Explanatory Memorandum to COM(2021)564 - Carbon border adjustment mechanism

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This page contains a limited version of this dossier in the EU Monitor.

dossier COM(2021)564 - Carbon border adjustment mechanism.
source COM(2021)564 EN
date 15-07-2021


1. CONTEXT OF THE PROPOSAL

• Reasons for and objectives of the proposal

The world is facing a profound climate crisis and the challenges of climate change require a global response. Strong international cooperation will strengthen the joint climate action needed by all the Parties of the Paris Agreement to meet the goal of holding the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels 1 .

The European Union’s international leadership must go hand in hand with bold domestic action. To meet the objective of a climate-neutral EU by 2050 in line with the Paris Agreement, the Union needs to increase its ambition for the coming decade and update its climate and energy policy framework. This process is already projected to start under the existing EU legislation. Furthermore, as announced in the European Green Deal 2 , the Commission has proposed a new EU target for 2030 of reducing greenhouse gas (‘GHG’) emissions by at least 55 per cent compared to levels in 1990 3 , based on a comprehensive impact assessment 4 . This objective has been endorsed by the European Council 5 and communicated to the United Nations Framework Convention on Climate Change making it internationally binding 6 . The European Climate Law, as agreed with the co-legislators, sets the new 2030 target while making the EU’s climate neutrality objective legally binding 7 .

To deliver on these GHG emissions reductions in line with the European Climate Law, the Commission proposes to revise where necessary all relevant policy instruments by July 2021 in a ‘Fit for 55 Package’, which covers in particular the review of sectoral legislation in the fields of climate, energy, transport, and taxation 8 . A carbon border adjustment mechanism (‘CBAM’), announced in the European Green Deal, is part of that package and will serve as an essential element of the EU toolbox to meet the objective of a climate-neutral EU by 2050 in line with the Paris Agreement by addressing risks of carbon leakage as a result of the increased Union climate ambition. The European Parliament adopted in March 2021 a resolution advocating for the introduction of a WTO-compatible carbon border adjustment mechanism 9 .

The Commission also announced in its EU Action Plan: Towards Zero Pollution for Air, Water and Soil 10 the promotion of relevant instruments and incentives to better implement the polluter pays principle 11 and thus complete the phasing out of ‘pollution for free’ with a view to maximising synergies between decarbonisation and the zero pollution ambition.

The Commission announced its intention to propose a CBAM in the European Green Deal. As indicated in the Communication ‘Should differences in levels of ambition worldwide persist, as the EU increases its climate ambition, the Commission will propose a carbon border adjustment mechanism, for selected sectors, to reduce the risk of carbon leakage. This would ensure that the price of imports reflect more accurately their carbon content. This measure will be designed to comply with World Trade Organization rules and other international obligations of the EU 12 ’.

This mechanism is an alternative to the measures that address the risk of carbon leakage in the EU’s Emissions Trading System 13 (‘EU ETS’) and is meant to avoid that the emissions reduction efforts of the Union are offset by increasing emissions outside the Union through relocation of production or increased imports of less carbon-intensive products. Without such a mechanism, carbon leakage could result in an overall increase in global emissions.

The Paris Agreement commits the international community to a continuous increase in the ambition of climate action to limit global average temperature rise in order to significantly reduce the risks and impacts of climate change. Each Party must prepare its own nationally determined contribution (‘NDC’) towards this global goal, reflecting its ‘highest possible ambition’ as well as its ‘common but differentiated responsibilities and respective capabilities, in the light of different national circumstances 14 .

As long as significant numbers of the EU’s international partners have policy approaches that do not result in the same level of climate ambition as the Union, and differences in the price applied to GHG emissions remain, there is a risk of carbon leakage. Carbon leakage occurs if, for reasons of differing ambitions related to climate policies, businesses in certain industry sectors or subsectors were to transfer production to other countries with less stringent emission constraints or imports from these countries would replace equivalent but less GHG emissions intensive products due to the difference in climate policy. That would risk undermining the effectiveness of the EU’s emission mitigation policies, and could also lead to an increase in their total emissions globally, thus jeopardising the reduction of GHG emissions that is urgently needed if the world is to keep the global average temperature to well below 2°C above pre-industrial levels.

