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How should Hong Kong prepare for the carbon exchange market?

The global carbon trading system developed rapidly in recent years. Although a unified market has not formed, countries are starting to develop a carbon trading system on a regional scale, adopting market-based practices. They are working together to fulfill emission reduction commitments and build linkages between various trading systems.

Facing the opportunities of the carbon trading market, the Green and Sustainable Finance Cross-Agency Steering Group recently published its preliminary feasibility assessment on the Hong Kong carbon market’s opportunities. The report supports Hong Kong to develop as a regional carbon trading centre.

What is a carbon trading market? What is its potential? If Hong Kong wants to develop as a carbon trading market, how should the city prepare for it?

We need to start with the basic concept of the carbon market. There are two types of carbon market, namely mandatory carbon market (i.e., emissions trading system, ETS) and voluntary carbon market (VCM).

The former has been incorporated into the carbon emissions trading system of various countries. In China, the government requires selected industries to perform mandatory emission reduction. This is called carbon emissions trading or mandatory carbon market.

The latter is to purchase carbon credits in the VCM, under the carbon credit mechanism, to achieve voluntary carbon targets set by enterprises.

Since its launch in mid-2021, the ETS system in the mainland has become the world’s largest emissions trading system, with a cumulative trading volume of over 800 million RMB. In the future, it will cover eight major industries, including power generation, petrochemical, chemical engineering, cement, steel, non-ferrous metals, paper and aviation building materials. About 8,000 to 10,000 enterprises will be regulated.

To achieve emission reduction targets, VCMs are an important complement for companies that wish to fulfill their corporate social responsibility. These companies reduce or offset their own carbon emissions from their business operations by purchasing carbon credits. This market has grown rapidly in recent years, with more companies around the world proposing net-zero emissions commitments with a timeline. In 2021, the trading volume of the global VCM exceeded US $1 billion for the first time, and the price of high-quality carbon credits often reaches US$30-50 per ton in the global market.

With reference to the forecast of the Taskforce on Scaling Voluntary Carbon Markets (TFVCM), the world needs to halve emissions from current levels by 2030 and become net-zero by 2050 to achieve the goals set in the Paris Agreement. This means that as compared to 2020, the market size needs to increase by 15 times by 2030 and expand by 100 times by 2050 to reach the target.

Therefore, Hong Kong should focus on the business opportunities of the voluntary carbon market. We are a leader in financial and professional services within the region, and we have advantages in linking domestic carbon assets and global capital. We can definitely take advantage of our professional knowledge, industry experience, and resource integration capabilities to develop tradable carbon credits and derivative financial products, together with transaction methods and regulatory mechanisms. This helps to guide global funds participate in regional and national low-carbon economic transformation.

In terms of mechanism design, it could be a good start to solve market pain points. At present, carbon trading in various countries face almost similar problems. Firstly, carbon trading is not market-oriented, and the circulation of carbon credits is not strong enough. Secondly, many companies that are in need cannot easily participate in carbon trading, and the cost of obtaining genuine information is comparatively high. Thirdly, there is no unified standard on carbon credits, and information asymmetry often exists between supply and price. Fourthly, the transaction process is not transparent and the procedures are complicated.

Hong Kong has the unique advantage of talents to perform well in the development of a carbon trading market, but it requires collaboration among government departments and professionals. Experts in the financial sector are needed to design a mechanism for increasing bankability and liquidity of carbon credits. Besides, experts in environmental protection and low-carbon technology are needed to develop methodologies on how to verify and audit carbon credits, based on the supply and demand potential of various industries.

In addition, experts in digital technology such as blockchain technology are needed. For instance, to utilize the industrial Internet of Things to grasp the generation of carbon credits automatically, and to ensure correct carbon credit data flow to the market. Lastly and most importantly, the design of the carbon credit trading market, such as the tradable carbon credit standards, transaction products and a convenient trading mechanism.

Carbon trading is an emerging industry and a new growth point of financial innovation in the world. We suggest conducting a pilot in the Greater Bay Area first. It is a good time to gather experts in their respective expertise to explore a feasible path for Hong Kong in accelerating its transformation towards digital economy and low-carbon economy, serving as a key feature of green and sustainable finance.

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