The Carbon Border Adjustment Mechanism (CBAM) proposed by the European Union is aimed at solving the issue of carbon leakage in the EU's carbon market. The system strives to guarantee that imports from countries with lower environmental standards do not compromise the EU's climate ambitions.

Carbon leakage refers to the situation where companies shift production to countries with weaker environmental regulations to avoid carbon pricing. As a result, more emissions are created from the same items in other nations, increasing global emissions. As a remedy, CBAM imposes a carbon price on imported goods that are equal to the price set by the EU's emissions trading scheme (ETS).

CBAM targets specific industrial sectors severely affected by carbon leakage, such as cement, iron, steel, aluminium, fertilisers, electricity, and hydrogen. This applies to both imports and domestic production and ensures a level playing field for European industry.

The mechanism works by requiring importers to purchase carbon credits to cover the emissions associated with their products. These certificates will be priced according to the EU ETS average carbon price. This means that the importers will have to pay the same carbon price as the EU producers, creating a level playing field for domestic and imported products. Transactions with EU’s important trade partners such as the UK, the US, China, and Türkiye are expected to be impacted by this change.

CBAM is expected to generate significant revenue for the EU, which will be used to fund Union's ambitious climate goals. The plan is that revenue generated will be used to finance renewable energy projects, support the development of clean technologies, and support the transition to a low-carbon economy to become #Fit for 55 as well as a support tool for the decarbonisation efforts of the least developed countries.

In conclusion, the EU's Carbon Border Adjustment Mechanism is a significant proposal aimed at addressing the issue of carbon leakage in the EU's carbon market. When it is adopted by the European Parliament and the Council, the rules and methodology for applying CBAM will be defined by the CBAM Committee. The transitional phase will enter into force as of 1 October 2023. For more information contact our ESG VAT and Customs specialists, Goker, Donna and Mattia.