Currently, the risk of carbon leakage is being addressed in the Union under the EU ETS. This is the world's first international GHG emissions trading system and has been in place since 2005. For the sectors covered by this system and most at risk of carbon leakage, this risk is currently managed through the granting of free allowances and compensations for the increase in electricity costs under state aid rules. However, free allocation under the EU ETS weakens the price signal that the system provides for the installations receiving it compared to full auctioning. It thus affects the incentives for investment into further abatement of GHG emissions.

At the same time, as the Union increases its climate ambitions, the divergence with third countries’ level of climate action is expected to widen, with an increased risk of carbon leakage for the EU. This would stem from the EU’s increasingly ambitious GHG emissions reduction targets that should reduce the overall number of ETS allowances. As a consequence, the carbon price signal from the EU ETS is strengthened, incentivising Union producers to reduce their emissions, but widening the difference with countries without carbon pricing mechanisms. Moreover, overall free allocation will also decline over time, in line with the reduction of the emission cap.

Considering the problems described above, this proposal addresses the problem of reducing GHG emissions in the Union, while at the same avoiding that these emissions reduction efforts are offset globally by emissions increase outside the Union. In this context, a CBAM is proposed with the overarching objective of addressing the risk of carbon leakage in order to fight climate change by reducing GHG emissions in the Union and globally.

• Consistency with existing policy provisions in the policy area

In the context of the ‘Fit for 55 Package’ the CBAM is not a self-standing measure. It is a climate policy measure aiming at preserving the integrity of the EU’s climate ambition towards the ultimate goal of climate neutrality. The role of the CBAM is to address the risk of carbon leakage and reinforce the EU ETS. There is thus a strong relation between the EU ETS and the CBAM.

As part of the ‘Fit for 55 Package’ the EU ETS is also proposed for revision 15 . This involves the extension of the EU ETS to maritime transport, as well as the introduction of emissions trading to the buildings and road transport sectors. Most notably, the higher climate ambition of the proposed amendments of the EU ETS appears in a more stringent cap on emissions, meaning that the overall number of allowances available will decline. A more stringent cap implies a stronger carbon price signal. The EU objective of climate neutrality and the decision to raise the climate ambition for 2030 also lead to a broader reconsideration of existing measures against the risk of carbon leakage. In particular, while free allocation of allowances effectively prevents carbon leakage risks, it weakens the carbon price signal for the Union industry compared to full auctioning.

As indicated by the European Green Deal, the CBAM would ensure that the price of imports reflects more accurately their carbon content. This measure has been designed to comply with World Trade Organization (‘WTO’) rules and other international obligations of the Union. Furthermore, President von der Leyen has underlined that ‘carbon must have its price – because nature cannot pay the price anymore. The Carbon Border Adjustment Mechanism should also motivate foreign producers and EU importers to reduce their carbon emissions 16 ’.

To this end active outreach to third countries would be important with regard to the understanding of and compliance with CBAM requirements. Moreover, the EU will engage with third countries whose trade to the EU is affected by this Regulation to explore possibilities for dialogue and cooperation with regard to the implementation of specific elements of the Mechanism. It should also explore possibilities for concluding agreements to take into account their carbon pricing mechanism.

The existing mechanisms to address the risk of carbon leakage are free allocation of EU ETS allowances and in some cases financial measures to compensate for indirect emission costs from increases in electricity prices due to the EU ETS (indirect emission costs). A CBAM is an alternative to those measures and would therefore have to replace them over time. However, to allow producers, importers and traders to adjust to the new regime, the reduction of free allocation should be implemented gradually while the CBAM is phased-in, in order to ensure that they are not cumulative.

• Consistency with other Union policies

The Union is extremely active in international fora to strengthen environmental global rules and to accompany trade partners and less developed countries on a path to decarbonise. CBAM will complement the international environmental action of the Union and favour decarbonisation in third countries.

Since 1992, the Union has worked to develop joint solutions and drive forward global action to tackle climate change. More specifically, action at EU level should aim to provide for cost effective delivery of long-term climate objectives, while ensuring fairness and environmental integrity. The establishment of a robust governance of the EU 2050 climate-neutrality objective will help to ensure that the Union remains on track to achieve this target.

