The quest for coherent climate governance and the importance of linking emissions trading schemes

Abstract

A diverse range of regulatory schemes in climate policy has produced a fragmented and crowded governance landscape. Devising pathways towards converging all of the different climate governance approaches would be a Herculean task, but it is argued here that this should not inhibit efforts to scale up regulatory initiatives in specific areas of climate governance. In this respect, it is argued that linking emissions trading schemes (ETSs) would significantly contribute to the development of creating more durable and connected climate governance arrangements. At present, the global expansion of ETSs raises risks of potential regulatory divergence, conflict, and the emergence of a disconnected patchwork of schemes. However, the expansion of trading schemes has also brought an increased interest in the feasibility of linkage between ETSs. This opinion argues that, in the absence of a comprehensive multilateral regime governing emissions trading, policymakers and scholars must instead refocus on the challenges of creating a coherent climate governance architecture from the bottom-up. It further suggests that the development and implementation of durable linkages between ETSs are critical building blocks in this quest.

The climate governance arena

The way in which the climate is being governed at the international level has evolved to date in a highly decentralised and fragmented fashion. Within this unsettled governance landscape, emissions trading schemes (ETSs) have emerged as stable, but nevertheless contested, components. Even though the EU's Emissions Trading Scheme (EU ETS) was launched in 2005, it has only been in recent years that ETSs have proliferated globally and that opportunities have opened to link the EU ETS with other trading schemes. The drivers influencing adoption of an ETS are multifaceted and reflect distinctly local conditions, ¹ whilst the ethics of emissions trading remains a matter of intense debate. ² Indeed, when first adopted as the EU's flagship climate policy, it was widely acknowledged that the EU ETS represented a ‘major novelty’ in the EU's approach to environmental regulation. ³ However, in the years since it came into fruition the EU ETS has assisted with making the regulation of carbon in the EU normal practice. Due to the successful implementation and operation of the EU ETS, it has also influenced the development of other ETSs beyond the EU. ⁴

Given the above developments and the urgency expressed by scientists regarding the need to mitigate climate change, ⁵ this opinion argues that greater focus is now needed on how to connect and strengthen existing and emerging climate governance arrangements, specifically in the context of ETSs, rather than reimagining an idealised vision of climate governance. In this context, the presence of ETSs – and their centrality to any climate governance landscape rooted in reality – must be acknowledged as an important political fact. ⁶ For example, it is extraordinarily unlikely that the EU's consistent (and persistent) commitment to emissions trading (although not a perfect system) will diminish in the coming years, particularly since the EU ETS is now also ‘a political prestige project for the EU’. ⁷ Consequently, whilst the contribution of market-based instruments to climate governance continues to attract criticism and caution, it would be counter-productive, as Dirix et al have argued, ‘to plead for a climate policy tabula rasa [as] [i]t is highly doubtful that any proposed alternative [to emissions trading] could be put into place…’. ⁸ This thinking rings true even more so now, than ever before. In the particular context of EU climate policy, it is clear that there is no obvious alternative to emissions trading that could quickly be ‘adopted and function as a common EU policy’. ⁹ There is instead, given that the multilateral treaty-making approach to forging global climate governance continues to progress at a glacial pace, an urgent need for increased scholarly and policymaking emphases on the less grand but more functional tasks of fostering complementarity in the context of ETSs across the existing and emerging array of disparate climate governance initiatives.

The challenge of building durable and rigorous climate governance frameworks from the bottom-up requires detailed analyses and practical policy recommendations as to how best to effectively connect governance arrangements in a fragmented and ever-more crowded global climate stage. There is a remarkable diversity of regulatory experimentation unfolding in climate policy and ETSs represent only one dimension – albeit an increasingly critical one – in this complex governance jigsaw. Climate governance is the province of every level of government and extends to encompass diverse initiatives of actors operating in the private arena. This has produced a multi-level governance landscape characterised by interactions between traditional territorial government actors and non-state actors. Devising pathways towards convergence of all climate governance approaches would be a Herculean undertaking, but this should not inhibit focused research and policymaking to advance complementarity in specific identifiable spheres of climate governance such as in the context of ETSs. As such, this opinion suggests the need to link together various ETSs with one another and also, within the distinct sphere of emissions trading, to climate governance.

The proliferation of emissions trading schemes and the merits of linking them

For EU policymakers, positioning the EU ETS at the heart of an international emissions trading framework has always been a guiding principle in the EU's approach to championing emissions trading. ¹⁰ Until recently, as Wettestad and Jevnaker have observed, ‘the development of emissions trading globally has progressed slowly [and] there have simply not been that many candidates for the EU to approach for linking purposes’. ¹¹ However, the launch of China's national scheme in 2021, ¹² further to South Korea's successful implementation of a national ETS in 2015, ¹³ confirms that emissions trading has emerged as the climate policy of choice for many jurisdictions. Indeed, over half of the parties to the Paris Agreement ¹⁴ have indicated their intention to use or consider the use of carbon-pricing instruments. ¹⁵ There are 25 operational ETSs today with a further 22 ETSs currently under development or under consideration across a range of regional, national, and sub-national levels. ¹⁶ Indeed, almost one third of the world's population lives in jurisdictions with an active ETS which together represents 55% of global GDP. ¹⁷

