EU Carbon Border Adjustment Mechanism will be implemented from 1 October 2023

At a Glance…

The Carbon Border Adjustment Mechanism (CBAM) is a measure to ensure that imported goods pay a price for their carbon emissions that is comparable to the price paid by EU domestic producers under the EU Emission Trading System (EU ETS). On 13 December 2022, the two EU co-legislators, the Council of the EU and the European Parliament, provisionally reached an agreement on the final text of the CBAM Regulation. During a transition period (1 October 2023 – 31 December 2025), EU importers will have to comply with reporting requirements, but will not need to purchase CBAM certificates yet. Once CBAM is fully in place from 2026 onward, EU importers will be obliged to purchase CBAM certificates corresponding to the embedded emissions of imported CBAM goods. Below, we explain key elements of the CBAM Regulation as it has been adopted, and how CBAM will work in practice.

Authors:  Yves Melin Wim Vandenberghe and  Jin Woo Kim

Background

On 14 July 2021, the European Commission presented a legislative proposal on CBAM as part of its flagship Green Deal and “Fit for 55” package focused on climate change and the environment. On 15 March 2022, the Council of the EU (composed of the Member States) agreed on its General Approach with limited changes to the Commission proposal. On 22 June 2022, the European Parliament (consisting of directly elected representatives) adopted its position, which is largely in line with the Commission proposal, except for the longer transition period, the expansion of CBAM products, the faster phase-out of free allowances, and the inclusion of export rebates. On 13 December 2022, the two EU co-legislators, the Council of the EU and the European Parliament, reached an agreement on the final text of the CBAM Regulation.

Key elements of the Council and Parliament agreement

Given that the end of CBAM’s transition period is linked to the phasing out of the free allowances under the EU ETS, CBAM was also discussed at trilogues concerning the EU ETS revision on 16-18 December 2022. The key elements of the agreement on CBAM are as follows:

CBAM goods: CBAM will cover cement, fertilizers, iron and steel, aluminium, and electricity, as initially proposed by the Commission, as well as hydrogen, certain precursors (basic materials that are used as inputs in the production of CBAM goods), and a few downstream products (e.g., screws and bolts). The EU’s ultimate objective is broad product coverage under CBAM. To that end, the Commission will conduct a comprehensive review before the transition period ends with a view to possibly include other industry sectors.

Scope of emissions: CBAM will cover both direct emissions (emissions generated from manufacturing CBAM goods) and indirect emissions (emissions generated from electricity used in manufacturing CBAM goods). This means that EU importers must already report indirect emissions during the transition period (see further below).

Governance: The governance of CBAM will be more centralised. Instead of the competent authorities of EU Member States, as suggested in the Commission proposal, the Commission will be in charge of most of the administrative tasks involved in the running of CBAM.

Transition period: The transition period will start from 1 October 2023 and end when the free allowances under the EU ETS starts to phase out. As free allowances will be phased out from 2026, as explained below, the transition period will end on 31 December 2025. CBAM will fully apply from 1 January 2026.

Free allowances under EU ETS: Free allowances given to CBAM sectors under the EU ETS will start being phased out from 2026 and completely disappear by 2034 according to the following timeframe: 2026: 2.5%, 2027: 5%, 2028: 10%, 2029: 22.5%, 2030: 48.5%, 2031: 61%, 2032: 73.5%, 2033: 86%, 2034: 100%. This is a compromise made by the Commission and the Council (which supported a complete phase-out by 2035) and the Parliament (which advocated a complete phase-out by 2032).

Review clause: Before the transition period ends, the Commission will conduct a comprehensive review and present a report to the Parliament and the Council, examining whether and how to expand CBAM. In particular, the Commission will assess: (i) whether to extend CBAM to other goods at risk of carbon leakage, including organic chemicals, plastics and other downstream goods, with the goal to include all goods covered by the EU ETS by 2030; and (ii) whether to include indirect emissions after the transition period ends and the methodology used to calculate indirect emissions.

Exports: For now, CBAM will only cover imports of CBAM goods into the EU. Although the Parliament suggested that the most efficient EU installations should receive free allocations under the EU ETS for emissions linked to their export of CBAM goods, this was not included in the final text due to concerns about being inconsistent with WTO rules. Such inclusion could be viewed as an export subsidy, which is prohibited under Article 3.1(a) of the WTO Agreement on Subsidies and Countervailing Measures.

Instead, by 2025, the Commission will assess the risk of carbon leakage arising from the export of CBAM goods 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.

Timing and impact

Transition period: 1 October 2023 – 31 December 2025: During the transition period, EU importers must comply with reporting requirements, but will not need to purchase CBAM certificates yet. EU importers must submit a CBAM report to the Commission, disclosing: (i) the quantity of imported CBAM goods; (ii) the embedded emissions in those goods; and (iii) if applicable, the carbon price paid in the country of origin for the embedded emissions.

Entry into force from 1 January 2026: Once CBAM is fully in place from 2026 onward, EU importers will be required to purchase CBAM certificates corresponding to the embedded emissions of imported CBAM goods in order to import them into the EU. The key features of CBAM, once it is fully in place from 2026, are as follows:

  • Authorised declarants: CBAM goods must be cleared through customs by declarants who are authorised to do so. EU importers must apply for an authorisation before importing CBAM goods.
  • CBAM declaration: EU importers must submit a CBAM declaration of the number of goods imported in the preceding year and their total embedded emissions, as verified. The embedded emissions in the imported goods will be calculated on the basis of direct greenhouse gas emissions per tonne of goods produced in the production installations.
  • CBAM certificates: EU importers must purchase CBAM certificates corresponding to the embedded emissions in the imported goods. The embedded emissions are either based on the default value or on the actual proven emissions, if lower.
  • Carbon prices already paid in the country of origin: CBAM certificates can be reduced to account for carbon prices already paid in the country of origin, but this needs to be certified by an independent person.
  • Geographical exemptions: Countries that adopt the EU ETS (Iceland, Norway, and Liechtenstein) or are linked with the EU ETS (Switzerland) are exempted from CBAM. The EU will further elaborate a mechanism for other third countries to be exempted in the future.

Next steps                                                               

After going through legal checks and translations of the final text, the Council and the Parliament will officially adopt the text, which is expected to take place in the first quarter of 2023. Further, although detailed rules on how to calculate embedded emissions of CBAM goods have not yet been determined, the Commission is expected to adopt implementing acts when the CBAM Regulation is formally adopted by the Council and the Parliament.

Conclusion: start preparing now and be ready soon

Importers of products currently within the scope of CBAM will have to calculate accurately the emissions embedded in the CBAM goods they import and submit this calculation in CBAM declarations. Failure to do so will mean having to purchase more CBAM certificates, thus, paying more, based on high default values. Importers must be ready to account for and report embedded emissions in imported goods from 2023 and be able to buy CBAM certificates from 2026.

Importers of products that are not currently covered by CBAM should also prepare and be ready for CBAM as, following the Commission’s review, scope of CBAM is likely to expand following the Commission’s review before the transition period ends. In particular, CBAM is bound to quickly extend further to downstream products that undergo complex manufacturing processes by using various raw materials (steel parts, plastics, etc.), as well as finished products (e.g., automobiles, machines, electronic devices and toys), as not doing so would very likely cause the manufacturing of such products to relocate to the EU’s periphery.

This article was initially published by Reed Smith LLp – here.



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