The Commission also announced the promotion of relevant instruments and incentives to better implement the polluter pays principle 17 and thus complete the phasing out of ‘pollution for free’ in the EU Action Plan: Towards Zero Pollution for Air, Water and Soil 18 with a view to maximising synergies between decarbonisation and the zero pollution ambition.

2. LEGAL BASIS, SUBSIDIARITY AND PROPORTIONALITY

• Legal basis

Articles 191 to 193 of the Treaty on the Functioning of the European Union (‘TFEU’) confirm and specify EU competencies in the area of climate change. The legal basis for this proposal is Article 192(1) of TFEU. In accordance with Articles 191 and 192(1) of TFEU, the Union shall contribute to the pursuit, inter alia, of the following objectives: preserving, protecting and improving the quality of the environment, promoting measures at international level to deal with regional or worldwide environmental problems, and in particular combating climate change.

• Subsidiarity (for non-exclusive competence)

Climate change is by its very nature a trans-boundary challenge that cannot be solved by national or local action alone. Coordinated EU action can effectively supplement and reinforce national and local action and enhances climate action. Coordination of climate action is necessary at Union level and, where possible, at global level, and EU action is justified on grounds of subsidiarity.

The introduction of an EU-wide CBAM will create a common and uniform framework to ensure an equivalence between the carbon pricing policy applied in the EU’s internal market and the carbon pricing policy applied on imports. Its aim is purely environmental and has a cross-border dimension, so it cannot be tackled independently by Member States. Due to its environmental nature and in order to avoid trade diversion, the CBAM should be more efficient applied at Union level in a uniform way, mirroring EU ETS and designed in a compatible way with WTO rules.

Moreover, should the CBAM not be applied in a uniform way, it would incentivise behaviours resulting in trade diversion and forum shopping, as third country exporters would import goods through EU jurisdictions applying the CBAM in the most lenient way.

This is not in contrast with deferring implementation and enforcement to competent national authorities, however this should be limited to implementation and enforcement.

·Proportionality

The proposal seeks to address the challenge of reducing GHG emissions in the Union while at the same time avoiding that these emissions reduction efforts are offset by emissions increase outside the Union. The policy choices therefore are clearly dictated by the aim to achieve the objectives of the CBAM, namely to address the risk of carbon leakage in order to fight climate change by reducing GHG emissions in the Union and globally.

The proposed product coverage of the CBAM is framed by the sectors and emissions covered by the EU ETS, the sector coverage of which is in turn based on various quantitative and qualitative criteria linked to the environmental objectives of the EU ETS, and the CBAM scope should be laid down by a reference to certain goods by way of their classification in the Combined nomenclature 19 . This serves the motivation for the measure, namely to ensure that risks of carbon leakage for certain energy intensive sectors are mitigated. The CBAM, builds on the climate logic of the EU ETS starting with sectors where emissions are the highest in absolute numbers and therefore where it would matter most.

The carbon content of products is an essential element of the CBAM as it indicates the GHG emissions (in carbon dioxide equivalent, ‘CO2e’) released during their production abroad. This is used to ensure that imported products are treated no less favourably than domestic products produced in EU ETS installations. As installations covered by the EU ETS are subject to a carbon price assessed on their actual emissions, imported products in the scope of the CBAM should also be assessed based on their actual GHG emissions. However, in order to allow businesses to adjust to such an approach it is proposed to start with a transitional period without financial adjustment.

As regards the administration of the measure empowering national competent authorities would maximise the effectiveness of the implementation and enforcement by taking into account national experiences in managing the EU ETS. A set-up with national competent climate authorities playing a key role mirrors to a large extent the set-up successfully used for almost a decade in the EU ETS.

• Choice of the instrument

The objectives of the present proposal can best be pursued through a Regulation. This will ensure direct applicability of a number of provisions concerning goods imported in the Customs Union. Moreover, this Regulation requires uniform and consistent application and enforcement throughout the Union in order to pursue the objectives of Articles 32 and 207 of TFEU.

Differing exposures to the risk of carbon leakage would provide limited justification for action at national level. Carbon emissions are not localised and like the EU ETS, the CBAM can achieve greater efficiency when uniformly applied on a broader scale.

