While rules and modalities on flexible mechanisms still need to be decided, governments and industry have begun to experiment with these new tools. In the EU, emissions trading between and within companies has currently attracted the most interest. Emissions trading is well suited to climate change policy as a means of translating national targets into sectoral and company targets. A less discussed advantage of emissions trading is that it becomes a way of focusing the attention of a company s management on climate change. Emissions trading is not a panacea, however, and both its efficiency and effectiveness will depend on how emissions trading schemes are implemented.
Governments face a number of difficult choices.
The allocation of permits is a prerequisite to trading. Grandfathering, i.e. each market participant receives permits on the basis of its previous emissions for free, has the advantage of not entailing net costs for market participants, which, by contrast, the auctioning of permits may have. Auctioning avoids possible incompatibilities with EU state aid rules, however, and benefits those that have taken early action or emit little. Industries that are already subject to a carbon tax might find auctioning the cheaper alternative. Grandfathering and auctioning can be combined, especially as a means to allow for new entrants.