Overview of the Japanese GX-ETS and Prospects for Phase II

Japan introduced the GX Emissions Trading Scheme (GX-ETS) as a central component of its “growth-oriented carbon pricing” strategy for achieving carbon neutrality. Following a three-year voluntary phase beginning in fiscal year 2023, participation became mandatory in April 2026. This paper provides an overview of the institutional design of the GX-ETS, with a focus on Phase II, and examines its distinctive features and future development. Unlike many existing emissions trading systems, the GX-ETS regulates emissions at the company level rather than the facility level and covers a broad range of sectors. Free allowances are allocated primarily through sector-specific benchmarks, which cover approximately 90% of regulated emissions, while grandfathering applies to the remainder. Benchmark stringency gradually increases from the emissions intensity threshold of the top 50% of firms to that of the top 32.5% by fiscal year 2030. This bottom-up approach emphasizes technological feasibility. The GX-ETS also incorporates measures that address carbon leakage and changes in activity levels, additional allocations linked to GX-related R&D, limited use of carbon credits, and a price corridor with upper and lower bounds. These mechanisms seek to reconcile emissions reductions with international competitiveness and innovation.

Nevertheless, important challenges remain. Phase II allocation levels are not derived directly from Japan’s Nationally Determined Contribution, while the initial carbon price corridor is unlikely to support large-scale deployment of emerging technologies such as hydrogen or CCS. Future reforms will therefore need to strengthen alignment with Japan’s climate targets, gradually strengthen carbon price signals, develop a liquid allowance market, and manage the transition to auctioning in the power sector beginning in 2033.