Abstract: This article delves into China's transition finance, specifically examining the understanding of price mechanisms and the concept of a just transition. It firstly emphasizes the importance of price incentives and equitable transitions. Furthermore, challenges in operational implementation are identified, including information deficiency in value supply chains, regulatory operability, the absence of credible third-party organizations, and the need to strengthen green and low-carbon market mechanisms. Finally, the article concludes with recommendations for achieving net-zero emissions and promoting transition finance's advancement through dynamic targets, streamlining regulations, and addressing weak links.
I. UNDERSTANDING PRICE MECHANISMS IN THE ADVANCEMENT OF TRANSITION FINANCE
Participating experts stressed that the advancement of transition finance and the utilization of price incentive mechanisms are not contradictory. A significant portion of the global discourse surrounding transition finance is entwined with critiques and excessive concerns about "greenwashing". This concern often stems from a deficient comprehension of the price mechanism.
The phenomenon of "greenwashing" can be classified into three distinct categories, namely:
The first category pertains to data fraud, encompassing data manipulation and instances of "greenwashing" caused by inadequate groundwork and a lack of transparency. To address this, reinforcing groundwork, enhancing regulations, and instituting public oversight are imperative.
The second category revolves around the procurement of carbon credits or offsets. Within the international arena, there exists a misconception that only carbon dioxide entirely absorbed or stored from the atmosphere (all-absorbing carbon credits) qualifies as carbon offsets. Conversely, the portion of reduced carbon emission intensity in certain sectors without altering production volume (relative carbon credits) is erroneously excluded. This misinterpretation underscores a lack of understanding of the price mechanism. In actuality, both types of carbon credits or offsets are equivalent in achieving the annual carbon emissions target and should merit equal incentives.
The third category involves carbon price arbitrage. Notably, some prominent companies exploit price differentials by purchasing low-cost carbon credits from developing countries to fulfill emission reduction goals, thus leading to carbon price arbitrage. While regulatory measures like promoting the organized connectivity of the carbon market can curb certain practices, it's important to recognize that price arbitrage is inherently temporary within the price mechanism. Concerns regarding major companies perpetually evading emission reduction obligations by acquiring inexpensive carbon credits over the next few decades are unfounded. Under the influence of the price mechanism, if the cost of emission reduction and technological expenses remain unchanged, these companies would eventually face significantly higher carbon prices resulting from their practices, compelling them to engage in emission reduction actively.
II. COMPREHENDING THE JUST TRANSITION IN THE ADVANCEMENT OF TRANSITION FINANCE
Participating experts underscored that a just transition is the optimization of the balance of interests between beneficiaries and the unemployed through market means. Achieving a just transition requires a combination of market and legal means, particularly through judicial remedies.
However, experts also explained that it's crucial to extend the concept of a just transition to include macro-level justice by focusing on three main facets:
Firstly, a just transition must navigate the connection between economic aggregate and future investment growth and the attainment of net-zero emissions. A just transition doesn't entail direct subsidies at the micro level to the unemployed after coal mines or power plants are shut down. Instead, at the macro level, it involves fostering new employment opportunities after heavy emitters are shut down through skill acquisition as the GDP maintains steady growth, providing increased societal employment prospects.
Secondly, a just transition accentuates the significance of organized and manageable market connectivity. This approach addresses potential inequities in carbon offsets and financial flows between developed and developing nations.
Thirdly, the design of the carbon border adjustment mechanism should prioritize equity between developed and developing nations. For example, in the context of the EU's Carbon Border Adjustment Mechanism (CBAM), revenue generated from carbon taxes on imports should not be included in public budget, but instead, be employed to purchase carbon credits from exporting or more extensively from developing countries so as to support their efforts to reduce emission stemming from export-oriented production.
III. OPERATIONAL CHALLENGES IN THE ADVANCEMENT OF TRANSITION FINANCE
Experts have emphasized that operational progress remains sluggish while there is a considerable push for transition finance. This sluggishness is attributed to four primary challenges:
Foremost, securing information concerning the emission supply chain's upstream and downstream facets poses a formidable challenge for enterprise carbon accounting, which is an indispensable starting point of transition finance. While carbon accounting methods and standards at the enterprise level are relatively clear, and the solutions released by the Partnership for Carbon Accounting Financials (PCAF) and the International Sustainability Standards Board (ISSB) are operable, difficulties arise in accessing data from the upstream and downstream of the supply chain, regardless the willingness, capability, and techniques possessed by major emission-control enterprises.
