Pragmatism vs principle: Carbon markets as a response to the EU’s CBAM

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Key points:

  • The EU’s Carbon Border Adjustment Mechanism (CBAM) is primarily designed to prevent carbon leakage from the EU by putting a price on the environmental damage caused by carbon emissions in countries which export certain products to the EU. However, it also aims to encourage decarbonisation in countries from which the EU sources its imports.
  • The CBAM’s design encourages exporting countries to develop domestic carbon pricing mechanisms as a way to reduce the fees for goods entering the EU, and keep the revenue from carbon pricing within their own borders.
  • Despite the controversy associated with the CBAM, some of the countries which have been most critical have also made the strategic decision to develop domestic carbon markets – in some cases, explicitly in response to the existence of the CBAM. This could enable millions of euros generated by carbon pricing to be retained in their countries. 
  • On this basis, there is some evidence that the CBAM is encouraging other countries to decarbonise. Should domestic carbon prices reach 50% of the EU’s, exporting countries would retain that portion of the revenue. For India, modelling suggests this would be an annual income of EUR 676 million, China would retain EUR 506 million and Brazil would gain EUR 143 million.

Rationale behind the CBAM

The EU’s Carbon Border Adjustment Mechanism (CBAM) imposes a levy on certain imports into the EU based on the level of carbon emissions associated with their production. It has faced criticism from various countries, particularly developing and emerging economies, which view it as a protectionist trade barrier.

The design of the CBAM is rooted in the principle that the polluter should pay for the environmental damage that they cause. Within the EU, this principle is already embodied in the Emissions Trading Scheme (ETS), which caps emissions from business and industry in line with the EU’s climate targets. Industrial installations have allowances to emit certain levels of greenhouse gases, and if they exceed their limit they must buy allowances from other ETS participants that have a surplus. This market establishes a price for carbon emissions within the EU.

Some emissions allowances in the ETS are currently allocated free of charge to certain installations which are deemed to be most at risk of carbon leakage by moving production to other countries with less stringent regulations and consequently higher emissions. The impetus for the CBAM was to reduce this free allocation but still ensure that EU businesses compete on a level playing field for carbon pricing with goods imported into the EU. 

CBAM is currently in a transitional phase which allows both the European Commission and EU importers to learn how the reporting mechanism will work in practice. From the beginning of 2026, EU importers of goods covered by the CBAM will be required to buy CBAM certificates matching the embodied carbon in the goods they import.

How CBAM prices carbon

The certificates will be priced to reflect the cost of allowances (European Emission Allowances – EUAs) in the EU ETS. This ensures that the carbon price on goods imported into the EU is the same as the carbon price of goods produced inside the EU.

At the moment, the CBAM applies to the highest-emitting industrial sectors: cement, aluminium, fertilisers, iron and steel, hydrogen and electricity. The number of sectors covered may be extended to others at risk of carbon leakage once the European Commission has reviewed performance in the transitional Period. The European Commission is also currently considering expanding CBAM’s scope to downstream products used in manufacturing processes.

While the CBAM was primarily designed to address carbon leakage, it is also intended to encourage decarbonisation in other countries. The mechanism is designed to avoid the double pricing of carbon, so if a certain price for embedded carbon in the goods has been paid in the country of production, this will be deducted from the total number of CBAM certificates that need to be presented. 

The total cost of the CBAM for importers is therefore: (embedded emissions × EUA price) – (embedded emissions × carbon price paid in exporting country).

This framework, in theory, provides incentives for exporting countries to establish a domestic carbon pricing regime. The primary reason is that this should limit the impact of the CBAM on exporting countries because the domestic cost of carbon in the exporting country will be deducted from total CBAM costs. Additionally, it would also allow the exporting country to retain the revenues resulting from its own carbon pricing regime rather than allowing these revenues to be collected by the EU.

International reactions to CBAM

The introduction of CBAM has ignited debate about how to align trade and climate goals, and concentrated attention on countries’ reactions to the measure. While the EU frames CBAM as a climate measure, other countries have concentrated on the trade impacts it will have.  

The principle behind the measure has received widespread criticism outside the EU, focused on two main areas:

  • The impact that CBAM might have on global trade. The BRICS countries have been particularly hostile.1There are currently 11 BRICS countries: Brazil, Russia, India, China, South Africa, Saudi Arabia, Egypt, United Arab Emirates, Ethiopia, Indonesia and Iran. The 2025 Rio de Janeiro Declaration called it “unilateral and discriminatory”, and Russia filed a complaint to the World Trade Organisation on the grounds that CBAM breaches trade agreements.
  • The impacts of the levy on developing countries with limited resources to reduce the carbon intensity of their exports to the EU. This has raised the issue of climate injustice, given that the levy is being introduced by a region where economic development was based on the use of fossil fuels.

However, in tandem with these criticisms, it is also evident that some countries are developing their own domestic carbon pricing mechanisms to reduce exposure to CBAM costs. This is a pragmatic response to the reality of the CBAM’s operation and a recognition that its design means that while a carbon price must be paid, the revenues generated by carbon pricing can be kept in the exporting country rather than paid into the EU as CBAM fees. The countries introducing their own carbon pricing mechanisms include some of the BRICS countries which have also been vocal critics.

