International lessons for designing India’s emissions trading scheme

Combating climate change has become one of the most pressing challenges of our time. As global temperatures rise and the impacts of climate change intensify, countries around the world are seeking strategies to reduce greenhouse gas emissions. One of the most powerful tools in this endeavour is the emissions trading scheme (ETS).

An ETS provides a market-driven approach to climate change. Governments set a cap on emissions for particular sectors and issue emission permits to companies in those sectors. These permits can be freely traded between companies, effectively setting a price on emissions and incentivising companies to lower their emissions. By reducing the cap over time an ETS plays a critical role in aligning national efforts with global climate goals, making it a cornerstone of modern climate policy.

Targets must drive meaningful emissions reductions while also allowing economic growth

As of 2024, comprehensive ETS regulations are in place in regions such as the EU, the UK, China, South Korea and, at the state level, in the US. With the Ministry of Power, Government of India (MOP), introducing its Carbon Credit Trading Scheme (CCTS) in June 2023, India is now poised to implement its own cap-and-trade scheme. There is now a valuable opportunity to learn from the experiences of these other global ETSs.

India’s trading cheme

Selecting the appropriate sectors for this ETS implementation is a critical first step. Energy-intensive industries and those with high greenhouse gas emissions present the greatest reduction opportunities. The focus should be on emissions that can be measured, reported, and verified with a high level of accuracy, ensuring that the trading scheme operates with integrity and effectiveness.

The Indian government plans to include sectors currently covered by its Perform, Achieve and Trade Scheme (a baseline and credit scheme to encourage companies to reduce energy consumption) within the CCTS framework.¹ These energy-intensive industries cover sectors such as fertilisers and aluminium and steel production. We recommend that sectors such as pharmaceuticals and data centres should also be included under the CCTS framework given their huge polluting potential.^2,3

The baseline data used to set targets under the new scheme must also needs to be considered. A technical committee appointed by the Bureau of Energy Efficiency will calculate the emission intensity targets using data from the baseline year. To establish these targets, the committee should use a five-year dataset rather than a single year to account for fluctuations and ensure a more reliable baseline . For annual targets, converting them into quarterly benchmarks could improve monitoring and provide early signals of potential shortages, allowing for timely corrective measures and enhancing market liquidity in the carbon market.

A robust digital monitoring, reporting, and verification system is needed

Striking the right balance in setting these targets is also crucial. Targets must drive meaningful emissions reductions while also allowing economic growth and industry stability. Setting targets that are too steep too quickly can lead to a substantial financial burden of compliance costs for businesses, particularly micro, small and medium-sized enterprises (MSMEs), which might struggle to manage these costs. Setting less stringent targets for MSMEs compared to those for larger corporations would help alleviate that burden. Overly stringent targets might also drive industries to relocate outside India. To mitigate this risk, placing a carbon tariff on imports (similar to the EU’s Carbon Border Adjustment Mechanism, which imposes a levy on carbon-intensive products, such as steel, cement, and certain types of electricity, imported into the EU), could be considered by the government.

International accord

The Paris Agreement envisions the creation of an international market in carbon credits. This means the quality of carbon credits generated in individual jurisdictions must be assured by a credible agency using an internationally recognised verification mechanism.

India’s government has enacted the Accreditation Procedure and Eligibility Criteria for Accredited Carbon Verification Agency Rules for the appointment of an accredited carbon verification agency.⁴ However, the Accreditation Rules currently lack mechanisms to ensure the impartiality of these agencies. Such an agency should be required to disclose any relationships it might have with the companies or other entities it is verifying, for example. Under Section 12 of the Indian Arbitration Act, 1999, an arbitrator must disclose any circumstances that might lead to doubts about their independence or impartiality – applying a similar principle to the appointment of accredited carbon verification agencies could enhance the credibility and integrity of the carbon verification process. Additionally, appointing multiple agencies and requiring emitters to periodically change the agency they use for verification would help to maintain the integrity and credibility of the process. This would be similar to the mandatory rotation of statutory auditors required under Indian Companies Act, 2013.

The data must also be credible, and the methodology used for monitoring, reporting and verification must be aligned with international standards, to enable Indian Carbon Credit Certificates (CCCs) to be traded with their international counterparts. A robust digital monitoring, reporting, and verification system is needed, specifically designed to prevent the double counting of carbon credits and maintain the integrity of India’s ETS.

Adopting measures to prevent price volatility will also be key to maintaining market stability

India’s ETS must also align with international standards to comply with measures such as the EU’s Cross-Border Adjustment Mechanism (CBAM). Without such alignment, Indian exports could face significant CBAM levies, posing a potential threat to India’s competitive position in the global market. It is therefore crucial for India to consider these international standards, inter alia, the sectoral and emission coverage, and implement the same its own carbon market framework. Furthermore, as discussed above, India will need to align its methodology for monitoring, reporting and verification of carbon credits with the established international standards, such as the GHG Protocol.

Policy requirements

Other policy measures are also needed to ensure the success of an ETS. For example, market stability must be maintained to prevent price volatility that undermines confidence and deters participation in markets.⁵  The government could implement measures such as setting floor and ceiling prices for carbon credits to prevent extreme price swings, as envisaged in Clause 12 of the CCTS.⁶ Additionally, adjusting emission reduction targets and allowances can help manage supply and demand dynamics.⁷ Currently, the Central Electricity Regulatory Commission  is designated as the regulator for trading under the CCTS Scheme. However, leveraging the expertise of the Securities and Exchange Board of India in market regulation could enhance the efficiency and stability of the carbon trading system, in a similar manner to the UK’s Financial Conduct Authority regulating the financial aspects of the UK’s ETS.

As India advances its climate policies, it is also essential to synchronise existing frameworks with the CCTS to create a cohesive and efficient regulatory environment. For instance, India’s Business Responsibility and Sustainability Reporting requirements, which mandate companies to disclose their environmental, social, and governance performance, should be aligned with the CCTS. Aligning the standards under BRSR with the CCTS would ensure that companies’ sustainability efforts are accurately reflected in both their reporting and their carbon trading activities, thereby fostering greater transparency and consistency.

Conclusion

Designing an effective ETS for India requires careful consideration of global best practices and the unique challenges faced by the Indian market. The introduction of the CCTS marks a significant step towards achieving India’s climate goals. However, its success hinges on aligning with international standards. Setting realistic yet ambitious targets is crucial to balance emissions reductions with economic growth. The integrity of the carbon market depends on robust monitoring, reporting, and verification mechanisms. Adopting measures to prevent price volatility will also be key to maintaining market stability. By addressing these issues, India can create a resilient and effective ETS that not only meets its national commitments but also positions itself as an important player in the global carbon market.