European Commission Proposes Carbon Border Adjustment Mechanism
On 14 July 2021, the European Commission (“the Commission”) issued a long-awaited proposal for a regulation on the establishment of a Carbon Border Adjustment Mechanism (“CBAM”). A key measure under the European Green Deal strategy to make the EU climate neutral in 2050, the CBAM would impose a carbon price on EU imports of certain goods from third countries with less ambitious climate policies in order to prevent so-called “carbon leakage.” As this mechanism would increase both administrative and monetary costs for businesses engaged in such importation, this newsletter highlights the background for, and main features of, the measure.
In terms of its overall purpose, the proposed regulation aims to safeguard the EU’s efforts to reduce its global carbon footprint from being undermined by “carbon leakage,” i.e. the situation where businesses, to avoid costs resulting from EU climate policies, transfer production to countries with less strict rules on permissible greenhouse gas (“GHG”) emissions. To reduce this risk and incentivize decarbonization by EU industries and trade partners, the CBAM would now regulate, by imposing a carbon cost that mirrors the carbon cost for EU-based producers, the levels of direct and indirect GHG emissions released during the production of (“embedded in”) imported goods that were not subject to emissions regulations in their country of origin.
The CBAM would apply to EU imports of certain cement, electricity, fertilizer, iron and steel, and aluminium goods that are listed in Annex I to the regulation, or of the processed products from such goods, originating in non-EU countries and territories. However, the mechanism would not cover imports from countries and territories that are listed in Annex II to the regulation, which currently include Iceland, Liechtenstein, Norway, Switzerland, and certain EU overseas territories and which may be expanded to others that cumulatively meet the following conditions:
- The EU Emissions Trading System (“EU ETS”) applies to that country or territory, or the EU has concluded an agreement with that country or territory linking the EU ETS and the country or territory’s emission trading system; and
- The price paid in the country of origin of the goods is effectively charged on goods listed in Annex I without any rebate beyond those that also applied in the EU ETS.
In addition, if a third country or territory’s electricity market is integrated with the EU’s internal electricity market through market coupling and there is no technical solution for the application of the CBAM to the EU importation of electricity from that country or territory, such importation may be exempted from the CBAM provided that certain conditions are cumulatively met.
3. Import Conditions
First, goods covered under the CBAM could only be imported into the EU by an EU-established declarant that is authorized by the competent authority of the relevant EU Member State (“authorized declarants”). The proposed regulation specifies in this regard that such authorization must be obtained in the EU Member State of establishment or, when transmission capacity for the import of electricity is allocated via explicit capacity allocation, in the EU Member State where the import is declared. The regulation further notes that any person may apply for such authorization, that applications must contain the information about the declarant set out in Article 5, and that authorization will be granted to any applicants who meet the criteria set out in Article 17.
Second, authorized declarants would annually, by 31 May, have to surrender to the competent authority of the EU Member State where they are authorized a number of CBAM certificates that corresponds to the total emissions embedded in the covered products that they imported during the previous calendar year. In particular, the declarants would have to ensure that the required number of certificates is available on their account in the EU Member State’s national registry of authorized declarants and that at the end of each quarter, the number of certificates on this account corresponds to at least 80% of the embedded emissions.
CBAM certificates would have to be purchased from the abovementioned competent authority at a carbon price calculated and published in accordance with Article 21 of the regulation. Authorized declarants could claim a reduction in the required number of CBAM certificates that corresponds to any carbon price that they have paid for the declared emissions in the country of origin of the good.
The competent authority would also, upon request by the declarant, re-purchase excess certificates remaining after the surrender but with a limitation to one third of the total CBAM certificates purchased during the previous calendar year. Any CBAM certificates remaining after the surrender and re-purchase would be cancelled by 30 June of each year.
Third, authorized declarants would annually, again by 31 May, have to submit to the competent authority of the EU Member State where they are authorized a CBAM declaration indicating:
- the total quantity of each type of the covered goods imported during the previous calendar year;
- the total emissions embedded in the covered products imported during the previous calendar year; and
- the corresponding number of CBAM certificates that they state to be surrendered in accordance with the regulation, after the reduction for the carbon price paid in a country of origin and the adjustment necessary to account for free allowances under the EU ETS.
In this regard, embedded emissions would be calculated on the basis of the actual emissions in the imported products or, when actual emissions cannot be adequately determined, on the basis of default values. For imported electricity, however, default values would be used unless the authorized declarant chooses to determine the embedded emissions on the basis of the actual emissions.
In addition, the authorized declarant would have to ensure that the declared embedded emissions are independently verified in accordance with certain criteria, while the declarations would also be subject to review by the competent authority until the end of the fourth year after the year in which they were submitted. To enable such verification and review, authorized declarants would for the duration of that period have to keep records of relevant information.
4.a. Registration of Third Country Operators and Installations
Operators of production installations in non-EU countries could request the Commission to register the information on that operator and its installation in a central database. Such registration would be valid for a period of five years from the date when it was notified to the operator, during which time information on the operator’s verified embedded emissions may be disclosed to authorized declarants for use in their verification of declared emissions.
Authorized declarants who fail to surrender the required number of CBAM certificates by the annual deadline or any other person who imports covered goods into the EU without surrendering CBAM certificates would be liable to pay a penalty. In addition, EU Member States may apply administrative or criminal sanctions for failure to comply with the CBAM legislation.
Furthermore, the Commission may extend obligations under the proposed regulation to imports of slightly modified like products when it determines, following a thorough investigation, that circumvention of the CBAM is taking place.
Under the EU’s Ordinary Legislative Procedure, the proposal must be jointly approved by the European Parliament and the Council of the European Union and is now sent to the former for a first reading. If adopted, the regulation would apply as of 1 January 2023 but most of its key provisions such as the abovementioned CBAM authorization, certificates and declaration requirements would only apply as of 1 January 2026. Moreover, a transitional period would apply until 28 February 2026 during which declarants importing goods would be obliged to submit quarterly “CBAM reports” to the competent authority of the importing EU Member State in accordance with Article 35 of the regulation.
Although the legislative procedure is still at an early stage and further amendments to the proposal are possible, exporters and importers of the covered products are recommended to already prepare for the increase in administrative and monetary costs that will result from the required CBAM authorization, purchase of CBAM certificates and submission of CBAM declarations. As Pierstone will continue to monitor the adoption of the proposed regulation, we can assist all business with any legal issues that they may encounter in that regard.
Do not hesitate to contact us should you require further information on and/or assistance with the CBAM or any other regulatory & trade-related matter.