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The EU’s Carbon Border Adjustment Mechanism and a WTO challenge

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Townsend Matthew
Matthew Townsend

Partner

London

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05 October 2021

There has been considerable speculation about the extent to which the EU’s proposed Carbon Border Adjustment Mechanism (CBAM) is consistent with principles under the WTO framework and, in particular, the General Agreement on Tariffs and Trade 1994 (GATT). It remains to be seen whether certain countries may seek to challenge the regime through the WTO remedy mechanisms.

We do not rehearse all of the possible trade arguments here (for those interested, there is a high-level briefing paper prepared by the Directorate-General for External Policies of the Union (April 2020) which sets out many of the key points). However, it is important to understand some of the main principles relevant to the discussions and to put the CBAM proposals into this context.

GATT concepts

There are two key GATT concepts which the Commission has clearly been very mindful of in the development of the CBAM scheme, namely:

  1. the principle of national treatment i.e. there should be no discrimination between an EU and non-EU product; and
  2. the most favoured nation principle i.e. there should be no discrimination between non-EU states.

Tariff debate

There has also been something of a debate about whether CBAM can be seen as a tariff and, if so, whether it would be consistent with the EU’s bound commitments under the GATT tariff schedule. 

This is touched upon in the DG’s April briefing and I won’t go into further detail here.  

Article XX

The other key point from a WTO perspective is Article XX of GATT. This sets out the principle that nothing should prevent a state from adopting measures “necessary to protect human, animal or plant life or health” or to conserve natural resources provided these measures are not applied in an arbitrary or unjustified way.

CBAM in practice

How CBAM (and its delegated acts) is applied in practice will be critical to how robust it is against a GATT based challenge. In this regard, provisions such as Article 9 and related measures are likely to come under significant scrutiny.

Critically, CBAM purports to treat domestic and non-domestic origin goods the same. The argument being that relevant domestic producers are subject to the emissions trading scheme (ETS) and related allowance costs whilst non-domestic exporters will need to account for equivalent costs through CBAM certificate purchase and surrender.

There are two critical points which underpin this debate.

  1. The need to remove free ETS allowances in respect of the CBAM sectors covered under the ETS such that there is truly a level playing field.
  2. The pegging of the price of the CBAM certificates to the ETS allowance price. 

Article 9 of CBAM

The Article 9 provisions of CBAM are potentially thorny (particularly when applying rules of origin to a good that has been through multiple phases of manufacture and assembly).

If a non-EU state has set a carbon price then it is permissible to reduce the number of CBAM certificates to be surrendered (unless there is an export rebate applied).

This leaves open the question of how a country that seeks to achieve its climate targets through routes other than a carbon price is treated. What other measures will be acceptable in this context given that they may achieve the same outcomes as a carbon price? Would a distinction in treatment by the EU be consistent with its GATT commitments?

WTO based challenge

Whilst there will continue to be speculation about the potential for a WTO based challenge, we should not lose sight of the fact that for a considerable amount of time the appellate body of the WTO has been somewhat moribund due to President Trump’s block on the appointment of members of the appellate body. 
Even when functioning as intended, the WTO would not necessarily provide a swift route to resolution of any disputes.

In reality, diplomatic engagement, extreme care on the drafting and a pragmatic application of the detailed rules of CBAM will likely prove more effective.

 

For more information of the background and purpose on the CBAM read our previous blog: The CBAM proposal - three key questions.