The inadequacy of China's growth momentum has emerged as a pressing issue along with economic downturns caused by the COVID-19 pandemic, as the country transitions from old to new growth drivers.

In light of the economic pressures, nurturing fresh growth drivers and identifying a new direction for development have become paramount. A green transition may have a significant role to play.

Embracing a green and low-carbon roadmap is key to achieving high-quality development - one that is innovative, coordinated, green, open and inclusive.

On the one hand, a green transition would act as a catalyst for continuous optimization and upgrade of the country's industrial structure. As the government applies relevant policies and regulations and companies adopt sustainable practices, China's economy will shift toward a path that values comprehensive low-carbon efforts, leading to long-term viability and resilience.

On the other hand, a focus on low-carbon development also drives a range of domestic demand. Initiatives such as urban and rural ecological construction, investments in scientific and technological innovation, and industrial upgrading will contribute to enhancing overall economic vitality and creating new growth opportunities.

By prioritizing low-carbon strategies, China will not only be able to navigate a path toward high-quality development and achieve economic transformation, but also unleash its enormous sustainable growth potential.

Effective market

It is crucial to fully acknowledge and comprehend the pivotal role played by a well-functioning carbon market in China's endeavor to achieve low-carbon transformation.

Among various emission reduction mechanisms, the carbon market is widely regarded as the most optimal. By utilizing market-based mechanisms to establish effective carbon price signals, it can effectively guide all relevant stakeholders to engage in the low-carbon transformation process in an orderly and highly efficient manner.

Compared to carbon taxes, which are determined by the government, carbon market prices, derived from market negotiations, are considered more efficient in price formation.

Moreover, carbon taxes do not provide positive incentives for the development and adoption of cutting-edge low-carbon technologies, which gives the carbon market a primary role in the green transformation process.

Although China has established the national Emissions Trading Scheme, its new carbon trading market is still facing a string of gaps and needs further enhancements to ensure efficient resource allocation.

For instance, carbon prices have been hovering at relatively modest levels - around 50 yuan ($7) to 60 yuan per metric ton with only minor fluctuations. Data from the World Bank, however, show that carbon prices should go from $40 to $80 per ton in order to achieve the goal of controlling temperature rises within 2 C.

The trading volume is also insufficient. During the compliance period of the ETS, nearly 80 percent of transactions occurred in the final month, with a total trading volume of less than 200 million tons — less than 1/40 of the annual trading volume in the European Union carbon market.

Last, carbon prices have not yet gained widespread influence. Effective carbon pricing can provide investors with valuable price signals for asset allocation and risk management. However, the current carbon market primarily functions as a tool for quota allocation, with its role in financial pricing and risk management yet to be fully realized.

There is an urgent need to establish an efficient carbon market that can truly accelerate China's low-carbon transformation efforts.

Required improvements

The ETS' effectiveness in incentivizing emission reduction and mobilizing low-carbon investments has been hindered by a series of mechanism issues, resulting in suboptimal outcomes. To address these challenges and fulfill its intended role, the carbon trading market is expected to be optimized in the following aspects.

First, establishing a clear carbon emissions cap is imperative. Effective carbon pricing relies on a well-defined cap, as demonstrated by theoretical analysis and international experiences. China should, therefore, come up with a ceiling quota for a specific future period based on past emissions volume and overall reduction targets.

Second, phase out the allocation of free quota. Allocation methods directly influence the scarcity of resources, which serves as the initial stage in price formation. It is necessary to ensure the gradual reduction of free quota, coupled with an increase in auctioned quota.

Third, it is essential to expand the coverage of the ETS to include industries beyond the power sector. The current situation, where high-emission sectors such as steel, chemicals, papermaking and aviation are left out calls for optimization in the near future.

Fourth, a mechanism to maintain price stability should be established. This mechanism is expected to foster expectations of stable and increasing carbon prices, encourage emission reductions, stabilize pricing within the industrial chain, and prevent production disruptions as well as aid in inflation management. A fixed carbon emissions cap will result in a higher level of price volatility. Therefore, it is important to take proactive measures by establishing a price stabilizing mechanism.

Fifth, the development of the carbon market should allow various entities, such as financial institutions, to participate in as soon as possible. The involvement of financial institutions is crucial for effective price discovery, expectation guidance and risk management. Additionally, leveraging the existing financial infrastructure could facilitate trading, custody and settlement in the national carbon market, and boost the development of carbon derivatives.

Sixth, efforts to promote market-oriented reform in energy pricing must be strengthened. The current electricity pricing system is not entirely market-driven, and this poses challenges in transmitting carbon price signals at the electricity price level.

Last, China should attach due importance to the development of the China Certified Emission Reduction scheme, in line with the current global development trends. CCER refers to emission reduction activities conducted by companies voluntarily that are certified by the Chinese government. These activities encompass renewable power generation, carbon credit and carbon removal projects, and are expected to expand further. Currently, enterprises can use CCER credits to offset up to 5 percent of their required carbon emissions allowance, though the reasonableness of this limit still warrants further discussion.