Emissions

Emitters can use futures when they want to fix the cost of the allowances they surrender each year.

The underlying: allowances and credits

What is traded in emissions markets falls into two kinds, depending on the system. An emission allowance is a permit to emit that a system with an upper limit (a cap) on emissions grants to businesses. A system that hands out allowances under an overall cap and lets them be traded is called cap and trade. In the EU system, one allowance corresponds to one tonne of emissions, measured as carbon dioxide equivalent¹. The allowances under Japan's Act on the Promotion of Smooth Transition to a Decarbonized Growth-Oriented Economic Structure (the "GX Promotion Act" below) are also permits written in units that each represent one tonne of carbon dioxide².

A credit is issued when actual emissions come in below an expected level of emissions (the baseline), and the difference is verified through monitoring and certified. A Financial Services Agency (FSA) study group document says there is no single definition of a carbon credit. It calls this form "baseline and credit," and calls the form that sets a cap on each company's emissions and trades the difference from actual emissions "cap and trade"³. Credits that are not necessarily based on a national scheme and are meant for companies to use voluntarily are called voluntary credits³. Japan's J-Credit is an example of baseline and credit, and it can be traded on the Carbon Credit Market of the Tokyo Stock Exchange⁴.

Here "emissions" covers both allowances and credits. A permit granted by a system is called an allowance, and a certified record of reductions is called a credit.

The two are also treated differently in law. A draft report of the International Organization of Securities Commissions (IOSCO), which the FSA document introduces, summarizes that under EU law allowances are financial instruments and voluntary credits are not. It adds that derivatives are normally subject to supervision by financial authorities⁵.

The system: cap, allocation, and surrender

The EU Emissions Trading System (EU ETS) began in 2005 and is now in its fourth phase, from 2021 to 2030. It covers power and heat generation, industrial manufacturing, and aviation, with shipping added from 2024, and together these account for about 40% of the EU's greenhouse gas emissions¹. The overall cap is lowered every year, and allowances are sold mainly at auction, with some handed out free of charge. From 2021, 57% of the total is in principle auctioned⁶.

Each year, businesses monitor and report their emissions and surrender allowances equal to them. Failing to comply brings heavy fines. Allowances can be traded among businesses, and a business with a surplus can sell it or hold it for the future¹.

Since 2013, power generators have been required to buy, in principle, all the allowances they need for generation. Some member states have exceptions⁷.

Under Japan's GX Promotion Act, an emitter above a set size notifies its emissions target, and when the notification is found appropriate, it is allocated allowances free of charge. The business reports its actual emissions in the following fiscal year, holds the notified quantity of allowances in its account on January 31 of that fiscal year, and that quantity is then retired (the allowances are extinguished by reducing the account record)⁸. For power generation, allowances will be allocated with or without charge from fiscal 2033⁹.

Forms of trading: auctions, futures, and options

EU allowances have different markets and specifications for each form of trading. EEX has held auctions of allowances sold by member states and others on its spot market since 2010, with delivery on the day after the trade and allowances and payment exchanged at the same time¹⁰. For futures, ICE Endex lists EUA futures. One contract is 1,000 allowances and is settled by delivery, with the allowances themselves delivered at expiry¹¹. The product guides of EEX and ICE Endex also include options on EU allowances¹².

Japan's spot market trades the underlying itself, not futures. This market is separate from the markets for listed financial instruments such as shares, only limit orders are accepted, and the trading unit is 1 tonne¹³. The underlyings in the table are J-Credits and excess reduction allowances. An excess reduction allowance is defined in the GX League rules set by the GX League secretariat, and only GX League representative participating companies that can open a credit account for excess reduction allowances may trade them¹⁴. Allowances under the GX Promotion Act do not appear in the underlying column of that material.

The GX Promotion Act provides that allowances must not be made the subject of speculative trading¹⁵, but that provision covers trading in the allowances themselves, and the text does not say whether derivatives on Japanese allowances are permitted.

