MAHARASHTRA NATIONAL LAW UNIVERSITY MUMBAI

TERM PROJECT FULLFILMENT OF THE ASSESSMENT

IN THE SUBJECT OF CORPORATE FINANCE

“EMISSION TRADING SCHEME: A MARRIAGE BETWEEN FINANCE AND ENVIRONMENT

PROTECTION”

SUBMITTED TO: Prof. ANAND SHRIVAS (COURSE INSTRUCTOR)

SUBMITTED BY: SHIV KUMAR SHARMA ROLLNO.2017 049

 INDEX

1. INTRODUCTION: ........................................................................................................................ 2

2. UNDERSTANDING CARBON TRADING SYSTEM: INSIGHT IN EUROPE’S CARBON MARKET: ....... 4

3. ECONOMICS OF CARBON TRADING: .......................................................................................... 8

A. Why Emission Trading Is Better Economic Option Than Green Tax:................................. 9

B. Visible Benefit of Carbon Trading:.................................................................................... 11
4. EMISSION TRADING IN INDIA: ................................................................................................. 13

A. Pilot Emission Trading Program in Surat, 2019 ............................................................... 14

B. Trading In Carbon Future Contract: ................................................................................. 15
C. Recommendation for Developing ETS Regime in India: ................................................... 15
5. CONCLUSION: ......................................................................................................................... 16

6. REFERENCES: .......................................................................................................................... 17

EMISSION TRADING SCHEME: A MARRIAGE BETWEEN FINANCE AND ENVIRONMENT

PROTECTION:

1. INTRODUCTION:

This paper aims to analyse scope of using financial instruments as a tool to combat environment
degradation by putting special emphasis on emission trading scheme (“ETS”). Emissions trading
are an environmental policy that seeks to reduce air pollution efficiently by putting a limit on
emissions.1 Under ETS polluters are given certain number of allowances consistent with those
limits, and then permitting the polluters to buy and sell these allowances. 2 The trading of a finite
number of allowances results in a market price being put on emissions, which enables polluters
to work out the most cost-effective way of reaching the required reduction.

1
Tejvan Pettinger, Carbon Trading Scheme, (May 1, 2021) https://www. economicshelp.
org/blog/2204/economics/carbon-trading-schemes/#:~:text=Benefits%20of%20 Carbon%20 Trading, may% 20
decide%20to%20buy%20more.
2
European Commission, EU ETS Handbook, p.80-81, (2015), https://ec.europa.eu/clima/s ites/clima
/files/docs/ets_handbook_en.pdf.

2
Economic analysis of law says that most effective policy measure should be adopted. 3 The
effectiveness of a policy is measured by comparing its benefits with social cost involved in it. An
effective policy is one which can mould people behavior without raising substantial social cost.
This paper will highlight principles from law and economics and will argue that ETS is an
effective policy tool. This argument is based on the analysis that ETS promotes reduction in
carbon emission from the player who is best suited to do so. Thus, not add any social cost.

The ETS is a complex policy decision. Success of ETS is dependent on many players of primary
and secondary security markets.4 This paper will study ETS regime in Europe and will analyse
role paid by various stakeholders. The paper by analyzing European ETS seeks to understand
essentials institutes for success of an emission trading scheme.

Emissions trading have been used with notable success to reduce emissions that cause acid rain.
It is currently being used in various attempts around the world to control emissions
of greenhouse gases. Recently, the government of India has also started a pilot ETS for heavy
industries in Gujarat. The paper highlights Indian approach towards ETS and suggests policy
measures which can be introduced in India.

This paper seeks to discuss how finance can act as a tool to incentivize changes in human
society. The paper will analyse economics of ETS and its scope in India. Based on this objective
the paper in first section defines scope of the article; in second section discuss working of ETS
by focusing structures used in Europe, in third section present economic analysis of ETS, in
fourth section highlights Indian position on emission trading and in the fifth section presents
meaningful conclusion to the study.

3
Yue jun Zang & Yi-Ming Wai, An Overview of Current Research on ETS, 87 (6) Applied Science 1804 (2013).
4
Betz, R. A., & Schmidt, T. S., Transfer patterns in phase I of the EU Emissions Trading System: A first reality
check based on cluster analysis, 16(4) Climate Policy 474–495 (2016).

