China's national carbon market, the world'slargest by volume of emissions, started operating on July 16, representinganother concrete step by the country in the development roadmap outlined in2015 and endorsed by the State Council, the country's Cabinet.The objectives ofthe national carbon market are to reduce carbon emissions through trading andto achieve China's 2060 carbon neutrality pledges.

Current participants include 2,225 powercompanies accounting for over 40 percent of China's emissions. Once fullyimplemented, the market will cover large firms in seven additional sectors－petroleumrefining, chemicals, nonferrous metal processing, building materials, iron andsteel, paper and pulp, and aviation.

The nationwide rollout of the carbon marketis built upon successful runs of pilot programs initiated as early as July2010. The eight programs are located strategically across the country in thecities of Tianjin, Baoding, Hangzhou, Chongqing, Nanchang, Guiyang, Xiamen andShenzhen. The trading scheme works by first setting caps on carbon dioxideemissions, then allowing price discoveries for carbon emissions through tradingamong participants in the market. Provided that carbon prices are high enough,such trading provides companies with financial incentives to save money bycutting emissions in the most cost-effective ways.

Since its launch, trading volumes havedropped after the first day's 4.1 million metric tons, falling to 15,841 metrictons on Sept 27, according to the Shanghai Environment and Energy Exchange.

With only a few of the 2,225 companieshaving access to such trade, the low trading volume is not unexpected. The lackof major financial institution involvement－investment banks,insurance companies, retail banks, commercial banks, asset management companies－is another reasonbehind the low liquidity.

Financial institutions are important marketliquidity providers. Taking the European Union Emissions Trading System (EUETS) as an example, the main traders are energy and industrial companies, whilefinancial institutions like banks also trade actively on behalf of smallercompanies and emitters. Financial institutions help companies manage risks andexploit opportunities created by both international and domestic carbonmarkets.

Serving as intermediary parties betweenparticipants in the market, they also help their clients understand marketmovements, anticipate market trends and manage exposure. At the same time, suchadvisory and trading services enable financial institutions to discover greenfunding from capital markets and channel it to the investment of renewableenergy and emissions reduction technologies.

Considering the novelty of carbon trading,the Ministry of Ecology and Environment, which oversees the national carbonmarket, remains wary of the speculative trading of financial institutions. Someexpect the government will gradually allow financial institutions to trade asthe market matures. Combined with plans to include companies from othersectors, these actions are likely to trigger more market activity.

Low carbon prices are unlikely to generateenough financial incentives. The current carbon price has been fluctuatingbetween a high of 58.7 yuan ($9.11) on Aug 4, and a low of 41.84 yuan on Sept9. This level is well below prices of carbon allowances in the EU, the world'ssecond largest carbon market, where one metric ton costs more than $60 inrecent months.

The low price is primarily caused by theoversupply of carbon allowances. The current intensity-based system allows thecap to be adjusted based on economic output, which means there is no fixed capon carbon allowances for each company. In addition, too many allowances havebeen handed out for free to companies, which lowers their cost butdisincentivizes their climate responsibility and liability.

Last year in a speech to the UN GeneralAssembly, President Xi Jinping pledged that China will help tackle climatechange by adopting more vigorous measures. The operation of China's carbonmarket reassures the world its commitment to zero emissions. However, this isno easy task given the complexity and size of China's economy.

Carbon futures as well as other derivativecontracts have been introduced in some other carbon markets. TheIntercontinental Exchange (ICE) launched ICE UK Allowances (UKA) Futurescontracts on May 21. The UKA Futures are deliverable contracts where eachclearing member with a position open at cessation of trading a contract monthis obligated to make or take delivery of UK allowances to or from the UKEmissions Trading Registry in accordance with the ICE Futures EuropeRegulations. The UKA Dec 21 Futures price closed at around 62.68 pounds permetric ton on Oct 6. Derivative contracts provide important signals on thesupply and demand of carbon allowances through price trends, helping businessesand policymakers understand the true costs of climate change.

In addition to introducing derivatives, itis also important for the government to further improve laws and regulations topromote transparency in the communication and measurement of emissions. Theseinclude but are not limited to transparency in compliance with measuring,monitoring, reporting and verification (MMRV) standards as encapsulated in theKyoto Protocol, transparency in allowance allocation mechanisms andtransparency in the availability of accurate, current and verified information.

