The very flexibility measures that make a tradable permit system efficient also make it vulnerable to fraud and manipulation. Market oversight provisions work to prevent these issues and facilitate price discovery by increasing transparency, containing risk, maximizing liquidity, and ensuring fair competition. Emission allowances can be seen as commodities or financial products, and existing structures for financial market regulation can then be applied to allowance trading. 

As the supply of allowances in a trading scheme with an absolute cap is fixed, allowance prices are especially sensitive to demand and thus vulnerable to external shocks and abuses of market power. To limit market power, regulators may impose limits to restrict the number of allowances held by any single participant (position limits) or other measures to prevent groups from colluding to manipulate price levels. Market oversight provisions cover primary markets (see allocation) and secondary markets and help ensure that all participants have equal opportunity to buy allowances at a price based on market fundamentals. In addition to allowances themselves, derivatives or financial contracts for future transactions which ‘derive’ their value from allowances can also be bought and sold. Buyers and sellers can seek each other out and trade over-the-counter (OTC), or go to an exchange where buyers’ bids and sellers’ offers are centrally agglomerated. In OTC trading, there is some ‘counterparty risk’ that the various actors trading cannot or do not fulfill their obligations, which can lead to potentially significant financial losses. To help mitigate this risk, market oversight provisions can promote trading on exchanges or at least through a central clearing party (CCP) which helps to pool risk and minimize the effects of any single unfulfilled contract. Registries and trade repositories can serve similar functions, in increasing transparency and helping to identify potentially market relevant dangers.

In addition to manipulation, outright fraud may be an issue to be addressed by market oversight. Electronic registries that are robust to hacking and know-your-customer rules imposing requirements on who can open a registry account to participate in the market can help guard against phishing attacks (personal information gathering leading to allowance theft) and carousel fraud (cross-boundary trade leading to tax evasion).

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Market Stability Provisions
Canada - Nova Scotia

RESERVE: In the first year of each compliance period, the government places 3% of allowances available under the cap of each year into a reserve. These allowances may be used for:

(1) Cost containment: Offering them for sale at set prices to participants at predetermined times throughout the year to cover their compliance obligations. Up to four reserve sales can occur in one calendar year. The initial price was set at CAD 50 (USD 37.28) in 2020, and this will rise annually by 5% plus inflation.

(2) New entrants: Accommodating new participants in the cap-and-trade program whose GHG emissions are not currently accounted for and that qualify for free allocation.

(3) Reserve for adjustments in output-based free allocation: Allowances from the reserve can be used as a buffer for uncertainty in output-based allocation for industrial facilities. If initial projections by the regulator on the yearly allocation levels fall short of necessary allocation based on real production levels, then output-based allocation according to allocation rules can be fulfilled by using allowances from the reserve.

Canada - Québec Cap-and-Trade System

AUCTION RESERVE PRICE: The auction reserve price sets the minimum price at which allowances are available at auction and increases annually by 5% plus inflation. It is set at CAD 17.36 (USD 12.94) for Québec and USD 17.71 for California in 2021. For joint auctions with California in 2021, the highest value in USD between Québec’s or California’s auction reserve prices, based on the exchange rate of the Bank of Canada the day prior to the auction, will be the auction reserve price for that particular auction.

RESERVE ACCOUNT: Québec maintains an allowance reserve to adjust levels of free allocation and sell to entities that do not have enough allowances to cover their obligations (“sales by mutual agreement”). The reserve is filled with set portions of the annual cap (4% for 2021 and beyond).

Sales by mutual agreement are held a maximum of four times per year at three price categories that contain an equal share of allowances on offer. Only covered entities in Québec are eligible to purchase allowances from the reserve, and only if they do not have valid compliance instruments for the current period in their general account.

In December 2020, Québec amended the prices of its three tiers to more closely align with California. For 2021, the prices of the three tiers are CAD 41.40 (USD 30.87), CAD 53.20 (USD 39.67), and CAD 65 (USD 48.47). However, if California has set higher prices per allowance for a corresponding category, Québec allowances would be sold at the highest of the prices of both jurisdictions according to the daily average exchange rate of the Bank of Canada published on its website on the day preceding the sale. Unlike California, the highest tier will not act as a price ceiling for Québec. Reserve prices increase annually by 5% plus inflation.

China - Beijing pilot ETS

PRICE FLOOR AND CEILING: The competent authority can auction extra allowances if the weighted average price exceeds CNY 150 (USD 21.74) for 10 consecutive days, and buy-back allowances from the market using a special funding source from the municipal budget if the price is below CNY 20 (USD 2.90).