Despite the global expansion of ETSs, it is important to acknowledge that the centrality of emissions trading to climate governance need not imply the normative superiority of this regulatory approach. Instead, it is possible to advance the much more modest yet important claim that policy experiences across many jurisdictions now confirms the meaningful and effective contribution of emissions trading to forging effective climate governance arrangements. Yet scaling-up this regulatory approach to form a global interconnected system of ETSs will present many challenges: indeed, it is likely that such convergence will be incremental and reliant on multi-speed pathways. However, whilst the advancement of linkage between trading schemes is a central element of the EU's vision for the EU ETS, it is reasonable to consider why, beyond this strong policy preference, linkage should otherwise matter. It is suggested that there are (at least) four core considerations to explain why focused engagement with linkage is necessary and overdue.

First, although linkage is a mechanism to promote and maintain complementarity between ETSs, it is important to recognise that innovative carbon pricing mechanisms beyond ETSs, such as carbon taxes, are now common and often operate as flanking measures to emissions trading. ¹⁸ This multiplicity of different regulations, even within the context of economic incentive approaches, has given rise to a ‘major concern’ of growing urgency: whether this proliferation of different regulations will ultimately produce an effective global climate governance framework. ¹⁹ Linking ETSs therefore engages with a discrete but core aspect of this ‘major concern’: the quest to promote and maintain complementarity between the EU ETS and other ETSs, in order to strengthen the global climate governance architecture.

Second, it may be asked why is complementarity between ETSs important? As Young has observed, the achievement of successful environmental outcomes is a function not only of the allocation of tasks to institutions operating at different levels of social organisation, but also of the interactions between such governance arrangements and whether these interactions are characterised by complementarity rather than conflict. ²⁰ In the context of emissions trading, the importance of promoting and preserving complementarity between schemes is a significant consideration given that ‘[i]nstead of looking to join a global cap and trade system, policymakers now often talk about creating an international system from the bottom up by linking markets organised in different political jurisdictions’. ²¹ At present the absence of a global framework means that governing emissions trading has raised the spectre of ‘a patchwork of carbon markets, where each jurisdiction sets its own rules and where linkage between carbon markets is highly doubtful’, however that does not mean attempts should not be made to achieve what is diametrically opposite to this position. ²² Indeed whilst such a prospect is not inevitable, the existing situation of the emergence of a disconnected patchwork of schemes with varying degrees of environmental ambition reinforces the relevance of further research concerning the modalities of linkage. It is not unrealistic to expect that the presence or absence of strong complementarity between schemes will materially influence the direction of emissions trading governance in the coming years by tilting the emerging governance landscape towards either an incrementally harmonising architecture or a more uncertain vista characterised by detached, atomised, and potentially conflicting schemes.

Third, economic theory strongly suggests that linking ETSs together could offer multiple benefits including: (i) increased efficiency, as a larger interconnected network of schemes could unlock more abatement options; and, (ii) increased liquidity, since there are more buyers and sellers which should reduce transaction costs. ²³ Moreover, the greater the prevalence of linkage between ETSs, the more reduced the risks of both carbon leakage and adverse distortions in international competitiveness. In fact, the economic rationale to implement a national (or regional) ETS logically extends to justifying linkage between schemes. The UK's Committee on Climate Change, a body statutorily tasked with providing independent and evidence-based advice to the British Government and Parliament, has endorsed the important contribution of linkage emphasising that ‘increased linking (rather than delinking) of international carbon trading schemes is desirable in promoting the least-cost international path to reducing global emissions’. ²⁴ Such economic factors are particularly significant given that the cost-effectiveness of climate governance initiatives is highly likely to prove critical to the ultimate success or failure of climate policy in many countries, especially in circumstances where public willingness to pay has been shown to be limited and the costs of mitigation are substantial. ²⁵ For example, the failure of the United States to ratify the Kyoto Protocol ²⁶ has been largely attributed to the twin interrelated concerns of ‘substantial compliance costs and domestic voters’ low willingness to pay.’ ²⁷

Fourth, the application and scope of linkage arrangements to governance initiatives beyond emissions trading is a particularly neglected consideration. Whilst the implementation of linkage between ETSs has been ‘understudied’, ²⁸ questions focused on linking climate governance initiatives beyond the orbit of emissions trading have barely surfaced in policymaking. Thus, there is an urgent need for sharper focus on how to nurture complementary interactions between economic instruments beyond market trading, such as carbon taxes. ²⁹ As policymakers consider how best to structure climate policies to eliminate or at least alleviate the potential for friction and conflict with other climate governance initiatives, it is reasonable to surmise that experiences of developing and implementing linkage(s) between ETSs could provide valuable lessons in the quest to establish coherent climate governance frameworks.

