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EU Carbon Border Adjustment Mechanism Compliance With WTO Rules

13 Aug 2021
By Iris de Orte Júlvez
This is the Tennessee Valley Authority (TVA) Cumberland Fossil Plant, better known as the Cumberland City Steam Plant. It is located on the Cumberland River in Cumberland City, Tennessee. Source: Roger Smith

Border carbon adjustments can be controversial and may include components of hidden trade protectionism. The Carbon Border Adjustment Mechanism (CBAM) proposed by the European Union (EU) has been designed to be compliant with World Trade Organization (WTO) rules.

Since the European Commission announced the details of the proposal of a CBAM on 14 July 2021, some countries, including Australia, have shown their discontent. The EU Carbon Border Adjustment Mechanism intends to put a carbon price on certain imports as part of a more ambitious plan to achieve a 55 percent carbon emissions reduction by 2030 and become climate-neutral by 2050. Since 2005, the EU has used the European Union’s Emissions Trading System (EU ETS), which allows the free allocation of emissions allowances to energy-intensive industries. Although this measure has been efficient when addressing carbon leakage, it has not provided effective incentives to reduce emissions.

The CBAM proposed by the European Commission aims to reduce carbon leakage, mitigate competitiveness risks, and increase greener production processes by replacing the system of free allocation. This system will impose the obligation to EU importers to buy carbon certificates based on the carbon price they would have paid if these goods were produced according to EU’s carbon pricing rules. By contrast, if EU importers can prove that they have already been subjected to carbon pricing in the country of production, the cost will be fully deducted.

The EU CBAM will be introduced gradually. Initially, this mechanism will apply to targeted goods at high risk of carbon leakage and carbon emissions such as iron and steel, cement, fertiliser, aluminium, and electricity generation that will become fully operational in 2026.

The main criticism from some Australian policymakers against the EU CBAM is that this measure is protectionist, suboptimal, and incompatible with international trade rules. While these concerns may be debatable in principle, there are many reasons to justify why the EU CBAM complies with the WTO principles as claimed by the EU.

In the first place, it is essential to understand that compliance with WTO agreements has not been taken lightly when designing the EU CBAM. Since the beginning of the discussions, the EU has involved different organisations and considered opinions from several stakeholders such as the Committee on International Trade, the Committee on Economic and Monetary Affairs, the Committee on Budgets, and the Committee on Industry, Research and Energy. In addition, the European Parliament itself has also published a legal assessment about how to achieve WTO compliance.

In particular, Pascal Lamy, former director-general of the WTO and former EU trade commissioner, has defined the CBAM as a precautionary measure as opposed to protectionist. Rather than protecting EU producers from foreign competitors, the CBAM aims at protecting people from the risk of climate change. According to Lamy, WTO agreements allow countries to introduce regulations to protect their people.

Kristalina Georgieva, current managing director of the International Monetary Fund, has also expressed her support to the EU CBAM in the absence of an agreement on carbon pricing among major emitting countries, which would be the preferred option. In a press conference hold in September 2020, Georgieva highlighted the following “Acting within the EU will not be enough. The EU cannot stop global warming on its own. But it can bring the world together.”

The lack of global agreements and harmonisation about carbon pricing implies that countries or organisations leading this movement face the risk of losing competitiveness in a global economy. The CBAM acts as a border adjustment to carbon emissions to achieve climate fairness and similar treatment between domestic and imported products based on the principle of non-discrimination in WTO law.

Out of the different options studied in the impact assessment drafted by the European Commission, it was concluded that introducing a CBAM on selected products through certificates based on actual emissions will be the most beneficial. This system is based on real emissions, demonstrating that all imports from countries with similar reduction emission policies will be treated equally. Furthermore, the CBAM designed by the EU intends to allow all importers to calculate their carbon intensities to demonstrate their actual emissions.

Despite the fact it has been widely discussed, there have been a few examples of carbon adjustment mechanisms, and none of them have been challenged for alleged violation of WTO rules as of today. Even if other countries challenged the EU CBAM for violating some WTO rules such as tariff bindings, national treatment, prohibition on quantitative import restrictions, or most-favoured-nation treatment, the General Agreement on Tariffs and Trade (GATT) contains some exemptions based on health and environmental reasons.

Some could argue that other measures less restrictive regarding trade could achieve similar environmental objectives. However, allocation of emission allowances, for instance, has demonstrated not to be sufficient.

In a globalised world where environmental quality is considered a public good, choosing not to implement specific measures to reduce pollution as a country’s competitive advantage can be regarded as a form of protectionism. Without a CBAM, Australia, benefits from exporting highly emissions-intensive products to countries with carbon pricing.

Indeed, the Sustainable Development Report 2021 released by United Nations ranked Australia last of all 193 countries assessed regarding actions taken to reduce global greenhouse gas emissions. This deliberate lack of action can lead to the view of Australia as a climate free rider on the efforts of other nations to combat climate change.

The CBAM proposed by the European Commission would not need to exist if all countries would apply carbon pricing. Based on the WTO principle of not favouring domestically produced goods over imports, the CBAM is only applicable to those products that have not been subjected to carbon pricing regulations in the country where the goods were manufactured. It is possible to argue that a single organisation should not pressure others to change their environmental policies. However, carbon pricing is not an aleatory tax. The purpose of this measure is to reduce carbon emissions and negative externalities. The protection of the environment is a shared responsibility, and as such, it needs to be driven by a global effort.

Iris de Orte Júlvez is a qualified lawyer in Spain and work in compliance at Polyglot Group. Her international experience in law ranges from Germany to Belgium as well as Spain, both in private plus public entities, including the Council of the European Union. She holds a LLM European Master in Law and Economics and has completed a Certificate IV in Compliance and Risk Management.

This article is published under a Creative Commons License and may be republished with attribution.