EXCHANGE: The China Beijing Environment Exchange implements a system of limits on price increases and decreases for trading over the exchange which is ±20% of the reference price (the weighted average price of all transactions on the previous trading day) to prevent large price fluctuations. It also sets the maximum position limit for the different market participants: the sum of their annual allocated allowances plus one million tonnes for the compliance entities, one million tonnes for institutional investors, and 50,000 tonnes for natural persons.

RESERVE: The competent authority could set aside up to 5% of allowances for regular and irregular auctions. To date, no auctions have been held.

China - Chongqing pilot ETS

EXCHANGE INTERVENTION: Depending on transaction types, if prices vary more than 10% or 30% in one day, the Chongqing Carbon Emissions Exchange can institute price stabilization measures, such as temporarily suspending trading or imposing a holding limit.

SALE AND TRADE LIMITS: Compliance entities must not sell more than 50% of their annual free allocation.

China - Fujian pilot ETS

RESERVE: 10% of the total cap is kept as a government reserve for market stabilization.

INTERVENTION: According to the (trial) ‘Implementation Rules of Emissions Trading Market Management in Fujian Province,’ the Fujian Economic and Information Center under the guidance of the competent authority—in consultation with an advisory committee—can buy or sell allowances in order to stabilize the market under certain conditions. These conditions include: market fluctuations (i.e., if the cumulative increase or decrease of allowance prices for ten consecutive trading days reaches a certain percentage); severe imbalances between supply and demand; or liquidity issues. More specifically, high prices may trigger allowance auctions from government reserves through the Haixia Equity Exchange. Low prices may trigger authorities to buy allowances from the market through governmental funds.

China - Guangdong pilot ETS

RESERVES: 5% of allowances are set aside for government reserves for new entrants and market stability. The specific rules for market stability are provided by its ‘Trial Measures for ETS.’

AUCTION RESERVE PRICE: Auctions under the Guangdong Pilot ETS are subject to an auction reserve price. Initially in 2013, the reserve price was set at CNY 60 (USD 8.69), and it was lowered to CNY 25 (USD 3.62) and increased to CNY 40 (USD 5.80) in steps of CNY 5 (USD 0.72) with each quarterly auction in 2014. In 2015, a so-called “policy reserve price” was set as an effective reserve price, which links the auction reserve price with the secondary market price. The reserve price was set at 80% of the weighted average price for allowances over the previous three months in 2015. In 2016, the policy reserve price was set at 100% of the weighted average price for allowances over the previous three months. The policy reserve prices for the four auctions for the 2016 compliance period were as follows: CNY 9.37 (USD 1.36), CNY 11.27 (USD 1.63), CNY 16.09 (USD 2.33), and CNY 15.15 (USD 2.20). When auctions were resumed in April 2020 for the compliance year 2019, the policy reserve price was set at 90% of the weighted average price for allowances over the previous three months considering the COVID impact.

OFFSET AUCTIONS: Guangdong introduced auctioning for PHCERs in addition to the existing secondary market trading modes, with an auction reserve price set by the Emissions Exchange Guangzhou and offset project developers. In the latest two auctions of PHCERs in 2020 (28 December 2020), the reserve price for one offset project was set at CNY 22.25/tonne (USD 3.22) (80% of the weighted average price for allowances over the previous three months). The offered 52,355 tonnes offsets were sold at the price of CNY 35.3/tonne (USD 5.12). For the other one, the reserve price was set as CNY 33/tonne (USD 4.78), with all the 9,789 tonnes offered being sold at the price of CNY 36.06/tonne (USD 5.23).

China - Hubei pilot ETS

RESERVE: 8% of the total cap is kept as a government reserve for market stabilization.

INTERVENTION: In case of market fluctuations, severe imbalances between supply and demand, or liquidity issues, the Hubei EEB—in consultation with an advisory committee consisting of government institutions and other stakeholders—can buy or sell allowances in order to stabilize the market. Specifically, if the allowance price reaches a low or high point six times during a 20-day time span, the Hubei EEB takes action.

EXCHANGE: The exchange limits day-to-day price fluctuations to between -10% and +10% respectively.

China - Shanghai pilot ETS

EXCHANGE: Depending on transaction types, if prices vary more than 10% or 30% in one day, the Shanghai Environment and Energy Exchange can institute price stabilization measures such as temporarily suspending trading or imposing holding limits.

RESERVE: A small share of the annual cap can be kept in a reserve for auctioning before the end of the annual compliance cycle as a market stability measure (see “Allocation” section).

