the pilots, such as the Guangdong ETS pilot, where the daily trading activity was more active between 2016 and 2017 than between 2013 and 2015. Many firms’ capacity to complete the processes of MRV emissions has been improved so greatly that their punctual compliance performances are much better during 2016–2017 than during 2013–2015. So, through these experiments conducted in the past years, the foundations, including the quality and quantity of emission data, trading platforms and rules, have been established and ameliorated, which could contribute significantly to the success of the future national ETS.

Furthermore, some aspects of pilot designs, after 6 years of continuous improvement, reflect a deft tailoring of a basically market-based scheme to a socialist market economy. The Shanghai ETS pilot, different from the others, allocated all allowances for the whole pilot period at one time, giving its firms ample room to balance between production and abatement, even though its within-period update hampered, to some extent, the effect of lump sum allocation. What could be learned from this is considering carefully the duration of the allowances in the future national ETS. The certainty in the cap affects the success of an ETS significantly. If single-year schedules of caps with adjustment are selected, the firms covered will not know their final allocation until the end of the compliance period and will be likely to begin proactive transactions just 1–2 months prior to the compliance deadline. In the long run, the carbon market would lack of price signals to promote clean production (Munnings et al. 2016). Besides, the market performance of the Hubei, Beijing, and Guangdong ETS pilots attracts public attentions. The daily trading activity in these three pilots became increasingly active, and the carbon prices were stable day by day during the past compliance periods, especially the period of 2016–2017. From this point, the future national ETS could consider the auction part embedded in the allowance allocation of the Guangdong ETS pilot, and the provision of no banking allowed in the Hubei ETS pilot, which results partly in the increasingly excellent market performance above.

Deficiencies and implications for the national ETS

Significant improvements had been observed in the seven ETS pilots during past compliance periods. Yet, several deficiencies exist in the market design and market performance, which are concluded through the consideration of both the market performance (internal and external) and the specific designs that may be a potential cause of the above market performance.

From the perspective of external performance, current carbon prices cannot work as a signal to shift away from pollution-intensive production. In general, the carbon prices are at a comparatively low level relative to the market price in international carbon markets (e.g., an average daily price of approximately 100 RMB/ton in EU ETS after its reform)Footnote 9 and marginal abatement cost (Goulder et al. 2017), which leads to insufficient incentives for green innovation investments. This indicates that carbon asset management, coupled with cap setting and allowance allocation, is inadequate and that the risk control methods, especially the price floor mechanism, do not work well enough. Besides, auction is of importance for an efficient ETS because of its strongly useful feature for enforcing a price floor (Munnings et al. 2016). Currently, it is absent in China’s ETS pilots except for Guangdong and Shenzhen. However, regulators in the Guangdong ETS pilot reduced the floor price for auctions repeatedly in actual operation, far below the initial planned floor price, which has seriously hampered its market effectiveness. In addition, incentives for covered firms to comply are not inadequate. Many firms have submitted full allowances to cover their emissions, but most of them are under the premise of postponing their initial compliance deadline repeatedly, demonstrating that China’s ETS pilots have difficulties in fulfilling the compliance obligation virtually. This is partly because of the lack of a strong regulatory system (Cong and Lo 2017). China’s regulatory infrastructure for ETS is far from intact, which is reflected in the relatively low financial penalties for non-compliance, lax legal enforcement, and the lack of an information disclosure system (Liu et al. 2015; Zhao et al. 2017). Regulators have manipulated the deadline to achieve a perfect compliance rate, resulting in excessive intervention into market activities and signaling that enforcement is not a credible threat. Hence, the phenomenon emerges in endlessly that covered firms are not either aware of carbon market rules or incline toward believing that local governments do not take enforcing compliance seriously (Zhao et al. 2016), or even some powerful firms could seek out ways to evade penalties for their failure to comply. Besides, public regulation is of importance for firms’ compliance in time. With air pollution getting more and more seriously, scholars tend to explore the dangerous of environmental exposure to toxic elements. Hwang et al. (2018) evaluated the effect of air pollution caused by cement plants on nearby residential areas and performed an exposure assessment of particulate matter (PM). Varshney et al. (2016) analyzed the potential health risk of exposure to airborne particulate matter. Meanwhile, the public themselves also pay more attention to environmental issues and take actions voluntarily to require a clear life environment. Wang et al. (2019) analyzed public environmental complaint behaviors and found that residents’ complaint is beneficial for firms’ environmental performance. The public has very limited access to data and information on the seven ETS pilots, such as the allocated allowances for each firm, the lists of the covered firms and data on agreement transfer happening in the over-the-counter market, which inhibits trading on the secondary market. As to the national ETS, attention should be given to a complete, transparent, and explicit regulation system.

