The European Union’s Newest Tool to Tackle Carbon Leakage

How CBAM is driving the urgent need for measuring product-level emissions so that companies don’t lose access to the EU market.

The European Union’s newest tool in fighting climate change is tackling “carbon leakage,” which happens when companies in jurisdictions with strict climate and environmental regulations move carbon-intensive production to countries with less stringent policies. The Carbon Border Adjustment Mechanism (CBAM) requires companies to report embedded carbon at the product level — and if they don’t do that, they risk losing access to the entire EU market. The EU is not alone in strengthening its carbon accounting requirements, either. Just last month, the UK Government launched a consultation on the introduction of a UK CBAM. This comes following the December 2023 announcement that the UK would implement a CBAM similar to the EU’s, which came into effect in October 2023. So, what are all of these new regulations and how can companies prepare for more stringent carbon accounting policies? Understanding what CBAM is, who it effects, how it will affect business operations, and what major economic risks it will present to companies that don’t address product-level emissions, is key for any company operating within the European single market.

Without regulatory guidance, the task of creating carbon accounting frameworks and disclosures has previously fallen to the voluntary market. These voluntary emissions reporting solutions often vary in process, scope, and transferability across supply chains. To address this shortcoming, RMI’s Horizon Zero project offers industry-tested guidance for calculating product-level emissions as well as standardized formats for exchanging those emissions in steel and aluminum sectors, which are impacted by CBAM.

The adoption of CBAM, and the pressure this will put on companies looking to be compliant, is likely to spur further adoption of carbon accounting solutions to avoid losing access to the entire EU market. Solutions that can offer product-level carbon accounting and exchange will have a leg up in this new regulatory environment. And solutions that adopt standardized methodologies for accounting and exchange will have a further advantage, as they can better integrate with the systems adopted by both their suppliers and customers, and ease what can otherwise be an arduous manual process.

CBAM 101
How does CBAM work?

Under CBAM, importers into the EU are required to report embedded emissions associated with certain products being imported. During the transition phase, lasting until January 1, 2026, importers will only be required to report total embedded emissions. Following this phase, importers will be required to purchase and retire CBAM certificates corresponding to the embedded emissions associated with their products, making it harder for products with high embedded emissions to enter the EU. The price of certificates will be set by the weekly average auction price of EU ETS allowances, the EU’s cap and trade system.

The embedded emissions of products include direct and some indirect emissions. Direct emissions refer to the emissions generated by the production process of the imported goods, for example the CO2 released from converting iron ore into molten ore for steel production. Indirect emissions refer to emissions associated with electricity consumption during the production of goods. Following the end of the transitional phase, until January 1, 2026, the CBAM scope is limited to direct emissions for iron/steel, aluminum and hydrogen. Direct and Indirect emissions will be in scope for cement and fertilizers. Actual emissions, or emissions based on the specific measurements from the production process, should be used where available. When unavailable, default emissions, as specified in EU documentation, may be used.

CBAM also distinguishes between simple and complex goods. Simple goods are produced from input materials that have zero embedded emissions (e.g., billets). Complex goods include the embedded emissions of relevant upstream products used in the production process (e.g., finished tubes).

Who does CBAM affect?

CBAM affects importers of iron and steel, aluminum, fertilizers, electricity, and hydrogen into the EU. Both importers and indirect customs representatives will need to apply for authorized CBAM declarant status — as entities needing to file CBAM reports — from their National Competent Authorities, the organization in each EU country tasked with managing CBAM within their jurisdiction.

When does CBAM take effect?

CBAM’s transitional phase began on October 1, 2023, and the first reporting period ended on January 31, 2024. During this transitional phase, importers were required to collect and report embedded greenhouse gas (GHG) emissions in products, but not to purchase or retire CBAM certificates. The full implementation of CBAM will begin on January 1, 2026 and will require importers to apply for authorized CBAM declarant status, and purchase and retire CBAM certificates corresponding to the embedded emissions of their imports.

Why is CBAM Important?

While climate disclosures have been increasing in most sectors, few companies report or calculate product-level emissions. CBAM may have the power to change this.

