Policing carbon markets

Carbon markets have emerged in recent decades as one of the most important tools for curbing industrial greenhouse gas emissions, but they present a number of novel enforcement challenges when compared with more conventional pollution regulations. These challenges include new regulators with narrow authority, lack of legal precedent, and more.

This paper aims to shed light on the practical issues involved in policing carbon markets. The authors present the first comprehensive analysis of the EU Emissions Trading System, a single programme that has been policed by 31 different national regulators. They find generally high rates of compliance but these have occurred alongside low rates of enforcement, a pattern that is known as the ‘Harrington paradox’. Variation in the probability and severity of fines explain just one-tenth of the variation in compliance rates. Enforcement strategies besides fines, such as ‘naming and shaming’, appear to have had little discernible effect on compliance either.

Key points for decision-makers

  • As carbon markets begin to lower their emissions caps, the rising cost of compliance will contribute to making it more challenging to police these markets effectively.
  • The authors of this paper have investigated how regulators are tackling these challenges in practice, conducting the first comprehensive analysis of compliance and enforcement behaviour in the EU Emissions Trading System (ETS).
  • They find high rates of compliance in the EU ETS – the rate of non-compliance has been around 1–3%, depending on how it is measured. Meanwhile, the authors’ best estimate is that total fines did not exceed €2.1bn. This illustrates the Harrington paradox, whereby firms generally comply with environmental regulations despite enforcement being low and punishment for non-compliance being rare.
  • Expected fines explain only a small fraction, around one-tenth, of the variation in non-compliance rates. There was no compelling evidence found for the effectiveness of other regulatory tools such as naming and shaming offenders or using regulatory discretion to reduce the free emission allowances of offenders.
  • As carbon markets grow in scope and in ambition, the author conclude that we should be prepared for the possibility that the challenges involved in policing carbon markets will grow as well, and regulators may have to increase their enforcement of the rules.
  • The evaluation of different regulatory tools in this paper presents a contribution for policymakers and regulators to identify which strategies are more or less promising and can serve as a basis for further experimentation and reform.