For this reason, the objectives of the present proposal can best be pursued through a Regulation. This will ensure direct applicability of its provisions.

Besides, conferring certain tasks related to implementation and enforcement to authorities in charge of climate and customs in Member States would address technical and methodological constraints and increase effectiveness.

3. RESULTS OF EX-POST EVALUATIONS, STAKEHOLDER CONSULTATIONS AND IMPACT ASSESSMENTS

·Stakeholder consultations

For the preparation of this proposal, the Commission designed and implemented a stakeholder’s consultation strategy, which encompassed both public and targeted consultations.

An inception impact assessment was published for feedback on 4 March 2020. A consultation took place until 1 April 2020 20 with the aim to collect feedback on the initial considerations of the project. In total 219 responses were submitted during this consultation period broken down into approximately 150 responses by trade federations, business associations and individual businesses, 20 NGOs, 20 citizens and the remaining from think tanks, academic/research institutions, trade unions and public authorities. The majority of responses came from the EU, with 24 from third countries.

Overall, the majority of replies expressed support for the CBAM, with the remaining being roughly divided equally between limited and no support. The vast majority of responses expressed cautiousness in the design of the measure requesting to consider all options possible. Among others, key areas emphasized were the impact on value chains and reliance on imports of raw materials, avoidance of excessive effects on final consumers, links to EU ETS and free allowances, distributional impact in affected sectors and across countries, especially developing economies and interaction with existing trade defence measures on raw materials.

In line with the Commission’s Better Regulations Guidelines an open public consultation 21 was also carried out between 22 July and 28 October 2020. The consultation aimed to gather opinions from citizens and organisations on the justifications, objectives, potential design and scope as well as impacts of the initiative. Respondents were also allowed to upload position papers. A total of 615 respondents participated in the public consultation. Of these, 6 responses were duplicates, leading to 609 valid contributions.

With respect to the problem of carbon leakage, most respondents state that carbon leakage is a real issue and that the CBAM can address carbon leakage, foster consumption of low-carbon products in the EU, and stimulate the deployment of low-carbon technologies and ambitious climate policies in third countries. On the effectiveness of current measures in the context of the EU ETS and state aid rules to limit carbon leakage, and on the ability of other regulatory measures to reduce GHG emissions companies, business associations and public authorities have a positive belief whereas citizens and other stakeholders are more critical. Respondents suggest that the CBAM should focus on products from activities already included in the EU ETS (especially those with the highest risk of carbon leakage) and account for entire value chains.

In addition to the above, the Commission services engaged in extensive bilateral consultations with public authorities within the EU and third countries, business associations, individual companies and NGOs. At the same time targeted consultations were undertaken by an external contractor who conducted a total of 25 in-depth interviews with senior managers and associations from the basic materials sectors, manufacturers, NGOs and policymakers. There were two rounds of interviews. First, 17 informal interviews were conducted at an early stage and served to identify relevant points of concern and open questions for further research. In a second step, eight additional interviews were conducted in order to test whether the judgements and concerns from the informal interviews were shared among a wider group of stakeholders. 17 stakeholders came from industry, 5 from NGOs and 3 from Member State institutions.

The results of the public and targeted consultations allowed the Commission to collect a significant number of views and opinions on the initiative. Both public and targeted consultations showed agreement on the necessity of a CBAM to address the risk of carbon leakage and help the Union to achieve its increased climate ambitions. The feedback received throughout these consultations has been used to inform the choice of the design elements and the preferred policy options. Result of the stakeholder consultation is summarised in the relevant annex to the impact assessment.

• Collection and use of expertise

The preparatory steps for the proposal rest on an array of studies and expert advice, analysing the potential design and scope of the CBAM as well as its environmental, social and economic impacts.

In particular, a study on the optimal design of the mechanism and its sectoral coverage was conducted with the support of external expertise to the Commission. The study reviewed the logic of intervention, assessed a range of alternative options and their feasibility, provided technical advice on technical design elements and provided support on the selection of sectors to be covered by the mechanism. Elements of this study are presented in the impact assessment 22 , while the full study is also published by the Commission 23 .

