The Enforcement Gap – Why India's Carbon Market Will Succeed or Fail Based on Incentives and Oversight
Introduction: The Architecture of a Carbon Market
Carbon markets are only as effective as the institutions that enforce them. Across the world, emissions trading systems (ETSs) have often faltered not because their economic logic was flawed, but because the conditions required for that logic to function—credible enforcement, meaningful price signals, and robust monitoring—were absent.
India is launching its Carbon Credit Trading Scheme (CCTS) against this backdrop. The ICM Portal went live in March 2026, initiating the formal transition from the Perform, Achieve and Trade (PAT) scheme to the CCTS. That transition carries baggage. PAT's decade-long record was marked by limited emissions reductions, persistent non-compliance, and a price discovery mechanism that functioned poorly.
Once fully notified, the CCTS will cover some 740 entities and more than 700 million tonnes of CO₂e, making it one of the world's largest emissions trading systems. The stakes are correspondingly high. Amidst mounting climate stress and geopolitical tensions, the question is whether the CCTS's design is sufficient to address the two deficiencies that have historically weakened carbon markets: inadequate economic incentives and weak external enforcement.
This guide examines the enforcement gap in India's carbon market, drawing on global experience, India's own PAT legacy, and the latest analyses from institutions such as the Observer Research Foundation (ORF) and the Institute for Energy Economics and Financial Analysis (IEEFA).
The Global Precedent: Why Enforcement Matters
Across the world, carbon markets have struggled with a recurring set of problems: oversupply, weak penalties, unambitious targets, and institutional fragility. These have undermined schemes from Brussels to Beijing.
The EU ETS Experience
The European Union Emissions Trading System (EU ETS) — the world's oldest and largest carbon market — spent its first decade plagued by oversupply and weak price signals. Prices crashed to near-zero in the early years, providing little incentive for industries to invest in decarbonisation.
The recovery came only after structural reforms, notably the Market Stability Reserve (MSR) , which replaced ad-hoc interventions with automatic supply correction. This reform took years to implement, during which time billions of euros of abatement opportunities were foregone.
The Lesson for India
The lesson is clear: market depth and price signals depend first on whether targets create genuine compliance pressure, and then on whether that pressure is consistently maintained. Without credible enforcement, even the best-designed market architecture will fail to deliver meaningful emissions reductions.
What Makes Enforcement Credible?
| Element | Why It Matters |
|---|---|
| Independent regulator | Prevents political interference and ensures consistent enforcement |
| Meaningful penalties | Makes non-compliance more expensive than compliance |
| Transparent price discovery | Enables participants to judge return on investment |
| Robust MRV | Ensures emissions reductions are real and verifiable |
| Ambitious targets | Creates genuine scarcity |
The PAT Legacy: A Warning from India's Own Experience
The Perform, Achieve and Trade (PAT) scheme was India's mandatory energy efficiency program covering more than 1,000 entities from 13 energy-intensive sectors. It operated for over a decade and was an important step in building market experience.
PAT's Compliance Record
The PAT scheme's compliance record did not collapse suddenly. It deteriorated because firms responded rationally to what they observed: delays, concessions, and the absence of action.
| Metric | PAT Cycle I | PAT Cycle II |
|---|---|---|
| Non-compliance rate | 9% | ~56% |
| Designated Consumers (DCs) unregistered | — | 86% of mandated ESCert purchasers |
| ESCerts purchased | — | Sold at floor price due to oversupply |
The ESCerts for PAT II, which should have been issued by December 2019, were only issued in August 2021, and trading did not conclude until October 2023. Nearly two years of slippage on a three-year compliance cycle.
The Deterioration
These procedural pushbacks signalled that compliance was a future problem rather than a current concern. This deterioration deepened when the non-complying DCs from the first two cycles were allowed to trade in the third cycle, effectively rendering even future consequences non-existent.
