Stocktake on the EU and UK Carbon Border Adjustment Mechanisms

Stocktake on the EU and UK Carbon Border Adjustment Mechanisms (CBAMs)

Just as the first reporting period for the EU carbon border adjustment mechanism concluded in January, India has become the first country to announce it will initiate WTO proceedings against the new measure. Across the channel, the UK has confirmed plans to implement its own CBAM by 2027 which will affect aluminium, cement, ceramics, fertiliser, glass, hydrogen, iron and steel sectors. We set out below a brief stocktake on the current position of this controversial measure, and key considerations for the UK as it takes plans forward.

Quick reminder: CBAMs are designed to address the risk of ‘carbon leakage’, i.e. the movement of industry (and associated emissions) from one country to another due to different costs applied to emissions intensive activities. CBAMs reduce the incentive to move by protecting domestic producers against cheaper, higher-emission imports from jurisdictions with lower emissions standards by imposing a charge on those imports equivalent to domestic regulatory costs. 

What has happened so far in the EU?

The EU Carbon Border Adjustment Mechanism (CBAM) has been in force since 1 October 2023. On a transitional phase, until 2026, importers of certain goods and precursors with the most significant risk of carbon leakage, e.g. cement and iron, are required to report the greenhouse gas (GHG) emissions ‘embedded’ in their imports. The first reporting period concluded on 31 January 2024. From 2026 onwards, importers will have to buy and surrender CBAM certificates for the GHG emissions embedded in their imports, with the price of CBAM certificates determined by the auction price of EU Emissions Trading System (EU ETS) allowances. 

Note: Currently, a proportion of EU ETS allowances are assigned to operators for free in sectors that are exposed to carbon leakage, to avoid unfair competition from imports. The downside to this policy is that recipients of free allowances are not incentivised to reduce carbon emissions. The free allocation of EU ETS allowances for emissions-heavy industries will gradually be phased out, with the CBAM correspondingly taking effect to mitigate against the risk of carbon leakage. 

The EU’s CBAM has attracted significant comment at the WTO, where members such as Brazil, China, Israel, Switzerland, Turkey and South Africa have expressed concerns that it may be discriminatory, not in compliance with the international environmental law principle of Common but Differentiated Responsibilities (CBDR), and not the least trade restrictive measure reasonably available to address climate change.[1] India has announced that it is planning to initiate a WTO dispute against the EU,[2] having raised the issue at a recent WTO Ministerial Meeting (MC13) in Abu Dhabi.[3]

What is planned for the UK?

The Department for Energy Security and Net Zero and HM Treasury conducted a public consultation in 2023 on proposals to minimise the risk of carbon leakage. Among them is a UK CBAM, similar to the mechanism adopted by the EU. These measures build on proposals by the UK Climate Change Committee (CCC) in its Sixth Carbon Budget. 

At present, free allowances are available to certain producers under the UK Emissions Trading System (UK ETS), the UK’s main carbon pricing instrument, which the UK maintained after leaving the EU. Introducing a CBAM would allow the reduction of these free allowances by addressing the risk of carbon leakage, supporting the UK’s net zero goals which are most likely the driving force behind the measure. In addition, a UK CBAM would to some degree apply to imports into the UK deflected from the EU as a result of the EU CBAM. See here for a summary of the key issues which Freshfields identified in its response to the consultation, in which we focused on the public international law aspects of the measures. 

Some elements of the UK’s CBAM proposal are to be welcomed, as it represents the beginning of a significant policy intervention by the UK government in line with its climate change ambitions. However, it is a complex undertaking, with many moving parts, as reflected in the responses to the initial consultation published in December 2023. In addition, developments with the WTO disputes relating to the EU CBAM will need to be taken into account by the UK in its plans. The delivery of the CBAM will be subject to further consultation in 2024.

[1] See directdoc.aspx (wto.org)

[2] See India and South Africa lead WTO backlash on EU carbon tax (euobserver.com)

[3] See India makes first objection to EU carbon levy at WTO summit (euobserver.com)