Options and Issues for Restricted Linking of Emissions Trading Systems

Linking emissions trading systems (ETSs) offers many potential benefits. These include economic benefits, such as increased access to abatement options; a potential reduction of carbon leakage risks; enhanced market liquidity and increased resilience to market shocks. There are also political benefits, as linking can signal enhanced cooperation and influence, limit competitiveness concerns, and enable jurisdictions to adopt more ambitious targets. In addition, linking can offer administrative and institutional benefits through shared administrative infrastructure, procedures, and costs. Linking may ultimately be necessary for an ETS to achieve its economic and political objectives, especially for smaller systems.

As the limited number of existing links attests, however, linking faces many challenges. Full linking requires a certain level of harmonization of, and thus compromises on, key ETS design elements. Full linking may also risk reduced ambition if one linked jurisdiction faces significant over-allocation of allowances, as well as real or perceived loss of regulatory autonomy. Jurisdictions may further have unequal institutional and technical capacities, and competing domestic objectives may need to be reconciled during the linking process.

This paper examines alternatives to full linking, focusing in particular on the potential advantages and drawbacks of “restricted linking”: options that enable the flow of units among jurisdictions, but with specific constraints such as quantity limits (“quotas”), or conditions such as exchange rates, to help address concerns that full harmonization might create.

The authors use four broad criteria (environmental benefit, economic benefit, political feasibility, and other practical and overarching considerations) and a simple model to help assess and compare options for restricted linking – in particular quotas, one-way linking, exchange rates and discount rates – with the situations of not linking or full linking.

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