As to enterprises, acquiring information within the GHG accounting system follows distinct levels of ease and challenge: Accessing data on Scope 1 (direct GHG emissions) stands as relatively straightforward, with a streamlined process in place. Moving to Scope 2 (indirect GHG emissions from the consumption of purchased energy, like electricity), the task becomes somewhat more intricate, requiring a heightened degree of effort for collection and verification. Scope 3 (indirect emissions stemming from upstream and downstream activities along the value chain) introduces a layer of complexity.
Secondly, there exists a need for enhanced operability in implementing relevant regulatory rules and approaches. Both domestic and foreign financial institutions often rely on regulatory directives, taking action only subsequent to regulatory issuance. While rules from entities like the PCAF and the ISSB have gained traction in developed nations, successful integration into China's practice of transition finance hinges on improving rule operability.
A third challenge lies in the absence of credible third-party organizations that establish industry standards and foster voluntary initiatives. Globally, the regulation of carbon emissions markets lags, with developed economies compensating through credible third-party entities that institute standards and voluntary initiatives. In China, however, the lack of trust in third-party organizations has hindered the establishment of industry standards, thus slowing operational progress.
Fourthly, it is necessary to strengthen the market mechanism for green and low-carbon transition by focusing on the following four aspects:
1. While the carbon market and green power trading market have been established, certain practical issues persist, such as reconciling green power within Chinese Certified Emission Reduction (CCER) and resolving double-counting concerns in large-scale green power trading.
2. Current carbon emission trading mainly involves CCER and Carbon Capture, Utilization, and Storage (CCUS), while the establishment of new projects like forest carbon sinks lags behind.
3. There is insufficient liquidity in the carbon market. 70-80% of transactions in the EU carbon market take place in normal times, while a significant proportion of transactions in China take place in the last two months before the compliance period.
4. The relevant legal system needs to be accelerated. The Electricity Law (revised in 2021) focuses on the overall power industry and less on new and renewable energy. The Energy Law has a draft for public comment but has not yet been formally introduced.
IV. OTHER RECOMMENDATIONS ON ACHIEVING THE NET ZERO GOAL AND PROMOTING THE ADVANCEMENT OF TRANSITION FINANCE
First, to attain the net-zero emissions goal, the implementation of dynamic annual targets is pivotal. This approach should harmonize with reasonable economic growth.
1. The total carbon emission target, along with a well-defined timetable and roadmap, must be clarified within the framework of the "1+N" policy system. The integration of dynamic targets for the upcoming years into each year's objectives ensures a steady path towards net-zero emissions.
2. It's imperative to strike a balance with early net-zero targets, avoiding undue aggressiveness. Sustaining a reasonable GDP growth trajectory is crucial. The pressing funding gap poses a significant constraint on realizing net-zero emissions. A stable GDP growth rate ensures the accumulation of savings, which can then be channeled partially towards future net-zero investments in R&D and necessary equipment.
Second, the pursuit of net-zero emissions demands a focused and meticulous approach underpinned by streamlined regulations. Encouraging a broader participation spectrum necessitates the merging of similar components and simplifying rules.
1. it is not better to have more institutions, alliances, methods, and measures; this aspect may go through a process of simplification to complexity and then gradually from complexity to simplicity, which is reflected in the fact that multiple institutions, multiple alliances, multiple standard-setting, multiple calculations, and multiple labors can be gradually simplified and harmonized.
2. For the numerous small and medium-sized emitters, as well as residential contributors, rule complexity should be avoided. This approach minimizes the burden of excessive data collection and calculation.
3. It is essential to eliminate redundant and ineffective checks on enterprises.
Third, effective development of practical transition finance hinges on addressing five critical weak links: data quantification, rights determination, trading processes, adherence to the rule of law, and information disclosure.
1. Key industry authorities and financial regulators should seize opportunities to collaborate, shaping relevant standards and resource guidelines. These efforts should specifically target challenges and pain points within the control and discharge industry.
2. Vigorously foster credible third-party organizations within the market to enable them to offer trustworthy services for green and transition finance.
3. Harness the pivotal role of the market in driving transition finance, and especially expedite the expansion of the carbon trading market industry and bolster market trading liquidity.
4. In tandem with fiscal and monetary policies and financial regulatory measures, the rule of law's significance in transition finance should be underscored. Timely introduction of pertinent laws and regulations is imperative, which facilitates their swift implementation by all stakeholders in the market.
This article was published as CF40 Policy Brief, and the author is Zhong Yi, research associate of CF40 Institute.
