Today, the European Commission published its long-awaited proposal for the review of the EU Emissions Trading System (ETS), setting the direction of the bloc’s cornerstone climate instrument for the 2031–2040 period. In doing so, it fires the starting gun on a key legislative file for a lengthy negotiation process which will take months to conclude. 

Flooding the Market: How the Commission’s ETS proposal risks killing the incentive to invest in decarbonisation 

The proposed two-tier adjustment to the Linear Reduction Factor (LRF), with a softer trajectory from 2031 onwards, alongside the interaction of carbon removals and international credits, marks a fundamental shift in the EU’s climate ambition. These proposed compensatory mechanisms allow for a longer emissions phaseout period, albeit without the same environmental benefit as emissions reductions. Adopting this approach would significantly increase the supply of allowances available to industry, thus resulting in higher emissions. Regarding the Market Stability Reserve (MSR), on the one hand, the Commission’s proposed dynamic thresholds, proportional to the overall cap and adjusted for a declining market, would help ensure the MSR responds appropriately as allowance scarcity increases in the 2030s. On the other hand, decreasing the intake rate of surplus allowances and removing the invalidation clause is a step too far. The MSR’s ability to permanently cancel allowances has been central to restoring market credibility and price stability. The combined effect of ending MSR invalidation and slowing the LRF poses a significant risk of persistent oversupply and weakening the investment signal needed to drive investment in low-carbon technologies and, therefore, to meet the 2040 climate target.  

Carbon leakage measures: a step backwards for ETS and CBAM 

The proposal extends the phase-out of free allowances to 2037, delaying the full implementation of the CBAM by four years. In general, 80% of free allowances would be granted upon submission of an approved decarbonisation plan, while only 20% would remain conditional on implementing investments and achieving emissions reductions. Delaying the phase-out of free allowances while making only a minimal share conditional on genuine decarbonisation investments will weaken incentives to decarbonise and slow the transition. Bellona urges the co-legislators to maintain the current phase-out timeline for CBAM sectors and introduce robust decarbonisation conditionalities for all free allowances across all other sectors. 

The indirect interaction of international credits and removals: positive signals, but the ETS cannot afford wishful thinking  

International carbon credits will not be eligible directly for compliance within the ETS. A facility managed by the Commission will purchase and use international credits to inject an equivalent volume of EU allowances, up to 260 million tonnes of credits, this means that the ETS will no longer need to deliver the same level of domestic emission reductions. In practice, this turns the provision of the Climate Law allowing “up to 5% of international credits” from an optional flexibility into a target in itself of around 2%. This both reduces domestic emissions reductions while assuming that international credits can deliver the same climate outcome as emission cuts in Europe – an assumption that depends on the quality of those credits. And given that high-quality international credits are likely to be scarce and expensive, they should be treated as a last resort strategic reserve. However, we welcome the upcoming review in 2033 which will confirm if an adequate supply of international credits is available. If this is not the case, the LRF will revert to 2.7% from 2036.  

Domestic permanent carbon removals (CDR) will be purchased via a facility to indirectly support the ETS trajectory. The proposal plans to include 250 million tonnes of additional allowances, the revenues of which will be used to centrally purchase removals, a significant volume that raises concerns about whether sufficient high-quality removals can be delivered within the expected timeframe. We welcome the proposal to manage this interaction centrally through the Commission. This is the right approach to ensure that removals can strengthen, rather than undermine, the carbon market, while sending a clear signal to project developers that demand will be there. Nevertheless, the review planned by 2034 exploring the role of nature-based removals presents a clear risk to the proposed role of permanent removals.  

This should only be considered the starting point. The framework must now be complemented by 1) revisiting the accounting of biomass emissions, 2) establishing a separate target for permanent removals within the post-2030 climate framework, and 3) putting in place a strong framework to protect and restore EU land sinks. 

More ETS revenues for industrial decarbonisation: improved mechanism design could maximise the impact 

One bright spot in an otherwise disappointing proposal is the use of ETS revenues to fund the transformation towards climate neutrality in Europe. By channelling auction revenues through the Industrial Decarbonisation Bank (IDB), the proposal opens the door for more efficient use of these revenues for industrial transformation, binds them more stringently to climate protection efforts, and makes the system more compatible with the Union’s single market. 

The ETS Investment Booster, the IDB’s first stage, allocates funding on a first-come-first-served basis, which undermines competition and efficiency. The proposed fixed premium is administratively simple as a disbursement mechanism, but it is doubtful whether it adequately mitigates specific investment risks while remaining cost-effective enough to let as many projects as possible benefit from the available funds. More competitive allocation processes and specifically tailored distribution mechanisms – like Carbon Contracts for Difference – should also be introduced in the early stage of the IDB. 

The proposal introduces new requirements for Member States to use a share of ETS revenues specifically for supporting decarbonisation investments in ETS 1 sectors. Furthermore, the proposed stronger safeguards and increased transparency on how Member States spend ETS revenues will help channel them into climate-effective investments. 

Context: 

The EU Emissions Trading Scheme (ETS) is the cornerstone of European climate policy and, since 2005, the main instrument putting a price on greenhouse gas emissions from industry, power generation, aviation and maritime transport. Following the adoption of the Union’s 90% net emissions reduction target for 2040, the Commission is legally mandated to reassess the system and ensure it is fit to deliver on the new level of ambition for the 2031–2040 period. Today’s proposal addresses the alignment of the ETS with the 2040 target, the future of free allocations and their role in preventing carbon leakage, the use of ETS revenues, and the reform of core technical parameters of the system, including the Market Stability Reserve (MSR), the Linear Reduction Factor (LRF), and the inclusion of permanent carbon removals.   

The press release was updated to correct a misinterpretation regarding CDR-backed allowances.

Contact: 

Andrea Spignoli 
Policy Manager – Sustainable Markets 
andrea@bellonaeuropa.eu  

Francesco Lombardi Stocchetti 
Policy Advisor – Sustainable Finance & Economy 
francesco@bellonaeuropa.eu