The EU has been increasingly resorting to unilateral internal environmental measures with extraterritorial implications to address pressing global environmental problems, including climate change, that are insufficiently regulated at the international level. One of the most well-known examples of such regulatory activity is Directive 2008/101/EC that included international greenhouse gas emissions from aviation in the EU Emissions Trading System (EU ETS). This provisionally required all airlines arriving at or departing from EU airports to surrender allowances, including for emissions occurring outside EU airspace. Largely due to political opposition by third countries, it was subsequently restricted to intra-EEA flights.

Such measures create different incentives for third country companies to adjust their practices and third country governments to emulate EU policies, sometimes giving rise to what Bradford identifies as a ‘Brussels Effect’. This blog post discusses one of the latest EU unilateral initiatives to address climate change, through the introduction of a carbon border adjustment mechanism (CBAM), which seeks to put a price on certain imported products that would reflect the emissions caused by their production in third countries. It thereby exhibits what Scott identifies as ‘territorial extension’, whereby the EU regulates activities with a territorial link to the EU, while taking into account (as a matter of law) conduct and circumstances beyond its borders.

This initiative presents some characteristics that raise important questions as to the legality and legitimacy of EU unilateral measures with extraterritorial reach. As the CBAM would amount to or resemble a cross-border tax, its economic nature is likely to cause political backlash. Also, the classification of the CBAM as one of the EU’s ‘own resources’ in the context of the recently agreed EU recovery fund to deal with the COVID-19 crisis raises additional concerns and complexities.

A Carbon Border Adjustment Mechanism as a ‘stick’ to incentivise third countries to raise their climate ambitions?

The objective of the CBAM is threefold. First, it is meant to reflect the true carbon content of products coming from third countries. Second, it aims to reduce the risk of carbon leakage, whereby certain industries transfer their production to third countries with less stringent policies on GHG emissions, thereby undermining efforts to reduce global emissions. Third, the CBAM emerges as a response to insufficient action on climate change by other states compared to the EU’s commitments. The EU aims to reach carbon neutrality by 2050, an aim that is more ambitious than the Paris Agreement, and which has been endorsed by all Member States, but Poland. While this aim has yet to be translated into a legal obligation, the recent Commission proposal to increase emission reductions to 55% by 2030 confirms this upward commitment trend. The EU anticipates that the introduction of a CBAM will incentivise other countries to take more ambitious domestic measures and to come to the negotiating table in order to reinforce multilateral efforts.

It is doubtful to what extent these objectives serve as convincing justifications for the introduction of a CBAM. Closely related to arguments about avoiding carbon leakage, are motives to protect the competitiveness of domestic producers, which would face additional costs compared to their international counterparts. When unilateral measures are used to primarily protect domestic competition, significant questions are raised as to the unilateral distribution of responsibilities relating to international climate externalities.

The legitimacy and acceptance of the EU’s unilateral action relates to the fundamental question of the outer limits of jurisdictional authority. Is and should the EU be entitled to regulate imports of products on the basis of the production process, which takes place outside and before the product crosses the EU’s borders? Most EU unilateral measures could be justified according to the principle of territoriality, broadly understood, on the basis of a link between the EU territory and the regulated activity. This can be supplemented by effects-based jurisdiction on the premise of regulating processes that partly take place abroad but have effects in the EU. While the EU has not to date explicitly relied on effects-based jurisdiction to justify unilateral measures outside the antitrust field, unilateral import restrictions might be better justified from an international efficiency perspective as a second-best policy to combat the [climate] externalities that stem from the production of exported goods.

The EU’s unilateral action through a CBAM could be accused of interfering with the national sovereignty of third countries, constraining foreign companies to comply with more ambitious climate policies than the ones applied domestically. This could be seen as contrary to the Paris Agreement, which is founded on the notion of nationally determined and differentiated contributions to the overall temperature goal. However, in light of the Paris Agreement’s provisions on increasing ambition and shortcomings of current commitments to meet the temperature goal, the EU could hardly be accused of acting against the Paris Agreement, particularly if it ensures that the CBAM dynamically responds to international developments.