Most of these planned carbon markets have been explicitly linked to the CBAM, providing some evidence that the EU’s aim of using the mechanism to encourage decarbonisation elsewhere is at least partially being realised.

Developing domestic carbon trading

An increasing number of countries are developing carbon pricing mechanisms, whether in the form of a tax or an emissions trading scheme. There are at least 80 carbon pricing schemes in place around the world, with others being developed.2Other countries are also considering introducing their own Border Carbon Adjustment mechanism. These include Australia, Canada, Norway, Taiwan and the UK.  This section outlines a number of carbon pricing schemes that have been proposed since the introduction of the CBAM, several of which are linked directly to its introduction.

Brazil

The Brazilian Emissions Trading Scheme (SBCE) became law at the end of 2024 and is scheduled to begin operating around 2030. Although the mechanism will be based on international models of cap-and-trade systems, it will also include provisions to share any benefits more equitably with traditional communities.

As well as reducing emissions, the goal of the trading scheme is to mitigate the barriers to trade that might result from border carbon adjustments such as the CBAM.

Brazil has also proposed establishing the Open Coalition for Carbon Market Integration, aiming to link carbon trading schemes internationally. The coalition would have a shared carbon emissions cap, with explicit provisions to help fund decarbonisation in countries with fewer financial resources. This is intended to support a just transition and address issues of equity associated with the unilateral nature of the CBAM. Brazil’s proposal will be one of the key focuses of discussion at COP30.

China

China led opposition to CBAM at COP29. Despite this, it has taken a strategic decision to expand the scope of its existing carbon market scheme from the power sector to include industries included in the EU CBAM such as cement, steel and aluminium.

India

Given the high level of exports of iron and steel to the EU, India is one of the most exposed countries to the CBAM. It established the Carbon Credit Trading Scheme in 2024 and is expected to begin operating in 2026. It will initially cover nine sectors, including those which are part of the CBAM. 

Despite its opposition to the CBAM, India has also been negotiating with the EU to manage its impact on India’s exporters. Cooperation on the development of India’s carbon pricing to enable exporters  – including small businesses – to reduce the impact of CBAM was explicitly included in the new strategic EU-India agenda announced in September 2025.

Indonesia

The Indonesian Economic Value of Carbon Trading Scheme began operating in 2023. Initially, it only covers the power sector, but it is eventually intended to increase its scope to other sectors, including those currently covered by the CBAM.

Taiwan

Taiwan introduced a carbon tax in January 2025. This scheme allows limited trading of permits from voluntary actions to reduce emissions. However, the government plans to establish an emissions trading scheme by the end of 2026. This shift to an emissions trading scheme is a direct response to the introduction of the CBAM. 

Vietnam

In August 2025 Vietnam expanded its emissions trading to thermal power plants and the iron, steel and cement industries. After an initial phase of operation, the scope of the trading mechanism will be expanded to other sectors between 2027 and 2030. The scheme was developed explicitly to help address the potential costs of the CBAM.

Others

Turkey, Malaysia and Serbia are also putting carbon pricing measures in place as a way of reducing exposure to CBAM costs. Both Turkey and Malaysia have explicitly linked the measures to the implementation of CBAM.3Page 26.

What these new markets mean for countries’ exposure to the CBAM

Modelling of the impact of CBAM with and without domestic carbon pricing highlights the economic gains that stand to be made from this pragmatic response to the CBAM’s implementation. As an example, if the domestic carbon price is set at 50% of the EU’s EUA price, then border fees are roughly halved and the revenues from the carbon pricing mechanism remain in the exporting country. If domestic carbon prices are set at an equivalent level to EUA prices, then CBAM costs are effectively removed.

Figure 1 illustrates the impacts on some countries that have specifically linked the development of domestic carbon markets to the introduction of the CBAM.

Figure 1

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    There are currently 11 BRICS countries: Brazil, Russia, India, China, South Africa, Saudi Arabia, Egypt, United Arab Emirates, Ethiopia, Indonesia and Iran.
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    Other countries are also considering introducing their own Border Carbon Adjustment mechanism. These include Australia, Canada, Norway, Taiwan and the UK.
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    Page 26.

Carbon Border Adjustment Mechanisms require coordinated global action

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Key points:

  • A Carbon Border Adjustment Mechanism (CBAM) charges a tariff on imports based on their emissions. Paired with a domestic carbon price, it aims to prevent carbon leakage – companies moving their emitting activities to other countries – and lead to an overall reduction in emissions. 
  • In 2023, the EU started its CBAM – the first to be implemented globally. This was met with a strong reaction from other countries, such as China, South Africa, India and Brazil, which criticised the mechanism for placing an unfair burden on developing countries and for breaking WTO rules. 
  • The EU CBAM will likely only reduce emissions slightly on top of the EU emissions trading system currently in place. An EU carbon price of USD 88 on all emissions reduces emissions by 21%, and the introduction of the CBAM only adds another 1.3 percentage points. 
  • Modelling suggests that the EU CBAM could cost developing countries USD 10.2 billion, with some countries, like Zimbabwe and India, most exposed.
  • The introduction of the EU CBAM has led to the announcement of more climate and international trade measures worldwide as countries try to limit their exposure to it. Thus far, this has resulted in an uncoordinated and confusing policy landscape. 
  • To ensure that climate and trade policies work to reduce global emissions, they should be aligned with UNFCCC principles and should provide exemptions to avoid placing additional burdens on developing countries.

