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The EU Emission Trading Scheme

Aspects of Statehood, Regulation and Accounting

Series:

Stefan Veith

The emission trading scheme is the most recent instrument of the EU environmental policy. Its underlying mechanisms and economic consequences are yet less straightforward than policymakers initially had expected: As this study shows, the regulation probably yields unintended distributional effects and imposes additional risk on the regulated companies. Consequently, meaningful accounting for emission rights is not only a necessity for regulators and customers, who need transparency, but also for investors on capital markets, who bear the additional regulatory risk. This study empirically assesses the usefulness of various accounting alternatives and provides evidence that cost and fair value approaches dominate the widely used mixed models.

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1 Introduction 1

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.1 Motivation for the Research With the introduction of the emission trading scheme (ETS) in 2005, European emission regulation took a major step towards market-based solutions. The new scheme’s mechanisms are unlike the ones of traditional instruments like eco taxes, and regulatory bodies took some time to develop adequate rules, as two anecdotes highlight. At the inception of the programme the regulators (i. e. EU Member States and the EU Commission) had issued too generous a number of allowed emissions. The price for emission rights duly dropped to only some cents per tonne in early 2007. This issue of oversupply was fixed by 2008 when the legal framework was eventually changed. Another case of regulatory failure is the rise and fall of international accounting norms for emission trading schemes. After a first draft had been presented in 2003-05, its final version was adopted in 2004 by the competent standard setting organisation. By 2005-05, it became apparent that this rule set would not be endorsed to EU law, and it was finally withdrawn. Since then, the accounting community has been debating on how to appropriately map the economic incentives of an ETS in a financial re- port. Both anecdotes illustrate that the mechanisms of an emission trade are not as straightforward as the policymakers had expected. The main reason is that a trading scheme is a policy instrument rooted in neoclassical economics that by design relies on the market. Emission trade is not only set out to mitigate pollu- tion, but...

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