Over the past three years carbon trading has emerged as one of the most important weapons in the fight against climate change, with politicians and business leaders of all stripes singing its praises.

The principle behind the idea is simple: make firms pay for their carbon emissions and they will, for the first time ever, have a financial incentive to cut carbon emissions.

But how do the various carbon trading schemes that have emerged work and how are they having an impact on United Kingdom firms? This quick guide offers a primer and update on the three most significant schemes to affect U.K. businesses: The European Union emissions trading scheme, the U.K.'s carbon reduction commitment and the U.N.'s clean development mechanism.

EU Emissions Trading Scheme

The EU Emissions Trading Scheme (ETS) is the first international trading scheme, and is widely regarded as crucial to help tackle climate change, both by providing a financial mechanism to help reduce Europe's emissions and a basis for an eventual global scheme.

It is designed to set a cap on emissions and allow businesses to buy or sell from each other the right to emit the gases that cause global warning. Firms exceeding their emissions cap have to buy extra credits to cover the excess, providing an incentive for them to come in under the capped level, while those that do not use up all their allowances can sell them, providing the least-polluting firms in the scheme with an extra revenue stream and an incentive to deliver deeper cuts.

The first phase of the scheme ran from the beginning of 2005 to the end of 2007. It was widely considered a failure because over-allocation of free allowances led to a huge price crash in 2006. It also emerged that some companies had made millions from the scheme by selling off the credits that they were freely allocated while delivering minimal cuts in emissions.

The second phase of the scheme launched at the start of this year. It will run until 2012 and more controlled allocation of allowances has led to a more stable price so far of between €20 (about US$29) and €30 (US$44)) per tonne.

From 2013, the third phase will begin. The proposals for the third phase are under review by EU member states, but they are expected to result in a significant reduction in the amount firms can pollute, an extension of the scheme to include more industries including aviation, and a huge increase in the proportion of credits that are auctioned to firms as opposed to allocated for free.

This is when the scheme will start to have a real effect, according to Sir Nicholas Stern, the economist behind the influential Stern report on the economic case for curbing emissions.

"Emissions trading is a powerful way of establishing co-operation across borders," he said recently. "The Emissions Trading Scheme is leading the way. Beyond 2012 there is an opportunity for it to be ambitious, long term, and open to trade with other countries and regions."

So what does the EU ETS mean for your business?