In addition to the qualitative study of the CBAM, a dedicated quantitative assessment of impacts was also conducted with support from the Joint Research Centre of the Commission and from external expertise, the first focusing on the CBAM’s impacts on material products and the later focusing on the CBAM’s impacts on electricity. These quantitative assessments provided insight into the environment, economic and social impacts of the initiative and are made publicly available as part of the impact assessment.

Finally, the analysis rests on additional literature review, studies and research papers submitted by academics in the open public consultation and other independent studies.

• Impact assessment

The Regulatory Scrutiny Board issued a positive opinion with reservations on the impact assessment, including suggestions for improvement 24 . The Impact Assessment report was further revised along these lines, in particular, an effort was made to ensure that it is self-standing with regards to the problem of carbon leakage, while strengthening its coherence with the proposal for the revision of the EU ETS, as well as providing better clarity on the key impacts and institutional choices and presenting in greater detail the views of different stakeholder groups.

The problem addressed by the CBAM is how to reduce GHG emissions in the EU, while at the same time avoiding that these emissions reduction efforts are offset by emissions increasing outside the Union (carbon leakage). To reflect this dynamic framework, the basis against which the impact assessment was built reflected the fact that the CBAM is put forward against the new agreed EU target of reducing net GHG emissions by at least 55 per cent (relative to 1990).

Six different options were assessed against this dynamic framework, all of which were designed to take account of WTO requirements and of the EU’s international commitments such as free trade agreements concluded by the EU or the Energy Community Treaty.

The first option for a CBAM is an import carbon tax, paid by the importer when products enter the EU. The tax would be collected by customs at the border based on a tax reflecting the price of carbon in the Union combined with a default carbon intensity of the products. Importers would have the opportunity to claim a reduction of the CBAM based on their individual carbon footprint and any carbon price paid in the country of production.

The second option involves the application on imports of a system that replicates the EU ETS regime applicable to domestic production. This option entails – similar to the system of allowances under the EU ETS – the surrendering of certificates (‘CBAM certificates’) by importers based on embedded emission intensity of the products they import into the Union, and purchased at a price corresponding to that of the EU ETS allowances at any given point in time. These certificates will not be linked to the EU ETS system of allowances but will mirror the price of these allowances to ensure a coherent approach to the pricing under the EU ETS. National climate authorities will administer the sale of the CBAM certificates and importers will submit declarations of verified embedded emissions in the imported products to these authorities tasked with managing the CBAM and surrender a number of CBAM certificates corresponding to the declared emissions. Such declaration and surrendering will occur – similar to that under the EU ETS – at a yearly reconciliation exercise taking place in the year following the year of importation and based on yearly trade import volumes. The carbon emission intensity of products would be based on default values; however, importers would be given the opportunity, at the moment of the yearly reconciliation exercise, to claim a reduction of the CBAM on the basis of their individual emission performance. They would also be entitled to claim a reduction of the CBAM for any carbon price paid in the country of production (which is not rebated or in other way compensated upon export).

Option 3 operates in the same way as option 2, however the carbon price of imports is based on actual emissions from third country producers rather than on a default value based on EU producers’ averages. Under this option, the importer will have to report the actual emissions embedded in the product and surrender a corresponding number of CBAM certificates.

Option 4 would apply in the same way as option 3. It consists of surrendering CBAM certificates on imported products. However, this option considers also a 10 years phasing in period starting in 2026 during which the free allocations of allowances under the EU ETS would be gradually phased out by 10 percentage points each year and the CBAM would be phased in. During this phasing in period, the CBAM would be reduced proportionally to the amount of free allowances distributed in a given sector.

Option 5 is a variant of Option 3 with a scope extended further down in the value chain. Carbon-intensive materials that are part of semi-finished and finished products would be covered along the value chain. For imports, the CBAM would again be based on the actual emissions from third country producers.

Option 6 consists of an excise duty on carbon-intensive materials covering consumption in the Union of both domestic and imported products, besides the continuation of the EU ETS including the free allocation of allowances covering production in the EU.

