The carbon market serves as a core policy tool for China to advance its dual carbon goals: peaking carbon dioxide emissions by 2030 and achieving carbon neutrality by 2060.

The market’s first compliance cycle launched in 2021, covering 2,162 key power generation enterprises whose total greenhouse gas emissions amounted to approximately 4.5 billion metric tons. This made China’s carbon market the world’s largest in terms of emissions coverage. As of September 24, the cumulative trading volume of allowances reached around 720 million tons, with a total transaction value exceeding 49 billion yuan ($6.8 billion).

Currently, China’s carbon market faces several key challenges:

1. Narrow Sectoral Coverage and Low Trading Activity

The national mandatory carbon market currently only encompasses the power generation, steel, cement, and aluminum industries. High-emission sectors such as petrochemicals and chemicals have not yet been incorporated, limiting the market’s ability to drive emission reductions across the broader economy.

Meanwhile, the voluntary greenhouse gas (GHG) emission reduction trading market—also referred to as the China Certified Emission Reduction (CCER) scheme—has approved methodologies for only six project types. The net emission reductions or removals of these projects can be quantified and used to offset emissions in the mandatory market, but the narrow coverage of sectors and projects means the scheme’s capacity to incentivize emission reductions remains insufficient and requires further enhancement.

2. Concentrated Participants, Low Liquidity, and Underdeveloped Allowance Allocation

Carbon trading is currently dominated by large emitters, while financial institutions and carbon asset management companies have limited participation. This lack of diversity reduces overall market activity and trading volumes, constraining capital flow and the application of financial instruments to support emission reductions.

Additionally, emitters receive free allowances based on relatively lenient industry benchmarks and can offset excess emissions through the reactivated CCER scheme. Small and medium-sized enterprises (SMEs) outside the mandatory compliance scope thus risk becoming “gray zones” for emission transfer, undermining both the effectiveness and fairness of carbon reduction policies.

3. Volatile Carbon Prices and Ineffective Price Mechanisms

Since its launch, China’s carbon market has exhibited a distinct “compliance-driven tidal pattern”: trading activity surges shortly before compliance deadlines, causing market congestion and sharp price fluctuations that increase compliance risks for enterprises.

This volatility stems largely from the failure of carbon price signals during non-compliance periods, when enterprises have little incentive to trade. Furthermore, information asymmetry and limited corporate understanding of the carbon market prevent prices from accurately reflecting the true cost of emissions and the real market value of reductions.

4. Poor Integration Between Mandatory and Voluntary Markets

The mandatory and voluntary carbon markets lack effective integration, weakening the emission reduction pressure on key emitters. In the mandatory market, frequent adjustments to rules governing CCER-based emission offsets and project eligibility have made it difficult for enterprises to form stable expectations.

Meanwhile, the voluntary market’s rules for project approval and emission reduction accounting are misaligned with those of the mandatory market. As a result, some voluntary reductions are not recognized in the compliance market, preventing mitigation outcomes from being transferred across systems.

Moreover, while the mandatory market imposes emission caps on emitters, its heavy reliance on free allowance allocation and strict limits on CCER offsets have diminished the complementary role that voluntary reductions could play in supporting compliance efforts.

Pathways to Strengthen China’s Carbon Market

To build a more effective, dynamic, and globally influential carbon market, targeted actions are needed to expand coverage, diversify participants, stabilize prices, and improve coordination:

（1）Phase-Based Expansion of Market Coverage

A phased carbon market expansion plan should be formulated, prioritizing high-emission sectors with sound carbon data (e.g., petrochemicals and chemicals). For medium-emission sectors like ceramics and glass, emissions data surveys should be conducted, and pilot monitoring, reporting, and verification (MRV) programs launched. For already included but underregulated sectors (e.g., steel and aluminum), more detailed accounting standards should be developed for specific product categories (e.g., specialty steel and recycled aluminum) to ensure targeted and effective emission reductions.

Simultaneously, the voluntary market should develop new methodologies for areas such as forestry and marine carbon sinks, as well as methane recovery. These efforts should be supported by a dynamic system for regular updates and revisions to encourage more extensive emission reduction initiatives.

（2）Expand Market Access and Optimize Allowance Allocation

Market access should be expanded by relaxing participation restrictions for financial institutions, enabling banks and funds to engage in activities such as carbon allowance pledge financing and carbon fund issuance. Pilots for carbon futures trading should be launched and made accessible to qualified financial institutions, while professional carbon asset management companies should be encouraged to provide custody and trading services for SMEs. Additionally, pathways for individual participation should be explored, with gradual access to direct trading for individual investors.

The allowance allocation mechanism also needs improvement: compliance requirements should be tightened by gradually reducing the share of free allowances and aligning sectoral benchmarks with international best practices. An early warning and compensation mechanism for “carbon leakage” should also be established—providing appropriate allowance subsidies for exporters in high-carbon industries, while extending carbon footprint tracking to non-compliant SMEs to prevent emission leakage via production relocation.

（3）Stabilize Carbon Prices Through Multifaceted Measures

First, introduce phased compliance settlement by splitting annual obligations into quarterly installments to alleviate trading congestion ahead of deadlines. Incentives for off-season trading should also be offered—for example, discounts on future allowance auctions for enterprises whose off-season trading volume exceeds 10% of their annual allowances.

Second, enhance transparency and market guidance by establishing a unified national carbon market information platform. This platform should regularly release industry emissions data, forecasts of allowance supply and demand, and trading activities of major enterprises, helping companies better respond to price signals and ensuring carbon prices reflect real reduction costs.

（4）Strengthen Integration Between Mandatory and Voluntary Markets

A clear management framework should be introduced to specify the offset ratios and eligible projects for CCER credits in the mandatory market. MRV standards should be aligned across the two markets, requiring voluntary projects to adopt the same accounting methods and monitoring equipment as the mandatory system—ensuring verified emission reductions are recognized in both markets.

Additionally, a linkage mechanism between compliance allowances and voluntary reductions should be developed, allowing enterprises to use surplus voluntary reductions to offset part of their future compliance obligations.

(Source: China Daily, October 15, 2025)