Pioneering carbon border adjustment mechanism enters into force

The world is facing a serious climate crisis and the challenges of climate change require global response. That is why the European Union (“EU”) is taking the lead and demonstrating international leadership with bold domestic action. With the European Green Deal (“Green Deal”), the EU has set out a roadmap of far-reaching and effective legislation to protect the environment and prevent climate change. The Green Deal sets out new policies to achieve the targets of a 55% reduction in carbon emissions by 2030 and zero carbon emissions by 2050. New sectoral criteria, carbon taxes and business models are gradually being introduced to achieve these targets.

The most prominent of the mechanisms on the Green Deal agenda is the Carbon Border Adjustment Mechanism (“CBAM”) which is especially significant for those exporting to the EU. Under the Green Deal, the CBAM was introduced to ensure that products at risk of carbon leakage are taxed according to their carbon intensity when imported into the EU. Currently, the risk of carbon leakage in the EU is addressed through the EU Emissions Trading Scheme (“EU ETS”).

The EU ETS operates on the principle of “cap and trade”, which means that greenhouse gas allowances are treated as a commodity or a product that can be traded on the EU carbon market. Companies covered by the EU ETS include power stations, industrial plants, and other large energy users, as well as airlines. The total amount of greenhouse gases that can be emitted by companies under the ETS is subject to a cap set at EU level.

As the EU increases its climate targets the gap with third countries that do not apply similar principles to combating climate change is gradually widening. While the EU ETS system incentivises EU producers to reduce their emissions, it also creates inequality between EU producers and producers from third countries without carbon pricing mechanisms. As the EU aims to reduce greenhouse gas emissions within its borders and globally to combat climate change, the CBAM was introduced to include exporters to the EU.

Key elements of the CBAM

The CBAM will initially apply to imports of certain goods whose production is carbon-intensive and where the risk of carbon leakage is highest, such as cement, iron and steel, aluminium, fertilisers, electricity, and hydrogen. These sectors have a high risk of carbon leakage and high carbon emissions.

In principle, imports of the in-scope goods from all non-EU countries will be covered by the CBAM. Certain CBAM exemptions will apply to countries involved in the EU ETS which are not EU members and those that have integrated their own ETS with the EU's. In this manner, products manufactured in Switzerland, Iceland, Liechtenstein, and Norway will not be subject to the CBAM. The CBAM Regulation entered into force on 1 January 2023, with a gradual transitional period until 31 December 2025.

During the CBAM transitional period, which started on 1 October 2023, embedded greenhouse gas emissions of products imported into the EU must be reported on a quarterly basis, with the first report due by 31 January 2024. The reporting will either be made by importing EU companies as reporting declarant or customs representatives through the CBAM transitional registry. If the importer is established outside the EU customs territory, the customs representative will be responsible for complying with the reporting obligations. According to the Implementing Regulation, the reporting declarant has the possibility to amend the CBAM reports for the first two reporting periods until the deadline for the submission of the third CBAM report. The scope of the CBAM will be evaluated before the end of the transitional period and is expected to cover all goods, subject to EU ETS by 2030 (e.g., lubricants, lime, glass, ceramics, pulp, paper, board, acids and bulk organic chemicals).

From 31 December 2024, importer EU companies must register as authorised declarants pursuant to Article 5 of the CBAM Regulation. Following end of the transitional period, the financial obligations under the CBAM will start to apply. Accordingly, each authorised declarant must submit a declaration to the competent authority by 31 May each year for the calendar year preceding the declaration. The declaration shall include information such as the total quantity of each type of goods imported, the total embedded emissions and the total number of CBAM certificates corresponding to the total embedded emissions. Furthermore, the authorised declarant must purchase and surrender CBAM certificates in an amount corresponding to the declared emissions embedded.

Transitional period

During the transitional period, the CBAM mechanism will apply as a quarterly reporting obligation with the first report due by 31 January 2024. During this period, importers will only be required to report the greenhouse gas emissions embedded in their imports without making any financial payments.

No later than one month following the end of each quarter, each reporting declarant shall submit a CBAM report for each quarter of a calendar year to the competent authority of the Member State of importation or, if the goods were imported into more than one Member State, to the competent authority of the Member State of the registrant's choice, containing information on the goods imported during that quarter.

The CBAM report shall include information such as the total quantity of each type of goods, the actual total embedded emissions, the actual total embedded indirect emissions and the carbon price to be paid in the country of origin for the embedded emissions.

Impact on Türkiye

Countries and companies exporting to the EU in the sectors identified in the CBAM will be directly affected by the CBAM Regulation. Türkiye is one of the countries that will be most affected by the regulation, as it is one of the largest exporters to the EU, with almost half of its exports going to the EU. In this context, a new competition between countries will emerge. As the carbon tax will be higher for exporters with higher carbon emissions, exporters with emissions within the reference levels set by the EU will have a competitive advantage over other countries.

Accordingly, Türkiye has started to take steps to harmonise with EU legislation. First, the Ministry of Trade established a Green Deal Study Group and published annual activity reports as a Green Deal Action Plan, which is expected to strengthen export competitiveness and become a roadmap for harmonisation with climate change policies. In addition, a regulation on the Emissions Trading Scheme is expected to be prepared and the harmonisation process in Türkiye is expected to continue. In this context, companies located in Türkiye and exporting to EU Member States will need to provide satisfactory information to importers located in EU Member States or, customs representatives, as the case may be. Thus, Turkish companies will need to start collecting data to be able to provide sufficient data when requested.

With CBAM’s entry into force, compliance with the legislation to avoid negative impacts on exports of high carbon emitting products to the EU and the sectors producing these products is of utmost importance.

Conclusion

With the aim of reducing greenhouse gas emissions within the EU, the CBAM provides for dissuasive taxation to combat climate change. The CBAM started its transitional phase on 1 October 2023 and requires quarterly reporting on the embedded greenhouse gas emissions of products imported into the EU. The first reporting deadline is 31 January 2024. However, the entire transitional period will end on 31 December 2025. Countries and companies exporting to the EU in the cement, iron and steel, aluminium, fertiliser, electricity and hydrogen sectors will be directly affected by the new regime. As Türkiye is one of the largest exporters to the EU, especially in iron and steel and aluminium, compliance with the CBAM Regulation is crucial for companies exporting to the EU in the mentioned sectors.

For more information on the new regulation and its impact on your company or business, please contact your CMS partner or your local CMS expert: Dr. Döne Yalçın, Arcan Kemahlı and Merve Akkuş.