Executive summary

On 30 March 2023, the United Kingdom (UK) Government launched a new consultation on "addressing carbon leakage risk to support decarbonisation." The consultation is wide-ranging, covering several interrelated policies including a carbon border adjustment mechanism (CBAM), mandatory product standards (MPS) on embodied emissions, other policy measures designed to boost demand for low carbon products, and emissions reporting.

The consultation will run for 12 weeks and will end on 22 June 2023. The full consultation is available here.

Detailed discussion

Overview

In May 2022, the UK Government committed to a consultation on CBAM which has now been published. Addressing "carbon leakage" has been an issue raised in numerous Government reviews and advisory bodies including Chris Skidmore MP's Net Zero Review, the UK Climate Change Committee and the Parliamentary Environmental Audit Committee.

Carbon leakage occurs when carbon-intensive production moves to countries where less stringent climate policies are in place than in the UK, or when UK products get replaced by more carbon-intensive imports.

The Government is soliciting views and evidence to consider a range of potential policy measures which are designed to reduce carbon leakage and support the decarbonization of UK industry. HM Treasury and the Department for Energy Security and Net Zero are the two lead Government departments for this consultation. The consultation is set out in two parts with Part 1 setting out options related to possible:

• Carbon border adjustment mechanism
• Mandatory product standards
• Product labelling and voluntary standards
• Public procurement and green private procurement

Part 2 of the consultation sets out proposals on emissions reporting including design and delivery features. The aim of setting out a system of emissions reporting would be to support the measures contained in part 1 of the consultation.

Sectoral coverage

The starting point for the UK Government in the consultation includes the coverage of the following sectors:

• Cement
• Chemicals
• Glass
• Iron and steel
• Non-ferrous metals
• Non-metallic minerals
• Paper and pulp
• Refining
• Fertilizer
• Power generation

The Government notes that the risk of carbon leakage will change over time, including the sectoral coverage of the measures discussed in the consultation, and could extend to potentially non-industrial sectors such as agriculture or timber. Ensuring that there are no gaps in the UK's carbon leakage mitigation regime is a priority according to the consultation.

Carbon border adjustment mechanism

One of the most important components of this consultation is on a potential UK CBAM, to address carbon leakage and support UK Net Zero ambitions. A CBAM is designed to be a mechanism to put a price on the carbon emitted during the production of carbon intensive goods that enter the UK. With the European Union introducing its version of a CBAM in October 2023, the UK consultation is timely. The issues raised in the consultation relating to a potential UK CBAM include:

• Potential scope includes products covered by the UK's Emissions Trading Scheme. A possible option proposed would be to initially implement the UK CBAM for a limited number of sectors and subsequently expand coverage of the regime in a phased way
• Application of UK CBAM to Scope 2 and Scope 3 emissions
• Use of emissions data and use of independently verified emissions data versus default values where independently verified data is not available
• Which carbon price would be used when calculating cost of UK CBAM
• The difference between the UK effective carbon price and the effective carbon price in country of origin
• Payment schedules and customs arrangements for UK CBAM

Mandatory product standards

Following earlier UK Government calls for evidence, the Government intends to pilot MPS on embodied emissions with a small number of sectors to determine the viability of the policy on a larger basis. An MPS is designed to set an upper limit on the embodied emissions for individual products placed on the UK market or produced in the UK. It would prohibit products which are more emissions intensive than a defined limit. The working assumption put forward by the Government is that MPS would apply to imports. The initial question in this section of the consultation asks whether the MPS pilot should consider:

• Targeting the steel sector only
• Targeting the steel, cement and concrete sectors
• Targeting steel, cement, concrete and chemicals sectors

Other considerations raised as part of the consultation include which emissions should be in scope of the measure, at which stage in the manufacturing supply chain it should be applied, whether to be applied at point of sale when the good is placed on the market or at the point of production.

Timelines for implementation

As set out in the consultation, the Government intends to proceed (depending on the outcome of the consultation) to introduce embodied emissions reporting in 2025. This would be followed by a phased implementation of the CBAM in 2026 in conjunction with reforms to the UK ETS allocation of free allowances. Any MPS would be introduced following successful pilots in late-2020s.

Addressing trade concerns

In the consultation, the Government has committed to implement the CBAM and other measures, "in a manner that is consistent with the Government's commitment to free and open trade, upholding the World Trade Organization (WTO) rules as well as respecting international climate change obligations taking into consideration countries' differing levels of development."

Achieving this in practice may be a challenge as the Government is seeking input on how to address the following trade concerns:

• Treatment of developing country exports as exempting high carbon intensity products from developing countries could undermine net zero objectives but not doing so could undermine development objectives
• International alignment on methodology, default values and verification of emissions reporting. In the case of MPS, regulatory alignment of standards
• Addressing circumvention of carbon leakage policy measures
• Supporting UK exports which may be at a commercial disadvantage due to higher costs of inputs
• Potential use of voluntary carbon markets in the future towards CBAM and/or MPS obligations

Boosting demand for low carbon products

The consultation is also seeking input regarding initiatives to grow the market for low carbon products. The Government outlines three ways this could be done:

1. Product labelling and voluntary standards: Through the development of product labels for carbon and voluntary standards while pointing to other environmental labelling schemes as points of comparison.
2. Public procurement: Using the UK/India Industrial Deep Decarbonisation Initiative (IDDI) as the starting point, through this consultation the Government is looking to assess the appropriate level of public procurement pledge for the UK to commit to.
3. Private procurement: The Government is seeking input into how more companies can be encouraged to participate in buyers' alliances such as the First Movers Coalition.

Emissions reporting framework

The consultation includes a possible emissions reporting framework and sets out options for the design of the framework and potential use of default values. The consultation then moves to the options available for the methodology for calculating reported emissions and associated metrics and scope. The consultation also covers necessary IT systems and the practicalities of reporting and verification of emissions reporting data.

Two additional points set out as part of the emissions reporting framework is that the Government is conscious of the possible burden on businesses and that any UK system should seek to align to the extent possible with reporting standards used by other countries or regional blocks.

Next steps

The introduction of a CBAM and other carbon leakage mitigation policies will have both direct and indirect impacts on businesses both in the UK and elsewhere. A holistic approach across value chains is required to effectively map and mitigate the impacts of the regime.

Businesses have until 22 June 2023 to respond to the consultation on "addressing carbon leakage risk to support decarbonisation." Given the wide-reaching impact of this consultation, businesses are encouraged to submit their responses in a timely manner.

In the meantime, businesses can:

• Assign internal responsibility for responding to the consultation and future management of the regime.
• Determine the customs codes and country of origin of goods imported into the UK to determine whether they may fall under the scope of a UK CBAM in order provide supporting evidence.
• Develop a strategy for engaging with the UK Government given policy development will extend beyond the end of the current consultation.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (United Kingdom)

• Derek Leith, Aberdeen | dleith@uk.ey.com  
• Marc Bunch, London | mbunch@uk.ey.com
• George Riddell, London | george.riddell@uk.ey.com
• Alwyn Hopkins, London | alwyn.hopkins@uk.ey.com