Cumulatively, 34 lakh out of 52 lakh ESCerts mandated for purchase at the end of all three cycles were left unattended.
The Baggage of Transition
The entities entering the CCTS are the same ones that operated under PAT, yet they have little reason to believe that the rules have fundamentally changed. The ORF analysis concludes that whether the CCTS inherits PAT's systemic gaps depends on three things that the design alone cannot guarantee: enforcement, verification, and price.
The CCTS Design: What Has Changed
The Institutional Framework
The CCTS operates through a three-tier institutional structure:
| Institution | Role |
|---|---|
| Bureau of Energy Efficiency (BEE) | Administrator—designs procedures, manages registration, oversees transfers |
| Grid Controller of India | Registry—maintains electronic accounts, tracks CCCs |
| Central Electricity Regulatory Commission (CERC) | Regulator—sets price bands, oversees market operations |
The Intensity-Based Design
The CCTS adopts an intensity-based approach — linking emissions targets to output rather than imposing absolute caps. This reflects India's development priorities and industrial growth trajectory.
As the IEEFA notes, "India's CCTS reflects a pragmatic approach to carbon market design. It accommodates industrial growth while building on existing institutional capabilities".
The Offset Mechanism
The CCTS includes an offset mechanism that allows non-obligated entities to participate voluntarily, generating credits from projects in renewable energy, forestry, waste management, and other sectors.
The Banking Provision
The CCTS allows unlimited banking of CCCs across compliance cycles, offering flexibility to manage production volatility and cost uncertainties. Borrowing is not allowed.
The Price Band
The government has proposed a price band to contain price fluctuations and provide market stability. The CERC CCC Regulations, 2026, notified on February 27, 2026, established the operational framework for the exchange of CCCs.
The Weak Penalty Problem: 0.6% to 7% of Profits
The CRH Analysis
A critical evaluation of emissions reduction targets by Climate Risk Horizons (CRH), a research organisation, has deemed the targets "modest and unambitious" — unlikely to drive changes in operations that would reduce emissions substantially.
The analysis warns that the cost of purchasing credits for major companies in the steel, aluminium, and cement sectors is between 0.6% and 7% of profits, assuming credit prices are $10 per tonne of carbon dioxide equivalent.
The Sectoral Breakdown
| Sector | Compliance Cost as % of Profits |
|---|---|
| Steel | 7% |
| Cement | 2% |
| Aluminium | 0.6% |
The "Pay to Pollute" Strategy
"For many high-margin polluters, 'paying to pollute' could become a preferred business strategy," said Anirudh, author of the CRH report.
This is precisely the outcome that carbon markets are designed to prevent. If it is cheaper to buy credits than to reduce emissions, the market fails its primary purpose.
The Modest Targets
India's greenhouse gas reduction targets under its carbon market are too modest to drive major industrial decarbonisation, allowing companies to meet targets through incremental efficiency gains.
For the steel sector, the 255 steel and iron companies obligated to meet targets are required to reduce their emissions intensity by 6% by 2026-2027 , achievable through "incremental improvements in process efficiency."
The Oversupply Risk: Too Many Credits, Too Little Scarcity
The Problem
The CRH analysis finds that in addition to the targets being "readily achievable," over the two-year compliance period, the cost of non-compliance is too low to incentivise the kind of systematic operational changes needed to drastically reduce greenhouse gas emissions.
The Oversupply Mechanism
When targets are modest and penalties are weak:
- Companies can easily meet their targets through incremental improvements
- Few companies need to purchase credits
- Credits accumulate, creating a surplus
- Surplus depresses prices
- Low prices reduce the incentive to invest in deeper reductions
The IEEFA Warning
Indefinite banking, though designed to offer flexibility and cost management, can create large credit surpluses under modest early targets, weakening carbon prices. Global experience shows that markets without early stability mechanisms face prolonged periods of ineffective price discovery.