China - Shenzhen pilot ETS

RESERVE: 2% of the total cap is kept as a government reserve for market stabilization.

INTERVENTION: In case of market fluctuations, the Shenzhen EEB can sell extra allowances from the reserve at a fixed price. Such allowances can be used only for compliance and cannot be traded. The government can also buy back up to 10% of the total cap. Once they are bought back, allowances can be also used for the market stability auctions.

China - Tianjin pilot ETS

Intervention: In case of market fluctuations, the Tianjin EEB can buy or sell allowances (on a fixed price or through auctioning) in order to stabilize the market.

China National ETS

Adjustment mechanisms to prevent abnormal price fluctuations, as well as risk prevention and control mechanisms to prevent market manipulations, are under development.

EU Emissions Trading System (EU ETS)

MARKET STABILITY RESERVE: The MSR started operating in January 2019. Its purpose is to address any supply-demand imbalance of allowances prevailing in the EU carbon market and to improve the EU ETS’s resilience to future shocks.

Thresholds: The European Commission publishes the total numbers of allowances in circulation (TNAC) by 15 May each year.
• When the TNAC is above 833 million, 24% (12% beyond 2023) of the surplus is withdrawn from future auctions and placed into the reserve over a period of 12 months.
• When the TNAC is less than 400 million allowances, 100 million allowances are taken from the reserve and injected into the market through auctions.

From 2023 onwards, the number of allowances held in the reserve will be limited to the auction volume of the previous year. Holdings above that amount will be invalidated. Thresholds, withdrawal rates, and cancelation provisions of the MSR will be reviewed in June 2021.

In 2019, a total of 397 million allowances were placed in the reserve. In 2020, the total number of allowances withdrawn amounted to more than 375 million, corresponding to a 35% reduction in auction volumes for that year.

Swiss allowance supply is not taken into account when the annual EU withdrawal amount is calculated, and Swiss auction quotas will not be reduced by the mechanism.

CANCELATIONS: As of Phase 4, a Member State may also cancel allowances from their auction share in the event that they take additional policy measures that result in closure of electricity generation capacity. The quantity of allowances cancelled shall not exceed the average verified emissions of the installation from five years preceding the closure.

German National Emissions Trading System

Additional allowances exceeding the cap can be acquired by entities in the fixed-price phase.

In 2026, auctions of allowances will contain a price corridor of a minimum price per tCO2 of EUR 55 (USD 62.82) and a maximum price of EUR 65 (USD 74.24).

A potential price corridor for the time after 2026 will be decided upon in 2025.

Japan - Saitama Target Setting Emissions Trading System

In general, Saitama does not use market stability provisions.

Japan - Tokyo Cap-and-Trade Program

In general, covered facilities trade over the counter and the TMG does not control carbon prices. However, as a discretionary mechanism, the TMG sells its own offset credits for trading in case of excessive price development.

Kazakhstan Emissions Trading Scheme
Korea Emissions Trading Scheme

AUCTION RESERVE PRICE: Regular auctions as well as auctions for market stability are subject to a reserve price determined by a formula (see “Allocation” section).

ALLOCATION COMMITTEE: An Allocation Committee is in place to implement market stabilization measures in particular cases:
• the market allowance price of six consecutive months is at least three times higher than the average price of the two previous years;
• the market allowance price of the last month is at least twice the average price of the two previous years and the average trading volume of the last month is at least twice the volume of the same month of the two previous years;
• the average market allowance price of a given month is lower than 40% of the average price of the two previous years; or
• it is difficult to trade allowances due to an imbalance of supply or demand.

The stabilization measures may include:
• additional auctioning of allowances from the reserve (up to 25%);
• establishment of a limit to the number of allowances in an entity’s account: minimum (70%) or maximum (150%) of the allowance of the compliance year;
• an increase or decrease of the borrowing limit;
• an increase or decrease of the offsets limit; and
• temporary setup of a price ceiling or price floor.

In 2016, the Allocation Committee doubled the borrowing limit to 20%; as well, an additional 0.9 million allowances were auctioned at a reserve price of KRW 16,200 (USD 13.73) of which almost one-third were sold. In 2018, the Allocation Committee auctioned an additional 5.5 million allowances from the stability reserve to ease the market in the lead-up to the 2017 compliance deadline; 4.7 million allowances were sold.