The Carbon Border Adjustment Mechanism as a new ‘own resource’ at the EU level – who is to ultimately pay the cost?

The introduction of a CBAM, while discussed in the past, resurfaced in the Commission’s European Green Deal in late 2019, and was reinforced in the European Council’s conclusions on the EU budget and recovery fund in July 2020. In particular, the CBAM has been identified as a significant new ‘own resource’ to be partly used for early repayment of the Next Generation EU (NGEU) recovery borrowing programme as a response to the COVID-19 crisis. The European Council called on the Commission to put forward a proposal on a CBAM in the first semester of 2021 with a view to its introduction at the latest by 1 January 2023. Its importance in this context has also been confirmed by the European Parliament.

It is still unclear how the CBAM would function as a new ‘own resource’ at the EU level. The CBAM is seen by some primarily as ‘a device intended to limit international competitive distortions’, rather than a direct source of revenue for the EU. Nonetheless, it could still have an indirect effect on ETS revenues. This is because the introduction of the CBAM would require the reduction or abolition of free allowances currently allocated to industries facing a high risk of carbon leakage due to international competition under the EU ETS. This would in turn increase revenues from the EU ETS. Unilateral measures aiming to influence external developments can thereby create momentum to increase ambition internally; potentially including more sectors and expanding auctioning of allowances to sectors that currently receive most of their allowances for free.

A carbon tax on imported products does not necessarily mean that the financial burden would fall on foreign producers exclusively. The cost would likely be reflected in higher prices of both imported products and domestic carbon-intensive products and ultimately might be borne by the consumer. This increase in prices could serve an informative function, possibly incentivising consumers to switch to less carbon-intensive products. Nonetheless, the fact that the EU explicitly identifies the CBAM as a fund-raising mechanism towards repaying debts in the context of aiding the Member States recover from the pandemic crisis, while at the same time lowering its commitments to provide financial aid to developing countries can be problematic for the EU’s international credibility.

The CBAM could potentially be effective in incentivising more ambitious action by third countries but it needs to be carefully designed so as to avoid harming the EU’s international relations. Learning from previous measures with extraterritorial reach, the CBAM could include clauses that respect and anticipate action by third countries in the form of ‘contingent unilateralism’. The introduction of a CBAM is already formulated in somewhat contingent terms by the Commission: ‘Should differences in levels of ambition worldwide persist, as the EU increases its climate ambition, the Commission will propose a carbon border adjustment mechanism…’ Contingency could take the form of a clause that would condition the application of the CBAM on the basis of international developments under the UNFCCC or the Paris Agreement; potentially involving an agreement on joint compliance or international emissions trading or international requirements on the adoption of domestic measures on carbon neutrality by 2050. Alternatively, it could take the form of an equivalence clause depending on the third country’s current and future measures to regulate carbon-intensive industries domestically. Such flexibility clauses would assist in convincing the rest of the world of the EU’s intentions to avoid carbon leakage and render commitments on climate change abatement effective, rather than protect the competitive position of domestic producers by passing costs onto foreign operators, amounting to protectionism.

What could the Carbon Border Adjustment Mechanism look like?

CBA measures generally seek to achieve a symmetry between the climate obligations imposed on domestic and foreign products. This can be done in different ways; by including imports into the scope of climate obligations and/or benefiting domestic products by excluding exports from such obligations (by granting some form of exemptions or rebates).

As emerges from the Commission’s public consultation questionnaire, different types of instruments are currently being considered.  First, the CBAM could take the form of a tax on products whose production is at a high risk of carbon leakage; either applied on imports at the EU border or as a carbon tax at consumption level (applied on both imported and domestically produced products). Sectors exposed to such risk of carbon leakage would, at least initially, be determined on the basis of existing methodologies applied in the third and fourth phases of the EU ETS. Second, the CBAM could be implemented through an extension of the EU ETS to imports requiring allowances to be purchased by either foreign producers or importers or through an obligation to purchase allowances outside the ETS pool, while mirroring the ETS price.