A Carbon Border Adjustment Mechanism is a carbon tariff on import

A Carbon Border Adjustment Mechanism (CBAM) is a policy that charges a carbon price on certain types of imports based on the amount of carbon emissions associated with their production. 

When paired with domestic carbon pricing, it aims to “level the playing field”: A CBAM aims to ensure that when a carbon price is put in place, the higher prices for carbon-intensive domestic goods do not lead to more imports of cheap, carbon-intensive goods from countries where carbon taxes are not in place. It aims to prevent ‘carbon leakage’, where carbon-intensive activities are moved to another location with less regulation on emissions, instead of being reduced, resulting in no overall decrease in emissions.

In the absence of domestic carbon pricing, a CBAM functions as a border tariff targeting carbon-intensive production and is not likely to contribute to further emissions reductions. 

EU CBAM has sparked discussions on climate and trade

In 2023, the European Union started implementing the EU CBAM, the first to be implemented globally. It is designed to ensure EU policies limiting emissions in specific sectors are not undermined by the import of carbon-intensive goods from outside the EU. The European Union writes that the CBAM also aims to “contribute to the promotion of decarbonisation in third countries.”

This has led to a wide range of reactions from different countries, including the development of new CBAMs and other trade policies, as well as harsh criticism. 

At COP28 in Dubai, countries expressed their concerns over the EU CBAM. There was an attempt by the BASIC group of countries – made up of Brazil, South Africa, India and China – to introduce “unilateral trade measures related to climate change” as a point on the COP agenda, which “could have resulted in an impasse in the climate talks.” The proposal received support from 134 countries, including key developing country negotiating blocs and the G77, but was not included in the final agenda. However, according to E3G developing countries’ sentiment towards CBAM and similar initiatives was included in the COP28 final text: “Unilateral measures should not lead to unjustifiable or arbitrary discrimination or restriction in international trade.”

Throughout 2024 and in the lead-up to COP29, discussions on trade measures and climate policy have ramped up. In June 2024, the BRICS group of countries1The BRICS group of countries is made up of Brazil, Russia, India, China, South Africa, Iran, Egypt, Ethiopia and the United Arab Emirates. released a statement condemning the introduction of trade policies “under the pretext of environmental concerns,” such as “unilateral and discriminatory” CBAMs. This statement was also included in the declaration for the BRICS Summit in October 2024.

Additionally, the BASIC group, chaired this year by China, is again pushing to have trade agreements on the agenda at COP as a separate agenda item, potentially resulting in disputes over trade stalling climate negotiations.

Application of the EU CBAM is ramping up

The EU CBAM was introduced as a component of the European Green Deal, a package of policy initiatives aiming to help the EU reach climate neutrality by 2050. As part of this package, the EU has implemented an emissions trading scheme (ETS), which is a cap-and-trade system to reduce emissions by putting a price on carbon. The ETS allocates a specific amount of emissions allowances to different participants in different industries, including electricity producers, heavy industry and intra-EU aviation. Over time, the cap is lowered and the amount of GHGs these industries are allowed to emit is reduced.

Currently, some ETS participants receive free emissions allowances as they are considered exposed to external trade. The allocation of free allowances means these businesses do not have an incentive to reduce their emissions and can even profit from selling their emissions allowances, if, for example, production levels fall. 

The implementation of the EU CBAM is “aligned with the phase-out of free allowances” under the EU ETS, as both moves reduce opportunities for ‘free’ emissions and therefore“support the decarbonisation of EU industry.” It will take until 2034 for the EU CBAM to be fully phased in and for the free allowances to be fully phased out.

The CBAM entered its ‘transitional phase’ on October 1 2023, which will end at the end of 2025. During this time, importers of affected goods are required to report on emissions but nothing will need to be paid for embedded emissions, which refers to the carbon emissions generated in the production of goods. 

From the start of 2026, the ‘definite period’ will begin and importers will have to purchase and “surrender” certificates corresponding to the carbon emissions embedded in imported goods impacted by the mechanism. This will start off as a small obligation, with businesses only needing to purchase certificates equivalent to 2.5% of their emissions in 2026, and will gradually be ratcheted up to cover 100% of emissions in 2034.

At first, the CBAM will apply to imports “whose production is carbon intensive and at most significant risk of carbon leakage: cement, iron and steel, aluminium, fertilisers, electricity and hydrogen.” When the CBAM is fully phased-in, this will account for over 50% of emissions in sectors covered by the ETS. It is also expected that the number of industries included in the CBAM will expand following further assessment to include, for example, ceramics and paper industries. 

The complexity of global trade interlinkages and national policies means that the understanding of what exactly the CBAM would mean is varied and impacts are not always well understood. While a resolution adopted by the European Parliament “stresses that Least Developed Countries and Small Island Developing States should be given special treatment” as the CBAM could potentially impact their development, current CBAM regulation does not provide exemptions from the mechanism for any developing countries.