Considering the internal performance, market liquidity in aggregate is still poor, although an increasing trend has emerged in some of the ETS pilots. The highest turnover rate is no more than 0.2% during the compliance periods. No one ETS pilot has an effective trading day ratio of 100% during a complete compliance period, and a more than 90% share of effective trading days is achieved only in the Shenzhen and Hubei ETS pilots. Currently, emission reduction relies more heavily on complementary measures than on carbon trading (Munnings et al. 2016), which might explain the quite low market liquidity. Besides, many uncertainties stemming from inappropriate designs, such as intensity-based cap setting, allowance allocation with within-period adjustment, and incomplete regulation systems, prevent firms from trading. A healthy level of liquidity acts as a prerequisite for price discovery. Regulators should first identify the resource of low liquidity and then improve trading activity accordingly. Moreover, given the wide differences in the market designs due to the diverse regional features, the seven ETS pilots operate in isolation, resulting in a highly fragmented market structure and tremendous difficulties in linking these pilots. This implies that regional development levels should also be taken into consideration when designing the national ETS because the application of unified market rules may cause the regional equity issues.

Discussion and suggestions for the national ETS

Based upon the above systematic analysis of China’s seven ETS pilots coupled with international experiences and domestic realities, this section aims to discuss potential challenges faced by China’s nationwide ETS. Then, suggestions and policy proposals are offered to facilitate an increasingly well-designed and functioning national ETS.

Challenges for the current times

As a unique socialist market economy, China’s distinctive aspects, related to economic, regulatory, and legal structures, present a range of difficult challenges that regulators must overcome by crafting design features that depart from those of other ETSs in mature market economies. It is of importance to clarify these challenges before the further step of establishing the national ETS. Hence, three key aspects are discussed as follows.

Uncertainty of economic development

Cap setting is the first priority when establishing an ETS, and it will influence directly the emission mitigation effect. A reasonable cap is determined by economic growth and business-as-usual emissions (Tian and Whalley 2009; Xiong et al. 2017). China is in a transition stage of economic growth, where industry structure upgrade is in a dominant position, and significant economic slowdown has emerged since 2013 (Xiong et al. 2017). Under China’s economic “new normal,” that the country’s future GDP development trajectory is much different from that in the past and is full of uncertainty. As a result, the binding force of a cap established according to an ex-ante forecast on China’s GDP growth rate is much more uncertain than is that in international mature carbon markets. In particular, an intensity cap would translate this uncertainty in GDP into uncertainty regarding overall emissions and result in China’s national ETS not being an absolute, but a hybrid, cap-and-trade scheme.

Given the above uncertainty in cap setting induced by China’s highly uncertain economy and the reality that China is in the process of industrialization and urbanization, the seven ETS pilots currently regard an intensity-based cap as a more enforceable way to curb emissions without compromising the economy (Tian and Whalley 2009; Xiong et al. 2017). Meanwhile, to avoid the emergence of over-allocation like the EU ETS or over-compliance that may harm economic growth, China’s ETS pilots have adopted either single-year schedules or within-period adjustment of caps, which have not been employed in any other carbon markets (Wang et al. 2018a). While providing potential flexibility in dealing with uncertainty in the economy, this short cap duration leads to a lack of long-term price signals to shift away from carbon-intensive production and to considerable uncertainties on the validity period of allowances as a kind of financial assets (Cong and Lo 2017). Moreover, the within-period adjustment based on the actual output in the compliance period results in the fact that allowances may be either awarded to or withdrawn from individual entities. Hence, the entities could not know the certain allocation until a few days before a compliance deadline and likely would not trade allowances actively in the carbon market, hampering market liquidity.

Heterogeneity of regional circumstances

Choosing several ETS pilots instead of a nationwide carbon market, at the beginning, is due to China being an incredibly diverse country in terms of sheer size, income disparities, industrial heterogeneity, and numerous institutional characteristics. All ETS pilots were designed uniquely to fit the diverse features in each region and have been in isolated operation so far. As to a top-down nationwide ETS with unified rules, how to limit equity–efficiency trade-offs and to determine the appropriate division of responsibilities among local governments are significant challenges.

China’s central and western provinces are generally less-developed but richer in resource than are the more populous and urbanized eastern regions. Distributing allowances disproportionately to central and western regions where many of the low-cost abatement opportunities exist, would facilitate a westward transfer of wealth and offset the costs of cost-effective abatement (Zhang et al. 2014). Therefore, the allocation among the different regions should fully premeditate regional heterogeneities in economic and emissions contexts as well as inter-regional cooperation and distributive efficiency. In addition, the national authorities are responsible for formulation of the rules, and the provincial-level authorities are responsible for implementation. Even though the national ETS is designed with the top-down consensus, its implementation and enforcement are heterogeneous at the local level considering the disparities in capacity, capability, familiarity, and contexts.