3
 2. UNDERSTANDING CARBON TRADING SYSTEM: INSIGHT IN EUROPE’S CARBON
MARKET:

A. Players in the Market

 Brokers: Brokers intermediate and facilitate bilateral contracts, bringing together two
independent counterparties to a transaction in the emissions market. In the emissions
space, specialist brokers have emerged, and established brokers in other assets have
moved into the emissions space. 5 The role of brokers in the emissions market has been
declining with the increase in exchange trading. Exchange trading has increased as the
market has become more commoditized, with mainly near-date homogenous contracts
being traded as opposed to long-term forward contracts. Due to this brokers do not have a
very large role in the carbon market anymore, although some brokers do still find niche
markets of products that are not commonly exchange traded, for example options. 6
 Installations: The primary participants in the market are installations covered under the
European Union Emissions Trading Scheme (“EU ETS”), who receive allocations of EU
Emersion Allowances (“EUAs”) in each phase of the scheme. EU ETS limits emissions
from more than 11,000 heavy energy-using installations (power stations & industrial
plants) and airlines operating between these countries.7 These installations need to
annually match their actual measured emissions with their holdings of EUAs (or other
acceptable units). If they are successful in reducing emissions below their EUA
allocation, they can sell the surplus. If they are short, they need to purchase EUAs.

 Traders: Like any financial asset, emission units vary in price over time and provide
another vehicle for traders to profit from. Traders are an essential component of the
secondary market.8

5
Peter Cox, The Post-Trade Infrastructure For Carbon Emissions Trading p.11, THE CITY OF LONDON
CORPORATION REPORT (2010), https://www.longfinance.net/media/documents/carbontrading_colc2.pdf.
6
Interplay between EU ETS Registry and Post Trade Infrastructure (2015), EUROPEAN UNION,
https://ec.europa.eu/clima/sites/clima/files/ets/oversight/docs/interplay_report_en.pdf .
7
European Commission. EU Emission Trading System (ET ETS), (May 1, 2021), https://ec.europa.eu /clima/policies
/ets_en#:~:text=It%20currently%20covers%20over%2010%2C000,its%20total%20greenhouse%20gas%20emission
8
Peter Cox, The Post-Trade Infrastructure For Carbon Emissions Trading p.13, THE CITY OF LONDON
CORPORATION REPORT (2010), https://www.longfinance.net/media/documents/carbontrading_colc2.pdf.
(Hereinafter “Peter Cox”)

4
  Central Counterparties (“CCPs”): CCPs have a large role in the secondary emissions
market. The majority of secondary trading in the emissions market takes place via
exchanges, such as ICE, EEX, CME, and Nasdaq OMX, and each exchange clears its
trades through a clearing house which acts as CCP to all trades. 9 The key objective of
clearing is to protect each party to a trade from the failure of their counterparty. Often
this is managed by a clearing house, which interposes itself between the two parties,
acting as buyer to the seller and seller to the buyer, and manages the risks by collecting
collateral from the two parties as protection against price movements. A clearing house
may also net the obligatons of its members to reduce the number of settlements that have
to take place.10 The exchanges also offer clearing services to OTC participants and as
such these associated clearing houses act as CCPs for OTC trades as well.
B. How Carbon Credits are Traded:
 Issuance of EUAs:

The Central Administrator at EU Level issues all allowances by creating them on the EU total
quantity account in the Union registry. The Central Administrator is responsible for transferring
allowances for auctioning and free allocation to the appropriate accounts. Member States are
responsible for allocating the allowances free of charge. Surrendering allowances EUAs are valid
for surrendering in any year throughout the trading period.

Allowances allocated for free in a given year are issued to ETS operators by 28 February of that
year.11 By 30 April of each year, ETS operators are required to surrender in the Union registry a
quantity of EUAs equal to the volume of their verified GHG emissions of the previous year. 12
There is a penalty of €100 per tCO2, increasing with EU inflation from 2013, in case of failure to
surrender allowances in time. This penalty does not, however, take away the obligation to
surrender the required amount of allowances.

9
European Union., Interplay between EU ETS Registry and Post Trade Infrastructure (2015), EUROPEAN UNION,
https://ec.europa.eu/clima/sites/clima/files/ets/oversight/docs/interplay_report_en.pdf . (hereinafter “EU Report
2015”)
10
Peter Cox, Supra note 8, p.17.
11
European Union, Technical Aspects of EU Emission Allowances Auctions Consultation Paper (2013),
https://ec.europa.eu/clima/sites/clima/files/docs/0002/cons_paper_en.pdf (page 8).
12
European Commission, EU ETS Handbook, p.80-81, (2015), https://ec.europa.eu/clima/s ites/clima
/files/docs/ets_handbook_en.pdf. (hereinafter “Handbook”).

