International reaction to the EU's proposed CBAM

International CBAM issues

At the heart of the debate lies two issues.

1. The treatment of lower income countries under the regime. At present, the proposals do not differentiate between goods from lower and higher income countries. Some observe this is quite deliberate as the EU seeks to address carbon leakage. Others see it as cutting across a key principle underpinning recent international climate agreements. Given the EU's ambition on climate, as reflected in the Fit for 55 package of climate measures, and the wider need for carbon pricing, it seems challenging to balance the two issues.
2. The flexibility given to third countries that have an existing legal framework for carbon pricing and how CBAM obligations for goods originating from those countries are calculated.

CBAM mechanisms

There are three mechanisms that seek to deal with these issues under the current draft CBAM regulation.

1. Article 2(5) exempts countries with an emissions trading scheme either under the EU ETS or which is fully linked to the EU ETS. In all cases, the exemption only applies where there is no carbon rebate on the goods. Importantly, exempt countries must be explicitly listed in the regulation to benefit.
2. Article 2(7) separately deals with a third country with an electricity market integrated with the EU's internal market through market coupling. Here, the Commission proposes a more nuanced approach in order to exempt the application of the CBAM under certain conditions by taking into account broader policy and other measures to achieve climate neutrality by 2050.
3. Article 9 allows importers making CBAM declarations to reduce the number of CBAM certificates surrendered in order to take into account the carbon price paid in the country of origin for the declared embedded emissions. There is very little detail on the methodology to be applied and this is expected to follow in delegated act(s). The Article provides a significant degree of leeway so third countries are watching carefully as to what the detailed rules will be and how far their current regimes can tick the box.

Impact of CBAM

Supporters of CBAM argue that the EU is perfectly entitled to dictate rules for the products placed on the single market provided they comply with international trade law. They also note that there is sufficient flexibility in the regime for imports to be relatively unaffected where they originate from a country with an adequate carbon pricing framework.

Of course, what is adequate is entirely in the eye of the Commission and some exporters may find the uncertainty alarming. The reality is that, assuming CBAM survives in its current form, it will push a number of third countries to develop carbon pricing and trading regimes that satisfy the new rules but this will take time.

One point to keep an eye on as the proposals evolve is the way CBAM and the Article 2(5) and Article 9 mechanisms in particular hinge on the concept of a country of origin (of the goods or payment of the carbon price or the ETS being established there). This is a notoriously thorny issue in trade law and, for many products, it will be far from clear what the country of origin would actually be.

The CBAM is a smart piece of law given the overall policy objectives. It will be interesting to see how the EU's major trading partners react over the coming months and how far adjustments need to be made.

For more information on the EU's proposed CBAM, read our previous blogs: The CBAM proposal - three key questions and The EU’s CBAM and a WTO challenge.