Linking Cap-and-Trade Systems and Green Finance

Abstract

Summary: Linking of two or more cap-and-trade systems promises gains in cost effectiveness and signals a strong commitment to carbon policy. Linking is also seen as one possible way of converging from regional climate policy initiatives toward a global climate policy architecture. Moreover, linking may be used to direct investment into low-carbon technology – one form of green finance – to low-abatement cost locations. Two linked systems have been established recently, one in Europe and one in North America. However, linking also comes with challenges, such as increased exposure to shocks originating in other parts of the linked system and a greater need for policy coordination. We first consider the benefits and challenges of linking conceptually, including its incentives for green financial flows. We then present some of the main features of the European and North American linked systems and outline the process that led to their establishment. Finally, we consider preliminary evidence on the workings of each linked system. We conclude that from a green finance perspective linking should be viewed as a long-term option.