China’s national carbon market stands as a pivotal component in the country’s ambitious “dual carbon” objectives, focusing on peak carbon emissions and carbon neutrality. However, despite its foundational role in China’s environmental strategy, the market grapples with enduring challenges that inhibit its overall effectiveness. Issues such as limited liquidity, erratic price signals, and the sluggish pace of sectoral inclusion underscore the complexities in evolving this market from a regulatory framework into a dynamic economic mechanism.
The China National Emissions Trading Scheme (CN-ETS) operates on an intensity-based approach, linking emission allowances to production output rather than capping absolute emissions. This system design aims to harmonize economic growth with emissions reduction targets but inherently results in a softer emission cap during the initial phases. Consequently, the incentive for trading allowances is muted, leading to subdued market activity and a lack of vibrant price discovery, which are vital for a functional carbon market.
At a microeconomic level, the trading ecosystem is predominantly compliance-driven. Market transactions tend to cluster around regulatory deadlines, resulting in volatile and sporadic trading volumes. Firms often hoard allowances as strategic reserves, especially amid policy uncertainties, preferring to delay trade rather than engage in frequent market transactions. This behavior crystallizes a market that, while operational on paper, lacks the fluidity and responsiveness seen in mature carbon markets globally.
Moreover, the expansion of the market to include additional high-emitting sectors continues to be impeded by significant data and governance constraints. The Monitoring, Reporting, and Verification (MRV) infrastructure, which ensures emissions data reliability, remains underdeveloped. Discrepancies and verification difficulties restrict the ability to encompass major industrial players like steel and cement manufacturers, thereby limiting the breadth and environmental impact of the CN-ETS. These technical hurdles highlight a critical area for reform in the effort to deepen and broaden China’s carbon market.
Externally, China faces growing pressure from international climate policies, notably the European Union’s Carbon Border Adjustment Mechanism (CBAM). This initiative effectively mandates stricter carbon accounting and market development as prerequisites for access to key global markets. The CBAM acts as a lever, catalyzing China’s urgency to enhance the precision of emissions data, extend market coverage, and refine price signaling mechanisms. The interplay between domestic reforms and international regulatory pressures is thus shaping the trajectory of China’s carbon market expansion.
Addressing these structural and operational challenges requires innovative institutional designs and financial instruments. One promising avenue is the introduction of carbon derivatives, such as futures contracts. These financial tools can enhance market liquidity by enabling hedging and speculative activities, thus stimulating continuous trading and more accurate price discovery. By providing firms with mechanisms to hedge against future price volatility, derivatives could transform the speculative landscape and align market dynamics with real economic incentives.
Policy stability emerges as another cornerstone for effective market functioning. Studies suggest that combining price stabilization mechanisms—such as price ceilings and floors—with adaptive quota adjustments can significantly promote green innovation across industries. Stable and credible carbon prices empower businesses to commit to long-term investments in low-carbon technologies. Without such policy clarity, firms remain hesitant, prolonging the market’s transitional state from compliance to proactive environmental strategy.
China’s regional pilot carbon markets continue to offer valuable lessons and innovation laboratories. Rather than phasing out, these local schemes complement the national framework by exploring regulatory innovations, financial product development, and greater participation from small and medium enterprises (SMEs). As experimental arenas, they provide insights into effective governance models and market mechanisms that could eventually scale to the national level.
Looking beyond China, lessons from Japan and South Korea illuminate alternative pathways for carbon market development. South Korea’s experience underscores the importance of market liquidity, achieved through the establishment of market makers and expanding financial institution involvement. These measures have invigorated the Korean ETS, making it an instructive model for China’s own efforts to activate trading and stabilize prices in its national market.
Japan’s approach takes a more gradual and flexible route. The GX-ETS, which blends voluntary participation with progressively stringent carbon constraints, demonstrates how a carbon market can evolve while preserving economic vitality. Findings from the Saitama pilot ETS reveal that firms can achieve emissions reductions without detrimental economic consequences, primarily through energy efficiency improvements and fuel switching rather than employment reductions, offering a nuanced perspective on industrial adaptation.
These international case studies collectively stress the multifaceted nature of carbon markets. Price signals alone are insufficient to drive deep decarbonization; complementary industrial policies, targeted innovation incentives, and stable regulatory environments are equally critical. For example, in South Korea, sectors with high marginal abatement costs respond sluggishly to price signals, necessitating targeted governmental support and technological advancement strategies to facilitate meaningful emissions reductions.
The synthesis of these insights suggests that China’s carbon market is poised to transition from foundational system-building to market deepening. This phase prioritizes enhancing market liquidity, fostering financial innovation, and stabilizing price expectations to guide firm behavior more decisively. Achieving these goals will require significant institutional reforms, particularly in upgrading the MRV framework and instituting robust price stabilization mechanisms to mitigate volatility and uncertainty.
Financial innovation, notably the deployment of carbon futures contracts, stands as a transformative development. By offering forward-looking price signals, these instruments can alter corporate strategies from passive compliance to active trading and risk management. Such evolution in market functionality is crucial for stimulating the scale and speed of emissions reductions necessary to meet China’s climate commitments.
International alignment, particularly in response to global instruments like the EU’s CBAM, also shapes the strategic imperatives for China’s carbon market. Integrating domestic and international carbon pricing standards ensures market credibility, facilitates trade, and positions China as a viable actor in the emerging global carbon economy. This alignment underscores the interplay of national policy design with evolving international climate governance.
In conclusion, the challenges that have thus far constrained China’s national carbon market are well understood and multifaceted, ranging from structural design issues to institutional weaknesses and external pressures. However, the emerging consensus points towards actionable pathways—enhanced MRV systems, financial market innovations, and sophisticated policy stabilization tools—that can unlock the market’s potential. The coming years will test China’s resolve and capability to execute these reforms effectively, determining the carbon market’s role in both national and global climate strategy.
Subject of Research: Environmental economics and carbon market development in China
Article Title: Carbon futures contract design and theoretical pricing in China’s National Carbon Market
News Publication Date: 17-Mar-2026
Web References: 10.26599/ECM.2026.9400029
References:
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Image Credits: Energy and Climate Management, Tsinghua University Press
Keywords: Environmental economics, carbon markets, emissions trading scheme, China, MRV, carbon futures, price stabilization, climate policy, carbon border adjustment mechanism, financial innovation