In June 2019, the Korea Development Bank and the Industrial Bank of Korea were officially designated as “market makers.” These institutions can draw on a government-held reserve of five million allowances in a bid to increase liquidity in the market. Both banks, along with the Korean Export-Import Bank, engaged in market transactions on a daily basis. This has improved market liquidity and reduced bid-ask spreads.

The reserve for market liquidity increased to 20 million allowances for the third trading phase.

Mexico
New Zealand Emissions Trading Scheme

A Fixed Price Option of NZD 25 (USD 16.21), which acts as a form of price ceiling, was introduced in 2009 and raised to NZD 35 (USD 22.70) for emissions produced in 2020. It will be replaced with a CCR once the transition to auctioning has occurred.

New Market Stability Measures: The ‘Climate Change Response (Emissions Trading Reform) Amendment Act’ enables new measures to be implemented via the auctioning mechanism. These include a CCR and an auction reserve price, outlined below.

COST CONTAINMENT RESERVE: The CCR is implemented via auctioning. A specified number of allowances from the CCR will be released for auction if a predetermined trigger price is reached, currently set at NZD 50 (USD 32.42) in 2021 and rising by 2% per year in line with projected inflation.

The volume of the reserve, in the years 2021-2025, will be composed of two sources:
1) units under the ETS cap which are to be withheld from auctioning in order to reduce the stockpile of units in circulation (~5.5 million per year); and
2) an additional volume equal to 5% of the total volume of the NZ ETS (~1.6 million per year), which will come from outside the cap and therefore must be “backed” by equivalent removals procured by the government, e.g., from international markets or through government funding of other domestic mitigation activities.

PRICE FLOOR: Via auctioning, the government will introduce a price floor of NZD 20 (USD 13.00) for the period 2020-2025. The price floor will operate through a reserve price below which NZUs will not be sold at auction. The minimum accepted bid at auction will rise by 2% for each subsequent year. In addition to the hard auction reserve price floor, the government plans to introduce a technical reserve price (TRP). The TRP will be set by referencing prices from the secondary market and will use a confidential methodology to determine a reserve price below which units cannot be sold. If the TRP is set higher than the hard auction reserve price, then it becomes the new reserve price floor for that auction.

Any unsold units can be carried over to the following auction within the calendar year, but will be cancelled if it is the final auction of the year.

Swiss ETS

As of January 2020, the Swiss legislation foresees the possibility of reducing auction volumes where there is a significant increase of allowances on the market for economic reasons. In this case, unauctioned allowances will lose their validity. The Swiss ETS is not subject to the EU ETS Market Stability Reserve.

United Kingdom

SUPPLY ADJUSTMENT MECHANISM (SAM):
A Supply Adjustment Mechanism based on the EU ETS Market Stability Reserve (MSR) may be implemented after the launch of the UK ETS. If the UK government decides to implement a SAM along these lines, it will hold a separate consultation on the design of the mechanism. Given that a SAM similar to the MSR would require a measure of the allowance surplus in the UK ETS (analogous to the Total Number of Allowances in Circulation in the EU ETS), a SAM cannot be operational until mid-2022 at the earliest. To reduce the risks at the early stages of the UK ETS and ensure minimum price continuity, the UK government has put in place a transitional Auction Reserve Price (see “Allocation” and “Transitional Auction Reserve Price (ARP)” sections).

COST CONTAINMENT MECHANISM (CCM):
The UK ETS has a Cost Containment Mechanism to avoid spikes in allowance prices by auctioning additional allowances. If the CCM is triggered, regulators can decide on whether and how to intervene. Additional allowances from within the cap can be introduced from three possible sources: the reserve in the Market Stability Mechanism Account; future auctions; or the auctioning of up to 25% of remaining allowances in the NER. The CCM is similar to the measures described in paragraph 29a of the EU ETS Directive.

Triggers: In the first two years of the UK ETS, the CCM has lower price and time triggers than the equivalent EU ETS provisions, to ensure its reactiveness. In the first year, the CCM is triggered if, for three consecutive months, the ETS carbon price is two times the average allowance price in effect in the UK in the two preceding years. In the second year, the trigger is increased to two and a half times the carbon price for three months. The CCM will revert to the EU ETS price triggers in the third year. This means it would be triggered if, for six consecutive months, the allowance price is more than three times the average market price of allowances during the two preceding years.

TRANSITIONAL AUCTION RESERVE PRICE (ARP):
To ensure a minimum level of ambition in the transition from the EU ETS to the UK ETS, a transitional Auction Reserve Price of GBP 22 (USD 28.21) is in place. The transitional ARP will be kept under review and the government will consult on withdrawing it as the system matures or if a SAM becomes operational. An ARP would not be implemented in a UK ETS fully linked to the EU ETS, as price convergence would be expected between the two markets.