The Banking Problem
The CCTS allows entities to bank surplus CCCs across compliance cycles. While this offers flexibility to manage production volatility and cost uncertainties, unlimited banking can also lead to surplus accumulation that depresses prices. Banking credits indefinitely and setting modest early targets may create credit surpluses that undermine price signals and investor certainty.
The Result
The market becomes a "business-as-usual" mechanism rather than a driver of industrial transformation.
The Missing Regulator: An Institutional Gap
The ORF Analysis
A study by the Observer Research Foundation (ORF) identifies a critical gap in the CCTS design: the absence of an independent regulator.
The Enforcement Challenge
The ORF analysis notes that across the world, emissions trading systems have often faltered because the conditions required for their economic logic to function—credible enforcement, meaningful price signals, and robust monitoring—were absent.
What Is Missing
India's CCTS, despite its promising architecture, faces similar risks. The institutions responsible for enforcement—BEE, Grid-India, and CERC—have overlapping but incomplete mandates. None is explicitly designed as an independent carbon market regulator with the authority to:
- Set and adjust targets independently
- Impose meaningful penalties for non-compliance
- Investigate market manipulation
- Ensure transparent governance
The Call for an Independent Regulator
Researchers recommend an independent regulator to ensure transparent governance and accelerate investment in low-carbon technologies. Without it, the CCTS risks repeating the enforcement failures of PAT and other predecessor schemes.
The Transparency Gap
Transparency is essential for market confidence. Only with knowledge of carbon prices can participants judge the return on investment to reduce emissions. In the first year of ICM, emissions for compliance purposes were measured over FY26, with trading to take place only late in 2026, by which time emissions will have been set in stone.
The Power Sector Omission: 55% of Emissions Left Out
The Scale of the Gap
The power sector accounts for roughly 40-55% of India's GHG emissions and sits outside the initial CCTS compliance boundary. Its exclusion simplifies implementation while recognising the complexities of electricity market regulation.
Why This Matters
| Effect | Implication |
|---|---|
| Largest emitter excluded | Single biggest source of emissions not covered |
| Weakened price signal | Reduced demand for credits |
| Incomplete market | Missing the primary channel through which carbon pricing shapes energy investment |
| Competitive distortion | Power sector faces no carbon compliance costs |
The IEEFA's Warning
In other carbon markets, power utilities are among the most active participants, and fuel-switching dynamics between coal and gas are among the strongest drivers of carbon price movements. Their initial absence will concentrate compliance demand among industrial firms whose trading may cluster around settlement deadlines.
Without a credible integration roadmap, the CCTS will lack the primary channel through which carbon pricing shapes energy investment.
The Ex-Post Issuance Problem: Trading After the Fact
What Is Ex-Post Issuance?
Under the CCTS, credits are issued only after verified performance against facility-level benchmarks. This means tradable supply enters the market with a lag — after compliance periods have ended, not before they begin.
The Problem
| Issue | Impact |
|---|---|
| Supply lag | Credits aren't available when firms need them |
| Banking behaviour | Firms may hold credits rather than selling them |
| Verification timelines | Delays in verification create supply uncertainty |
| Willingness to sell | Firms may be reluctant to sell surplus credits |
The Result
Early-stage market dynamics in any emissions trading system tend to reflect a period of learning, and India's CCTS is likely to be similar. Factors such as ex-post credit issuance, the gradual development of trading participation, and the capital-intensive nature of industrial abatement suggest that liquidity and price discovery will evolve over successive compliance cycles.
The Impact on Price Discovery
The market may struggle to generate continuous price discovery, which is essential for long-term investment decisions. Communicating clear long-term targets and having a predictable path for benchmark changes are particularly important as industrial investment decisions often span 15–30 years and require confidence in the durability of the price signal.
The Role of Banking: A Double-Edged Sword
The Banking Provision
The CCTS allows entities to bank surplus CCCs across compliance cycles, offering flexibility to manage production volatility and cost uncertainties.
