April 20, 2023 European Parliament approves EU Emission Trading System reform and new EU Carbon Border Adjustment Mechanism
Executive summary On 18 April 2023, the European Parliament approved key legislative elements of the "Fit for 55" legislative package: European Union Emission Trading System (EU ETS) reform and the new EU Carbon Border Adjustment Mechanism (CBAM). Affected businesses will need to understand new requirements and upcoming reporting obligations. The EU's "Fit for 55" legislative package, initially announced in July 2021, is viewed as a key enabler for helping Europe reduce emissions by at least 55% by 2030 (from 1990 levels). These targets are enshrined in the European Climate Law and are part of the wider European Green Deal strategy to achieve climate neutrality by 2050. "Fit for 55" contains (i) comprehensive changes to the EU ETS, (ii) a proposal for a CBAM and (iii) revisions to the Effort Sharing Regulation (ESR), all setting emissions-reduction targets, as well as (iv) directives governing renewable energy, energy efficiency and energy taxation, to mention just a few. Over the past months, various components have progressed through the legislative process. On 18 April 2023, the European Parliament voted in favor — with a significant majority — of revising the EU ETS and implementing the CBAM. The next step will be for the texts to be endorsed by the EU Council and published in the EU Official Journal 20 days later. Key principles of CBAM The CBAM is a climate measure that aims to address the risk of carbon leakage by ensuring equivalent carbon pricing for imports and domestic (EU) production that is subject to carbon costs under the EU ETS. While the EU ETS applies to installations based in the EU and to certain production processes and activities, CBAM will apply to certain goods imported to the EU. Scope of goods covered CBAM will cover the following product categories:
This product list has significantly increased, compared to the list in earlier drafts of the regulation; downstream products are included, not just raw and semi-finished materials. Therefore, the list will apply to a larger number of businesses. Political discussions seem to favor extending CBAM, by 2030, to cover all product categories that are subject to the EU ETS. This would include polymers, diverse chemicals, mineral oil products, paper and pulp, among other categories. Transition period: 1 October 2023 through 31 December 2025 Between 1 October 2023 and 31 December 2025, transitional provisions will apply. Only quarterly reporting will be required and purchasing CBAM certificates will be optional. Instead, importers (customs declarants, indirect representatives) will have to report, on a quarterly basis, embedded emissions in goods imported during that quarter of the calendar year, detailing direct and indirect emissions as well as any carbon price effectively paid in a third country. Notably, from 31 December 2024, importers must have an "authorized CBAM declarant" status to qualify for the import of in-scope goods. How it will work Under new CBAM rules, importers are required to report total verified greenhouse gas (GHG) emissions embedded in goods imported in a given calendar year. Following the transitional period (at the end of 2025), the financial impact of CBAM will gradually grow, with a progressive phase-in of CBAM costs until 2034. Carbon cost paid at origin can be deducted from the payable CBAM charges (provided that evidence of the cost can be provided). Payment of CBAM charges will be facilitated through the purchase and surrender of CBAM certificates, which will be priced at the weekly averages of EU ETS allowances auctions. During the calendar year, the importer must ensure that the number of CBAM certificates in its CBAM registry account at the end of each quarter corresponds to at least 80% of the embedded emissions in imported products since the beginning of the calendar year. The importer must surrender CBAM certificates in the exact number corresponding to emissions embedded in goods imported in the calendar year, in addition to submitting an annual CBAM declaration. Definition of embedded emissions CBAM charges correspond to embedded emissions in the named product categories and the definition of embedded emissions to be declared has been extended to indirect emissions. The declaration of emissions can be made based on actual emissions, which need to be determined based on a schema provided by the EU regulators, the details of which are not yet finalized; additional implementing legal acts containing details will be published. If actual emissions are used, they must be accredited by independent verifiers. If no actual emissions are available, standard "default" values must used that reflect average emissions for a certain product manufactured in a specific country or region. If no reliable data to determine such standard values is available, the EU Commission will determine default values based on the worst-performing EU installations. Details will be subject to additional legal guidance documents, which are yet to be published. Exemptions and extended circumvention practices CBAM will not apply to goods of non-preferential origin in Switzerland, Liechtenstein, Iceland and Norway. There are only a small number of exemptions, including for low-value consignments up to EUR 150 and certain military imports. Examples of circumvention practices have been slightly extended in what is now an open catalogue of practices that may consist of, but are not limited to:
Key changes to the EU ETS One significant change to the current system is the phase-out of free allowances. Effectively, from 2026 to 2034, the free allowances granted to EU manufacturers will fade on a progressive curve, consequently increasing the cost of manufacturing for businesses if processes remain the same. The following phase-out rates for free allowances will apply:
Furthermore, revisions of EU ETS will include the following changes:
It is important to note there will be no export rebates or refunds of carbon payments. All revenues generated by the carbon market will be spent on climate and energy-related projects. In addition, a new EU Social Climate Fund will be set up in 2026:
Implications for businesses CBAM and the reform of the EU ETS will affect businesses both in the EU and across the globe, from an operational perspective and in terms of strategic decision-making. Impacts may be either direct or indirect. A holistic approach across the value chain and supply chain is recommended. EU-based operators subject to EU ETS must plan for increasing carbon costs if usage of conventional fuels is continued. Consequently, increased costs may affect competition on the EU and global market for emission-heavy businesses. With the new EU ETS II, the price of conventional fuels will further increase and may catalyze the need for transformation in this sector. It is worth noting the EU and the EU Member States nationally provide large, diverse programs of grants and incentives to support businesses in the transition. Additional revenues from the carbon market will bring further funding opportunities as part of the EU Innovation Fund, especially for businesses investing in innovative low-carbon technologies. Immediate steps to take The transition phase for CBAM is planned to be effective from 1 October 2023 and requires immediate action to prepare for new reporting obligations. Initial steps include:
Furthermore, from a strategic point of view, businesses should assess the potential financial impact of CBAM and EU ETS based on the current supply chain and take appropriate actions to mitigate the financial impact. Other anticipated changes in the energy and electricity taxation areas (e.g., revisions to the Energy Taxation Directive) may also be worth considering. Activities could involve rethinking supply chain structures, sourcing strategies, merger and acquisition activity, production planning and investment planning to achieve technical improvements to reduce embedded emissions in imported products. It will be important for businesses to monitor developments as the legislative process continues for CBAM and the closely interlinked EU ETS reform. ____________________________ For additional information with respect to this Alert, please contact the following: Carbon Border Adjustment Mechanism
Emission Trading System
Innovation Fund
EMEIA Sustainability Tax Services
Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor | |||||||||||||||||||||
|