The EU CBAM is projected to only slightly reduce emissions

The EU CBAM is anticipated to slightly reduce emissions when implemented in alignment with a domestic carbon price. 

A 2021 study conducted by UNCTAD estimated that a carbon price set at USD 88 per tonne of carbon would result in CO2 emissions being reduced in the EU by 704 million tonnes. A CBAM implemented on top of this would reduce emissions outside the EU by 59 million tonnes, but would increase emissions in the EU by 13 million tonnes – a net reduction in emissions of just 45 million tonnes. Therefore, a CBAM results only in a slightly improved overall emissions reduction – equivalent to 6% of the emissions reductions from the carbon pricing mechanisms itself. While an EU carbon price of USD 88 reduces global emissions by 21%, the introduction of the CBAM only adds another 1.3 percentage points.

However, at the same carbon price, a CBAM would reduce carbon leakage by more than half (55%), from 15.1% when only carbon pricing is used to 6.9% when a CBAM is in place. 

Other studies have shown similarly modest reductions in emissions:

  • The Asian Development Bank (ADB) calculated that implementing both the ETS and CBAM with a 100 euro carbon price would reduce global carbon emissions by 1.26%, with the CBAM contributing approximately 0.2% of these emissions reductions, and this would be accompanied by a 0.4% reduction in global exports to the EU. 
  • The African Climate Foundation and the London School of Economics (LSE) calculated that, with a carbon price of 87 euros covering all products, a CBAM would only result in a 0.002% additional reduction in global carbon emissions. This suggests that a CBAM encourages a shift in carbon-intensive production between countries more than it encourages an overall reduction in emissions.
  • The European Commission estimated in 2021 that its initial proposed CBAM design would reduce emissions from affected EU industries by 1% by 2030, while global emissions from these industries would be cut by 0.4% over the same timeframe.
  • A 2009 study by the Brookings Institution and Syracuse University found that any emissions reduction resulting from a CBAM would occur not by incentivising the trade of less carbon-intensive goods, but primarily due to decreased international trade.

In the studies above, estimates of overall global emissions reductions do not consider the knock-on benefits from a CBAM, such as incentivising clean energy investment.

Projected economic impact of the EU CBAM

A fully implemented CBAM should incentivise investment in emissions reductions for carbon-intensive exporters, so they are not required to pay as high tariffs at the EU border. Additionally, it allows exporters whose production of goods is relatively ‘cleaner’ or less carbon-intensive to capture higher margins.  

Based on current emissions intensities, the World Bank’s Relative CBAM Exposure Index shows that Zimbabwe, Ukraine, Georgia, Mozambique and India will be the countries most exposed to the CBAM. Countries such as the US, Australia and the UK will likely have little-to-no exposure to the CBAM. Some countries, such as Colombia and Albania, are anticipated to gain more competitiveness as they produce products covered by CBAM in a way that is cleaner than the EU average.

Figure 1. Countries most and least exposed to the EU CBAM
Source: World Bank, 2023

The 2021 UNCTAD study highlighted that developing countries could lose USD 10.2 billion in income due to the implementation of the EU CBAM. Non-EU countries are anticipated to lose USD 14.2 billion, while the EU gains USD 5.9 billion. Overall, there is a net income loss of USD 8.3 billion. 

Anticipated impacts in other regions include:

Ultimately CBAM’s impact on other economies will depend on how other players globally respond to its implementation. The more countries decarbonise their exports to the EU, the less they will feel its impacts and the greater their margins. Some countries are already considering carbon pricing and other mechanisms that will reduce their exposure to the CBAM.

Announcement of the CBAM has sparked strong reactions 

While the EU supports the introduction of the CBAM as a mechanism to increase climate ambition both within and outside the EU, not all countries share this perspective. 

The CBAM has been perceived as a protectionist measure, particularly by the African negotiating group and BRICS. Criticisms have focused on two areas: the EU CBAM possibly being in violation of World Trade Organization (WTO) rules and burdening developing countries. 

While the EU CBAM has been designed to be compliant with WTO rules, not all countries agree. Countries such as China, Brazil, India and South Africa have criticised the EU CBAM at international fora, including the WTO, for being a unilateral measure – the EU intends to implement it independently and “without requiring consensus or agreement from other countries.” 

India’s Finance Minister Nirmala Sitharaman has denounced the CBAM as a “trade barrier”. Brazil has strongly opposed the policy due to it being “discriminatory” and has warned that it may hamper global climate efforts. However, the EU is “confident the measure would survive a possible challenge at the World Trade Organization because it applies to domestic producers as well imports,” according to the Financial Times.

Developing countries have argued that they are disproportionately burdened by the CBAM, hindering economic growth and “further take[ing] away the ability of developing countries to finance decarbonisation”. As a major exporter, China also strongly opposes the policy. The EU CBAM will expose a lot of Chinese exports to tariffs and it is likely that “similar measures from other countries including the US, UK, Canada and Japan may amplify the exposure of Chinese exports to border adjustment taxes.”

