CBAM and the domestic carbon price: legal and financial pitfalls of the new EU regulation

The draft implementing regulation recently published by the European Commission contains pitfalls for importers: standard voluntary offsets have been completely excluded, and there is a risk of a currency lag.

Sustainability consultant Ribhu Deo discussed these and other risks on LinkedIn following his analysis of the document.

Key provisions of the regulation

Objective: to establish rules for reducing the number of CBAM certificates that an importer must surrender, based on the actual price paid for carbon emissions in the country of origin.

• A carbon price is considered to include both payments within an emissions trading system (ETS) and carbon taxes.
• The importer must prove that the producer actually paid the tax. Any discounts, offsets, or free allowances received by the producer from their government will be deducted from the declared carbon price. In other words, only the net financial burden borne by the producer is subtracted.
• The authorized CBAM declarant must retain evidence that the foreign carbon price was paid and that the imported goods were in fact subject to this price.
• An "independent person" must verify that the emissions price has been paid and that no hidden compensation was obtained. Such a person does not necessarily have to be an accredited emissions verifier (as defined in Implementing Regulation (EU) 2018/2067), provided they meet specific criteria for independence and qualification.
• For tax deduction calculations, the foreign carbon price is converted into euros. The regulation requires the average exchange rate of the European Central Bank (ECB) for the calendar year preceding the CBAM declaration to be used.

The draft regulation divides carbon allowances into two separate categories:

1. Domestic allowances (without restrictions). If a foreign company purchases carbon allowances obtained as a result of emission reduction measures within its own national jurisdiction to meet local carbon tax/emissions trading system (ETS) requirements, the EU accepts this. The bloc will recognize the price paid for these domestic allowances, without setting any "additional qualitative or quantitative criteria."

2. International offset allowances. The price paid for offset allowances acquired outside the national jurisdiction will be recognized only if they meet the standards set by Article 6 of the Paris Agreement. Even if international allowances fully comply with these standards, there is a strict quantitative limit: the share of international carbon allowances used to determine the "actual carbon price paid" cannot exceed 10% of the declared and verified emissions of a facility subject to the third country's carbon pricing mechanism.

What are the risks?

The expert highlighted the following issues that importers and producers might face:

1. By requiring importers to account for any forms of compensation, the EU is demanding an unprecedented level of transparency regarding foreign industrial subsidies.

“How will an EU importer be able to prove that a business outside the EU has not received a concealed energy discount or tax benefit from its government, which would reduce its carbon tax? This places a huge investigative burden on the 'independent person',” the expert asserts.

2. Using the ECB average exchange rate for the previous calendar year simplifies things for the EU, but creates significant currency risk for importers dealing with volatile currencies.

“If a currency depreciates significantly during the year of production, using the previous year's exchange rate may overstate or understate that carbon price when converting into euros,” explains Rhibhu Deo.

3. Strict adherence to the exchange rate calculated as “the average for the previous calendar year,” as provided in Article 3, introduces unfair financial risk.

“A fairer system would allow declarants to use the ECB exchange rate valid on the date of legal settlement of foreign carbon emission obligations, or at least the average quarterly rate corresponding to the actual period of production,” the consultant says.

4. The proposal completely excludes standard voluntary carbon market (VCM) credits – such as Verra, Gold Standard, or standard Clean Development Mechanism credits – as international offsets under CBAM. If a credit does not pass a strict, government-approved ITMO process under Article 6.2 or is not registered in the central UN registry under Article 6.4, money spent on that credit has no legal value for deduction within the framework of CBAM.

5. The draft regulation mandates the use of quotas under Articles 6.2 and 6.4 for international offsets, but the global market for these approved ITMOs is still in its early stages, accompanied by significant uncertainty and unclear communication. The expert notes that the UN Article 6.4 mechanism is just being launched, and very few bilateral agreements under Article 6.2 have been fully completed and registered in CARP. This forces importers to rely on a market architecture that barely functions. Producers from outside the EU will face difficulties in finding enough relevant Article 6 quotas to use even the 10% limit, Rhibhu Deo is confident.

Next steps for operators

The consultant recommends the following actions:

1. Audit your portfolio of carbon emission quotas. Stop relying solely on voluntary emission market quotas for exports to EU countries. Begin assessing the availability and cost of UN-approved quotas in accordance with Articles 6.2 and 6.4, bearing in mind the strict 10% quantitative limit.

2. Determine your net carbon price. Conduct an internal audit of all state aid, energy subsidies, and free ETS quotas that your enterprise receives. Upgrade your ERP systems to mathematically separate these discounts from your gross carbon tax payments, as EU auditors will require evidence of the net financial burden.

3. Prepare an evidence repository. Start archiving official receipts from tax authorities and records from your internal ETS register now. Ensure that this data can be clearly attributed to specific product batches (CN codes) destined for the EU.

4. Create legal safeguards with EU buyers. EU importers will need your tax and subsidy data so they can claim CBAM deductions. Conclude non-disclosure agreements (NDAs) in advance to ensure your confidential financial data will be provided only to an independent auditor and not used by buyers for commercial price negotiations.

Recently, EcoPolitic reported that Ukraine is seeking a compromise with the EU regarding metallurgy during wartime. The Ukrainian metallurgical industry is not asking for a waiver of European rules or climate goals, but is already integrating into EU standards, investing in decarbonization and production modernization, while requesting support during the full-scale war.