The Bank of Canada has published a discussion paper by Michael King, of its international department, on carbon markets and emissions trading, which calls for simplicity and transparency in the design of a system for Canada.

The paper provides an overview of carbon markets and explains how emissions trading can be important in encouraging the efficient reduction of carbon dioxide emissions. It also examines the steps required to establish a cap-and-trade system, and reviews the European experiences with emissions trading.

King highlights the lessons learned from the EU Emissions Trading System on how to design a market that operates efficiently and effectively. “By learning from the experience of other countries, Canada can avoid the uncertainty and volatility witnessed in carbon markets abroad while benefiting from an efficient trading mechanism that contributes to the welfare of all Canadians,” it suggests.

The paper suggests that an effective cap-and-trade scheme features: a regulated absolute cap to set a clear goal; an allocation of allowances that assigns responsibility to firms; a trading facility to allow cost-effective reductions; a monitoring and reporting system to ensure accountability; and a reconciliation with effective enforcement to ensure compliance.

“Thorny issues that need to be addressed include setting the level of the cap, allocating allowances across firms, setting rules for banking allowances, and linking with other schemes or allowing the use of project-based offsets,” it concludes. “Whatever choices are made, simplicity and transparency will ensure the most effective outcome.”