With respect to the effectiveness of the CBAM against its overarching objective of addressing the risk of carbon leakage in order to fight climate change by reducing GHG emissions in the Union and globally, the impact assessment showed that all the policy options achieve positive impact. In that respect, all CBAM options were found to achieve a stronger reduction of emissions in the CBAM sectors in the Union, relative to the case of higher ambition and free allocation. With regards to incentivising third country producers to move towards cleaner production processes, all policy options bring about positive results. On that criteria, the options allowing for the possibility to demonstrate actual emissions are particularly effective, with options 3, 4 and 5 also showing strong positive results. All options were found to be coherent with the EU ETS.

On providing protection against carbon leakage, option 4 followed by 3 and 5 bring about a stronger positive impact, while options 1, 2 and 6 would be less effective. All policy options are designed in a way that respects the EU’s international commitments.

The CBAM will apply on imports of goods at the price of carbon determined by the EU ETS system through the system of auctions. Importers would either be charged on the basis of a default value or based on the actual emissions embedded in the imports. The possibility to demonstrate that the carbon efficiency of their product is better than the default value, would increase the complexity of the system, but this also provides emission reduction incentives for the share of materials that is exported to the EU.

Overall the impact of the CBAM on employment is limited. Changes in employment are largely driven by the presence (or not) of free allocation. Retaining free allocation results in a slight increase in employment in the CBAM sectors. The complete removal of free allocation in the absence of a CBAM leads to the highest employment losses. The application of the CBAM on material industrial products is likely to have limited impact on consumer prices because the measure is targeted at products upstream in the value chain and affects goods for final consumption only indirectly.

Compliance costs are assumed to arise for importers located in the Union that would be subject to the CBAM obligations. This could be done either based on a default value or by providing verified information about actual emissions. While the monitoring of these actual emissions would take place outside the Union, the responsibility – and thus costs – of providing the verification regarding this monitoring to authorities lies with the importers. For options 1, 2, 3, 4 and 5, when emissions are declared at default value, monitoring of the emissions from the production process is not necessary and therefore also limited costs are incurred. However, if importers decide to claim to use the actual emissions from the production process, the monitoring creates additional costs for the business. Under option 6, default values have to be determined both for materials and manufactured goods. Administrative effort is relatively low for producers of materials in the EU, which means producers do not have to demonstrate the carbon intensity of their production.

Electricity generation is addressed separately to material products. Applying a CBAM to the electricity sector requires taking into account its uniqueness that distinguishes it from basic materials, including the methods for its transportation, through constrained, monopoly networks, and the broad set of technologies employed for its production.

In line with approaches applied to the material products, a reference value for emissions embedded in imported electricity needs to be established in the context of determining the corresponding CBAM obligation. Two alternative options are employed to determine the reference value for embedded emissions for electricity namely (a) average GHG emission intensity of the EU electricity mix and (b) average GHG emission factor of the EU electricity mix. As with other options, however, importers would still have the possibility to prove that their installation level emissions are lower than the above reference values.

On the basis of the above, the impact assessment concluded that option 4 provides clear benefits relative to all other options considered. It is therefore suggested to introduce a CBAM on selected products in the form of CBAM certificates based on actual emissions. It is also suggested to introduce CBAM progressively against a correspondent reduction of allowances allocated for free in the corresponding EU ETS installations. This policy option ensures a high level of effectiveness for the CBAM.

A system based on actual emissions on imported goods ensures a fair and equal treatment of all imports and a close correlation to the EU ETS. The CBAM system will, however, need to be complemented by a possibility to base calculations on a set of default values to be used in situations when sufficient emission data will not be available. Moreover, during an initial transitional phase, where importers may not be able to produce yet the data required by system on actual emissions, a default value could also apply. This option will need to be designed to fully respect the EU’s international commitments, in particular WTO rules, and therefore it will be necessary to ensure that if a default value applies, importers are in all cases given the opportunity to demonstrate that they perform better than such value based on their actual emissions. Moreover, with regard to the phase in of the CBAM and the corresponding phase out of the free allowances, it will need to be ensured that at no point in time over this period, imports are afforded less favourable treatment than domestic EU production.

Further, the introduction of CBAM certificates based on actual emissions would protect against the risk of carbon leakage while incentivising third country producers to move towards cleaner production processes, with the support of Official Development Assistance when applicable.

