Preparing for Trading on the World’s Largest Carbon Market

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A version of this article appeared in Caixin:


Market-based carbon allowance pricing

The first on-spot trading of allowances in the Chinese national carbon market will begin in Shanghai this month. This will mark the launch of the largest carbon market in the world, initially targeting 4 billion tons of emissions from energy utilities alone.

Price discovery on day-1 of trading is critical and, just like IPOs, the preferred first trading day price-setting mechanism for carbon and other emissions allowances is by way of auction.

Noting that financial markets depend on price certainty and transparency, with under a week to go before commencement of trading on the China national ETS we still do not know the mechanism for determining the day-1 trading price.

International best practice

This article introduces and compares two international precedents, the first day on-exchange trading for US sulphur dioxide (SO2) allowances in 1993, and that of the recent UK carbon dioxide (CO2) allowances.

The United States

In the early 1990s, the U.S. Congress passed the Clean Air Act Amendment of 1990 which imposed a cap and trade scheme to target utilities’ emissions of SO2 in order to control acid rain.

In March 1993, the United States Environmental Protection Agency (EPA) took out a small portion of the SO2 allowances freely issued to utilities to be first auctioned by the Chicago Board of Trade (the CBOT, founded in 1848 and regulated by the US Federal Futures Regulatory Commission), which was designed for an open and transparent market-based pricing for SO2 allowances.

It is worth noting that OTC trading for SO2 allowance had already started prior to the auction.

The allowances were auctioned by sealed bids. The auctioned allowances consisted of 2 types: one type was the spot allowance, which could be used from 1995 to 2000; the other type was the advance allowance, which could be used only after 2000. Each allowance corresponded to 1 tonne of SO2 emissions.

Regarding the composition of the bidders, utilities and non-utilities (including brokerage companies and investment institutions) were respectively responsible for 48% and 52% of spot allowance bidding, and for 32% and 68% of advance allowance bidding. However, almost all successful bidders were utilities, responsible for 95% of spot allowance purchases and for 99% of advance allowance purchases.

Through multiple bids, the Carolina Power & Light Company purchased 85,103 allowances, including 13,083 spot allowances for approximately US$2 million and 72,020 advance allowances for approximately US$ 9.5 million. On the other hand, through a single bid, Duke Power Company purchased 25,000 advance allowances for US$ 3.7 million.

On the day of the auction, the Mayor of Chicago, Professor Ronald H Coase (Winner of the Nobel Prize for Economics), Dr. Richard L Sandor (the creator of Carbon Trading) and other representatives were present at the Chicago Board of Trade to witness events.

The EPA collected a total amount of auctioned proceeds of US$21.4 million. 50, 010 spot allowances were sold at prices between US$131 to US$170 per tonne. 100,000 advance allowances were sold at prices between US$122 to US$140 per tonne.

The EPA later returned the auctioned proceeds to the utilities, as the first-day auction was designed for the market to set an initial price for the allowance in an open and fair manner.

The CBOT later announced the commencement of trading SO2 allowance futures contract on CCX, which enabled all entities and relevant institutions along the supply chain to participate in price discovery and hedging under the financial regulators’ supervision.

The United Kingdom

The UK carbon market went live on the 19th of May this year, where the British government held the first nationwide carbon allowance auction on the Intercontinental Exchange (ICE). Two days later, on the 21st of May, the UK allowance daily futures contracts also commenced trading on ICE. Starting on the 19th of May, the 2021 UK carbon allowance auction will be held every two weeks, involving a total amount of 83 million metric tonnes of CO2. In the meantime, 39.1 million carbon allowance will be handed to energy utilities for free.

Any qualifying individual or institution could open an account at the UK Emissions Trading Registry and participate in the first-day allowance auction and secondary market trading.

In addition, the British government has established a Cost Containment Mechanism which means when the UK carbon price reaches a triggering price, being twice the average EU carbon price in the past two years, the British government may intervene to cool the market.

Before the auction of carbon allowances on the 19th of May, the UK carbon price reached £50.23 per metric tonne. Among the 15 bidders, 14 were successful and obtained 6.052 million carbon allowances at an average clearing price of £43.99 per metric tonne, which was almost twice the Auction Reserve Price (£22 per metric ton) set by the British government. After the allowance auction ended, the UK carbon price fell pack to £45.75 per metric tonne.

The above change of carbon price before and after the auctioning on 19th May 2021 demonstrates the effectiveness of the auction as a price discovery mechanism. The high carbon price at the beginning of the day was driven by high interest from investors in the first round of the auction. In addition, the high carbon price could have been influenced by the historical peak (€56.90 per tonne) of the EU carbon price on 14th May 2021. Analysis from the Independent Commodity Intelligence Services (ICIS) on the EU power and carbon markets opined that the UK carbon price is expected to “trade in line” with the EU carbon price following “an initial period of volatility”.

The subsequent drop in the UK carbon price on the same day could have been caused by the price discovery mechanism of the auction, which drives the carbon price towards a true market level. Although the initial UK carbon price on the first trading day was much higher than the triggering price, it quickly dropped after the auction, and the British government did not intervene through the Cost Containment Mechanism.


Regardless of the pricing mechanism to be adopted on the first day of China national carbon allowance trading this month, it is recommended that policymakers should shortly afterward introduce an auction mechanism for pricing and allow sufficient freedom for OTC allowance (compliance) trading among institutions. From the experience of the compliance markets in EU and the US, a regulated, standardized and professional daily allowance spot trading and settlement mechanism is essential to fostering institutional-led trading liquidity. Without institutional-led liquidity, carbon price discovery, or “pricing right” as it is called in China, would be reduced to mere concept.


About the authors

Jeff Huang is the founder of AEX (Hong Kong) Holdings Limited, a company developing carbon and power markets based in Hong Kong ( He was previously Managing Director at the Intercontinental Exchange (ICE) for the Greater China Region having graduated with a Master’s Degree from the Beijing Foreign Affairs University.

Ben McQuhae is the founder of sustainability focused law firm Ben McQuhae & Co based in Hong Kong ( He is a co-founder and Executive Committee member of the Hong Kong Green Finance Association ( and represents Hong Kong on the United Nations Financial Centres for Sustainability network (



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