The domino effect

The introduction of the EU CBAM has triggered, both directly and indirectly, a cascade of carbon pricing announcements from other countries. Countries are aiming to reduce their exposure to the CBAM by introducing their own carbon pricing mechanisms and incentivising the production of less carbon-intensive products.

Resources for the Future wrote that implementation of a CBAM could “lead to a virtuous cycle, where more and more countries adopt carbon pricing”. 

The carbon taxes and emissions trading schemes currently in effect worldwide cover almost a quarter of all global emissions. As of September 2024, there were “78 different carbon pricing and taxation mechanisms in the world,” according to WTO Director-General Ngozi Okonjo-Iweala. Between 2009 and 2022, the WTO was notified of over 5500 trade measures linked to climate objectives.

Box 1. Policy responses to the EU CBAM

United Kingdom

In October 2024, the UK government confirmed that it will introduce a CBAM for some sectors from January 2027, with the primary aim of addressing the risk of carbon leakage. The UK CBAM will operate similarly to the EU CBAM but with some differences in the sectors covered. For example, the UK CBAM will not cover imported electricity. 

There have been calls for better alignment with the EU CBAM, “suggesting that this would reduce the economic risk to the UK.” Already the UK steel and energy industry has successfully demanded the UK government align EU and UK mechanisms more closely following the closure of Port Talbot steel works in 2024. 

United States

There has been ongoing debate in the US about potentially implementing a CBAM. However, without a unified domestic carbon pricing mechanism a CBAM would not be able to accurately reflect the emissions-related costs borne by US producers. Without carbon pricing, it would likely only work as a tariff costing foreign exporting countries without requiring domestic producers pay the same fees – therefore not contributing to overall emissions reductions. 

There has been much activity in Congress focused on implementing a CBA-like mechanism. Multiple bills to enact a US version of a CBAM have been introduced, including the Republican-endorsed Foreign Pollution Fee and the Democrat-sponsored Clean Competition Act. Recent statements from Republicans Donald Trump and JD Vance have defended tariffs against dirtier producers to protect US industry. 

Canada

The Canadian government launched a consultation to explore establishing its own CBAM in 2021. 

Australia

In Australia, the government launched a review to assess the potential of a CBAM to prevent carbon leakage. The recommendations are due to be presented before the end of 2024.

Fraying trade relationships between major blocs are driving developed and developing economies to consider their own CBAMs and carbon taxes. The EU has suggested that India consider setting its own carbon price or CBAM to reduce tariff payments to the EU. Malaysia’s Investment, Trade and Industry Ministry has been advised to “think about adopting a carbon tax or carbon pricing more broadly, but also consider adopting its own Malaysian CBAM,” with a pilot in the steel industry.

However, only one of 80 low and lower-middle income countries has implemented a carbon price. Implementing a carbon price could help countries avoid paying higher CBAM fees as exporters will be incentivised to reduce the carbon-intensity of their goods. This raises concerns that they are unprepared for the end of the EU CBAM transition phase in 2025.

Lacking coordination 

The rapid introduction of various carbon pricing mechanisms has so far lacked coordination, resulting in an increasingly confusing global trade landscape. There are also wide disparities in carbon pricing among countries, ranging from as low as  USD 6 per tonne in South Korea to around USD 80 per tonne in the UK and EU in June 2024. 

Governments and stakeholders have expressed concerns that the “evolving patchwork” of national plans could undermine climate action, by fragmenting trade and “fail[ing] to provide businesses with the predictability and assurances they need to drive transformation of production and supply chains.”

The International Institute for Sustainable Development (IISD) warns that because every CBAM regime will be different to comply with national policies, there is a risk that exporters will have to comply with many different requirements, including the measurement, reporting and verification of the carbon embedded in their goods. 

This would make it difficult for developing countries and small producers to meet the high cost of compliance, potentially excluding them from the marketplace. This could restrict international trade, with knock-on impacts for poverty alleviation and sustainable development.

Box 2. Not all CBA mechanisms are made the same

The label ‘CBA’ (carbon border adjustment) can be applied to a wide range of mechanisms. The IISD suggests six key factors in how a CBAM is developed that can greatly affect its potential impact:

  1. Trade scope: Will the tariff be charged only for imports, or also provide rebates for exports? 
  2. Country exceptions: Will there be any tariff exceptions for specific countries, such as developing countries or countries with more ambitious climate policies?
  3. Scope of coverage: Will the mechanism cover only ‘direct’ emissions, or also ‘indirect’ emissions from energy used in the production of products and ‘precursor’ product emissions embodied in imported CBAM goods? 
  4. Carbon accounting methodologies: How will the carbon intensity of products be measured and defined?
  5. Credit for foreign action: If a foreign producer is already subject to a carbon price or climate-related fee in their own country, will this be considered and compensated for?
  6. Use of revenues: How will the funds generated from the CBAM be used? Sending the money back sends a strong signal that the regime was not about protecting domestic producers and could compensate for the need for compliance.

A CBA mechanism would need to be designed to complement distinct national policies, as well as inevitable costs for foreign producers arising even in the “most thoughtfully crafted BCA regime.”