USA - California Cap-and-Trade Program

AUCTION RESERVE PRICE: USD 17.71 per allowance in 2021. The auction reserve price, the minimum price at which allowances are available at auction, increases annually by 5% plus inflation, as measured by the Consumer Price Index.

RESERVE: Allowances from each annual cap were placed in an Allowance Price Containment Reserve (APCR) (1% from the 2013-2014 compliance period; 4% from the 2015-2017 compliance period; and 7% from the 2018-2020 compliance period). Until the end of 2020, these allowances populated three price tiers in equal quantities. AB 398 replaced the three tiers with a new structure of two tiers and a price ceiling starting in 2021. AB 398 also directed where remaining allowances from the earlier APCR would be distributed. Specifically, two-thirds of those allowances are spread evenly across the two new price tiers. The remaining one-third (which had been spread evenly across the original three price tiers), plus unsold allowances that have been transferred into the APCR (about 37 million to date), are placed in the price ceiling reserve. In addition, the Cap-and-Trade Regulation also sets aside portions of annual allowance caps for the two lower price tiers from 2021-2030.

Although no reserve sale has been held to date, CARB will offer a reserve sale when auction settlement prices from the preceding quarter are at least 60% of the lowest price tier. CARB will also offer a reserve sale just before the compliance obligation deadline, if requested by at least one covered entity.

At the price ceiling, a covered entity can purchase allowances (or if no allowances remain, “price ceiling units”) up to the amount of its current unfulfilled emissions obligation. The revenues from the sale of price ceiling units will be used to purchase real, permanent, quantifiable, verifiable, enforceable, and additional emissions reductions on at least a metric tonne for metric tonne basis. Sales at the price ceiling will only be conducted if no allowances remain at the two lower tiers.

In 2021, the two cost containment reserve tiers and the price ceiling are set at USD 41.40, USD 53.20, and USD 65.00, respectively. Tier prices increase by 5% plus inflation (as measured by the Consumer Price Index).

USA - Massachusetts Limits on Emissions from Electricity Generators

AUCTION RESERVE PRICE: The auctions have a reserve price of USD 0.50 per allowance.

USA - Regional Greenhouse Gas Initiative (RGGI)

AUCTION PRICE FLOOR: USD 2.38 per short ton in 2021, increasing by 2.5% per year (to reflect inflation).

RESERVES: Since 2014, RGGI has operated with a cost containment reserve (CCR), consisting of a quantity of allowances in addition to the cap which are held in reserve and only released to the market when certain trigger prices are reached. Beginning in 2021, allowances provided within the CCR will be equal to 10% of the regional cap.

Trigger price: USD 13.00 in 2021 (increasing by 7% annually compared to the previous year thereafter; having increased at 2.5% annually starting from USD 10 between 2017 and 2020).

In 2021, RGGI started implementing an emissions containment reserve (ECR). Under the ECR, allowances are withheld from auction if certain trigger prices are reached, up to an annual withholding limit of 10% of the emission budgets (i.e., the share of each state in the regional cap) of participating states. Allowances withheld will not be re-offered for sale, effectively adjusting the cap downward. In 2021, the trigger price is set at USD 6, increasing by 7% compared to the previous year thereafter. Maine and New Hampshire are not participating in the ECR.

Colombia
Indonesia
Montenegro
Russian Federation - Sakhalin
Ukraine
USA - Pennsylvania
USA - Transportation and Climate Initiative Program (TCI-P)
USA - Washington
Vietnam
Brazil
Chile
Japan
Pakistan
Philippines
Taiwan, China
Thailand
Turkey
USA - New Mexico
USA - New York City
USA - North Carolina
USA - Oregon

Studies

Kachi, A. & Frerk, M. (2013) Carbon Market Oversight Primer. International Carbon Action Partnership.

INTERPOL Environmental Crime Programme (2013). Guide to Carbon Trading Crime.

Schneck, J. & Monast, J. (2011) Financial Market Reform and the Implications for Carbon Trading. Nicholas Institute, Duke University.

Pirrong, C. (2009) Market Oversight for Cap and Trade: Efficiently Regulating the Carbon Derivatives Market. Brookings Institution. 

U.S. Commodity Futures Trading Commission (2011). Report on the Oversight of Existing and Prospective Carbon Markets.

Keyzer, P., et al. (2012). Integrity and oversight of the New Zealand Emissions Trading Scheme. Carbon Market Institute.