ECM Carbon Market Special | Where is China’s carbon market heading?

China’s national carbon market has been widely seen as a cornerstone of its “dual carbon” goals. Yet persistent challenges remain: weak liquidity, unstable price signals, and slow sectoral expansion.

Drawing on eight recent studies published in Energy and Climate Management, spanning China as well as experiences from Japan and South Korea, a clearer picture is emerging—not just of current constraints, but of the path forward.

A market that runs, but not yet flows

China’s national ETS (CN-ETS) is built on an intensity-based system. As Zhang et al.¹ explain, this design—where allowances are tied to output—helps balance economic growth with emissions control, but also results in a relatively “soft” cap in the early stages, dampening trading incentives.

At the operational level, deeper structural issues persist. The market remains largely compliance-driven, with trading concentrated near deadlines and long periods of inactivity in between. As Wen et al.⁷ describes it, the system “is primarily compliance-driven, suffers from insufficient liquidity, is dominated by block trades, operates on a limited scale, and is marked by significant price volatility.”

This lack of activity is not incidental. Firms tend to hold onto allowances rather than trade them, viewing them as strategic assets under policy uncertainty. The result is a market that functions administratively—but not yet dynamically.

Data and policy constraints slow expansion

Beyond liquidity, expansion remains a critical bottleneck. Dai et al.⁸ identify data governance—particularly the MRV (Monitoring, Reporting, and Verification) system—as a key constraint. In practice, inconsistencies in emissions data and verification challenges continue to limit the inclusion of high-emitting sectors such as steel and cement.

At the same time, external pressure is mounting. The EU’s Carbon Border Adjustment Mechanism (CBAM) is effectively imposing a reform timeline, pushing China to accelerate improvements in data quality, market coverage, and price formation.

Together, these domestic and international constraints are reshaping the pace and direction of market expansion.

Making the market work: finance and stability matter

If the problem is structural, so is the solution. Several studies converge on the importance of institutional design and financial innovation.

A key policy direction is to introduce carbon derivatives. As Wen et al.⁷ notes, carbon futures can “enhance liquidity, improve price discovery, and stabilize price volatility,” while also providing firms with hedging tools. By creating forward price signals, such instruments could fundamentally change market behavior.

Another critical priority is to strengthen policy stability through price stabilization mechanisms. Zhu et al.³ find that only a more complete policy mix is effective: “Only an ETS applying both the price-based (price limits) and quantity-based (updating cap) PSM, indicating a more complete policy design, would have a significant effect in inducing green innovation” This underscores a broader point—stable and credible price expectations are essential for long-term investment decisions.

Meanwhile, Dai et al.⁸ emphasize that China’s regional pilot markets still play an important role. Rather than being replaced, these local ETSs continue to serve as testing grounds for innovation in regulation, finance, and SME participation.

Lessons from Japan and South Korea

Experiences from neighboring countries offer valuable insights into how carbon markets can evolve.

In South Korea, improving liquidity has been a central focus. Yong-cheol Park et al.⁴ notes that institutional measures such as market makers and expanded participation by financial institutions have been introduced “to enhance market liquidity,” helping to activate trading dynamics.

At the same time, price signals alone are not always sufficient. Studies on Korea’s⁵ marginal abatement costs show that achieving around a 20% emissions reduction would require a carbon price of approximately KRW 50,000 (about USD 36) per ton. However, some sectors remain relatively unresponsive, highlighting the need for complementary industrial policies.

Japan provides a more gradual pathway. Its GX-ETS combines voluntary participation with progressively stronger constraints, aiming to align emissions reduction with economic growth². At the micro level, evidence from the Saitama ETS suggests that firms can reduce emissions without negative economic impacts. As Xinyue Yang et al.⁶ finds, regulated facilities may cut emissions “by lowering their overall energy consumption or by shifting to energy sources with lower emission factors,” rather than reducing employment.

From system building to market deepening

Taken together, these findings suggest that China’s carbon market is entering a new phase. The focus is shifting from establishing the system to strengthening its market functionality, where carbon pricing is increasingly expected to serve as a meaningful signal guiding firm behavior.

Looking ahead, three priorities stand out: strengthening institutional design (especially MRV systems and price stabilization mechanisms), developing financial tools such as carbon futures, and enhancing international alignment in response to policies like CBAM.

The direction is clear. The challenge now is execution.

Reference:

1. Zhang X, Yu R, Karplus VJ. The development of China’s national carbon market: An overview. Energy and Climate Management, 2025, 1(2): 9400015. https://doi.org/10.26599/ECM.2025.9400015

2. Liu X, Jin Z. Carbon pricing mechanisms toward net-zero emissions in Japan. Energy and Climate Management, 2025, 1(3): 9400019. https://doi.org/10.26599/ECM.2025.9400019

3. Wang B, Zhu W, Song D. Why the effectiveness of ETSs on green innovation differs? The perspective from price stabilization mechanisms. Energy and Climate Management, 2025, 1(4): 9400020. https://doi.org/10.26599/ECM.2025.9400020

4. Park J-a, Lee Y-h, Park Y-c, et al. A review of the operational results of the K-ETS (2015–2024). Energy and Climate Management, 2025, 1(4): 9400025. https://doi.org/10.26599/ECM.2025.9400025

5. Kim YJ, Yoo SJ. Marginal GHGs abatement cost in the Republic of Korea’s economy. Energy and Climate Management, 2025, 1(4): 9400024. https://doi.org/10.26599/ECM.2025.9400024

6. Yang X, Arimura TH. Assessing the impact of Saitama Emissions Trading Scheme on energy consumption and economic performance at the facility level. Energy and Climate Management, 2026, 2(1): 9400026. https://doi.org/10.26599/ECM.2025.9400026

7. Zhang Y, Weng Y. Carbon futures contract design and theoretical pricing in China’s National Carbon Market. Energy and Climate Management, 2026, 2(1): 9400029. https://doi.org/10.26599/ECM.2026.9400029

8. Dai C, Pollitt MG. Aligning China’s local and national carbon markets under global carbon pricing. Energy and Climate Management, 2025, 1(3): 9400017. https://doi.org/10.26599/ECM.2025.9400017

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