5
  Voluntary Offsets:
Participants can also choose to voluntarily ‘cancel’ allowances, or in other words have them
permanently withdrawn from circulation and deleted from the Union registry, without using
them for compliance. This is done primarily as a ‘voluntary offset’ measure or for environmental
reasons, namely that deleting allowances will increase the amount of abatement activity that
takes place within the scheme. This is based on the reasoning that if the number of allowances in
the ETS decreases then the price of the remaining allowances rises, which in turn creates a
greater incentive for internal abatement measures. A specific deletion account exists within the
Union registry for this purpose.13
 Secondary Market Trading in E.U. Carbon Market:

Anyone with an account in the EU registry can engage in the trading of EUAs. In practice,
trading is mostly done by energy and industry companies with obligations under the ETS, as well
as by financial intermediaries. Trading can be done either:

o Via auctions,
o Through organised exchanges, or
o Directly between buyers and sellers, commonly referred to as Over-the-Counter (“OTC”). 14
 Auctioning: By auctioning, EUA units are distributed to the highest bidder. During
Phase I and II of ETS, Member States were allowed to auction off allowances. Only few
Member States chose to do this, and only auctioned off a limited amount. 15 In 2013 the
goals were to have auctioneering covering 20 per cent of allowances, and 57 per cent by
the end of Phase III (2013-2020).16 The final goal is to reach 100 per cent allocation by
2027.

 Generally, most of the EU countries auction their allowances from common platform. As
per the European Commission website, Twenty-eight countries (25 EU Member States
and 3 EEA/EFTA countries) auction their allowances on the common auction platform.

13
Handbook, Id, p.68.
14
Handbook, Id, p.69-70
15
Martin Chemnitz Mortensen, Emission Allowance Trading Following the Adoption of MiFID II (2014), AALBOG
UNIVERITY, https://projekter.aau.dk/projekter/files/206648680/Speciale_endelig_version_.pdf.
16
European Commission, Free Allocation, EC, (May 1, 2021), https://ec.europa
.eu/clima/policies/ets/allowances_en#tab-0-0.

6
 To this end, they have signed a joint procurement agreement. Currently, the European
Energy Exchange (“EEX”) in Leipzig is the common auction platform. 17

 Through organized exchanges: An exchange is an electronic platform that matches

buyers and sellers. These exchanges operate nationally as well as internationally, but are
set apart from intergovernmental and governmental authorities, and operate on the free
market. Some of the famous exchanges offering allowance transfer services are ICE
(InterContinental Exchange), EEX (European Energy Exchange) and NasdaqOMX
Commodities.18
 Over-the-Counter (“OTC”): means a method of trading that does not involve an
exchange. In over-the-counter markets, participants trade directly with each other,
typically through telephone or computer links. In addition to trading at an exchange or
OTC via a broker, bilateral trades directly between two parties who are known to each
other are also possible. In the beginning of the ETS, the majority of trading took place via
brokers in the OTC markets as most of the products were not liquid or standardised
enough to be traded on exchanges. However, derivative contracts have become more
standardised over time, reducing the need for customised deals executed through
brokers.19Thus, exchanges are becoming preferable trading venue.

Regulatory Framework of Carbon Trading:

1. EU Registry: The EU Registry is centralized electronic accounting system that ensures

the accurate accounting of EU allowances issued under the EU ETS and international
credits.20In 2012, EU formed a single registry which has replaced all pre-existing
registries formed by the member states. A participant trading in EUA either through
auction, or exchange, or OTC requires having an account with the EU ETS Registry
before being allowed to trade. Whenever, trades have been confirmed, either OTC or

17
European Commission, Auctioning, EC, (May 1, 2021), https://ec.europa
.eu/clima/policies/ets/allowances_en#tab-0-0.
18
Peter Cox, Supra note 8, p.16-17.
19
Report to Parliamentary Committee- EU, Towards an enhanced market oversight framework for the EU
Emissions Trading Scheme (2010), https://ec.europa.eu/clima/sites/clima/files/docs/0034/com_2010_yyy_en.pdf.
20
European commission, Union Registry, EC, (May 1, 2021), https://ec.europa.eu/clima/policies/ets/registry_en

7
 through exchanges, instructions are sent to the Union registry for the physical transfer to
take place (also called delivery).21
2. Pricing Mechanism: The idea behind EUAs was to find market-discovered price to
achieve the most efficient ways of reducing emissions. Under this system trading reveals
the carbon price to meet the desired target. The flexibility that trading brings means that
all firms face the same carbon price and ensures that emissions are cut where it costs least
to do so.22 This trading based system brings flexibility that ensures emissions are cut
where it costs least to do so. A robust carbon price also promotes investment in clean,
low-carbon technologies.23
 The exchanges dealing in EUAs handle both spot and derivative contracts. The majority
of trade is now in derivatives contracts. This is similar to the situation in most energy
markets (to which the carbon emissions market is closely associated) in which the futures
markets are the principal price setting mechanisms and spot trade tends to be done at
prices benchmarked to the futures price.24
Laws governing carbon trading:

Earlier, only derivative contracts of emission allowances were under the scope of the EU
Markets in Financial Instruments Directive (“MiFID”).25 However, as per the revised framework
under Markets in Financial Instruments Directive II, all types of trade in emission allowances are
classified as financial instruments. This implies that trades in EUAs are regulated and subject to
same regulations to which other financial instruments are subject to.

