Emissions trading systems (ETS) are increasingly being introduced as a way of cost-effectively reducing greenhouse gas emissions to meet ambitious national climate change targets, including Nationally Determined Contributions and net-zero long-term goals under the Paris Agreement. A key concern for governments and industry, however, is how to protect industry’s global competitiveness and prevent “carbon leakage”, that is, the transfer of production to world regions with less ambitious climate policies that would lead to an increase in total emissions. To address this concern, ETS allowances are typically allocated for free to greenhouse gas (GHG)-intensive or trade-intensive industries at risk of carbon leakage.

The type of free allocation design is important because it directly impacts on the financial performance of companies. It also determines how companies are rewarded. Those that have invested more in GHG reduction technologies will be rewarded better under a benchmark (BM)-based allocation approach, where allocation is based on the level of production multiplied by an emissions intensity benchmark. Those that have invested less in such technologies will be rewarded better under a grandfathered approach, where allocation is based on historic emissions. However, while BM-based allocation is generally regarded as a fairer method, it is also considered more difficult to design and implement.

This Asia Society Policy Institute issue paper, Developing Effective Benchmark-Based Allocation for Industrial Sectors: The Case of the Korean ETS, shows how BM-based allocation has been successfully implemented for some of Korea’s most important industrial sectors, steel and petrochemicals. It provides valuable insights and recommendations for other countries to develop an effective allocation system in a timely and efficient way.