Emissions trading is a market-based instrument for climate change mitigation. In an emissions trading scheme (ETS), a regulator defines an upper limit (cap) of greenhouse gas (GHG) emissions that may be emitted in clearly defined sectors of an economy (scope and coverage). Emission permits or allowances are given out or sold (allocated) to the entities that are included in the ETS. By the end of a defined time period, each covered entity must surrender a number of allowances corresponding to their emissions during that period. Installations that have emitted less than the number of allowances they hold can sell any excess to other participants in the scheme. Entities with low abatement costs thus have an incentive to reduce their emissions, while those facing higher costs can elect to comply by purchasing allowances from the market.
Emissions trading provides greater environmental certainty in controlling overall emissions compared to an emissions tax, which defines a fixed emission price without restricting the quantity of GHG emitted from industries. In both cases, rules for compliance
and enforcement (MRV & enforcement) ensure that polluters pay for the environmental costs of their actions. Allowing installations to determine when and where to reduce emissions makes ETS a flexible and cost-efficient policy instrument. The institutional and legal framework in place should enable price discovery by fundamental market forces free of fraud and manipulation (market oversight).
Since the introduction of the first regional ETS for GHG in the European Union in 2005, many other systems have emerged in North America, Asia and the Pacific region at the regional, national, and local levels (see the ICAP ETS Map). Several other jurisdictions are currently considering implementing their own domestic ETS, while some established ETS have taken steps to reform and, in some cases, link their systems. By sharing experiences and knowledge at these stages of development, ICAP contributes to the establishment of a well-functioning global cap and trade carbon market.