Lack of institutional foundation

The institutional foundation of an ETS consists of legislation, supervision, MRV, and emission compliance systems (Jiang et al. 2016a). China’s national ETS has been under construction; yet, it is authorized only by NDRC, not a legislature, and the ETS pilots are created by local administrative regulations except for the Shenzhen and Beijing ETS pilots that are authorized by subnational laws. As a result, no national law has yet to explicitly enshrine goals relating to China’s ETS. Explicit mention of the ETS by the State Council or National People’s Congress would likely make this scheme more politically binding.

Furthermore, the supervision and MRV system lag remarkably in China’s current ETS. This shortcoming significantly affects the data reliability and market transparency and further hampers the effective operation of an ETS. To date, specific regulatory institutions responsible for China’s ETS pilots have not been set up in China. In addition, there are no explicit distinctions between obligations and rights and a clear supervision function explanation in the existing scheme. NDRC acts as the leader, rule maker, and regulator in China’s ETS, which is not advisable for long-term development. Under this circumstance, information related to ETS is difficult to find in public. Basic information, such as the allowances distributed to each firm, is difficult to find. Even the lists of the covered firms are not disclosed publicly. The online trading data from the secondary market represent the best accessible information, but they are collected by third-party agencies and are not verified by official institutes. Regarding allocation of allowances, related rules also lack the essential transparency and clarity. Most of them are depicted barely in very generalized terms without specific details.

Suggestions and policy proposals

So far, China’s seven ETS pilots have experienced five compliance periods and the nationwide ETS has been started with the coverage of electricity sector as its first step. However, compared with other mature international markets, China’s carbon market is still in its infancy. By discussing the urgent challenges for the current time, suggestions and policy proposals are offered from two key aspects of China’s national ETS development.

Determining cap duration and allowance allocation

An optimal cap is set based on the ex-ante forecast of China’s current GDP growth rate. However, because of the remarkable uncertainties remaining in China’s economy, the cap setting in China’s ETS needs more considerations and greater balance between certainty and flexibility. Currently, China’s national ETS starts with the inclusion of the electricity sector only. Comparatively speaking, the data foundation regarding historical emissions in electricity sector is easy to access and their products are single enough to control the future market. As a result, this study suggests that regulators in China’s national ETS consider the possibility of extending cap duration from a single year to several years, as in the case of the EU ETS, and dropping within-period adjustments to electricity firms. Given that flexibility is necessary to prevent unexpected changes in economy from harming the compliance performance (Munnings et al. 2016), reasonable adjustments of allowances are preferred at the market level than at the firm level. If GDP turns out higher than projected, an auction of reserved allowances by regulators could be used to add additional allowances into the market while stable market price. In contrast, a buyback scheme could be implemented to reduce the excess allowances when GDP turns out to be lower than projected.

The wide diversities in China make equity striking in the design of the national ETS. Regulators should coordinate regional divergences with national carbon market unification and ensure consensus on rules across regions, including scope coverage and allocation, trading management, MRV system, and compliance supervision and enforcement. The electricity sector, as the only sector covered in China’s national ETS with a relatively strong statistical basis, is comparatively suitable to use benchmarking method for allowance allocation. Hence, this study proposes that the central government, referring to EU-harmonized allocation rules during 2013–2020, should follow the principle of “one product, one benchmark” and directly issue allowances to single installations based on a unified emission benchmark value, irrespective of where the units belong (Jiang et al. 2016a). This proposal, however, must be conducted along with the electricity market reform, which enables free trade of electricity across borders (Zhou et al. 2016). Besides, free allocation for the power generation can hardly provide incentives for the electricity sector to cut its activity level (Wu et al. 2014). Auction should be imported gradually as a substitute for grandfathering in the national ETS.

Improving the institutional foundation

First, legislation construction is fundamental to the healthier development of an ETS. This study recommends highly that regulators to build an all-around ETS legal system from top down as soon as possible. In particular, national-level legislation is needed urgently for China’s nationwide carbon market, especially regarding the legal properties of allowances, rights and obligations, and other fundamental aspects. The regulators could take international experiences as reference. The “California Environmental Quality Act” in the USA, the “Climate Change Act” in the UK, and the “Directive 2003/87/EC” in the EU all appeared in the form of legislation to facilitate the development of their carbon markets (Liu et al. 2015). Furthermore, the clarification of the demarcation between local and central legislative jurisdictions and the harmonization of their relationship should also be put on the legislative agenda (Jiang et al. 2016a). Disclosure should be changed from voluntary to mandatory and be embodied in the legislative framework, including systematic, detailed, and transparent procedures, to remedy China’s weak statistical basis.

Second, the construction of supervision, management and MRV systems initiated synchronously along with the legal system is highly recommended. A multi-level supervision system, that is, government-level and social-independent regulatory authorities, may be necessary for the purpose of regulating the whole process. A unified strong MRV and enforcement system across different regions is of special significance for the equity and efficiency of China’s national ETS. Therefore, formulating a series of national harmonized MRV guidelines should be undertaken as soon as possible. An industry association of emission verification should be founded, and the corresponding capacity building should be strengthened.