EU ETS Reform: Part III – Market Stability Reserve (MSR)

The MSR review criticized for not being “bold enough”

 

19 July 2021

The Market Stability Reserve (MSR) is a crucial instrument designed to remove from the market the historical surplus of allowances as well as newly created one due to the pandemic. The MSR was launched in 2019, replacing the backloading procedure (one-off removal) that was implemented between 2014-2016. In its first two years of operation, the MSR absorbed nearly 700 million allowances, representing 24% of the total number of allowances in circulation (TNAC).

According to the MSR Decision, the EU executive was required to conduct two assessments of its functioning, scheduled for 2021 and 2026. This year, the MSR review was integrated in the reform of other parameters of the EU ETS architecture such as a higher linear reduction factor of the overall cap or updated carbon leakage protection rules.

Currently, the MSR is designed to remove 24% of the surplus each year, if the TNAC exceeds 833 million allowances (upper threshold). This intake would have fallen to 12% from 2024. Under the EU Commission’s new proposals intended to tighten the EU ETS, the 24% intake rate would be kept until 2030. This time, the EU executive plans to address the “threshold effect” that could occur when the TNAC gets close to the upper threshold. “Uncertainty about this happening or not could create price volatility on the market and increase the risk of market abuse.”, says the proposal.

When the TNAC is between 833 -1096 million allowances, the intake will be calculated as the difference between the TNAC and the 833 million threshold. The normal 24% intake will apply only when the TNAC is above 1096 million allowances. According to the EU executive, “this addresses the threshold effect, all the while maintaining an efficient MSR intake if the TNAC is higher.”

Still, the MSR review has been criticized for not being bold enough. “Is far from addressing the market’s main issues, it barely adds a few patches and increases the risk of exceeding the cap”, said climate think tank Sandbag. Previous studies have recommended reducing the MSR thresholds: the low threshold from 400 million to zero and the upper threshold from 833 million to 100 million.