Australia, which is among the largest polluters per capita in the developed world, is exploring ways to reduce its greenhouse gas emissions and has set a target for reducing emissions at 5% below 2000 levels by 2020. One of its current initiatives, the carbon pricing mechanism—often referred to as the carbon tax—requires polluters to pay an amount proportional to the carbon dioxide equivalent emitted during a given year.

However, Prime Minister Tony Abbott, who was elected in September, had made it an election pledge to revoke this controversial tax, which was adopted two years ago. In light of the potential change, the debate over how to achieve the 2020 emissions target is ongoing.

Under the present system, polluters must purchase carbon units up to the level of their emissions. These units were initially set at a rate of roughly US$21 (AU$23) per ton. In mid-2015, the number of units is scheduled to be capped and the applicable rate will thereafter be set by market forces via an auction format. Any excess emissions at this stage will be charged at a 100% premium to the auction price for the period, theoretically increasing the incentive for businesses to reduce pollution.

Proponents of the system argue it is the most cost-effective solution, with the increase in costs eventually being passed onto customers. However, a recent government report showed that during a 12-month period, ending in September, emissions dipped by a disappointing 0.3%, despite the US$6.3 billion cost to industry.

In light of its opposition to the current mechanism, the new government is promoting its alternative Direct Action climate policy. Details have been relatively scant thus far but a central element to the plan is a “reverse auction” mechanism in which a US$1.4 billion fund would be distributed to those firms that can reduce emissions at the lowest cost. Critics argue that under this system, the largest polluters would not be punished for failing to address harmful output and the true cost of reducing emissions would be greater than it is under the present mechanism.

Recent polls show that the public has not yet been won over by either option. General consensus appears to favor removing the carbon tax yet is skeptical on the adequacy of the Direct Action policy as a replacement. Given that 40% of carbon emissions are beyond the scope of the tax and would have little incentive under the proposed Direct Action policy, any resolution is unlikely to be a definitive solution.

As it stands, removing the carbon tax would relieve Australian corporates of a near-term burden, but concerns would still remain. Some say current reduction targets are insufficient, and global climate talks set for next year in Paris may place added pressure on the government to revisit its longer-term emission targets.

You should consider the investment objectives, risks, charges and expenses of the Matthews Asia Funds carefully before making an investment decision. This and other information about the Funds is contained in the prospectus or summary prospectus which may also be obtained by calling 800.789.ASIA (2742). Please read the prospectus carefully before you invest or send money as it explains the risks associated with investing in international and emerging markets. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Fixed income investments are subject to additional risks, including, but not limited to, interest rate, credit and inflation risks. In addition, single-country and sector funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific industry, sector or geographic location. Investing in small- and mid-size companies is more risky than investing in large companies as they may be more volatile and less liquid than large companies.

The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information.

Matthews Asia Funds are distributed in the United States by Foreside Funds Distributors LLC

Matthews Asia Funds are distributed in Latin America by HMC Partners

© 2014 Matthews International Capital Management, LLC

© Matthews Asia

Read more commentaries by Matthews Asia