What Banking Enables
| Benefit | Description |
|---|---|
| Production volatility management | Firms can smooth compliance costs across cycles |
| Cost uncertainty mitigation | Firms can bank credits when prices are low |
| Intertemporal arbitrage | Firms can sell credits when prices are high |
The Risk
Unlimited banking can also lead to:
- Surplus accumulation that depresses prices
- Price suppression as firms hold credits off the market
- Delayed price discovery as banking creates a lag between compliance and trading
The IEEFA's Warning
Banking, a valuable flexibility tool, lets companies manage compliance costs over time and rewards early action. Yet, when combined with modest early targets, large surpluses can build up, meeting future compliance obligations without requiring new investment and dampening prices.
The No-Borrowing Rule
The CCTS does not allow borrowing. This means entities cannot borrow CCCs to meet current compliance obligations, which reinforces the importance of banking as the only intertemporal flexibility mechanism.
The IEEFA and ORF Analyses: A Consensus on Enforcement
The IEEFA Framework
The IEEFA has examined how benchmark calibration, power sector sequencing, and companion policy coordination will shape price formation in the CCTS. The analysis is structured around four interconnected themes:
- Financial market participation: When and how financial intermediaries can be brought into the market
- The design choices India faces in responding to border carbon costs (CBAM)
- Sectoral expansion including the implications of incorporating the power sector
- Managing offsets and Article 6 opportunities
The ORF Analysis
The ORF analysis poses three critical research questions:
- In what ways have inadequate economic incentives and weak enforcement emerged as recurring challenges in emissions trading systems globally?
- What design choices has India incorporated into the CCTS to address these challenges?
- Are these design choices adequate to overcome them?
The Emerging Consensus
Both analyses point to a common conclusion: the CCTS's success depends on credible stringency, robust MRV, and genuine enforcement.
The Window of Opportunity
As the IEEFA notes, communicating clear long-term targets and having a predictable path for benchmark changes are particularly important as industrial investment decisions often span 15–30 years and require confidence in the durability of the price signal.
The Path Forward: What Needs to Change
Recommendation 1: Strengthen Targets
The current targets are "modest and unambitious." Future compliance cycles need emission targets that strongly signal towards preventing long-term carbon lock-in and accelerating the adoption of low-carbon production routes.
Recommendation 2: Increase Penalties
The cost of non-compliance must be sufficiently high to make "paying to pollute" an unattractive strategy. Environmental Compensation penalties should be meaningful enough to drive real investment in decarbonisation.
Recommendation 3: Establish an Independent Regulator
An independent carbon market regulator with real enforcement authority would ensure transparent governance and consistent application of rules.
Recommendation 4: Include the Power Sector
The power sector, responsible for 40-55% of emissions, must be brought into the compliance mechanism. Without it, the CCTS will lack the primary channel through which carbon pricing shapes energy investment.
Recommendation 5: Implement a Price and Supply Adjustment Mechanism
A Price and Supply Adjustment Mechanism (PSAM) — comprising consignment auctions — would ensure market stability and prevent the costly corrections that have challenged compliance carbon markets worldwide.
Recommendation 6: Ensure Transparent Price Discovery
Open auctions to discover the price of permits are essential. Only with knowledge of these prices can participants judge the return on investment to reduce emissions.
Recommendation 7: Maintain Credible Enforcement
The government needs to make sure it enforces the requirement that all industries hold enough permits to cover their emissions per unit of output.
Recommendation 8: Ensure Transparent Benchmark Methodology
The IEEFA emphasises that "transparent, rules-based benchmark methodology and independent verification alongside industry data will be important" in navigating the market's dynamics effectively.