Access to the European single market, the world’s third-largest economy, will now be restricted to companies able to report and, starting in 2026, pay for the emissions associated with their imports. For importers, this will necessitate rigorous product-level emissions accounting. Exporters from the European Union will also be affected: prior to CBAM, European producers were largely exempt from having to make EU ETS payments, in order not to disadvantage them against imports from outside the EU. With CBAM, these free emissions allowances will go away, and both importers and local producers will be paying a carbon price. The intent is that affected industries in the EU, such as Europe’s large auto industry, will prioritize the purchase of low-emissions materials from both local producers and importers, in order to reduce the cost of compliance.

In the context of an increasingly global market for goods, data for complex goods will be difficult to come by — with component materials likely coming from a variety of countries that may not yet be as advanced in their carbon accounting journey. This has garnered some criticism of the new law, which opponents see as protectionist, and is likely to disproportionately affect under-developed and vulnerable economies.

Regardless, CBAM’s transitional phase has already begun. The 2026 deadline for retiring the associated CBAM certificates is not far off either. Remaining a part of the European single market is surely a goal for any importer currently engaged with the EU, and companies will need solutions to assure that they are compliant.

How can software and more effective GHG accounting help with CBAM compliance?
Product-level emissions accounting

Historically, companies have reported emissions at the corporate rather than product level, hindering the ability to compare the climate impacts of goods. Identifying and reducing emissions within companies’ supply chains is also key to meeting net-zero commitments and avoiding the most disastrous climate outcomes. According to the UN Global Compact, Scope 3 emissions (those associated with supply chains) account for more than 70 percent of a business’s carbon footprint. Consistent product-level emissions accounting is required for comparability and fairness across sectors — and for CBAM compliance.

Software solutions with product-level carbon accounting options will be more beneficial than those that solely provide company-level reporting, by allowing companies to reduce their reporting burden to a single solution, rather than using multiple platforms.

How standards foster interoperability

To achieve consistency across product-level calculations, emissions reporting standards are key. Current product-level accounting standards, such as WBCSD’s Pathfinder Framework, allow for comparability of emissions calculations across a broad range of sectors. When used in concert with sector-specific guidance, such as RMI’s Steel and Aluminum GHG Emissions Reporting Guidance, emissions for complex products, required under CBAM, can be better understood and shared.

RMI has previously extolled the virtues of open data standards for use in carbon accounting. Open standards allow for wider adoption, across both software customers and independent software vendors, which will help the industry reach a tipping point in readily available product-level carbon emissions data. Standardized data and data formats enable systems to work interoperably, leading to overall efficiency and therefore greater emissions visibility.

Ease of auditing and verification

Another area where software can help with CBAM compliance is to ease the burden of auditing and verification. While verification is not required in the transitional phase, starting in 2026, verification requirements will be enforced.

Software solutions such as SAP’s Sustainability Data Exchange tout their ability to provide “standardized audit-ready” values. A fully digital trail of supply chain emissions will become an essential part of being compliant with CBAM moving forward, and companies and solution providers who adopt such an approach will have a leg up on those who do not yet have a systematic approach to complying with CBAM and similar reporting requirements.

Looking ahead

With the first reporting period already open, and the UK adopting similar measures, it’s clear that CBAM is a reality that must be addressed if importers are to maintain access to the EU market. The initial scope of CBAM will focus largely on high-emitting products, but the EU has signaled an interest in expanding that scope over time.

While these regulations directly affect European markets, the United States’ Securities and Exchange Commission recently released rules governing corporate disclosure of emissions in North America. While this was expected to be a watershed moment for increasing the transparency of climate change-related risks, the final rule failed to include product-level or Scope 3 emissions reporting requirements, marking a misalignment in emissions reporting requirements across geographies. US exporters who adopt product-level reporting will be well-positioned to enter outside markets as countries adopt more stringent regulatory environments.

Software and accounting solutions that help to ease the reporting burdens of supply chain and product-level emissions data are going to be a necessity for companies looking to remain competitive. A greater focus on product-level accounting, the adoption of open standards across a large swath of market participants, and the ability to audit emissions calculations are all crucial elements needed to cope with this post-CBAM world.