Implications of a Carbon Ratings Agency on the European Union Exchange Trading Scheme

Abstract: Carbon trading under the Kyoto Protocol expanded further through the EU Emissions Trading Scheme (EU ETS). The EU ETS is a cap and trade system where EU allowances are usable for complying with emission caps or sold to the market. The scheme is also linked to the UN carbon markets. This means the allowing of more permits to enter into the system. The EU ETS is designed to achieve the overall EU emissions reduction objective at comparatively lower costs. Despite the problems of over–allocation, the first phase from 2005 to 2007 managed to establish the development of various spot, futures, and options markets for the trading of EU allowances. The EU Commission has implemented measures to deal with the problem of over–allocation. Currently, The Carbon Rating Agency (TCRA) is launched to assist in the setting–up of a clearer relationship between carbon price and delivery risk to enable the carbon market to mature. This paper draws on insights of the more established but reasonably comparable credit rating agencies (CRAs) to assess implications of TCRA to the second phase development of the EU ETS.

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