As regards electricity the preferred option is to apply the CBAM based on the carbon emission factor including the possibility for importers to demonstrate lower emissions. Both options contribute to mitigating the risks of carbon leakage by discouraging in the mid-term the build-up of carbon-intensive power generation sources in the vicinity of EU borders which might replace EU-based generators exposed to increasing carbon costs. However, the option based on the carbon emission factor displays superior effectiveness in preventing carbon leakage while keeping administrative costs low.

The choice of policy option 4 for material products and the carbon emission factor for electricity would introduce a proportionate mechanism to address climate change by reducing GHG emissions in the Union and avoiding that these emissions are replaced by emissions outside the Union. In addition, the gradual phase out of free allocation under the EU ETS in the sectors concerned, combined with the gradual phase in of CBAM, would ensure a prudent and predictable transition for businesses and authorities.

• Regulatory fitness and simplification

The impact assessment indicates that a CBAM would result in relatively higher compliance costs for SMEs compared to large enterprises. The exact degree of difference between the two groups could not be quantified based on the currently available data.

The fact that a CBAM is initially introduced on imports of a few basic materials and basic material products results in large businesses being the main impacted ones. Therefore, the practical impact of import related measures would have little practical impact on SMEs, even though that impact would be relatively higher than for large businesses if compared on the amount imported. For that reason the impact assessment did not carry out a SME test, neither did it perform a separate SME consultation, although the views of, and implications for, SMEs have been assessed as part of the Commission’s Online Public Consultation,

For these reasons also, no special measures for SMEs are foreseen in this Regulation.

• Fundamental rights

The proposal respects the fundamental rights and observes the principles recognised in particular by the Charter of Fundamental Rights of the European Union 25 . In particular, it contributes to the objective of a high level of environmental protection in accordance with the principle of sustainable development as laid down in Article 37 of the Charter.

4. BUDGETARY IMPLICATIONS

Most revenues generated by CBAM will go to the EU budget 26 . In the special European Council of 17-21 July 2020 27 , EU leaders agreed on the recovery instrument NextGenerationEU. The instrument will provide the EU with necessary means to address the challenges posed by the COVID-19 pandemic and, therein, support investment in the green and digital transitions. In order to finance it, the Commission will be able to borrow up to EUR 750 billion on financial markets. In that context, the European Parliament, the Council and the Commission agreed that ‘the Institutions will work towards introducing sufficient new own resources with a view to covering an amount corresponding to the expected expenditure related to the repayment’ of NextGenerationEU 28 . The Commission committed to put forward proposals on new own resources, which would include the CBAM in the first semester of 2021.

5. OTHER ELEMENTS

• Implementation plans and monitoring, evaluation and reporting arrangements

Within the framework of the overall package of environmental measures adopted and applied by the EU, which illustrate the EU's continued pursuit of a higher level of environmental ambition than many of our trading partners, it is considered appropriate to begin moving from a system in which carbon leakage is addressed by free allowances to a system in which carbon leakage with respect to imports is addressed by a carbon border adjustment mechanism as soon as this is reasonably possible, taking into account the technical and economic feasibility, including administrative constraints and the legitimate expectations of all economic operators, in an even-handed manner.

Concurrently balancing these multiple objectives pleads in favour of the gradual introduction of a carbon border adjustment mechanism, as soon as is reasonably possible, so that during an initial and relatively short pilot phase without any financial adjustment, operators can adjust themselves to the new system, including its additional administrative requirements, and the authorities can obtain experience with respect to the operation of the new system.

Once that pilot phase is complete, the process of transitioning from free allowances to a carbon border adjustment mechanism will accelerate in earnest and in a manner that ensures no discrimination between domestic and imported goods, or between imported goods from different countries, in full compliance with the EU's international obligations and rights.

The Commission will ensure that arrangements are in place to monitor and evaluate the functioning of the CBAM, including its enforcement against fraudulent practices, and evaluate it against the main policy objectives. Given that the CBAM is one of the policy proposals under the ‘Fit for 55 Package’, monitoring and evaluation could be carried out in alignment with the other policies of the package.

Before the end of the transitional period, the Commission will report to the European Parliament and the Council on the application of the Regulation and, if appropriate, will make a legislative proposal to extend the CBAM to other goods than those listed in Annex I and possibly also to other emissions, and introduce other possible changes to improve its functioning. For that, it is necessary to firstly monitor the effect of the CBAM.