Moving discussions on climate and trade forward

As in previous years, trade-related climate measures are likely to be brought up during discussions at COP29, as countries express their differing views. 

There is a need to create a clearer understanding of the impacts of implementing the EU CBAM, as well as other potential climate and trade measures. International cooperation can help set agreed on principles and best practices for the development of CBA mechanisms, helping to prevent future trade frictions. Without a unifying trade-climate framework, this will lead to prohibitively high costs that disproportionately burden the poorest countries and smaller firms.

Climate and trade goals can be aligned in a way that prioritises fair economic relations and embodies the UNFCCC principles, including “common but differentiated responsibilities and respective capabilities and their social and economic conditions.”

The WTO released a report in October 2024 that outlines “pathways for coordinated approaches on climate action, carbon pricing, and the cross-border effects of climate change mitigation policies with a view to achieving global climate goals.” The International Chamber of Commerce (ICC) has also released a set of “global principles” to guide countries in introducing their own CBAMs and avoid disjointed mechanisms. The principles highlight that CBAMs should support Paris Agreement goals as “the primary objective,” ensure WTO compliance, respect UNFCCCC and Paris Agreement Principles, and provide targeted exemptions for most vulnerable countries. 

Existing and future climate finance commitments and obligations need to be met to enable developing countries to bear the costs of decarbonisation and compliance with CBA mechanisms. A key moment during COP will be discussions on the New Collective Quantified Goal on Climate Finance (NCQG), which has the potential to unlock trillions in critically-needed climate financing for developing countries.

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    The BRICS group of countries is made up of Brazil, Russia, India, China, South Africa, Iran, Egypt, Ethiopia and the United Arab Emirates.

Asia’s booming voluntary carbon market

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Key points:

  • Asian governments and companies are trying to keep up with the global trend of developing voluntary carbon markets (VCM) by scaling up local versions. New initiatives have been set up to make buying and selling voluntary carbon credits in the region easier.
  • While there is no money to be made yet, market players are hoping that building the infrastructure for carbon trading will increase the size of the VCM, attracting foreign investment to the region.
  • However, there are a number of issues with the current VCM, including a lack of standardisation, poor quality credits, transparency and low pricing, as well as increasing scrutiny over the wider use of carbon offsets. These issues are hampering progress in the existing global markets. If they are not overcome, those looking to benefit from the booming Asian markets risk wasting resources on projects that are unproven to benefit local communities or the environment. 
  • While initiatives are starting to address these concerns, the future of the VCM remains unpredictable.

The global VCM

Carbon markets enable the trading of carbon credits – each equivalent to one tonne of carbon dioxide (CO2) emissions – and now cover close to a fifth of global emissions. While the majority of carbon markets are compliance markets – in which governments allow the trading of emissions to meet mandatory targets – the VCM, where companies and individuals can choose to buy carbon credits to offset their carbon footprint, has exploded in recent years. Between 2020 and 2021, the value of the global VCM grew fourfold, reaching almost USD 2 billion, with some analysts estimating the market could grow to USD 50 billion by 2050. This growth is driven mainly by rising demand from companies as they face increasing pressure to develop and meet net-zero goals. Between 2021 and 2022, the number of global corporations with net-zero goals increased by 150%.

However, there are a number of issues that prevent the VCM from providing a considerable source of finance for project developers while having real climate impact. Growing scrutiny over the use of carbon offsets, uncertain regulations and global economic slowdown have seen the purchase of credits dry up in recent months, making the future of the VCM unclear.

Recent developments in the Asian VCM

While the majority of the projects that sell carbon credits are located in Asia, South America and Africa, historically the majority of trading has taken place in Europe and the US. Now market players are taking the first steps to scale up the VCM in Asia. In theory, this would increase funding for the protection of nature and low carbon technologies in the region and enable companies to offset emissions and meet net-zero goals through buying credits. 

There is no money to be made yet, but companies are eager to tap into the anticipated financing opportunities. The potential funds raised by offsets generated in Asia is estimated at USD 10 billion annually by 2030. Asia is already the world’s largest producer of carbon offsets, producing 44% of global credits, and is home to some of the world’s most valuable investable carbon stock. Additionally, of the more than 1,600 companies that have committed to net-zero targets globally, nearly a quarter are from Asia, potentially increasing regional demand for credits. 

Main players in the offset boom

Carbon trading platforms and voluntary domestic initiatives to facilitate the buying and selling of carbon credits have recently been set up in Singapore, Thailand, Hong Kong and Malaysia, with others planned in Japan, Indonesia, India and South Korea.

Key players and new developments in Asian carbon markets

Singapore currently dominates the Asian VCM, hosting platforms Aircarbon Exchange and the newly-launched Climate Impact X (CIX), which was founded by state investment fund Temasek and others to position Singapore as a carbon trading hub. These platforms are anticipating increased demand for credits after Singapore announced that, from 2024, companies can use VCM carbon credits to offset up to 5% of their taxable emissions. This is the first time a carbon tax scheme has allowed the use of VCM credits, and highlights the increasing overlap between voluntary and compliance markets, particularly in Asia. 

