What has been announced
On June 3, 2021, a draft of a European Commission (“Commission”) proposal for a regulation on the establishment of a Carbon Border Adjustment Mechanism (“CBAM proposal”) became public. The CBAM proposal is a key element of the European Green Deal1 and seeks to address the risk of “carbon leakage” by regulating greenhouse gas emissions (“GHG”) embedded in cement, electricity and certain fertilizers and in certain iron, steel and aluminum products (“covered products”) upon their importation into the European Union (“EU”).
Calls for an EU border adjustment mechanism have been around for many years, but concerns relating to the consistency of such a mechanism with the EU’s obligations under the World Trade Organization (“WTO”) have been around for at least as long, with other WTO members considering it to be a protectionist instrument. The CBAM proposal is a reflection of the EU’s efforts to balance its climate change ambitions with the related objectives of not harming its internal industry while acting in accordance with its WTO obligations.
Broader legislative package
While still in draft form, the CBAM proposal offers an insight into the Commission’s plans ahead of the expected publication of the formal CBAM proposal on July 14, 2021. The formal proposal will be part of a broader legislative package aimed at reducing the EU’s GHG emissions by 50-55 percent by 2030. The CBAM should “integrate” into the EU’s Emissions Trading Scheme (“ETS”) and should serve as an alternative to the financial measures and allocation of "free" (as opposed to auctioned) allowances provided for under the EU’s ETS Directive.2
How it will work
Under the current draft, importation of products covered by the CBAM can only be done by “authorized declarants” that will have to lodge “CBAM declarations” annually. These declarations will reflect direct and indirect GHG emissions embedded in the imported products. Regulated entities (importers) will need to surrender a corresponding amount of “CBAM certificates.”
In principle, the CBAM proposal reflects a preference for the declaration of an actual installation-specific value of the specific embedded emissions of an imported good rather than a preference for default values. Each authorized declarant shall ensure that the declared embedded emissions are verified by an independent verifier. In the situation where actual GHG emission values cannot be verified—for example, as a result of the authorized declarant's failure to submit the required information—default values shall be used to determine the number of CBAM certificates to be surrendered. Default values are proposed to be set at a relatively high level corresponding to the emissions of the 10 percent worst performing sites in the EU for each of the processes involved in the production of goods.
Interaction with global carbon pricing
In order to support the use of carbon pricing elsewhere in the world, the CBAM proposal provides for the possibility of offsetting the cost compliance with the CBAM against a carbon price paid in the country of origin of the imported good. Declarants may apply for compensation—i.e., a reduction in the number of certificates to be required—if a carbon price has already been paid in the country of origin for the embedded emissions in the imported goods.
Grandfathering of emissions data
The CBAM proposal also foresees the possibility of “operators” of installations (i.e., production sites) in the third country requesting that the CBAM authority confirm the embedded emissions in goods produced in an overseas installation. Following such “registration,” operators may disclose the relevant information to authorized declarants, who can then—in turn—rely on the relevant information for a period of two years, without any further verification being required.
The present draft proposal envisages that imports of the covered products originating in Iceland, Liechtenstein, Norway and Switzerland shall be exempt from the CBAM requirements (since these jurisdictions are already subject to a carbon price). In principle, imports of the covered products originating in all other countries would be covered by the present CBAM proposal. However, the draft provides for the possibility of the Commission adopting delegated acts through which it can extend the number of countries exempted from the CBAM requirements. Such determinations should reflect the inclusion of such a country into the EU ETS or the fact that an agreement has been concluded on the linkage of the EU ETS with the country’s own emission trading system (as is the case for Switzerland).
Entry into force
The expected date for the entry into force of the CBAM is foreseen as January 1, 2026, but a transitional period of three years starting as early as January 1, 2023 is envisaged during which “a simplified system” will apply. Default values, based on EU benchmarks, would apply during this period, and the authorized declarant of covered goods would need to settle a “CBAM price” (expressed in EUR per megawatt hour for electricity and EUR per metric tonne for all other goods) based on these values. The CBAM price itself would be calculated as the average of the closing prices of all auctions of EU ETS allowances conducted on auctioning platforms.
Finally, the CBAM proposal envisages the creation of a CBAM Authority that would be responsible for the mechanism’s administration, i.e., for authorization of declarants that are entitled to import goods, accreditation of verifiers, review of CBAM declarations and management of CBAM certificates.
The final proposal, due on July 14, 2021, may reflect a significant overhaul of the current informal draft. It is possible, in particular, that the formal proposal will feature a reduced list of covered products. Furthermore, once unveiled, the CBAM proposal will be subject to the EU’s ordinary legislative procedure and therefore will be reviewed and modified by the European Parliament and the Council of the European Union (with input from civil society, trade organizations and other private sector participants).
How to prepare
Nevertheless, it is fair to expect that the current structure of the CBAM as an extension of the EU ETS to imports (as opposed to the use of a carbon tax or a carbon customs duty, which were also considered (see our March 6, 2020, Legal Update “European Commission Starts Consultation Process for Carbon Border Adjustment Mechanism”3)), will not change. Exporters and importers of the products provisionally covered by the CBAM proposal should therefore start preparing for an increase in the administrative burden relating to imports as well as an increase in the costs of importation of such products as a result of the need to purchase CBAM certificates and to comply with CBAM declaration requirements.
How we can help
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 these proposals.
2 Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC, OJ L 275, 25.10.2003, pp. 32–46.