EU implements a Carbon Border Adjustment Mechanism to combat carbon leakage to third countries

The EU has had a carbon market for industrial installations since January 2005. It is known as the EU emissions trading system or EU ETS. The EU ETS works on the "cap and trade" principle: a cap is set on the total amount of certain greenhouse gases that can be emitted by the operators covered by the system. The cap is reduced over time so that total emissions fall. Within the cap, operators buy or receive emissions allowances, which they can trade with one another as needed. The limit on the total number of allowances available ensures that they have a value. The price signal incentivises emission reductions and promotes investment in innovative, low-carbon technologies, while trading brings flexibility that ensures emissions are cut where it costs least to do so.

With the EU ETS becoming ever stricter in light of the EU's climate targets, there is a risk of the system being circumvented by certain companies, which relocate carbon-intensive industries outside the EU and import the products thus manufactured. These practices generate "carbon leakage", which the EU now addresses through the Carbon Border Adjustment Mechanism (or CBAM).

While the objective of the CBAM is to prevent the risk of carbon leakage, it could also encourage producers from third countries to use technologies that are more efficient in reducing greenhouse gases so that fewer emissions are generated. For that reason, the CBAM is expected to support the reduction of greenhouse gas emissions in third countries.

The legal basis for the CBAM is Regulation (EU) 2023/956, and the EU Commission's Implementing Regulation (C/2023/5512 final).

How will the CBAM function?

The CBAM will function as an import levy on imported CO2.

In-scope goods can only be imported into the customs territory of the EU by an authorised CBAM declarant, who could represent more than one importer.

The CBAM is to be based on a declarative system in which the CBAM declarant annually submits a declaration of the embedded emissions in the goods imported and surrenders the number of CBAM certificates (a certificate in electronic format corresponding to one tonne of CO2e of embedded emissions in goods) which correspond to those declared emissions.

The embedded emissions in goods are calculated pursuant to the methods set out in Annex IV of the CBAM Regulation.

A CBAM declarant will have to submit a CBAM declaration in the CBAM for the preceding calendar year by 31 May of each year (for the first time in 2027, for the year 2026).

The CBAM declaration shall contain the following information:

• the total quantity of each type of goods imported during the preceding calendar year, expressed in megawatt-hours for electricity and in tonnes for other goods;
• the total embedded emissions in the goods, expressed in tonnes of CO2e emissions per megawatt-hour of electricity or, for other goods, in tonnes of CO2e emissions per tonne of each type of goods;
• the total number of CBAM certificates to be surrendered; and
• copies of verification reports, issued by accredited verifiers.

The price of CBAM certificates would be the average of the closing prices of EU ETS allowances on the common auction platform for each week.

Excess CBAM certificates remaining on the account of the declarant will be repurchased by the EU Commission on behalf of the Member State where the CBAM declarant is established.

Scope

The CBAM only applies to the goods listed in Annex I of the CBAM Regulation on their importation into the customs territory of the EU. It concerns cement, electricity, fertilisers, iron and steel, aluminium and chemicals.

For certain goods, only direct emissions are taken into account.

Goods imported from third countries, where their production has already been effectively subject to a carbon pricing system that is fully linked with or similar to the EU ETS, are exempt from the CBAM.

Goods originating from Iceland, Liechtenstein, Norway and Switzerland are also excluded from the CBAM.

Goods of little intrinsic value, goods contained in the personal luggage of travellers, and goods to be moved or used in the context of military activities are excluded from the scope of the CBAM.

Timing

The CBAM Regulation will generally apply from 1 October 2023.

From 1 October 2023, importers of CBAM goods will be required to report to the European Commission on the amount of CO2 emitted during the production of CBAM goods outside the EU on a quarterly basis. This report must be submitted no later than one month after the end of each quarter. Article 35 of the regulation specifies what information must be included in the report.

Businesses should assess whether they plan to import CBAM goods this year, even though the reporting procedure will be clarified later. If such imports are scheduled after 1 October 2023, it may be advisable for businesses to conduct an inventory of the CO2 emissions associated with these goods together with their non-EU producer(s).

However, the CBAM Registry (a standardised electronic database containing the data regarding the CBAM certificates of authorised CBAM declarants, similar to the EU ETS registry) and related obligations will only apply from 31 December 2024. The obligation to submit CBAM declarations will only apply from 1 January 2026.

From 1 January 2026 onwards, an importer of CBAM goods will be required to register with the national CBAM authority. (Businesses can apply for CBAM registration from 1 January 2025.)

Additionally, starting from 1 January 2026, businesses will be obligated to pay for the CO2 emissions generated in the production of CBAM goods outside the EU. This payment will be in the form of purchasing CO2 certificates from the national CBAM authority.

During the transitional period, importers or indirect customs representatives are to report on the quantity of imported goods, direct and indirect emissions embedded in them, and any carbon price due for those emissions, including carbon prices due for emissions embedded in relevant precursor materials.

Osborne Clarke comment

The reforms to the EU's carbon market will cover many sectors of the economy. There will be a cost associated with emitting CO2, including for producers outside of the EU. Indeed, the indirect goal of the CBAM is to incentivise non-EU producers of the in-scope goods to make their production processes more sustainable and efficient.

The UK, now outside the EU, has not yet committed to introducing a CBAM of its own. However, from March to June 2023, the UK government did consult on potential policy measures to mitigate carbon leakage risk in the future. Policies under consideration include a CBAM, mandatory product standards, and demand-side policies such as product labelling and public procurement initiatives to help grow the market for low carbon products, as well as embodied carbon emissions reporting which could support the implementation of potential mitigation policies. While UK importers wait for the government's response to the consultation, UK exporters will need to prepare to help their customers within scope of the EU CBAM.

If you would like assistance with registering to become an authorised CBAM declarant, and with your CBAM declarations, please speak to your usual Osborne Clarke contact, or with one of our experts listed below.