3. ECONOMICS OF CARBON TRADING:

This section will discuss economic and financial principles which favour carbon trading over
taxing carbon emission. Economics generally provides a behavioral theory to predict how people
respond to laws.26 Economics looks legal decisions or policies as an incentive or a sanction

21
Handbook, Supra note 12, p.69.
22
Handbook, Supra note 12, p.5.
23
European Commission, EU Emission Trading System (ETS), (May 1, 2021),
https://ec.europa.eu/clima/policies/ets_en#:~:text=It%20currently%20covers%20over%2010%2C000,its%20total%2
0greenhouse%20gas%20emissions.
24
Peter Cox, Supra note 8, p.21-22.
25
European Commission, Ensuring Integrity of European Carbon Market, (May 1, 2021),
https://ec.europa.eu/clima/policies/ets/oversight_en
26
RICHARD POSNER, ECONOMIC ANALYSIS OF LAW (7th ed., 2007).

8
against human behavior. These economic theories help to understand how particular law will
affect human behavior.27

Economics looks law as a tool for efficient allocation of resources. 28 An efficient allocation is
one in which cost involved is less than the gain from the allocation. Economic analysis of law is
handy tool for analyzing how law will affect businesses. As business are motivated with profit
making. Efficiency and profitability are so closely related that policy makers can use the
efficiency principles to influence business behavior.29

For example: “A” emits smoke that dirties the wash hanging at “B’s” Laundry. A can completely
stop the pollution by installing scrubbers on its stacks, and B can completely exclude the smoke
by installing filters on its ventilation system. Installing filters is cheaper than installing scrubbers.
If B start legal proceeding then court will issue an injunction order against A. This will cause
serious harm to the business.

The law and economic approach which aims to ensure efficient allocation of resources argues
that resources should be allocated in such a fashion which cause minimum social cost. In above
example this can be done if B install filter on its ventilation. However, B as a rational person will
not bear cost of installation rather will go for injunction against A. This will cause lot of harm to
the business. The most efficient scenario in this case will be “B install filter and A compensation
cost”. This will ensure behavior change minimum social cost.

A. Why Emission Trading Is Better Economic Option Than Green Tax:

Emissions trading, also known as ‘cap and trade’, is a cost-effective way of reducing greenhouse
gas emissions.30 To incentivize firms to reduce their emissions, a government sets a cap on the
maximum level of emissions and creates permits, or allowances, for each unit of emissions
allowed under the cap. Emitting firms must obtain and surrender a permit for each unit of their

27
Richard A Posner, The Decline of Law as an Autonomous Discipline, 1962–1987, 100 HARV. L. REV. 761
(1987).
28
Ronald H. Coase, The Problem of Social Cost, 3 J. L. & ECON. 1 (1960).
29
ROBER COTTER, LAW & ECONOMICS 9, (6th ed, 2012).
30
Patrick Bayner, The European Union Emissions Trading System Reduced CO2 Emissions Despite Low Prices,
PNSA, (May 3, 2021), https://www.pnas.org/content/117/16/8804.

9
emissions. They can obtain permits from the government or through trading with other firms.
The government may choose to give the permits away for free or to auction them.

Firms that expect not to have enough permits must either cut back on their emissions or buy
permits from another firm.31 For a given permit price, some firms will find it easier, or cheaper,
to reduce emissions than others and will sell permits. If there are too many such firms in the
market, the price of permits, the total number of which is set in advance by the cap, will decline,
inducing some firms to reduce their emissions reduction efforts. 32 Only when the price of permits
is just right will the number of permits offered for sale by firms that can reduce emissions at low
cost be equal to the number of permits demanded by firms for which emissions reductions are
costly.33 This process of trading ensures there is a unique price for all firms coordinating their
activities and drives down emissions to the level allowed under the cap cost-effectively.

There is no reason to expect that a permit price that clears the market at a point in time will
continue to do so in the future. As economic conditions and emitting firms’ circumstances
change, permit prices will fluctuate, becoming more expensive when demand is high relative to
supply (for example when the economy is growing robustly) and cheaper when demand is lower
(for example when ample renewable electricity reduces the requirement for thermal generation
firms). This approach is quite opposed to the carbon tax mechanism.

In carbon tax mechanism there is no incentive for firms to innovate new technique or show
market coordination. When carbon tax (usually in form of cess) is levied burden of tax is
transferred to the customer. However, there is no mechanism which ensures that firms producing
new technology are not unduly tax rather than can get incentivized for its actions. Further, as this
approach is market based, it is more flexible as firm can decide what suits better for their
business. They can select either from innovating new technology or paying more prices to buy
additional carbon permits from market.

For example: “A” & “B” are two heavy polluting industries in a Country “C”. Government of C,
has decided to allocate 500 allowances which allows to emit 5000 ton CO2 in atmosphere to both
31
Handbook, Supra note 12, p.5.
32
Handbook, Supra note 12, p.5.
33
Peter Cox, Supra note 8, p.10.