Other platforms are hoping to expand investment in Asia’s VCM. For example, Hong Kong’s Core Climate is the only exchange to offer settlement for the trading of international voluntary carbon credits in Chinese currency, opening up the VCM for mainland China’s participation. Meanwhile, Malaysia’s Bursa Carbon Exchange is the first Shariah-compliant carbon exchange in the world, potentially attracting foreign Islamic finance. 

Carbon exchanges in Thailand and Malaysia also aim to help companies meet import requirements and improve national industry competitiveness, especially in the face of tariffs on high-carbon imports, such as the EU’s upcoming carbon border adjustment mechanism. Both countries allow domestic offsets to be traded internationally. However, other countries, including Indonesia and India, have recently imposed restrictions on the exports of carbon credits generated from their territories to prioritise the domestic use of credits for meetingnational climate targets. While more clarity is needed on these regulations, this is raising concern among buyers.

Risks of a poorly regulated VCM

While the VCM has strong ambitions globally and in Asia, a lack of regulation and transparency means the market is currently overrun with cheap, low-quality offsets that are not funding genuine climate solutions, which is increasing the reputational risks for both sellers and buyers. 

Lack of standards: The VCM is largely unregulated and lacks a standardised approach, with carbon registries, such as Verra and Gold Standard, issuing credits in line with their own standards, resulting in a highly-fragmented market in which the type and quality of credits offered vary wildly (see below). Alongside unreliable verification of credit quality and lack of transparency, this makes it difficult for buyers to determine which credits are high quality, especially as quality is not necessarily linked to price. The extensive range of private and public schemes for certifying and trading credits in Asia complicates efforts to standardise, and contrary to their goal of streamlining VCM trading, new carbon exchanges have so far created more division in the market. For example, CCER credits issued under China’s voluntary emission reduction programme and traded via domestic emissions trading schemes can also be traded internationally on the VCM, however low quality and transparency has limited this so far. 

Low-quality credits: The current VCM is dominated by low-quality credits, with around 80% generated from projects that avoid emissions, rather than reduce or remove them. If a project is not actually removing CO2 from the atmosphere, it is not offsetting emissions. Determining ‘additionality’, which refers to whether or not the project would have gone ahead without the carbon credit revenue, is also difficult. Investigations have found that most renewable energy projects are not additional, making the credits worthless from a climate perspective, and that over 90% of rainforest carbon offsets issued by Verra (which is currently working with carbon exchanges in Singapore, Thailand and Malaysia to facilitate use of their standards) did not result in emissions reductions. As a result, price and demand for Verra’s rainforest credits dropped and Verra is currently revising its methodologies to verify rainforest credits, which may limit their issuance in Asia. Asian carbon credit projects are likely to be made up of forestry projects that face these same additionality concerns, as well as issues regarding the permanence of carbon stored due to land use changes and wildfire risks. Renewable energy credits are also still issued in some Asian schemes, such as via China’s CCER scheme. CIX is taking this a step further and promoting the use of a new type of credit for the protection of forests, even when there is no to low risk of deforestation. While protecting forests is important, it does not remove CO2 and should not produce credits that allow companies to continue to emit. 

Consequences for local communities: Carbon offset projects have often come at the cost of local communities and indigenous peoples, who are frequently not consulted and, at times, forced off their land. This is particularly concerning as many of the carbon sinks targeted by offsetting schemes are located in areas without indigenous or local land rights – especially in Asia. Increased interest in carbon markets may drive government officials to bypass consultations and fast-track potentially harmful projects in order to capture financial benefits. For example, in 2021, Malaysian officials signed over USD 76.5 billion of carbon credits and natural capital from a state forest to a small Singaporean company without involving local communities and indigenous leaders in the decision-making process.

Cheap offsets: In part due to their low quality and oversupply, offsets have historically been very cheap. The average price of global VCM credits was USD 4 per tonne of CO2 in 2021 and fell as low as USD 1.7 per tonne in January 2023 as purchases stalled. And prices from projects based in Asia generally receive below average prices. Such low prices tempt companies to purchase credits rather than decarbonise their practices , with the World Bank estimating that, by 2030, a price of USD 50-100 per tonne is needed to limit warming to below 2oC. While some predict that VCM pricing issues will be resolved as a preference for high-quality offsets will create a more expensive sub-market, this has not happened in practice.

Indeed a number of factors suggest supply will continue to outstrip demand:

  • Reputational risk: As questions grow around the legitimacy of offsets, companies are increasingly at reputational risk from the purchase of carbon credits 
  • Article 6 uncertainty: Discussions on Article 6 of the Paris Agreement, which sets out rules for international trading of carbon credits, have so far been inconclusive, stalling progress on new carbon trading plans for both government and industry 
  • Recession fears: Traders and analysts anticipate that polluters will reduce buying amid soaring inflation, rising energy prices and economic instability.

Firms bought 4% fewer credits in 2022 compared to 2021 and retirements of renewable energy and forestry credits declined in two consecutive quarters for the first time due to falling demand. In addition, the VCM is currently oversupplied, with a current reserve of over 683 million tonnes – over four times the total amount of credits traded in 2022. There are concerns that diminishing demand and oversupply will flood the market, further lowering the price and integrity of credits and threatening the overall functioning of the VCM. 

