India's carbon credit trading scheme spins a maze of regulatory complexity

A complex and unwieldy regulatory and monitoring process could raise the costs for Indian companies

The carbon credit trading mechanism that India will roll out offers domestic companies a path to adjust to the European Carbon Adjustment Mechanism that has raised the bar for exports. The CBAM will begin with a transitional phase with effect from October this year for certain carbon-intensive goods such as cement, steel aluminium and fertilisers.

On June 28, the power ministry issued a notification announcing the Carbon Credit Trading Scheme (CCTS), 2023. Quoting an unnamed government official, S&P Global Commodity Insights said, “The actual trades of carbon credits on Indian exchanges are about 18 months away.”

This time lag is understandable because the government will need at least six months to write and clarify market codes and regulations.

In the enthusiasm to ensure the readiness of industry for CBAM, however, the power ministry has brought in complexity in the process that will likely make the cost of the carbon credit high for Indian companies.

Regulation is one opaque area. For one, there is no role for the market regulator, the Securities and Exchange Board of India (Sebi). Indeed, the power ministry and Sebi have spent more than ten years in a court battle about who gets to regulate the futures market in power. A Supreme Court in October 2021 decided that for power, the spot market with a limited physical forward delivery of up to eleven days would be regulated by the Central Electricity Regulatory Commission (CERC). Sebi would regulate the futures and option market.  

The Indian Carbon Credit Trading Framework, as the scheme will be officially known, acknowledges only one regulator: the CERC. Since, however, carbon credit is essentially a financial market, as defined by the Supreme Court order to be regulated by Sebi, this could become a point of concern.

It is these regulatory challenges that also colour the proposed structure of the market. The notification said direct oversight of the functioning of this market will be done by a National Steering Committee. This committee will comprise 18 ministries and departments, one of the largest such inter-ministerial oversight bodies ever set up in India.

The committee, with the secretary, power as the ex officio chairman, not only has powers of recommendation but also the powers to “monitor the functions of the Indian carbon market”. The committee is, thus, an executive agency to run the market.

It is under this committee that the Bureau of Energy Efficiency will operate as the market’s administrator. There will also be separate technical committees to develop compliance mechanisms. Registrations of market players will be handled by the Grid Controller of India; the CERC will run the market, under which will come the power exchanges where the trading will take place.

The power ministry will decide if the compliance systems are working fine including issuing notifications of greenhouse gas emissions intensity targets with the Ministry of Environment and Forests.

This is a maze where the chances of any company losing its way on compliance is high. The notification also does not absolve companies from their obligations under the mandatory greenhouse gas emissions rules. Buying a carbon credit from the market is just an additional option in the circumstances.

As reported by <i> Business Standard, <p> other than the power exchanges Indian Energy Exchange, Hindustan Power Exchange and Power Exchange India Limited, there are commodity markets such as NCDEX and MCX that are keen to set up these platforms for carbon trading. But the regulatory firewall created implies that approval as a Sebi-operated market does not necessarily qualify an exchange to trade in the new carbon credit market. It is probable that rules will be written to accommodate these entities, but it is difficult to ascertain who has the powers to do so.

Also, the market will conceivably need capital safeguards to guard against default risks. This, too, will be separate as the mechanism does not offer any migration passages to the platforms run by not only Sebi but also by the Reserve Bank of India such as access to linked products like those of currency derivatives, a key requirement to build financial volumes. The only handshake offered is through the presence of a joint secretary of the finance ministry in the national committee. There is no room for coordination built in at the lower rungs, including that of CERC.

“The level of complexity raises the risks that these will be loaded onto the price of the carbon credit to be traded in the market,” said Gaurav Bhatiani, Director, Energy and Environment, at RTI International, a global climate and policy advisory firm.

The S&P report notes that India is one of the world’s largest issuers of carbon credits. Between 2010 and 2022 India issued 278 million credits in the Voluntary Carbon Market, accounting for 17 per cent of global supply, according to a Greenhouse Gas Special Emissions report issued by the same agency in January this year. The numbers make it evident that the attraction to set up a large carbon trading market is high.

Under an earlier notification of 2021 the central government has brought in 11 sectors into the contours of a National Carbon Market. These sectors are petroleum refineries, cement, steel, chlor-alkali, aluminum, thermal power plants and fertilisers. They are supposed to be compliant with the greenhouse gas emission norms that are periodically revised by the environment ministry.

Any company falling short of the norms automatically searches for a carbon abatement certificate. Since those certificates were not available till now, companies had been asking the government to allow them to buy them in the trans-national voluntary carbon markets, especially of Europe, to comply with export norms

Finally, the Indian framework does not make clear if those global certificates will run parallel to the domestic ones in the new regime. Rohit Kumar, secretary general, Carbon Markets Association of India, has voiced this concern in a letter to the power ministry.

The other challenge, Bhatiani pointed out is that these certificates should be fungible, across platforms and possibly also across tenors. While financial markets love to divide certificates to derive more value, the carbon market is better off with a standard product. The notification is silent on this crucial aspect but market players expect uniformity both for offset and compliance.