Emissions trading is a way of introducing flexibility into a system where participants have to meet emissions targets. These participants may be countries (as in the case of the Kyoto Protocol), or companies (as in the case of a domestic emissions trading scheme). Participants can buy units to cover any emissions above their targets, or sell units if they reduce their emissions below their targets. The presence of a market for these units creates a value for emissions reductions which stimulates investment in the most cost-effective areas. Emissions trading leads to a reduction in compliance costs compared to meeting the same target through domestic/internal means only.
The Clean Development Mechanism (CDM) of the Kyoto Protocol allows projects in developing countries to generate emission credits if they result in emission levels lower than would otherwise be the case; these credits can be marketed and eventually counted against a developed country's emission obligation. The IEA provides analysis on the effectiveness of the different emissions trading scheme options, both at international and domestic level.