EU CBAM will impact supply chains

The EU Carbon Border Adjustment Mechanism (CBAM) marks a key milestone in the EU’s attempts to become climate-neutral by 2050 and in the nearer term reduce its emissions by more than 55% within the decade.

The mechanism will be introduced in two phases: a 'transitional' phase, which started on 1 October 2023 and which will run to the end of 2025; and a 'full implementation' phase starting from January 2026.

The CBAM will contribute to the EU’s climate goals by imposing a levy on importing certain carbon-intensive goods into the EU, acting to level the playing field between EU importers and producers on carbon pricing. It also aims to prevent 'carbon leakage' – where EU production is displaced to countries with more lax climate policies outside of the Union.

How will it work?

The CBAM will initially apply to the import of iron, steel, aluminium, hydrogen, electricity, cement, and fertiliser, with the intention of eventually covering all sectors encompassed by the EU’s Emissions Trading Scheme by 2030.

In the transitional phase, compliance with the CBAM is initially a reporting exercise, with companies expected to disclose their embedded emissions from imported goods on a quarterly basis.

However, from 2026 onward companies must buy carbon certificates corresponding to the carbon price that would have been due if the goods had been produced under the EU’s carbon pricing rules. When the mechanism is fully implemented, CBAM certificates must be surrendered on an annual basis.

A mitigating factor for the initial cost of the CBAM for importers will be the availability of 'free allowances'. Under the current EU ETS, producers benefit from such allowances with a carbon price paid on emissions only once the allowances have been considered.

These allowances will be gradually phased out from 2026, until the full carbon price is payable by businesses from 2034 onward. During this period, EU importers will only need to purchase CBAM certificates for a certain percentage of their emissions, starting at 2.5% in 2026 and then increasing each year until the phase-out date.

Who is affected?

The EU importer is primarily responsible for compliance. The EU importer must register with the relevant national competent authority to submit CBAM reports and eventually use the same authority to purchase CBAM certificates.

Broadly, any EU company importing CBAM goods that originate in a non-EU country will be impacted, with limited exemptions available. Goods originating in countries with an ETS linked to the EU ETS, such as Switzerland, or who participate in the EU ETS, such as Norway, Iceland, and Liechtenstein, are exempt from the CBAM. Consignments of goods with a value of less than 150 euros ($163) fall outside the mechanism’s scope.

The impact of the CBAM will reverberate across the global supply chain because EU importers will submit reports that rely heavily on obtaining emissions data from their non-EU suppliers –this aspect is likely to present the most significant challenge.

Actions for traders

Enforcing trader compliance with the CBAM will be crucial to its success.

During the transitional period, penalties may be applied where reports aren’t submitted or are incomplete, supported by action from EU authorities. Once the full implementation period starts, the reports must be verified by an independent body. The CBAM regulations also allow for national customs authorities to carry out compliance checks on behalf of the EU.

EU importers must act quickly to understand what actions to take to comply with CBAM obligations. As a priority, businesses importing CBAM goods should:

• assign internal responsibility for managing CBAM compliance, which is likely to require a cross-functional approach
• identify which goods they import are within the scope of the CBAM
• proactively engage and support their suppliers in obtaining reporting data
• exporters of CBAM goods to the EU should take a similar approach to ensure they are prepared to provide appropriate data to their EU customers.

The UK is one of the countries most exposed because of its significant levels of trade with the EU, particularly regarding iron, steel, and aluminium exports. UK businesses exporting CBAM goods to the EU should conduct an immediate impact assessment on their exposure.

What comes next?

The EU has acted swiftly and decisively by introducing the CBAM, although it has been criticized for its unilateral approach.

The EU is often a first mover in regulatory reform, and its influence in taking the lead on this issue can already be seen globally. The UK announced its own CBAM plans in mid-December, while Turkey and Australia are also reportedly considering following suit. The EU CBAM has caught the attention of US lawmakers, having been a topic of discussion at the recent COP28 conference on climate change in Dubai.

Similar mechanisms in other countries will share the same overarching principles as they are developed and rolled out, with differences in detail and execution likely. For example, the UK’s CBAM will cover slightly different sectors to the EU’s by including imported glass and ceramics but excluding the electricity sector.

The EU CBAM is likely to evolve further before being fully implemented, as the EU will review how the mechanism is managed before the end of 2025. This review will include expansion to other sectors such as organic chemicals and polymers, as well as potentially covering the embedded emissions found in the transport of CBAM goods.

Impact on supply chains

Traceability of often complex supply chains is a hallmark requirement of the CBAM, mirroring trends in cross-border trade generally. While such traceability brings an increased administrative burden, it also presents an opportunity to review the optimisation of supply chains from a cost, efficiency, and risk perspective.

Businesses with international supply chains can gain an advantage by acting quickly in assessing the implications for their activities.

More immediately, with the first CBAM reports due to be submitted by the end of January, businesses should act quickly to review their international trade activities and guard against the unwanted risks of non-compliance.

If you would like to discuss this further, please get in touch with Ian Worth, or your usual Crowe contact.

This article was first published on 26 January in Bloomberg Tax.