The Australian government has stated that cutting greenhouse gas emissions is the best way to limit climate change impacts and keep the economy competitive in a world moving toward cleaner energy. Yet, last year, Australia’s biggest industrial polluter received millions in carbon credits despite rising emissions, sparking calls for changes to the safeguard mechanism, the government policy applied to the country’s 219 largest industrial climate polluting facilities.

Emissions trading, also known as ‘cap and trade,’ is one regulatory tool for reducing greenhouse gas emissions across industries. It has been implemented in several countries, including the EU, through Programs like the European Union Emissions Trading System (EU ETS). Australia does not currently have a broad-based emissions trading scheme (ETS). But emission permits regulation doesn't just apply to climate policy, it’s also relevant to other environmental policies, such as policies curbing SO2 or wastewater.

A new paper, Designing Emission Permits Regulation for Multiple Compliance Periods, led by Dr Xingyu Fu, Lecturer in the School of Marketing at UNSW Business School, examines how emission permits can be designed across multiple compliance periods. Specifically, the study looks at how regulators can use flexibility effectively so these policies deliver real environmental and economic benefits.  

“Australia does not have a full economy-wide ETS. Still, mechanisms such as the Safeguard Mechanism for large greenhouse gas emitters and the Hunter River Salinity Trading Scheme in NSW, regulating water salinity, show that tradable emission permits approaches are already part of the Australian regulatory toolkit," said Dr Fu. “The paper's insights on how inter-temporal compliance flexibility in such schemes shapes production, competition, and environmental outcomes are therefore directly relevant for Australian policy design and business practice across different pollutants.” 

More broadly, Dr Fu said his research studies how to design cap-and-trade-style emission permits regulatory systems when firms comply over multiple periods, and when regulators can allow or restrict intertemporal compliance flexibility (for example, banking/borrowing of emission permits across periods, long/short compliance periods for emission permits).

The trade-offs in designing permits 

Governments issue emissions permits (or allowances), which give companies the right to release a set amount of greenhouse gases – typically one tonne of CO₂ equivalent. These permits form the backbone of compliance markets. Dr Fu’s research challenges a common policy assumption: “Neither fully flexible (e.g., unlimited banking/borrowing) nor fully non-flexible designs are generally welfare-optimal,” he said.

The paper, published in Manufacturing & Service Operations Management, found that giving companies too much or too little flexibility in how they use permits is rarely effective. A balanced, middle-ground approach can deliver better results for both the environment and the economy – even if it makes business competition more intense.

Learn more: How a new carbon accounting system helps reduce emissions

He explains why: “This result comes from the trade-off between compliance flexibility's industrial benefits (smoother production) against its environmental costs (intertemporal shifting of pollution to other periods, overwhelming nature's short-term self-cleaning absorptive capacity).” 

Instead, the study found that partial-flexibility regulatory tools – such as transfer caps/discounts, one-way transfer, or permits (tax hybrid policy) – can outperform both extreme policies. For businesses, this balance can also have unexpected effects: “Compliance flexibility in emission permits can sometimes intensify competition and reduce aggregate industry profits," said Dr Fu.

Why regulators need a new playbook 

So why focus on compliance periods and flexibility? “Among the various design features of emission permits, temporal flexibility in compliance is a critical consideration. Regulators influence temporal flexibility by specifying different compliance period lengths or by allowing or prohibiting inter-temporal transfer of permits," Dr Fu explained.

"Inter-temporal transfer, also known as inter-temporal banking and borrowing, enables firms to save unused permits for future use or draw on future allocations to meet current needs. Extended compliance periods provide firms with greater flexibility to reduce emissions when it is most cost-efficient.” 

Design choices vary worldwide. For example: 

• The Regional Greenhouse Gas Initiative in the US uses a three-year compliance period. 
• The Tokyo ETS applies a five-year period. 
• The Acid Rain Program allows banking and borrowing for sulphur dioxide permits, but restricts it for nitrogen oxide permits. 
• The EU ETS initially banned transfers between periods in Phase 1 but allowed them in Phase 2. 

“We want to give regulators a design playbook for the degree of temporal flexibility – how much to allow, and in what form – so that policy can match the volatility and environmental stakes of a particular setting,” said Dr Fu. 

Practical guidance for climate policy and business strategy 

The study’s insights offer clear, practical guidance for both policymakers and business leaders in carbon markets. “Avoid the extremes," Dr Fu recommended. 

"Defaulting to fully flexible or rigid regulatory designs is rarely optimal from a social welfare point of view. Start from partial-flexible policy instruments (for example, transfer caps/discounts; permits–tax hybrid policy) and tune them. Match compliance flexibility to context. When environmental damages of the emissions are severe or underlying market volatility is high, restrict temporal flexibility; otherwise, allow more.” 

And for businesses, he noted that more compliance flexibility in environmental policy can intensify market competition.

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Emission permits and climate policy FAQ

Q1. What is emission permits regulation?
Emission permits regulation is a policy tool where governments issue allowances giving firms the right to emit a specified amount of pollutants.

Q2. How does compliance flexibility affect emission permits?
Compliance flexibility allows firms to bank or borrow permits across compliance periods, balancing economic efficiency with environmental impact.

Q3. Does Australia have an emissions trading scheme?
Australia does not have a full economy-wide ETS, but policies like the Safeguard Mechanism and Hunter River Salinity Trading Scheme use permit-based regulation.

Q4. Why is partial flexibility better than full flexibility in emission permits?
Research shows that partial flexibility avoids the downsides of both extreme rigidity and unlimited flexibility, improving overall welfare.

Q5. What are examples of emission permits systems worldwide?
Examples include the EU ETS, Regional Greenhouse Gas Initiative in the US, Tokyo ETS, and the Acid Rain Program for sulphur dioxide in the US.