The way(s) forward

The classic definition of linkage denotes the recognition by the regulatory authority of one ETS of allowances (or emission reduction credits) generated by an external scheme for the purposes of compliance with the participating entity's domestic emissions reduction obligations. ³⁰ Variations of this definition, such as Gilbert's perspective, explicitly provide that schemes ‘need not be restricted to national trading schemes alone’. ³¹ A more expansive understanding of linkage has been advanced by Metcalfe and Weisbach to include ‘policies that allow regional or national carbon regimes to interact in such a way as to narrow or eliminate differences in the marginal cost of abatement between different regions or countries’. ³² The conceptualisation of linkage offered by Burtraw et al extends the definition of linkage to include the process of incremental alignment of design features across trading schemes or linkage by degrees. ³³ By conceptualising linkage in this way – as a spectrum incorporating a range of potential connections between ETSs with scope to incrementally deepen – governance frameworks can accommodate differently evolving pathways towards convergence. It would be prudent for such frameworks to facilitate ‘docking stations’ too, spaces in the infrastructure inviting new participants to ‘dock in’. ³⁴

The global growth in recent years of ETSs has been accompanied by increased interest in the feasibility of implementing linkages between schemes. ³⁵ However, in the absence of a comprehensive multilateral regime governing emissions trading, policymakers and scholars must instead focus on the challenges of creating an international carbon trading architecture from the bottom-up by linking ETSs. It has been suggested that ‘[u]nless there is a radical change of circumstances a “global deal” leading to the creation of a world-wide cap-and-trade system will remain a political utopia’. ³⁶ However, rather than waiting for evolution of the post-Paris Agreement architecture, various transnational, national, and sub-national entities have developed ETSs. A multilateral deal is not the only way, nor is it – in the present context – the most likely path to create a globally linked emissions trading framework.

The EU's experience with emissions trading has provided a ‘useful laboratory for considering the political, economic, and administrative challenges that would be faced by a global trading system’. ³⁷ However, creating the necessary building blocks to facilitate linkage of the EU ETS with other ETSs will require close coordination to ensure compatibility of critical design features. The potential for the emergence of diverging emissions trading design features is increasingly likely and particularly concerning. The development of a globally connected trading architecture is heavily reliant on making sure that certain fundamental design features are shared by all ETSs. Whilst this does not require that all trading schemes are identical, it does require that all of them aim to share a common approach to embedding critical design features into their frameworks, particularly since the integrity of any emerging global framework will only be as secure as its weakest link. ³⁸

Whilst bottom-up linkages between ETSs may be viewed as reflecting the feasible rather than the optimal, the significance of such linkages is readily apparent when acknowledged as elements of a building blocks approach to incrementally advancing effective and expandable governance frameworks. To date, linkage in practice has been minimal: the EU-Switzerland linkage ³⁹ and the California-Quebec ⁴⁰ linkage providing two successful such examples. The EU ETS, being both large and well-developed, is often viewed as playing the role of docking station with most other trading schemes as ‘takers’ of the design features of the EU. ⁴¹ Indeed, this proved to be the case with the integration of Norway with the EU ETS, ⁴² whilst the Swiss-EU relationship ⁴³ also reinforces the conclusion that smaller states are more likely to be willing to adapt their rules to facilitate linkage with the EU. However, the process of establishing linkage with other trading schemes beyond the EU's immediate geographic and economic orbit may well necessitate compromises on the part of the EU too, as has been indicated by analyses of the scope for potential linkage between the EU ETS and South Korea's ETS. ⁴⁴

Fundamentally, the implementation of linkage does not require that candidate partner schemes share identical design features but rather, as Roßnagel has observed, that ‘the systems should be similar enough for the objectives of one system not to be compromised by differences in the design of another system’. ⁴⁵ Linkage models have been advanced in the literature, such as frameworks to assess the compatibility of potential partner schemes based on a series of defined core convergence criteria. ⁴⁶ It has also been suggested that the EU ETS is becoming a model to which other schemes converge, but it is unlikely that organic alignment alone will provide the necessary level of compatibility. ⁴⁷ Instead, as Türk et al have observed, ‘it is crucial to start early with the establishment of frameworks and procedures to promote harmonisation of critical design measures’. ⁴⁸ In the continued absence of an agreed multilateral climate governance architecture, the promotion of ambitious and internationally coordinated climate policy is likely to rely on different frameworks developing at different times based on partial agreements and variable geometry. The sheer breath of experimentation characterising today's climate governance landscape presents problems of regime interaction which exist beyond the discrete context of governing emissions trading. Nonetheless, achieving progress towards a more rigorous climate governance architecture is imperative given the alarm expressed by climate scientists that the window to avert catastrophic climate change is closing. There is no single solution to avert climate change, nor is there a silver bullet to the governance challenges which it creates. In this sense, climate change is quite rightly acknowledged as a ‘wicked problem’ par excellence. ⁴⁹ However, it is argued here that the development and implementation of durable linkages between ETSs will prove to be critical building blocks in the quest to construct a more coherent climate governance architecture.