We study non-compliance in an emissions trading system in which firms
may bank and borrow permits. We find a condition involving auditing probability that
characterizes compliance and allows us to analyze the time paths of actual emissions,
reported emissions and violations. We find two interesting time instants. At the first
time instant, reported emissions begin to be lower than the actual emissions, and at
the second time instant, the reported emissions become zero and the actual emissions
become constant. The results indicate, among other things, that a given penalty scheme
may fail to induce compliance over the whole planning interval, even though it achieves
compliance over the initial stage.

• Emissions trading, non-compliance and bankable permits