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EU Parliament and Council agree rules for levies on climate-damaging imports

Negotiators from the Council of the European Union and the European Parliament have paved the way for the introduction of a CO2 levy on the import of ‘climate-damaging’ manufactured goods into the EU.

However, although political agreement has been reached on the Carbon Border Adjustment Mechanism (CBAM), the corresponding draft regulation still has to be confirmed by the representatives of the EU member states and the European Parliament. It must then be adopted by both institutions before the regulation can enter into force.

Through the CBAM, the EU wants to impose a CO2 levy on certain imported goods if they come from countries whose climate protection measures do not match the climate protection level in the EU. Under the envisaged regime, businesses would have to buy certificates for the import of these goods that reflect the amount of CO2 emitted during their production.

A proposal for a corresponding regulation had been presented by the European Commission on 14 July 2021 as part of its "Fit for 55" climate protection package, after the European Parliament had spoken out in favour of such a regulation. The CO2 levy is intended to promote global climate protection and ensure a level playing field within and outside the EU.

According to the agreement now reached, the new legal framework is to apply to a number of sectors as early as October 2023, including iron and steel, cement, fertilisers, aluminium, electricity and now also hydrogen. The CBAM will come into force in stages: in the first few years, only reporting obligations would be envisaged.

Indirectly affected are also EU manufacturers that process products covered by the CBAM, as the CBAM is likely to lead to higher procurement costs for them and thus reduce their competitiveness.

According to the council, whether the agreement reached can actually be implemented will depend, among other things, on whether corresponding associated changes in other EU laws are also possible. In particular, the EU Emissions Trading Scheme (EU ETS) would have to be amended, as CBAM and EU ETS intertwine, the council said.

Companies that are part of the industries covered by the EU ETS must hold an EU emission allowance for every tonne of greenhouse gases emitted. For a certain amount of CO2 emissions, they receive free allowances. For emissions exceeding this amount, however, they have to buy additional allowances. This is intended to provide an incentive for businesses to reduce their greenhouse gas emissions. According to experts, however, the EU ETS can lead to goods being produced in other countries at lower cost without corresponding climate protection requirements. These goods are then imported into the EU. Due to this "carbon leakage" effect, global CO2 emissions would not be reduced, but merely shifted from the EU to other regions. The planned CBAM is supposed to prevent this.

The council said the agreement now reached would also mean that emitters in the sectors concerned would no longer be issued free emission allowances, as a combination of CBAM and free credits would probably constitute a violation of World Trade Organisation (WTO) rules according to current assessments.

Christian Lütkehaus, expert for ESG at Pinsent Masons, said there were still many open questions with regard to the envisaged new CBAM  regime: "The WTO issue is indeed obvious, but how the competitiveness of EU exports in the directly affected sectors is to be ensured if companies no longer receive free emission allowances still seems uncertain. Indirectly affected are also EU manufacturers that process products covered by the CBAM, as the CBAM is likely to lead to higher procurement costs for them and thus reduce their competitiveness. Not least in view of these unresolved issues, representatives of EU business have expressed reservations about the path taken and have instead signalled a preference for suitable multilateral climate agreements".

The Commission said that the CBAM should provide an incentive for other countries to increase their climate protection measures. If they achieve the same level of climate protection as the EU, their imports could be exempted from the CO2 tax, according to the proposal.
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