10
industries. In end of the year, A and B must ensure they have sufficient number of permits
matching their carbon emission otherwise they will be penalized. A innovates new technology so
that it can reduce carbon emission. As a result it required only 300 allowances in the year.
Whereas, B opted to burn more fossil and at the end of the year it ended using 200 more
allowances than what was allotted to it. To meet regulatory requirement under this system, B will
buy 200 allowances from A by paying more money. Thus, A will receive incentive for
innovation where as B will end up paying more money.

B. Visible Benefit of Carbon Trading:

The European Union Emissions Trading System, or EU ETS, is currently the world’s largest
system. It operates in all 28 EU countries plus Iceland, Liechtenstein and Norway, limiting
emissions from more than 11,000 heavy users of energy including power stations and industrial
plants, and airlines operating between the ETS member countries. In total, it covers
around 45% of the EU’s greenhouse gas emissions.

The World Bank’s State and Trends of Carbon Pricing (May 2018)34 reports that there are 51
implemented or scheduled carbon pricing initiatives worldwide. These include ETSs in
Switzerland, South Korea, and New Zealand and several US states and Canadian provinces, as
well as national-level carbon taxes.

China officially launched a major national emissions trading scheme in December 2017 after
piloting seven schemes at local government level. It plans to introduce the national scheme first
to the energy sector, with full implementation by 2020, to become the largest ETS in the world.

As per the official publication of the EU current ETS regime cover around 40% of total emission
of the union. As per the Koyoto protocol the union has committed to reduce 55% of its green
house emission by 2030. Therefore, it is expected that it will penetrate ETS further as a policy

34
State Trends of Carbon Prices, (MAY 2, 2021), WORLD BANK, https://open knowledge.
worldbank.org/handle/10986/29687.

11
measure.35 As per the impact assessment report presented in the European Commission, the ETS
scheme has helped to reduce carbon emission by 35% between years 2005 to 2019. This is a
significant development as ETS not only have turned out to be an effective emission but also an
economically viable way to reduce CO2.36

The reasons for showing trust in ETS regime and its success in past are usually as follow:

 ETS sets market price for carbon emission: By creating a market for GHG emissions,
an ETS puts a clear price on carbon. It means that the costs caused by the emissions–
such as the impact on public health, costs linked to extreme weather or the extinction of
certain animals and plants – are made visible and integrated into the price of goods and
services.37 This is because of the fact that a firm emitting large amount of GHG would be
required to buy more allowances. The cost of these allowances will be reflected in its
product price.
 ETS puts limit on emission: In an ETS, the government sets a clear emissions target,
capping the maximum amount of emissions that are allowed in selected sectors of the
economy. This ensures that the desired environmental outcome will be reached. 38 Over
the period of time government can gradually reduce number of emission allowances
issued to industries. This implies industries are required to gradually reduced emission
otherwise they will be penalised.
 ETS provides flexibility to industries: An ETS provides great flexibility for individual
companies to decide how to best meet their obligations. Companies can reduce their own
emissions and/or buy surplus permits from other companies. 39 Governments often allow
companies to bank permits to be used at a later date. In many systems, they may also use
domestic or international offset credits from emissions reduction projects in sectors not

35
European Commission, EU Emission Trading System (ETS), (May 1, 2021),
https://ec.europa.eu/clima/policies/ets_en#:~:text=It%20currently%20covers%20over%2010%2C000,its%20total%2
0greenhouse%20gas%20emissions.
36
European Commission, A European green Deal, (May 3, 2021), https://ec.europa.eu/info/strategy/priorities-2019-
2024/european-green-deal_en.
37
7 Arguments for Emission Trading, INTERNATIONAL CARBON ACTION PARTNERSHIP, (May 3, 2021)
http://www.mexico2.com.mx/uploadsmexico/file/ICAP_ETS_Brief_2.pdf.
38
Benefits of Emission Trading Scheme, IETA, (May 3, 2021),
https://www.ieta.org/resources/Resources/101s/Benefits%20of%20Emissions%20Trading.pdf.
39
Alexander Eden & Charlotte, Unger Benefits of Emissions Trading (2018), ICAP
https://icapcarbonaction.com/en/?option=com_attach&task=download&id=575

12
 covered by the ETS. These individual choices mean that the costs of staying under the
ETS cap are minimized, not only for the companies, but for society as a whole.

Despite of the following benefits the ETS have its own pitfall. The first and the most serious
drawback of the scheme is difficulty in setting price and number of permits to be allotted. It can
become complicated deciding how many permits to allow. For example when the EU introduced
a system of carbon trading, in the initial period of 2005-07 the price of carbon permits were
driven down to zero because the EU misjudged the number of permits. 40 However, it is believe
that over the period of the time market will start working on its own and optimal number of the
allowances and price for emission can be determined.

