Fundamental issues and solutions in the design of China's ETS pilots: Allowance allocation, price mechanism and state-owned key enterprises

This paper analyzes the three main fundamental issues in the design of China's ETS pilots, including allowance allocation, price mechanism and state-owned key enterprises, and proposed suggested solutions. For the issue of allowance allocation, we suggest that the gradual hybrid mode could be applied at the beginning, which starts with mainly free allocation and then increases auction ratio gradually. And grandfathering is a suitable method of free allocation. For the issue of price mechanism, we suggest a price floating zone with open market operation to reduce the uncertainty of prices. For the issue of state-owned key enterprises, we suggest a good coordination with SASAC, defining the state-owned property right and supervision right when state-owned key enterprises are involved into the carbon market, and the local government can set rules of allocation and transaction to limit their potential market power.