The final design of the CBAM needs to be carefully crafted, taking into account both internal legal complexities, relating to the competences and decision-making procedures of the EU as well as external legal requirements stemming from the EU’s international commitments. The introduction of a tax would require unanimity in the Council, a hurdle that is difficult to overcome, while an amendment to the coverage of the EU ETS to include importers would only require qualified majority. At the same time, achieving compatibility with WTO law, an explicit commitment both in the EU Green Deal and the Commission’s inception impact assessment, will also very much determine the legal design of the EU’s CBAM.

CBA measures are not inherently incompatible with WTO rules, but they need to be designed carefully so as to avoid violation of relevant WTO principles. Among others, these include non-discrimination among trading partners, the so-called MFN principle, and non-discrimination between domestic and imported products, the so-called national treatment principle. Exceptions as to the country of origin and the extent to which a particular country has taken comparable action could be problematic from a WTO perspective, at least at first sight. From an MFN perspective, the CBAM could be problematic if it differentiates on the basis of a third country’s policy on climate change. From a national treatment perspective, the CBAM cannot be introduced without adjustments to the current measures under the EU ETS addressing the risk of carbon leakage. These provide for a higher number of free allowances to sectors at high risk of carbon leakage and flexibility to Member states to compensate the most electro-intensive sectors for increases in electricity costs as a result of the EU ETS through national state aid schemes.

If the CBAM violates one of the relevant substantive obligations of WTO law, it could potentially be justified under Article XX GATT as necessary to protect the life and health of humans and/or animals or as relating to the protection of exhaustible natural resources. The CBAM should also be designed and implemented in such a way so as to avoid protectionism and demonstrate that it is not a disguised restriction to international trade or an arbitrary or unjustified discrimination among countries where the same conditions prevail, in accordance with the chapeau of Article XX. This has often been, and is anticipated to be in relation to the CBAM, the most challenging aspect of the use of GATT exceptions. Both the type of instrument and the sectors and products need to be carefully selected and justified. The EU indicated that it would start with one or two sectors (e.g. cement or steel) in order to test and prove the mechanism before expanding to other sectors. However, this could be problematic from a WTO perspective, particularly if the EU makes exceptions for certain carbon-intensive domestic sectors, while applying a CBAM for products largely produced abroad. The chapeau requirements could also affect the flexibility embedded in the design and implementation of the CBAM. Designing the CBAM flexibly to reflect the different adjustment needed in relation to products coming from countries with different climate policies or from least developed countries, might pose challenges for its WTO justification but at the same time is needed to enhance the legitimacy and the environmental integrity of the measure.

Conclusion

In light of diverging levels of climate commitments around the world, including the decision of the US to withdraw from the Paris Agreement, the introduction of a CBAM is certainly a promising mechanism to address climate externalities and for the EU to ensure that its commitments on climate change are not undermined globally. However, the design and implementation of such a unilateral measure has to be carefully crafted. The EU cannot be assumed to be a ‘green hero’, acting for the benefit of humanity through a carbon tax.  In order to anticipate and better reflect the complexities of introducing a CBAM, the EU should take into account the interests and concerns of third country actors affected by its measure. This requires active steps to consult with both domestic and foreign industry and government interests in order to design a measure that is both effective in reducing global GHG emissions and is procedurally and substantively fair. The element of adjustment inherent in a CBAM, seeking to align divergent climate obligations on operators based in different parts of the world, should reflect continuous developments and account for distributive impacts beyond EU borders.

Ioanna Hadjiyianni is a Lecturer in Public Law at the University of Cyprus. Before joining UCY in January 2019, she was a Max Weber Postdoctoral Fellow at the European University Institute. She received her PhD from the Dickson Poon School of Law, King’s College London in 2017. Her thesis was published as a monograph with Hart Publishing in 2019, titled The EU as a Global Regulator for Environmental Protection: A Legitimacy Perspective. The monograph was shortlisted for the ‘2020 SLS Peter Birks Book Prize for Outstanding Legal Scholarship’. Prior to joining King’s, she was a Schuman trainee at the Committee on Petitions at the European Parliament. Ioanna holds an LLM in Environmental Law and Policy from University College London and an LLB in English and European Law from Queen Mary University of London.