Secondly, the ETS allowances when traded in secondary market may lead to speculations and
price manipulation. This leads to windfall trading in ETS allowances which hardly serves any
purpose in emission reduction. It is observed in EU, that ETS has created winners (companies
with surplus allowances) and losers (electricity consumers, both industrial and residential). 41
Windfall profits in essence represent a transfer of income with a few emissions-intensive
producers making profits at the expense of consumers. Due to market manipulating practices
many developing countries prefer to go for simple carbon tax regime instead of complicated ETS
system.

4. EMISSION TRADING IN INDIA:

India is the second largest source of green house gas emission. The country is trying to develop
ETS since 2012.42 However, till today there is not a developed emission trading market or central
or state sponsored trading scheme in India. The Indian framework of emission trading can be
analysed in two parts: First, pilot emission trading program in Surat, 2019 and Second, trading in
carbon future contract.

40
European Commission, EU Emission Trading System (ETS), (May 1, 2021),
https://ec.europa.eu/clima/policies/ets_en#:~:text=It%20currently%20covers%20over%2010%2C000,its%20total%2
0greenhouse%20gas%20emissions.
41
Tim Liang, Assessing the effectiveness of the EU Emissions Trading System (2013), THE CENTRE FOR CLIMATE
CHANGE ECONOMICS AND POLICY (CCCEP), https://www.lse.ac.uk/GranthamInstitute/wp-
content/uploads/2014/02/WP106-effectiveness-eu-emissions-trading-system.pdf.
42
India: An emission trading case study (2015) , EDF, (May 3, 2021), https://www.edf.org/sites/default/files/india-
case-study-may2015.pdf

13
 A. Pilot Emission Trading Program in Surat, 2019
The Environmental Protection Act of 1986 and accompanying rules empower the Ministry of
Environment and Forest (hereinafter “MOEF’) to limit adverse effects of industrial activity. In
addition, the State Pollution Control Boards (hereinafter “SPCBs”) have the power to implement
emissions trading systems within their jurisdictions. The Gujarat Pollution Control Board
(hereinafter “GPCB”) launched India’s first ETS—and, the world’s first cap and-trade market in
particulate pollution—on July 15, 2019, in the form of a large-scale pilot programme in Surat,
Gujarat.43

The Surat ETS began with two months of mock-trading to allow for intensive stakeholder
capacity building before coming into full force on September 15, 2019. The trading in ETS
allowances is done with the design of a sophisticated trading platform in partnership with the
National Commodities and Derivatives Exchange (NCDeX). 44 The GPCB has partnered with
researchers from top academic institutions across the world to develop ETS rules and evaluate
the benefits and costs.

An initial report on performance of ETS in Surat has made following observations 45:

 ETS has helped in reduce particulate emissions by 29 percent from current levels.
 ETS has lowered the costs of reducing particulate emissions.
 There is an increase average industry profit, relative to status quo regulations.

However, the pilot project has also indicated some of the major loopholes of the ETS regime. As
per the project high monitoring cost is required to ensure success of ETS. It is necessary to
ensure proper count of carbons emitted by the industry while undertaking pollution activities.
Otherwise, there will be no sanctity associated with the cap and trade system. If industries will be
allowed to manipulate their carbon count then there would not be any incentive for them in
buying allowances or brining innovation.

43
Siddharth Goel, Gujarat’s Emission Trading Scheme is India’s First Real Battle in War Against Air Pollution,
Wire, (May 10, 2021), https://thewire.in/environment/gujarat-air-pollution-emission-trading-cap-trade.
44
Michael Greenstone, The Surat Emissions Trading Scheme 2019, EPIC India, https://epic.uchicago.in/wp-
content/uploads/2019/10/ETS_INDIA_ResearchSummaryFinal-.pdf.
45
Id.

14
 B. Trading In Carbon Future Contract:
Though in India does not have its own ETS for domestic industries still Indian industries are
playing important role in carbon trading. In India carbon trading is done as future derivative
contracts through recognized exchange, i.e. the National Commodities and Derivatives Exchange
(NCDeX).

Many Indian industries have registered themselves with the UNFCCC’s Clean Development
Mechanism (CDM). As per the scheme certifies Indian industries can sell their carbon print to
developed countries (known as CER “carbon emission receipts”) which have their carbon
market.46For example: Indian company if reduces its carbon emission by say 500 unit then it can
sell this reduced emission to a industry in developed country which is required to meet its green
investment obligation under UNFCCC framework or under EU ETS.

Till 2012, there were 1,200 registered projects under UNFCCC. India has contributed about 13
% of the total issued CERs from over 450 projects that have seen issuances. Th e registered
projects represent an investment of over INR 1.6 trillion and have generated over 170 million
Certified Emission Reductions (CERs) that can be used by developed countries to meet their
compliance requirements under the Kyoto commitments. As per the report in 2012, carbon
trading market in India was about 22, 000 Crores to 44, 000 Crores.