• Detailed explanation of the specific provisions of the proposal

Chapter I sets out general provisions, including the subject matter, the scope of the proposal (Articles 1 and 2) and the definitions of the key terms (Article 3). Annex I defines in detail the scope of the proposal, listing the goods and the GHG emissions relating to each of those goods. Annex II indicates the countries and territories of origin excluded from the application of the measure.

Chapter II contains provisions on obligations and rights of declarants of goods. More specifically, it contains provisions on the conditions to apply for an authorisation to import CBAM goods (Articles 4 and 5), the obligation of an authorised declarant to submit an annual CBAM declaration by 31 May of each year and the content of that declaration (Article 6), the principles for the calculation of the emissions embedded in goods imported to the EU during the previous calendar year (Article 7, as further outlined in Annex III) and the process of verifying these emissions by accredited verifiers (Article 8, complemented by reporting requirements and verification principles in Annexes IV and V). It also sets out the principles for taking into account a carbon price paid in third countries (Article 9). Last, under Article 10, an operator of an installation in a third country has the possibility to request to the Commission to be included in a central database. Once registered, the operator may opt to disclose information about the embedded emissions verified to an authorised declarant. The authorised declarant can use that disclosed information to fulfil the obligation to declare verified information on embedded emissions when importing the goods produced in the installation registered in the central database to the Union.

Under Chapter III, there are the general provisions on the administrative set up of the competent national authorities, the role of the Commission – also as a central administrator - and the disclosure of information (Articles 11, 12, 13 and 15). The chapter also contains provisions on the main characteristics of the national registries and its accounts (Articles 14 and 16) and decisions of the authorities regarding the authorisation to import (Article 17), the accreditation of verifiers (Article 18) and the review of CBAM declarations (Article 19).

Chapter IV contains provisions regarding the CBAM certificates. Articles 20 to 24 establish detailed rules on the life cycle of the CBAM certificates, from their sale to the control of their surrender or, if any, re-purchase, and their final cancellation. Article 20 concerns in detail the sale of certificates by the competent authorities. Article 21 is about the calculation of the price of the certificates, done by the Commission, on a weekly basis. Article 22 lays down the procedures to ensure that each authorised declarant fulfils its obligation to surrender certificates in the national registry. Article 23 establishes the right of an authorised declarant to ask the competent authority to re-purchase a limited number of CBAM certificates remaining on its account after surrender. Finally, Article 24 specifies that, by 30 June of each year, the competent authority is required to cancel the certificates remaining in the account of each declarant after surrender and re-purchase, if any.

Chapter V deals with how customs authorities should deal with the procedures for the administration of goods at the border (Article 25). Under Chapter VI, penalties for no compliance are set in Article 26 and a special provision on circumvention is provided in case there are changes in the pattern of trade (Article 27).

Chapter VII contains provisions regarding the exercise of the delegation to the Commission to adopt delegated acts (Article 28) and the examination procedure for implementing acts (Article 29). The power to adopt delegated acts is referred to in Articles 2, 18 and 27. Articles 2, 5 to 9, 21, 25, 31, 33 and 35 contain provisions on implementing powers.

Chapter VIII contains provisions in Article 30 on the evaluation of the Regulation and its review.

Chapter IX (Article 31) deals with the reduction of the CBAM obligation to reflect the transitional allocation of EU ETS allowances for free in installations producing, in the Union, the same kinds of goods which are covered by the proposal.

Chapter X contains specific provisions to be applied during an initial transitional period. In those provisions, a CBAM with no financial adjustment aiming at collecting data and raising awareness of declarants will apply in the first years. That transitional period will have a duration of three years, from 1 January 2023 to 31 December 2025, as established in Article 32. Declarants will report on a quarterly basis the embedded emissions corresponding to their imports of the previous quarter, detailing direct and indirect emissions and reporting any carbon price paid abroad. Customs authorities will inform declarants of their CBAM obligations and exchange information with competent authorities.

Last, Chapter XI indicates the entry into force of the proposal, with some of the provisions applying only during the transitional period and others starting to be applied in 2026 (Article 36).