The Market Stability Reserve (MSR) is an automated mechanism that controls the supply of carbon allowances within the EU Emissions Trading System (ETS). It addresses market imbalances by removing surplus allowances or releasing them in times of scarcity, ensuring price stability and strengthening the incentive for decarbonization.
The Market Stability Reserve (MSR) is a crucial rule-based instrument established in 2019 to enhance the resilience and effectiveness of the EU Emissions Trading System (EU ETS). Its primary purpose is to address the large structural surplus of emission allowances that historically weakened the carbon price signal, making it less effective at driving meaningful climate action. By automatically adjusting the annual supply of allowances for auction, the MSR provides greater predictability for all market participants, from regulated industrial players to investors in carbon assets like EU Allowances (EUAs).
The MSR's operation is transparent and based on a pre-defined set of rules linked to a key metric: the Total Number of Allowances in Circulation (TNAC). This figure is published by the European Commission each year.
How It Works
- Allowance Intake (Reducing Supply): If the TNAC is above a set threshold (currently 833 million allowances), a specific percentage (the “intake rate”) of the allowances in circulation is withdrawn from the market. These allowances are not auctioned that year but are instead placed into the reserve.
- Allowance Release (Increasing Supply): Conversely, if the TNAC falls below a lower threshold (400 million allowances), a fixed number of allowances are released from the MSR and added to the auction volumes, preventing excessive scarcity and price shocks.
- Permanent Invalidation: To ensure the MSR contributes to the EU's long-term climate goals, a cancellation mechanism was introduced. Each year, the number of allowances held in the reserve is compared to the previous year's total auction volume. Any allowances in the MSR above that amount are permanently invalidated, meaning they can never be used for compliance, effectively tightening the overall emissions cap.
Concrete Example
Imagine the European Commission calculates the TNAC to be 1.1 billion allowances, which is well above the 833 million threshold. The MSR would automatically trigger, withdrawing a percentage of these allowances (e.g., 24% under previous rules) from future auctions and placing them in the reserve. This reduction in the available supply puts upward pressure on the EUA price, reinforcing the financial signal for companies to invest in lower-carbon technologies. This stability makes the carbon market a more reliable asset for investors seeking impact and diversification.