The government also needs to strengthenlegal punishments for fabricating emissions data and exceeding emissionsallowances. According to the Measures for the Administration of Carbon EmissionTrading issued by the MEE, which has been in effect since February, the fine acompany will have to pay is a maximum of 30,000 yuan. Such a slap on the wristis far from enough to push companies to implement emission reduction plans.

Cooperation has been set up between thecarbon market in the EU and that in California. The two, as well as others, maylink up to create a global carbon market. Whether China will be part of it isstill unknown. Judging by the increased accessibility in China's financialmarket during the past 30 years, it wouldn't be a surprise to see the Chinesecarbon market open up to the outside world gradually. For now, though, foreigninvestors are not allowed to directly participate in China's carbon market.

Whythe 2030/2060 emissions targets are crucial

Climate change is one of the biggestchallenges of our times. We must act urgently to reduce carbon emissions andmake the transition to sustainable growth. As a large economy willing toshoulder corresponding responsibilities, China has set an ambitious goal topeak carbon emissions by 2030 and achieve carbon neutrality by 2060. Achievingthese goals will not be easy and needs collective action. Everyone is a stakeholderin global climate change.

We are glad to see the business communityembrace green transformation. In our latest 2021 Global CEO Outlook survey, 30percent of CEOs told us they plan to invest over 10 percent of their revenuestoward sustainability measures in the next three years. All respondents in oursurvey are CEOs from companies with an annual revenue of at least $500 millionand a third with more than $10 billion. If you put the numbers together, thisamounts to a substantial investment.

On top of that, the road to a net-zero economywill also need support from green finance. Many studies estimated that Chinaneeds to invest over 100 trillion yuan ($15.46 trillion) in the coming decadesto achieve its emissions goals. Government funds will likely only cover aportion of the investment; so, financing by the capital markets is verymuch-needed. China has the world's largest volume of green loans and is secondin terms of green bonds－and there is still a lot of room to grow. In addition, to build amultilayered ecosystem of green finance, other products such as carbon tradingmarkets, ESG－environmental, social and governance－investment and greeninsurance should also be further developed.

Financial institutions are clearlyimportant players here and they need to set up a forward-looking strategy forgreen transformation. They should also stress test their risk exposure relatedto environmental and climate change. These risks can arise either from physicalfactors (like floods, wildfires, and storms) or from transitions (like rising costsor reduced market opportunities due to higher emissions standards). Whilephysical risks are probably more visible, the growing effects of transitionrisks must also be carefully evaluated.

When China announced its 2030/2060emissions targets, some people might have been skeptical whether China shouldset such ambitious goals. The time between China achieving peak emissions andcarbon neutrality is only 30 years, compared to at least 40 years for mostadvanced countries. However, I have always been very confident that China willaccomplish its goals, given its strong manufacturing sector and the rapid developmentof the digital economy.

Take renewable energy, for example. Chinais already a global leader in wind and solar power equipment production. Of theworld's 15 largest wind power equipment manufacturers in 2019, eight were fromChina. In addition, China also has the world's largest installed capacity ofwind and solar power, both accounting for over one-third of the global total.Furthermore, the use of digital technologies, such as AI, big data and theinternet of things has greatly accelerated the development of renewable energy.For example, a big hurdle for wind power is that it is subject to weatherconditions and some power generated may be lost. The use of AI in China's windpower industry has improved demand forecasting and reduced waste. With enhancedefficiency, China's abandonment rate of wind power dropped from around 20percent in 2016 to 3 percent in 2020, a remarkable improvement.

Meanwhile, the rapid development of digitaltechnology also means growing power consumption. Electricity consumption ofdata centers in China reached 60-70 billion kilowatt-hours in 2019, accountingfor nearly 1 percent of the country's total power usage. With the deepening ofthe information age, it is estimated that the power usage of data centers willdouble by 2030 and represent about 1.5-2 percent of China's electricityconsumption. Renewable energy clearly has an important role to play in reducingcarbon emissions with the increasing use of digital technologies.

In summary, digital and greentransformation will be the key trends in the coming years and bring bothchallenges and opportunities. Companies should carefully consider thesedevelopments, design a clear strategy and work with stakeholders to tacklethese priorities.