Fixing the cost of allowances with futures

An emitter can fix the future cost of buying the allowances it is short of by buying futures, which hedges the cost. The general mechanics of futures are covered in Overview of Commodity Derivatives.

Consider a hypothetical example in which fees and interest on margin are ignored. Company X, which owns a facility covered by the EU system, expects to be short of 10,000 allowances (10,000 tonnes) against its emissions a year from now, and buys 10 contracts of the EUA future for the expiry month at 80 euros per tonne (1,000 allowances per contract). The example counts the total of payments and receipts from the trade to delivery, including the daily differences from mark-to-market. Daily mark-to-market and margin on futures are covered in Futures Margin and Daily Settlement.

Figure description

This is the profit or loss at expiry on buying one tonne of an EUA future. Around the agreed price, it is a gain if the final settlement price is higher and a loss if it is lower. The vertical axis is per tonne; for 10,000 tonnes it gives the cash flows of the future in the table below.

The results when the final settlement price is 100 euros, 80 euros, or 60 euros per tonne are as follows.

If the market price rises to 100 euros, the future pays (100 − 80) × 10,000 = 200,000 euros, which nets against the 1.0 million euros for buying in the market to give 0.8 million euros. If it falls to 60 euros, the future costs 200,000 euros, which together with the 0.6 million euros for buying in the market makes 0.8 million euros. In both cases the cost is fixed at 80 euros per tonne. When the price falls, the cost would have been 0.6 million euros without the future, so the 200,000-euro difference is the burden of having bought the future.

This example shows the result when the expected emissions and the quantity bought are exactly the same. If actual emissions are lower than expected, the surplus allowances are sold in the market or carried forward, and the gain or loss on them is set by the market price.

Price risk and changes to the system

Futures carry risks other than changes in the market price. As in Company X's example, if the quantity bought differs from the quantity actually needed, the difference is exposed to the market price. A buyer of futures who holds to expiry is obliged to receive the allowances and pay for them, so it also needs to have an account ready to receive the allowances.

When thinking about allowance prices, changes to the system also affect allowance prices, alongside market supply and demand. EU material explains that a falling cap signals to businesses the long-term scarcity of allowances¹. A growing surplus of allowances pushes prices down, and the Market Stability Reserve (MSR) is a mechanism to reduce it¹⁷.

In the EU, in the first phase from 2005 to 2007, the cap was set by estimates without reliable emissions data, so more allowances were handed out than were emitted, and the allowance price fell to zero in 2007. First-phase allowances could not be carried over into the second phase¹⁸. After that, too, emissions falling below expectations after the 2008 economic crisis and the large inflow of international credits caused a surplus of allowances to build up from 2009. The EU set up the MSR in 2018 and began operating it in 2019. When the total number of allowances in circulation exceeds 1,096 million, the MSR removes allowances from auctions to reduce supply¹⁷.

As a recent change to the system, the 2023 revision lowered the EU cap to a level equal to a 62% reduction from 2005 by 2030, and reduced free allocation¹. On July 17, 2026, the European Commission put forward a proposal to review the EU ETS Directive¹⁹. A review of rules such as the cap bears on the premises of allowance prices.

Delivery in practice and records

For ICE Endex EUA futures, the last trading day is the last Monday of the contract month. However, if that Monday is a UK bank holiday, or if there is a UK bank holiday in the following 4 days, it is the second-to-last Monday of the delivery month. A clearing member with an open position on the last trading day is obliged to deliver allowances to a Trading Account or to receive them from it. The delivery period runs from 9:00 a.m. (London time) on the business day after the last trading day to 3:00 p.m. on the third business day¹¹.

Records of allowances are kept in a registry in the EU, and under Japan's GX Promotion Act the record in the allowance account book determines who holds an allowance¹²⁰.

What this page does not cover

Futures and options on Japanese allowances or J-Credits, and the specifications of EU options, are not covered on this page.

