How Does China’s Carbon Trading Market Work for Foreign Businesses?

China’s Emissions Trading Scheme (ETS) is the world’s largest carbon market by covered emissions, surpassing the EU ETS in scale. For foreign-invested enterprises (FIEs) operating in China, understanding the carbon trading market is essential for compliance, cost management, and strategic opportunity. This FAQ answers the most common questions foreign businesses have about China’s carbon market.

1. What is China’s carbon emissions trading scheme (ETS)?

China’s national ETS is a cap-and-trade system that sets emissions limits for covered entities and allows them to trade allowances. Launched officially in 2021, the scheme initially covered the power generation sector. Covered companies receive free allowances based on their production output and sector-specific benchmarks. Companies that reduce emissions below their allowance level can sell surplus allowances; those that exceed their allowance must purchase additional permits or face penalties. The system is administered by the Ministry of Ecology and Environment (MEE) and operates through the Shanghai Environment and Energy Exchange.

2. Which sectors are covered by the ETS?

3. Are foreign-invested enterprises automatically covered by the ETS?

Yes, if an FIE operates a covered sector facility with emissions above the threshold, it is subject to the same ETS rules as domestic Chinese companies. There is no exemption or different treatment for foreign ownership. FIEs must register in the ETS, submit verified emissions reports annually, and surrender sufficient allowances to cover their actual emissions. Many FIEs in the power, cement, steel, and aluminum sectors are already participating.

4. How are ETS allowances allocated?

Allowances are allocated primarily through free allocation based on output and sector-specific benchmarks. For the power sector, the benchmark is calculated per unit of electricity generated, with different benchmarks for different technology types (ultra-supercritical, supercritical, subcritical coal, gas-fired, etc.). Companies with emissions below their allocated allowances have a surplus they can sell; companies above their allocation must buy additional allowances. A small portion of allowances is reserved for auctioning, with plans to increase the auction share over time in line with the system’s development.

5. How does carbon trading work operationally?

Trading occurs on the Shanghai Environment and Energy Exchange. The process involves: (a) registering as a trading entity on the exchange; (b) opening a trading account and a carbon allowance account; (c) receiving allowance allocations (annually, typically in Q3); (d) submitting verified annual emissions reports; (e) surrendering allowances equal to verified emissions within the compliance period (typically by December 31); and (f) buying or selling allowances through the exchange platform or over-the-counter. Trading is conducted in Chinese yuan (RMB) and prices are influenced by supply-demand dynamics within each compliance period.

6. What has been the price of carbon allowances?

Prices have shown a clear upward trend, reflecting tightening benchmarks and expanding coverage. Analysts project prices reaching RMB 120-150 per tonne by 2028-2030 as the system matures and auctioning increases.

7. Can foreign businesses trade carbon allowances freely?

Foreign businesses registered as ETS participants can trade allowances to meet their compliance obligations. However, speculative trading by non-covered entities is restricted. Foreign financial institutions seeking to participate in the carbon market must comply with China’s financial regulations and typically need to establish a China-regulated entity or partner with a local financial institution. The carbon derivatives market, including carbon futures, is under development at the Guangzhou Futures Exchange and may offer additional trading opportunities once launched.

8. What is the China Certified Emission Reduction (CCER) scheme?

The CCER scheme allows companies to generate carbon credits from voluntary emission reduction projects (renewable energy, forestry, methane capture, etc.) and sell them to entities that need to offset their emissions. CCER credits can be used by ETS participants to cover up to 5% of their compliance obligation. The CCER scheme was reopened in 2024 after a multi-year suspension, with updated methodologies and stricter validation requirements. Foreign companies can invest in CCER projects in China but must comply with restrictions on foreign ownership in certain sectors (e.g., forestry land use).

9. How does the ETS affect my company’s costs and competitiveness?

The ETS introduces a cost of carbon that varies by sector and efficiency level. Efficient operators with emissions below their benchmark receive surplus allowances they can sell, generating a new revenue stream. Less efficient operators face additional costs to purchase allowances. The cost impact at RMB 100/tonne is approximately RMB 8-12 per MWh for coal-fired power and RMB 30-50 per tonne of cement or steel. Companies can invest in energy efficiency and low-carbon technologies to improve their benchmark position and reduce compliance costs over time.

10. What are the reporting and verification requirements?

ETS participants must: (a) submit annual GHG emissions reports using the MEE’s prescribed methodology and templates; (b) have these reports verified by an MEE-accredited third-party verification agency; (c) submit the verified report to the provincial EPB by the annual deadline; (d) maintain a monitoring plan approved by the authorities; and (e) keep detailed records of all energy consumption, production, and emission data for at least five years. The verification process involves document review, site visits, and data cross-checking against multiple sources.

11. What are the penalties for ETS non-compliance?

Penalties for ETS violations include: (a) fines of RMB 50,000 to RMB 200,000 for failure to submit a verified emissions report on time; (b) fines of RMB 50,000 to RMB 100,000 for failure to surrender sufficient allowances; (c) deduction of the shortfall from the following year’s allowance allocation at a rate of 1:1 (shortfall:deduction); (d) public disclosure of non-compliant entities on the MEE website; and (e) potential restrictions on access to government incentives and preferential financing. While current penalties are relatively low compared to the EU ETS, they are expected to increase significantly as the system matures.

12. How should FIEs prepare for ETS participation?

Recommended preparation steps include: (a) determine whether any China facility meets the sector and threshold criteria for coverage; (b) establish robust emissions monitoring and data management systems aligned with MEE methodology; (c) engage a qualified third-party verifier early to understand verification requirements; (d) develop internal capability to manage allowance trading, potentially including a carbon trading desk; (e) identify and implement cost-effective emission reduction measures to improve benchmark position; and (f) model the financial impact of various carbon price scenarios for budgeting and investment decisions.

13. Can I use international carbon credits for compliance in China?

Under current rules, only CCER credits generated from domestic Chinese projects are eligible for compliance in China’s ETS. International carbon credits, such as Certified Emission Reductions (CERs) from the Kyoto Protocol’s Clean Development Mechanism or credits under Article 6 of the Paris Agreement, are not accepted for ETS compliance. However, the MEE has indicated openness to linking China’s ETS with other national systems in the future, and Article 6 bilateral agreements between China and other countries may enable credit transfers in the longer term.

14. What is the difference between the national ETS and pilot carbon markets?

Before the national ETS launched, eight pilot carbon markets operated in Beijing, Shanghai, Tianjin, Shenzhen, Chongqing, Guangdong, Hubei, and Fujian. These pilots covered different sectors and had different rules. Since the national ETS launched, the pilots continue to operate for sectors and entities not yet covered by the national system. Companies in pilot regions may face dual reporting obligations until the national ETS fully absorbs their sector. The pilots have been valuable testbeds, with cumulative trading volume exceeding 400 million tonnes of CO2 by 2025.

15. What are ETS trends through 2026-2030?

Key developments expected in China’s carbon market include: (a) expansion to eight sectors by 2028; (b) introduction of auction-based allowance allocation increasing to 10-20% of total allowances; (c) launch of carbon futures on the Guangzhou Futures Exchange; (d) tightening of sector benchmarks to align with China’s 2030 peak emissions target; (e) potential introduction of a carbon price floor mechanism; (f) gradual increase in the CCER offset limit beyond 5%; and (g) improved market liquidity through financial institution participation and increased trading frequency.

Common Pitfalls for Foreign Companies

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