European Union Emissions Trading System
A cap-and-trade system that fixes total emissions and lets the market discover their price, turning a constraint into a line in the accounts.
Directive 2003/87/EC, completed by a market stability reserve operating since January 1, 2019. The European carbon market sets a declining cap of allowances for covered installations and lets participants trade them. Coverage started with power generation, heavy industry and intra-European aviation; maritime transport has been added since 2024. By construction, abatement happens where it costs least. Yet the system's history is the correction of an initial flaw: for a decade, too many allowances, too freely handed out, and a price too low to weigh on any investment decision. The reserve now withdraws surpluses under an automatic rule, and it is what made the price meaningful. On the insurance side, insured industrial assets carry a transition risk, since their operating costs follow a volatile price. The registries, which have already suffered allowance theft, create a liability and fraud risk. A new class of insurable subject matter has also appeared: cover for surrender obligations when an installation is halted by an accident.
The emissions trading system established by Directive 2003/87/EC was completed by a market stability reserve operating since January 1, 2019, which withdraws surplus allowances from circulation under an automatic rule.
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