Notes

1. European Commission, "About the EU ETS," under "What is the EU ETS?" "How does the EU ETS work?," and "Key changes agreed in the 2023 revision of the ETS Directive," among others. Checked on October 4, 2026. ↩ ↩² ↩³ ↩⁴ ↩⁵ ↩⁶

2. Act on the Promotion of Smooth Transition to a Decarbonized Growth-Oriented Economic Structure (in Japanese), Article 32, paragraph 1 (definition of decarbonization growth investment operator allowances). The text checked on e-Gov on October 4, 2026, which includes the amendment in force from April 1, 2026. ↩

3. Financial Services Agency, "Study Group on Financial Infrastructure for Carbon Credit Trading (1st meeting), Secretariat material" (June 10, 2024; the title is rendered here in English by the writer, and the original is in Japanese), page 4, "About carbon credits" (an excerpt from the Ministry of Economy, Trade and Industry's "Summary of the Carbon Credit Report"). The material describes voluntary credits as "not necessarily based on a national scheme, etc., and meant for voluntary use by companies, etc." ↩ ↩²

4. The same material, page 5, "Main examples in Japan and abroad." ↩

5. The same material, page 22, summary of the IOSCO draft report, the item on the nature of carbon credits as traded instruments. ↩

6. European Commission, "Auctioning of allowances," under "Questions and Answers: Auctioning" (57% of the total auctioned in principle from 2021). ↩

7. European Commission, "Free allocation," under "Allocation to modernise the energy sector." ↩

8. The same Act as above, Article 33, paragraph 1 (notification), Article 34, paragraphs 1 and 3 (free allocation and recording in the account), Article 35, paragraph 1 (report of actual emissions), Article 36, paragraph 3 (holding on January 31 of that fiscal year), and Article 37, paragraph 1 (retirement). ↩

9. The same Act, Article 27, paragraph 1. The text writes "Reiwa 15" in the Japanese era calendar, which is fiscal 2033. ↩

10. European Energy Exchange AG, "EU ETS1 Auctions," overview and the table "EU ETS1 Auctions at EEX" (Delivery day t+1, Minimum lot size 500 EUAs, Fulfilment Delivery versus payment). ↩ ↩²

11. ICE Endex, "EUA Futures," Product Spec (Contract Size, Last Trading Day, Settlement Method, Delivery Terms, Delivery Period, Delivery Delay, Delivery Failure). ↩ ↩² ↩³ ↩⁴

12. The product list on the EEX site ("EU ETS1 Spot, Futures & Options") and "View Options" on ICE's EUA futures page. ↩

13. Japan Exchange Group, "Outline of the system (Carbon Credit Market)" (in Japanese; the title is rendered here in English by the writer), the background and the table "Outline of the market system" (underlying, settlement date, order types, trading unit, settlement method). Checked on October 4, 2026. ↩

14. Tokyo Stock Exchange, "Overview of the Carbon Credit Market" (August 2025, 5th edition; the original is in Japanese), the table "Outline of the system (excess reduction allowances)" (participants) and the glossary table (definition of excess reduction allowance). Checked on October 4, 2026. ↩

15. The same Act, Article 38, paragraphs 1 and 2 (trading, ban on speculative trading). ↩

16. European Commission, "Auctioning of allowances," under "Who can bid in the auctions?" ↩

17. European Commission, "Market Stability Reserve," under "About the Market Stability Reserve (MSR)" and "How does the MSR work?" (surplus since 2009, establishment in 2018 and start of operation in 2019, and removal from auctions when TNAC exceeds 1,096 million). ↩ ↩²

18. European Commission, "About the EU ETS," the description of "Phase 1" (2005 to 2007). ↩

19. European Commission, "About the EU ETS," the notice at the top of the page (July 17, 2026 proposal to review the Directive). Checked on October 4, 2026. ↩

20. The same Act, Article 46 (who holds an allowance is determined by the record in the allowance account book). ↩