The Effectiveness of the MSR in Stabilizing EU ETS Market and Incentivizing Low-Carbon Investment

Abstract

The EU ETS introduced the Market Stability Reserve (MSR) in 2019, to balance out the surplus in its allowances, improve the market stability, and thus, restore its incentives for low-carbon investments. However, the effectiveness of the MSR is yet to be tested. Taking the Covid-19 pandemic as a social experiment, we prove that the MSR activated a stronger rebound in carbon price by boosting market expectations after the major demand shock, and thus stabilized the European carbon market. While sensitivity analysis shows trivial impact of MSR when no significant demand shock happens, which dispels the concerns about its disturbance of market stability. Noticing the close relationship between carbon price and green-stock indices, we infer that the presence of MSR improved the resilience of low-carbon investments to external shocks. The results prove the effectiveness of the MSR and justify the introduction of similar market stabilizing mechanisms in other emission trading schemes.

Keywords: Market Stability Reserve, EU ETS, Bayesian structural time-series model, Casual impact, Policy Evaluation