However, after 2012 developed countries have stopped their trading in carbon emission with
developing countries. This is because of failure of Koyoto protocol. Now, developed countries
are no longer mandated to ensure reduction in their carbon emission as they were in earlier
regime. Thus, there is no incentive for developed countries in borrowing carbons from
developing countries like India.

C. Recommendation for Developing ETS Regime in India:

By looking at achievements of ETS system around the world it is recommended that India should
also develop its internal ETS system. Environment and global warming concerns are real and it’s
a high time to mitigate probable future harms. The major benefit of developing ETS system for
developing country like India, with huge population and carbon emission, would be market

46
Carbon Market Roadmap for India 2020, Ministry of Environment and Forest, (May 3, 2021),
https://ncdmaindia.gov.in/ViewPDF.aspx?&pub=2.pdf.

15
driven cost assessment of pollution. The ETS system will allow heavy industries to either opt for
innovation and reduce carbon emission or pay market based prices for extra allowance. To
effectively implementation this system India need to develop following infrastructures:

 Appointment of central depository: The ETS system is managed and controlled by a

central depository. The central depository is en-charged for insuring allowances to heavy
industries and monitoring carbon emission by such industries. As done in the pilot project
Ministry of Forest and Environment can be considered to appoint as nodal agency in this
regards.
 Declaring allowances as securities: The allowances issued by the central depository
must be declared as security. This will ensure robust secondary market for such
allowances. An efficient secondary market is essential for effective working of ETS
system. As success of ETS is dependent on industries buying and selling allowances
without any hindrances.
 Selecting adequate industries and sector under the scheme: The success of carbon
market, just like any other market, is dependent on volume of trading. India must
implement a national level carbon trading programme which covers all heavy polluting
industries. This will ensure robust trading in secondary market which will help in price
discovery.
 Monitoring: To ensure success in carbon trading market it is necessary to ensure high
standard of practise are being followed by industries as well as by players in secondary
market. This means both the Ministry of Forest and Environment and SEBI have to
continuously monitor carbon emission as well as dealing in secondary markets
respectively.

5. CONCLUSION:
This paper has analysed Emission Trading Scheme (“ETS”) and highlighted how finance can be
used to protect environment. The ETS is a popular tool used in the Europe to control green house
emission. The system works on “cap” and “trade” model which allow market to determine price
for carbon emission. This paper has studied economic analysis of ETS and concluded that it is

16
better option than green tax as it allows firms to decide between introducing innovations or buy
allowances at market driven price.

Over the years many countries have shown inclination to adopt ETS as matter of national policy.
However, hardly serious steps have been taken by any government across the globe mainly due
to inadequate commitment towards environment. The Indian government has recently introduced
pilot ETS project in Surat. Interim reports from the project seem positive. This paper have
suggested to implement a national level ETS programme by introducing sufficient infrastructures
such as traders, registry etc. If the programme can be introduced in full spirit it can probably
become a good example of how financial innovation can help in combating environment
problems.

6. REFERENCES:

BOOKS:
 European Commission, EU ETS Handbook, p.80-81, (2015), https://ec.europa.eu/clima/s
ites/clima /files/docs/ets_handbook_en.pdf.
 RICHARD POSNER, ECONOMIC ANALYSIS OF LAW (7th ed., 2007).
 ROBER COTTER, LAW & ECONOMICS 9, (6th ed, 2012).

REPORTS:
 Carbon Market Roadmap for India 2020, Ministry of Environment and Forest, (May 3,
2021), https://ncdmaindia.gov.in/ViewPDF.aspx?&pub=2.pdf.
 Peter Cox, The Post-Trade Infrastructure For Carbon Emissions Trading p.11, THE CITY
OF LONDON CORPORATION REPORT (2010),
https://www.longfinance.net/media/documents/carbontrading_colc2.pdf.

 Report to Parliamentary Committee- EU, Towards an enhanced market oversight

framework for the EU Emissions Trading Scheme (2010),
https://ec.europa.eu/clima/sites/clima/files/docs/0034/com_2010_yyy_en.pdf.

17
 ARTICLES:
 7 Arguments for Emission Trading, INTERNATIONAL CARBON ACTION PARTNERSHIP,
(May 3, 2021) http://www.mexico2.com.mx/uploadsmexico/file/ICAP_ETS_Brief_2.pdf.
 Alexander Eden & Charlotte, Unger Benefits of Emissions Trading (2018), ICAP
https://icapcarbonaction.com/en/?option=com_attach&task=download&id=575
 Benefits of Emission Trading Scheme, IETA, (May 3, 2021),
https://www.ieta.org/resources/Resources/101s/Benefits%20of%20Emissions%20Tradin
g.pdf.
 Betz, R. A., & Schmidt, T. S., Transfer patterns in phase I of the EU Emissions Trading
System: A first reality check based on cluster analysis, 16(4) Climate Policy 474–495
(2016).

