Policy action

The EU remains the leader in carbon pricing, strengthened by recent announcements of a more ambitious reduction target for Emissions Trading Scheme (ETS) sectors of 62% by 2030, aided by the introduction of a new ETS covering buildings and road transport. Notably the scheme includes greenhouse gas (GHG), not just carbon, currently covering over 40% of the jurisdiction’s emissions, although this will soon be much higher.

In December 2022, the EU also announced the Carbon Border Adjustment Mechanism (CBAM), a historic policy breakthrough which targets imports of products in carbon-intensive industries and seeks to prevent carbon leakage. Despite backlash from trading partners, we see the CBAM as further incentive for these countries to adopt their own carbon pricing systems, inching the world towards a global carbon price. We keep EU’s ‘High’ rating unchanged, supported by carbon policy ambition and momentum.

Previously, we noted China’s encouraging path on the way to carbon pricing, as it launched its ETS, with plans to expand to seven further sectors beyond the power sector. Even without further expansion, the scheme is already the world’s largest, covering 40% of national emissions, according to International Carbon Action Partnership (ICAP). We keep China’s ‘Medium’ rating in this category unchanged.

The US has not seen much change on carbon pricing over the past year, but the Regional Greenhouse Gas Initiative (RGGI) timeline for potential joiners has been in flux, with Pennsylvania and North Carolina possibly joining soon. According to BloombergNEF (BNEF), Pennsylvania alone joining could expand the size of the US carbon market by 80%. Additionally, three other states have separate cap-and-trade programs planned for 2023. Moreover, in 2023 the US is expected to raise its official estimate of the Social Cost of Carbon, a measure of the economic damages caused by each ton of carbon pollution produced today, prompted by a recent estimate of 190 USD by the Environmental Protection Agency (EPA). Given that the government’s estimate is used in policy making, and alongside the various ETS expansions planned for 2023, we notch up the US rating on carbon pricing to ‘Low to Medium’, on grounds of encouraging policy momentum.

India keeps its ‘Low to Medium’ rating for now. Last year the trade of Energy Saving Certificates (ESCerts) under the existing Perform, Achieve and Trade (PAT) Mechanism, which does not explicitly target emissions reduction but does lay out a framework for carbon pricing, was halted due to poor demand. Since then, the Indian Bureau of Energy Efficiency presented a draft blueprint for the phased introduction of a national cap-and-trade scheme. In December 2022, an amendment to the 2001 Energy Conservation Act, establishing the legal basis for a voluntary carbon credit trading scheme, was passed through the Upper House of parliament, and therefore the provisions of the act have been in force since 1st January 2023. The focus now is on implementation.

For the political environment pillar, we keep EU’s ‘High’ rating due to accelerating momentum on climate action, catalysed by Russia’s war in Ukraine. The REPowerEU plan, put forward by the European Commission in May 2022, constitutes a step in the right direction. The plan includes a proposal to increase the share of renewables in final energy in 2030 from 40% to 45%. Within the EU, Germany and Spain stand out with their 2030 renewable electricity generation targets raised to 80% and 70%, respectively.

In China the central government published the 14th Five Year Plan for the energy sector, laying out a general direction – as well as specific tasks and goals – for the energy system for 2021-2025. At the 20th Party Congress, President Xi affirmed China’s net zero commitment, but emphasised a cautious approach to balancing its transition ambitions against the need for energy security. We maintain China’s ‘High’ rating on political environment but will be monitoring its policy direction, particularly with respect to coal.

In the US, the IRA was the most notable piece of climate-related legislation to date which supports its ‘Medium’ rating for policy environment.

India maintains its ‘Low’ rating as its coal capacity is likely to continue rising, aided by subsidies for both fossil fuels and renewable energy, including direct subsidies, fiscal incentives, price regulation and other government support. While coal subsidies in absolute terms have remained unchanged since 2017, they are still approximately 35% higher than subsidies for renewables.

The EU continues scoring ‘High’ in this category. The European Central Bank (ECB) remains at the forefront in mitigating climate risk, with its climate action plan covering corporate bond purchases, collateral framework, disclosure requirements and risk management. In 2022 the ECB carried out the climate stress testing exercise, assessing how prepared banks are for dealing with financial and economic shocks stemming from climate risk, and published a thematic review on a risk-based supervisory approach to climate change and environmental degradation.

In the US, we believe the green tax incentives within the IRA represent enough of a shift in policy to warrant an upgrade in US’s rating to ‘Medium to High’.

China keeps its ‘Medium’ rating, with its ‘1+N’ climate policy framework storing the potential for transformation, though more clarity and detail is required to understand its implementation scope and timeline. On the monetary policy front, the People’s Bank of China (PBoC) also continues making progress by exploring the role of monetary policy in encouraging financial institutions to support carbon emission reduction.

We stick to India’s ‘Low’ rating under the policy incentives pillar. The country has not announced any dedicated fund, though a plan to issue Sovereign Green Bonds is a part of the Union Budget 2022-23 announcement.

The EU keeps its ‘Medium to High’ rating. In addition to the ECB’s contribution to the NGFS framework, EU’s foreign policy agenda is increasingly integrating climate action into the assistance programme. The EU’s contribution for climate finance to developing economies amounts to 23.4 billion EUR to date.

Both China and US keep their ‘Low to Medium’ rating. Climate talks between the two countries resumed in late 2022, after being suspended for months amid tensions over trade, Taiwan and other security issues. While this is clearly a step in the right direction, uncertainty over the future path for negotiation and implementation remains high.

Finally, India keeps its ‘Low’ rating. In the run-up to COP27, India updated its 2030 Nationally Determined Contributions (NDC) targets and approved the plans to cut emissions intensity of its GDP by 45% by 2030. For its rating to rise, India has to show more ambitious policy action and evidence of implementation in coming years.