EU Emissions Trading Scheme Overhaul.

The EU Emissions Trading Scheme (EU ETS) is Europe’s flagship policy launched in 2005 to reduce anthropogenic emissions and curb global warming. It was adopted to align the EU with its 2040 Climate Target: to reduce net emissions by 90% by 2040. The EU ETS has shown its effectiveness by reducing emissions from European power and industry plants by around 50%. However, while effective for reducing emissions, the EU ETS has been widely criticised for also - allegedly - reducing industry competitiveness for European producers due to heavy imposed carbon taxes. This is partly why on the 17^th of July, the European Commission announced a proposed revision of the scheme for the period after 2030 to “strengthen Europe’s industrial competitiveness”. While at first glance this may seem positive for EU businesses, it may not be as straightforward as it first appears.

What is the EU Emissions Trading Scheme?

The EU ETS is a scheme based on the idea of making polluters financially responsible for the greenhouse gases they emit. It does so by introducing a cap-and-trade system, where a cap limits the total GHG emissions organisations can emit and a market allows them to trade “allowances” (one allowance representing one tonne of CO2e), letting organisations that need to emit more purchase more allowances. This makes it more economically interesting for organisations to reduce their emissions as a result, to both avoid carbon taxes and to simultaneously be able to sell allowances back unto the market.

The ETS covers around 40% of the EU’s emissions by involving three key sectors:

• electricity and heat generation,

• industrial manufacturing,

• and aviation and maritime transport.

Criticism of the EU ETS.

The EU ETS is being criticised for making it harder for energy-intensive industries like steel, aluminium, and cement to compete internationally. Producers argue that they are penalised twice: once through the price of allowances and again through the risk of losing market share to competitors operating under looser and cheaper climate rules abroad. This has fuelled concerns over carbon leakage - where companies relocate production outside of the EU altogether which would undermine both European jobs and the scheme’s climate goals. Carbon leakages are meant to have been tackled through the Carbon Border Adjustment Mechanism (CBAM) which imposes a carbon tax on goods produced outside of and placed in the EU and as such levelling the playing field. However, CBAM is designed to address imported goods not the exports of EU products, therefore, some argue it does not fully address international competition fairness.

Interestingly, it is worth noting that the reality is less clear-cut than the political rhetoric suggests. Most independent assessments have found little evidence that carbon prices have damaged EU competitiveness so far. Independent assessments have also shown that carbon leakage measures, such as CBAM, have also been effective in reducing the risks of organisations relocating productions to other jurisdictions.

Support for the EU ETS.

Despite the political noise, support for the ETS remains strong across much of the EU - especially from businesses who have recognised the EU ETS as an opportunity for innovation, competitiveness, and long-term resilience.

The EU ETS has also proven to be a strategic necessity through its track record, which has shown to have reduced emissions from covered sectors by around 50% since 2005. The scheme is also expected to meet its objective of a 62% reduction in emissions by 2030.

150 businesses including Tata Steel and Unilever have also issued an open letter arguing that weakening the ETS now would send the wrong signals to the companies that have already invested heavily in decarbonisation. In their view, ambitious climate policy and fair competition are not mutually exclusive and therefore the ETS can – and should – act as a tool that will help European industry remain resilient and competitive.

EU ETS Overhaul.

The EU ETS Directive requires the European Commission to periodically review how the scheme is performing, and several of those review clauses were due in 2026. But the timing of this particular review owes as much to politics as to legal obligation: in March 2026, the Council explicitly asked the Commission to bring forward their  review to address carbon price volatility against a backdrop of energy shocks and intensifying global competition that has put Europe’s industrial future under strain. The result of this sits at the centre of a live debate with one side arguing that the ETS needs to be loosened to relieve pressure on industry while the other side arguing that any loosening undercuts the clear political signal the carbon price is meant to send.

As a result, the Commission framed the overhaul as a “rebalancing” to keep the ETS central to the EU’s climate ambitions and energy transition while giving industry room to adapt. The new ETS package sets the legal framework for Phase 5 of the scheme (2031-2040) and introduces a set of proposals, including:

• A slower pace of reduction: the annual cap reduction rate of allowances (the Linear Reduction Factor) would fall from 4.3% today to 3.7% for 2031-2035, and then to 1.7% from 2036. The reduction rates remain aligned with the 2040 [EA5] Climate Target of a 90% reduction in emissions to ensure a transition that maintains industrial competitiveness while steadily decreasing the total volume of allowances available in the market.

• Longer-lasting free allowances: energy-intensive sectors like steel and cement would keep receiving free allowances until 2038, rather than 2034 as previously planned though increasingly tied to conditions. From 2031, 80% of free allowances would be handed out upfront (if organisations have a decarbonisation plan with investments focused on the EU), with the remaining 20% only allocated once a company can prove that its decarbonisation investments in the EU have been successfully implemented and have achieved the planned emission reductions.

• New funding mechanisms: with a stronger objective on investment as requested by hard-to-abate sectors, the revised ETS will introduce a €100 billion funding mechanism through the Industrial Decarbonisation Bank. The first phase of the bank will consist of an “Investment Booster” (400 million allowances worth around €30 billion) to fast-track investments. From 2031 onwards, the Bank will support Carbon Contracts for Difference or carbon premiums to derisk investments and provide long-term revenue stability.

The Council, Parliament, and Commission agreed on Q1 2027 as the target for the review agreement once ongoing negotiations between the three parties conclude.  

What This Means in Practice.

Looking at the general direction of the amended EU ETS 2026 proposal, organisations in the EU must remain focused on adopting carbon reduction initiatives. A slower Linear Reduction Factor and extended free allocation may buy organisations more time and lower near-term compliance costs but they don’t remove the underlying obligations, it only delays it. This means that organisations that are already working to decarbonise their operations and building the evidence base today – emission data, investment plans, verified reductions – will be best placed to benefit in the long-term. Although the EU ETS mostly applies to large organisations in hard-to-abate sectors, it also demonstrates the general direction that all sectors and organisations will also need to adopt the appropriate measures to align with the EU’s decarbonisation objectives. Large organisations will increasingly prioritise suppliers and partners who can demonstrate climate-aligned strategies and initiatives.

Membership organisations have a crucial role to play in supporting their members – both small and large – by helping them understand how the EU ETS and its amendments impact their businesses and industry. Membership organisations can also provide the resources and guidance on what measures are necessary and viable through their industry-wide knowledge and network. They must lead their members, establish best practices, and provide the necessary guidance to future proof their industry.

CAFA exists to make that happen. We are the resource and network dedicated to net zero and sustainability for the membership sector. By joining CAFA’s free membership, organisations can access a wide range of resources, peer-to-peer network, and technical support.

For more information on the EU’s climate legislation landscape, CAFA has prepared a resource mapping all the most significant cross-sector legislation, regulation, and policies. Join CAFA today to access this resource and many more.