 European Commission, A European green Deal, (May 3, 2021),

https://ec.europa.eu/info/strategy/priorities-2019-2024/european-green-deal_en.
 European Commission, Auctioning, EC, (May 1, 2021), https://ec.europa
.eu/clima/policies/ets/allowances_en#tab-0-0.
 European Commission, Ensuring Integrity of European Carbon Market, (May 1, 2021),
https://ec.europa.eu/clima/policies/ets/oversight_en
 European Commission, EU Emission Trading System (ETS), (May 1, 2021),
https://ec.europa.eu/clima/policies/ets_en#:~:text=It%20currently%20covers%20over%2
010%2C000,its%20total%20greenhouse%20gas%20emissions.
 European Commission, EU Emission Trading System (ETS), (May 1, 2021),
https://ec.europa.eu/clima/policies/ets_en#:~:text=It%20currently%20covers%20over%2
010%2C000,its%20total%20greenhouse%20gas%20emissions.
 European Commission, EU Emission Trading System (ETS), (May 1, 2021),
https://ec.europa.eu/clima/policies/ets_en#:~:text=It%20currently%20covers%20over%2
010%2C000,its%20total%20greenhouse%20gas%20emissions.
 European Commission, Free Allocation, EC, (May 1, 2021), https://ec.europa
.eu/clima/policies/ets/allowances_en#tab-0-0.
 European commission, Union Registry, EC, (May 1, 2021),
https://ec.europa.eu/clima/policies/ets/registry_en

18
 European Commission. EU Emission Trading System (ET ETS), (May 1, 2021),
https://ec.europa.eu /clima/policies
/ets_en#:~:text=It%20currently%20covers%20over%2010%2C000,its%20total%20green
house%20gas%20emission
 European Union, Technical Aspects of EU Emission Allowances Auctions Consultation
Paper (2013), https://ec.europa.eu/clima/sites/clima/files/docs/0002/cons_paper_en.pdf
(page 8).
 European Union., Interplay between EU ETS Registry and Post Trade Infrastructure
(2015), EUROPEAN UNION,
https://ec.europa.eu/clima/sites/clima/files/ets/oversight/docs/interplay_report_en.pdf
 India: An emission trading case study (2015) , EDF, (May 3, 2021),
https://www.edf.org/sites/default/files/india-case-study-may2015.pdf
 Interplay between EU ETS Registry and Post Trade Infrastructure (2015), EUROPEAN
UNION,
https://ec.europa.eu/clima/sites/clima/files/ets/oversight/docs/interplay_report_en.pdf .
 Martin Chemnitz Mortensen, Emission Allowance Trading Following the Adoption of
MiFID II (2014), AALBOG UNIVERITY,
https://projekter.aau.dk/projekter/files/206648680/Speciale_endelig_version_.pdf.
 Michael Greenstone, The Surat Emissions Trading Scheme 2019, EPIC India,
https://epic.uchicago.in/wpcontent/uploads/2019/10/ETS_INDIA_ResearchSummaryFina
l-.pdf.
 Patrick Bayner, The European Union Emissions Trading System Reduced
CO2 Emissions Despite Low Prices, PNSA, (May 3, 2021),
https://www.pnas.org/content/117/16/8804.
 Richard A Posner, The Decline of Law as an Autonomous Discipline, 1962–1987, 100
HARV. L. REV. 761 (1987).
 Ronald H. Coase, The Problem of Social Cost, 3 J. L. & ECON. 1 (1960).
 Siddharth Goel, Gujarat’s Emission Trading Scheme is India’s First Real Battle in War
Against Air Pollution, Wire, (May 10, 2021), https://thewire.in/environment/gujarat-air-
pollution-emission-trading-cap-trade.

19
 State Trends of Carbon Prices, (MAY 2, 2021), WORLD BANK, https://open knowledge.
worldbank.org/handle/10986/29687.
 Tejvan Pettinger, Carbon Trading Scheme, (May 1, 2021) https://www. economicshelp.
org/blog/2204/economics/carbon-trading-schemes/#:~:text=Benefits%20of%20
Carbon%20 Trading, may% 20 decide%20to%20buy%20more.
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CENTRE FOR CLIMATE CHANGE ECONOMICS AND POLICY (CCCEP),
https://www.lse.ac.uk/GranthamInstitute/wp-content/uploads/2014/02/WP106-
effectiveness-eu-emissions-trading-system.pdf.
 Yue jun Zang & Yi-Ming Wai, An Overview of Current Research on ETS, 87 (6) Applied
Science 1804 (2013).

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