With the implementation of the carbon border adjustment mechanism (“CBAM”), the European Union (“EU”) aims to set a new global regulatory standard for pricing emissions, introducing a border levy on embedded emissions in a range of goods imported into the EU. The CBAM is set to significantly impact businesses globally with strict emissions reporting requirements, though the precise impacts are unclear. This current regulatory uncertainty makes it challenging for industry leaders to prepare their businesses for the CBAM’s full implementation.
The CBAM introduces a border levy for embedded carbon emissions in products at high risk of carbon leakage. Carbon leakage occurs when manufacturers move production from a region with stringent emissions measures to one with less strict regulations, potentially increasing overall emissions. To counter this, the EU has exempted certain industries at high-risk of carbon leakage from its emissions trading system (“ETS”) by offering them free emissions allowances, effectively exempting them from paying a price for their emissions. But the CBAM will phase out these free allowances, moving towards a level playing field where all economic participants pay for their emissions.
This new regulatory regime will apply to specific products only as defined by their import CN codes, including iron and steel, aluminium, cement, hydrogen, energy and fertiliser. However, the EU is already considering expanding it to other products, including downstream products, embedded emissions associated with the transportation of goods or indirect ‘Scope 2’ emissions for products like aluminium or hydrogen.
On 1 January 2026, the CBAM will enter an eight-year phasing-in period, introducing reporting and compliance requirements while gradually phasing out the free emissions allowances under the EU ETS. Currently, the CBAM is in a transitional phase, during which the European Commission is gathering feedback on its practical workings. However, during this transitional phase, CBAM reporters are already experiencing practical challenges in complying with requirements:
Monitoring, reporting and verification (“MRV”) of embedded emissions is challenging. Not only is it difficult to precisely measure the accurate amount of embedded emissions while avoiding under or over-reporting, but regulatory uncertainty exists around what methodologies to use. Initially, during the transitional phase, the European Commission allowed the use of so-called default reference values for specific product categories. However, from mid-2024, this will only be allowed for complex goods, with a limit of 20% of total embedded emissions. Additionally, the Commission’s methodology for calculating embedded emissions does not align with the International Standards Organisation’s (“ISO”) methodologies (ISO 14064-1), creating regulatory fragmentation.
The CBAM is expected to evolve significantly. In response to reporting challenges during the transitional phase, the Commission is already considering ways to simplify and streamline the reporting process. This may include revising the reporting format, continuing to allow default values or raising the minimum reporting value from €150. In addition, the Commission will publish a report before the end of 2024 assessing the need to include downstream products. A second report is due by 2026, assessing the inclusion of embedded indirect emissions and expanding the CBAM to other sectors, for instance, organic chemicals, polymers and pulp and paper. Legislative proposals will likely accompany these reports.
The involvement of 27 competent authorities could lead to a lack of harmonised standards across the EU. All EU Member States must implement the rules nationally through their competent authorities. Although common in EU regulation, this could result in a fragmented approach to CBAM standards. Additionally, some national authorities may struggle with staffing, leaving businesses unsure of who to contact in case of compliance challenges.
In an already tense global trade environment, the CBAM could heighten trade tensions. Import duties, trade tariffs or border levies always risk retaliatory action. Recently, when the EU announced import tariffs on Chinese battery electric vehicles (“EVs”), China threatened retaliatory tariffs on key EU imports. Despite efforts by the EU to engage in diplomatic dialogue on the CBAM with global trading partners, initial reactions have not put worries of retaliatory action to bed, for example, India is unwilling to engage in a dialogue on CBAM with the EU, calling the border levy unfair and not acceptable.
“Developing economies are viewing CBAM as a non-tariff barrier that is likely to put onerous financial pressure on industrial units in developing markets like India, without any accompanying commitments on clean finance, cleantech collaboration or import commitment of ‘premium’ green products. Considering that the UK and possibly the United States may replicate CBAM-like regulations, this would end up deepening the rift between Global North and Global South players. Climate partnership and diplomacy require more collaboration between the North and South and the CBAM needs more accompaniments that facilitate this collaboration.”
– Amrit Singh Deo, Senior Managing Director and Head of Public Affairs India
“For China, the CBAM poses significant challenges to businesses such as steel and aluminium, which have higher energy intensity and greater exposure to the EU market. Even though China has a domestic emissions trading system, whose establishment was in close collaboration with the EU, its scope is yet to cover all that is included in the CBAM, and the carbon price is far too low, compared to that in the EU, to offset the CBAM levy impact. These practical challenges may cause additional friction in the already-strained bilateral trade relations and exacerbate the fragility of the global supply chain.”
– Rachel Hsueh, Managing Director and Head of Public Affairs China
Additional regulatory and compliance burdens could threaten the security of supply. With pandemic-era supply chain issues still fresh in mind, imposing import barriers to key industrial inputs could put the security of supply for the EU’s industry at risk. Although the CBAM ultimately aims to create a level playing field for sustainable industry, additional administrative burdens in the short term could lead to increased costs for key industrial inputs. At a time when the EU is looking to strengthen the competitiveness of its industrial base, the regulatory and compliance burden from CBAM could have the opposite effect.
Given these challenges, it is crucial for businesses to stay abreast of the latest regulatory and legislative developments, anticipate critical issues and proactively engage with national and EU stakeholders to mitigate emerging risks. FTI Consulting’s experts can help businesses navigate these uncertainties, leveraging an extended bench of seasoned public and government affairs experts in Brussels and across Member States with years of experience in policymaking across a number of key areas:
- Monitoring and intelligence of the latest regulatory developments as the EU moves towards the full implementation of the CBAM, as well as adopting secondary legislation and reviews.
- Advocacy and engagement strategy and implementation support to help businesses engage with EU decision-makers and stakeholders and achieve their policy objectives.
- Business strategy development to mitigate risk and minimise the impact of CBAM on the business and leverage CBAM compliance as a unique differentiator compared to competitors.
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Authors: Pierre Dechamps, Senior Advisor; Suparna Arora, Director & Job Boonstra, Consultant, all in our Energy & Industrials team in Brussels.
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The views expressed in this article are those of the author(s) and not necessarily the views of FTI Consulting, its management, its subsidiaries, its affiliates, or its other professionals.
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