Our Services
| Service | What We Do |
|---|---|
| Compliance Assessment | Understand your obligations and assess your position |
| Gap Analysis | Calculate your shortfall and develop a mitigation strategy |
| Credit Procurement | Help you buy CCCs at the best price |
| Regulatory Advisory | Stay informed about enforcement developments |
| Legal Documentation | Draft watertight agreements and handle regulatory filings |
| Policy Monitoring | Track regulatory changes and enforcement trends |
Why Choose Carboned.in?
| Reason | Why It Matters |
|---|---|
| Legal Expertise | Led by Siddharth Gupta, Advocate, Calcutta High Court |
| Regulatory Knowledge | Deep understanding of CCTS, BEE, and enforcement mechanisms |
| Market Intelligence | Real-time insights on pricing and compliance trends |
| End-to-End Support | From assessment to compliance |
Your first consultation is completely free. No obligation. Just honest advice.
Conclusion: The Market Is Only as Strong as Its Enforcement
India's Carbon Credit Trading Scheme is one of the world's largest new carbon markets. Once fully notified, it will cover some 740 entities and more than 700 million tonnes of CO₂e. But the architecture of a carbon market is only as strong as the institutions that enforce it.
Without credible enforcement, meaningful price signals, and robust monitoring, the CCTS risks repeating the failures of PAT and other global emissions trading systems.
Key Takeaways
| Aspect | What You Need to Know |
|---|---|
| PAT Legacy | 103 lakh ESCerts issued vs 52 lakh obligation |
| Non-Compliance | Rose from 9% to 56% in PAT cycles |
| Weak Penalties | Compliance costs are 0.6%-7% of profits |
| Modest Targets | 2-5% reductions by 2026-27 |
| Missing Regulator | No independent enforcement authority |
| Power Sector | 40-55% of emissions excluded |
| Ex-Post Issuance | Supply lags behind demand |
| IEEFA Warning | Window to shape design choices is open before path dependencies harden |
The Choice Is Yours
| Option | Outcome |
|---|---|
| Understand the enforcement landscape | Navigate compliance effectively, avoid penalties, capitalise on opportunities |
| Ignore the enforcement risks | Face higher costs, missed opportunities, competitive disadvantage |
How Carboned.in can help
Our team covers every dimension of India's carbon market — pick the service that matches where you are.
Frequently Asked Questions
Why does enforcement matter for carbon markets?+
Carbon markets are only as effective as the institutions that enforce them. Without credible enforcement, markets can suffer from oversupply, weak price signals, and limited emissions reductions.
What was the PAT legacy?+
The Perform, Achieve and Trade (PAT) scheme was marked by limited emissions reductions, persistent non-compliance, and poor price discovery. Non-compliance rose from 9% in Cycle I to 56% in Cycle II.
What is the weak penalty problem?+
The cost of purchasing credits for major companies is between 0.6% and 7% of profits, making "paying to pollute" a potentially preferred business strategy.
What is the oversupply risk?+
Modest targets and weak penalties could create a surplus of credits, depressing prices and reducing the incentive to invest in deeper reductions.
Why is an independent regulator important?+
An independent regulator with real enforcement authority would ensure transparent governance and consistent application of rules.
Why is the power sector excluded?+
The power sector, responsible for 40-55% of emissions, is currently excluded from mandatory compliance, weakening the market's effectiveness.
What is ex-post issuance?+
Credits are issued only after verified performance, meaning supply enters the market with a lag. This can weaken price discovery.
What is the banking provision?+
Unlimited banking of CCCs is allowed, but borrowing is not. This can help smooth compliance costs but also risks surplus accumulation.
What is the Price and Supply Adjustment Mechanism?+
A mechanism recommended by IEEFA to ensure market stability and prevent costly corrections.
How can Carboned.in help?+
We provide compliance assessment, credit procurement, regulatory advisory, and legal documentation. ---
Siddharth Gupta is the founder of Carboned.in and specialist counsel for India's carbon compliance framework — advising obligated entities, project developers, and buyers on CCTS, CR-I registration, and credit transactions.
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