In December 2022, the EU institutions (the European Commission ("Commission"), Council of the European Union ("Council") and the European Parliament ("EP")) reached agreement/political consensus on two major instruments. Agreement was reached on the reform of the EU Emissions Trading Scheme ("ETS") on December 17, 2022,1 and the Carbon Border Adjustment Mechanism ("CBAM") on December 13, 2022.2
The two instruments are closely linked to the extent that the CBAM will work in parallel with the EU ETS by applying a carbon price to imported goods that is equivalent to the carbon price that is applied to goods manufactured in the EU as a result of the EU ETS.
The essence of the CBAM has remained unchanged as compared to the initial Commission proposal (see our 2021 Legal Update European Commission Presents Proposal for Carbon Border Adjustment Mechanism). Importers should now start to prepare for implementation, even if the official legal texts still need to be published.
CBAM in a Nutshell: Product Scope, CBAM Certificates and (In)direct Emissions
The CBAM is centered around a requirement to surrender "CBAM certificates" that reflect the carbon price of the embedded emissions in the covered products that are imported into the EU. In this way, CBAM works in parallel with the EU ETS by applying a carbon price to imported goods that is equivalent to the carbon price that is applied to goods manufactured in the EU as a result of the EU ETS.
Whereas the Commission had initially proposed that the mechanism should apply to imports of cement; electricity; certain fertilizers; and certain iron, steel and aluminum products, the Council and the EP have extended the scope to also include hydrogen, some "precursors" (such as cathode active materials) and a limited number of so-called "downstream products" such as screws, bolts and similar articles of iron or steel (together, "the covered products"). The mechanism will apply to imports from non-EU countries except countries covered by the EU ETS, i.e., Iceland, Liechtenstein, Norway and Switzerland. In addition, in order to enhance the compatibility with the EU's obligations in the World Trade Organization ("WTO"), third countries will be able to apply for exclusions from the CBAM subject to the condition that the country has an equivalent domestic carbon pricing mechanism.
As envisaged under the Commission's proposal, only "authorised declarants" will be permitted to import covered products. The declarants will need to report on the direct and indirect (under certain, to be announced, "well-circumscribed" conditions) embedded emissions in the imported covered products on an annual basis and will need to surrender a corresponding amount of CBAM certificates.
Third country producers are responsible for communicating information about the embedded emissions for covered products to EU importers. Operators and installations in third countries may register under the CBAM. The verified information on the embedded emissions of these operators and installations may be used by authorised declarants as the basis for their own declaration. Where actual emissions cannot be determined, default values are to be used.
Link with EU ETS Reform and Entry into Force
The adoption and finalization of the CBAM was dependent on conclusion of the negotiations on the reform of the EU ETS, which were also part of the EU's Fit-for-55 Package. Insofar as EU ETS reform means that the current mechanism of "free" allocation of EU ETS allowances will be phased out over a nine-year period between 2026-2034, the CBAM will only apply to that proportion of the emissions that do not benefit from such free allowances. This aspect has been introduced, in the words of the Council, to "fully respect" WTO rules. The pace of the phasing out of the system of free allowances will gradually increase during this period.
Whereas the Commission's proposal had envisaged the CBAM to start applying with a limited "reporting obligation" as of January 1, 2023, this starting date has now been pushed back to October 1, 2023. As of January 1, 2026, the obligation to surrender CBAM certificates in respect of imports of covered products will start to apply.
No Export Rebates (for Now)
One critical issue that, as of yet, remains unresolved is that of "export rebates." Whereas the CBAM addresses the issue of carbon leakage on the EU market, it does not cover EU exports to third-country markets. That is to say, at present, no mechanism of export rebates in respect of the export of imported products to which the CBAM applied is foreseen. It was expected that discussions on this would be part of the conclusion of the reform of the EU ETS, but this turned out not to be the case.
In this regard, the Council's press release on the adoption of the CBAM notes that "[f]urther work is also required on measures to prevent carbon leakage on exports." The EP's press release notes that "[b]y 2025, the Commission shall assess the risk of carbon leakage for goods produced in the EU intended for export to non-EU countries and, if needed, present a WTO-compliant legislative proposal to address this risk. In addition, an estimated 47.5 million allowances will be used to raise new and additional financing to address any risk of export-related carbon leakage." EU industry associations have already forcefully spoken out against the apparent absence of a mechanism of export rebates in the version of the CBAM as agreed upon by the EU.
In addition, by the end of 2027, the Commission will conduct a complete review of CBAM "including an assessment of progress made in international negotiations on climate change, as well as the impact on imports from developing countries, in particular the least developed countries (LDCs)."
The Council's press release highlights the "provisional and conditional nature" of the agreement reached on the CBAM. It is unclear whether, with the agreement on the EU ETS reform several days later, the agreement on the CBAM is now definitive and unconditional. In any event, the precise legal requirements arising from the CBAM regulation will only definitively emerge once the text of the regulation has been adopted and published in the EU's Official Journal. We will publish additional, more detailed Legal Updates in due course.
Mayer Brown has a wealth of experience in advising not just on emissions trading but also on the policy and regulatory aspects of the EU ETS. This, together with our leading trade practice, positions us well to advise on the intricacies of the proposed CBAM.
1. Council of the EU, 'Fit for 55': Council and Parliament reach provisional deal on EU emissions trading system and the Social Climate Fund, December 18, 2022. Available at https://www.consilium.europa.eu/en/press/press-releases/2022/12/18/fit-for-55-council-and-parliament-reach-provisional-deal-on-eu-emissions-trading-system-and-the-social-climate-fund/; and European Parliament, Climate change: Deal on a more ambitious Emissions Trading System (ETS), December 18, 2022. Available at https://www.europarl.europa.eu/news/en/press-room/20221212IPR64527/climate-change-deal-on-a-more-ambitious-emissions-trading-system-ets.
2. Council of the EU, EU climate action: provisional agreement reached on Carbon Border Adjustment Mechanism (CBAM), December 13, 2022. Available at https://www.consilium.europa.eu/en/press/press-releases/2022/12/13/eu-climate-action-provisional-agreement-reached-on-carbon-border-adjustment-mechanism-cbam/; and European Parliament, Deal reached on new carbon leakage instrument to raise global climate ambition, December 13, 2022. Available at https://www.europarl.europa.eu/news/en/press-room/20221212IPR64509/deal-reached-on-new-carbon-leakage-instrument-to-raise-global-climate-ambition.
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This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.