European Union: “FIT FOR 55”- Carbon Border Adjustment Mechanism regulation signed

In brief

On 10 May 2023 the Council of the European Union and European Parliament signed the regulation implementing the EU Carbon Border Adjustment Mechanism (“CBAM”). CBAM will enter into force twenty days after it is published in the Official Journal of the European Union. Below we will provide further detail on the regulation and highlight some aspects that have been amended when compared to the initial proposal.

In more detail

The new CBAM Regulation is targeted at imports of products in carbon-intensive industries. The objective of CBAM is to prevent dilution or offset or EU carbon reduction efforts by increasing emissions outside its borders through the relocation of production to countries that have less ambitious policies to fight climate change (so-called “carbon leakage”).

By increasing the economic cost of high-carbon imports, CBAM promotes the import of goods from non-EU businesses that are subject to high climate standards that are equivalent to those applicable in the 27 EU member states. As such it is also designed to encourage other countries in the world to join the EU’s climate efforts by introducing their own measures to tax or price emissions.

In-scope industries and products

The CBAM Regulation has enlarged the number of industries covered by the mechanism to include the import of cement, iron and steel, aluminium, fertilizers, electricity and hydrogen. Derivatives and some precursors of these products are included in the scope and listed and identified with each HS code in the Annexes I of the CBAM Regulation. The targeted gases covered by the CBAM Regulation will be the emission of carbon dioxide, nitrous oxide and perfluorocarbons. Direct and indirect emissions will be taxed for cement, fertilizers, and electricity. Iron, steel, aluminium and hydrogen will be only taxed for their direct emissions. Compared to the first proposal, hydrogen is added to goods already covered during the transitional period.

The in-scope products may vary in the definitive period as the CBAM Regulation leaves the door open to make further industries and products subject to the CBAM during the transitional period. 

Application for authorization

Any importer established in an EU Member State shall, prior to importing goods into the customs territory of the Union, apply for the status of authorized CBAM declarant. In circumstances where importers appoint an indirect customs representative and the indirect customs representative agrees to act as an authorized CBAM declarant, the indirect customs representative shall submit the application for an authorization. This obligation to obtain authorization also falls on an indirect customs representative when the importer is not established in a member state. A CBAM account number will be issued to each authorized CBAM declarant.

The CBAM Regulation foresees the establishment of two key bodies:

-    A CBAM Registry: containing data on authorized CBAM declarants, operators and installations in third countries; and 

-    A Common Central Platform: for the sales and repurchase of CBAM certificates. We note that this platform (as further described below) differs from the market under the EU Emissions Trading Scheme (ETS) that allows operators to trade in emission rights. 

The Commission shall facilitate automatically and in real time all the available information of CBAM declarants to the customs authorities.

Transitional Period

As expected, the CBAM Regulation will start applying, without financial adjustments, as of 1 October 2023 followed by a transitional period until January 2026. During this period importers of goods falling within the scope of the CBAM will only have to report greenhouse gas emissions embedded in their imports and there will be no adjustment. 

This transition period is aimed to collect information from stakeholders in order to better implement a suitable methodology for the definitive system and also to create awareness on the need to request the status of authorized CBAM declarants, where applicable.

Importers will have to report on a quarterly basis the embedded emissions in goods imported during the previous quarter of the calendar year, setting out direct and indirect emissions as well as any carbon price effectively paid abroad. This reporting-only process will apply until the end of 2025, with the last CBAM report, for the three months ended 31 December 2025 needing to be submitted by 31 January 2026. 

Definitive period

The phasing-out of free allocation under the ETS will take place in parallel with the phasing-in of CBAM in the period 2026-2034.

By 31 May of each year, and for the first time in 2027 for the year 2026, each authorized CBAM declarant shall use the CBAM registry to:

- submit a CBAM declaration for the preceding calendar year; and

-  surrender the number of CBAM certificates that corresponds to the embedded emissions declared and verified. 

Authorized CBAM declarants will be required to keep records of the information used to calculate the embedded emissions until the end of the fourth year after the year in which the CBAM declaration has been or should have been submitted. To ensure that all the embedded emissions are reported, the CBAM Regulation sets forth that CBAM declaration should be verified by an accredited verifier in accordance with Implementing Regulation (EU) 2018/2067 as is already in place for EU ETS.

Authorized CBAM declarants will be able to buy CBAM certificates from member states through the Common Central Platform. The Commission will set the price of CBAM certificates considering the average of closing prices of EU ETS allowances on the auction platform expressed in EUR/tonne of CO2 emitted. This means that unlike the EU ETS system, this Common Central Platform does not allow for the CBAM certificates to be traded among operators.

The excess of the CBAM certificates remaining on the account of the declarant in the CBAM Registry after the certificates have been surrendered can be sold to the member state where that authorized CBAM declarant is established. This repurchase order is limited to one third of the total number of CBAM certificates purchased.

Enforcement measures

The Commission is provided with a rather broad toolkit to address practices of circumvention of CBAM if there are indications of this happening based on "relevant and objective data". This allows the Commission to negate changes in current production processes or shipments that lack an economic justification. Compared to previous legislative versions of CBAM, the Commission's discretionary here seems broadened and more detailed.

In addition, the customs authorities shall not allow the importation of goods covered by CBAM by any person other than an authorized CBAM declarant. Failing to comply with any formal obligation will be subject to penalties. The competent customs authorities will be entitled to impose penalties where an authorized CBAM declarant has failed to comply with the obligation to surrender CBAM certificates or that a person has introduced goods into the customs territory of the Union without complying with the obligations. Member States will register penalties imposed in the CBAM Registry. 

Challenges to CBAM

We note that despite the changed proposal it may still be questioned if, for example, CBAM is compatible with WTO. Although the Commission is of the opinion that it is, it remains to be seen whether the conditions to rely on the environmental exceptions contained within the WTO rules such as in Article XX (g) of GATT are met. 

We are monitoring any developments concerning CBAM closely. If you have any concerns or questions about what CBAM may mean for your business, please contact your key Baker McKenzie contact or the authors of this article. 

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