Improving market integrity and transparency

Following calls to increase the integrity and transparency of the VCM, new initiatives have been established to develop guidelines and restore confidence in the market. The Integrity Council for the Voluntary Carbon Market (ICVCM) aims to create industry-backed standards and guidelines to establish a quality baseline for carbon credit generation and trading that is credible and transparent, while the Voluntary Carbon Markets Integrity (VCMI) Initiative has developed a code of conduct with stakeholders to ensure that standards are implemented correctly. While the guidelines released by both initiatives last year were criticised by some for being too stringent and overbearing (and by others for not being strict enough), they present a starting point for moving forward. 
Additional guidance from the UN high-level expert group (HLEG) on net-zero emissions has reiterated that offsets cannot be used at the expense of genuine emissions reductions. The VCM should emphasise quality over quantity, with companies only using carbon offsets as a last resort for emissions that are very difficult to avoid, especially because, due to limited available land and resources, high-quality carbon offsets are finite.

Equity and justice in carbon taxes

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Key Findings 

  • Forty-six countries around the world have introduced a carbon price and many have been slowly increasing it over time
  • The carbon price needs to be ambitious enough to drive down emissions, and a minimum price of USD 40-80/tCO2e is necessary to achieve a 2°C world 
  • Whether a carbon tax disproportionately impacts low-income households is highly dependent on a country’s wider socio-economic context 
  • A number of countries have demonstrated it is possible to implement a carbon tax that does not impact low-income citizens disproportionately.

Carbon tax as a tool to fight climate change

Economists overwhelmingly agree that a carbon tax is a necessary policy for speeding up the transition to a lower carbon economy by incentivising companies and people to change their behaviour. As long as the tax is high enough (experts say a price of USD 40-80/tCO2e is needed to meet a 2°C goal), it can both help companies and individuals move away from high-emission products and incentivise new, sustainable industries. And carbon taxes have proved to be effective. One analysis found that Norway’s carbon tax reduced carbon pollution by 2% in its first decade, while another study found that the EU cap-and-trade system probably reduced emissions by 4% between 2008 and 2016. This was achieved with a much lower carbon price than we see today. Another consideration in favour of introducing a carbon tax now, during a period of economic recovery from the COVID-19 pandemic, is that there is an opportunity to put spare labour capacity to more productive use. 

Denmark is currently considering raising its carbon tax from 170 crowns to 1500 crown/tCO2e (USD 27 to USD 234/tCO2e) to help meet its 2030 target to cut greenhouse gas emissions by 70%. It is following other countries around the world that are raising carbon prices, including Canada, Germany and Ireland. Globally, there are now 46 countries with a carbon tax, covering 22% of global emissions. All Scandinavian countries have a carbon tax, with Sweden’s currently the highest at EUR 114/tCO2e. 

The distributional impact of carbon taxes

In theory, putting a price on carbon shows companies the true cost of the products they make and consumers the real price of the goods they buy, because they include externalities (the impact of the products that are not accounted for in the price, such as pollution and CO2 emissions). For example, people buying big new cars or big new homes pay more carbon tax as these items have a bigger carbon footprint, making smaller alternatives more attractive. According to one estimate, in 2015 the richest 10% of the world’s population were responsible for 52% of cumulative CO2 emissions, with the top 1% alone accounting for 15%. Heavily taxing the materials and energy they consume could be a way to even out income inequality in countries where higher income taxes have been unpalatable in the past. 

Carbon taxes are not necessarily regressive (they disproportionately burden low-income groups, as opposed to progressive, that try to shift the burden onto those who can better afford it). In theory, because low-income households earn less, basic necessities take up a greater proportion of their income than is the case for high-income households. This means they are disproportionately impacted by any rise in the cost of these necessities. But while this is generally true for electricity, it is less the case for transportation and heating fuels. This is because instead of spending more money on fuels, they will often just use less of them. 

The regressive effects are also less significant when measured against household consumption, as opposed to income. This is because low-income households can under-report key components of their income, and consumption is typically higher than stated incomes.

Whether a carbon tax has a higher impact on poorer citizens for any country largely depends on:

  • Equality/inequality in the distribution of income
  • How the carbon tax is levied
  • How the carbon tax revenue is spent

Sweden provides a good example to follow

Sweden’s experience in implementing one of the highest carbon taxes in the world may be most analogous to Denmark. The two countries have similar Gini-coefficients – Denmark’s is 0.26, Sweden’s is 0.28, indicating that both have low levels of income inequality. Sweden introduced its carbon tax in 1991 at EUR 25/tCO2e and slowly increased it over a number of years to EUR 114/tCO2e in 2021. The carbon tax was introduced at a high level for motor fuels and heating fuels in households and services, and a low level for heating fuels in industry. The slow increase in price gave households, businesses and supporting policies time to adapt.

Between 1990-2018, Sweden’s GDP grew 83% while its emissions decreased by 27%. Analysis showed that different deciles of Sweden’s income distribution pay roughly the same share of income on transport fuels. Similarly, the inequity in phasing out fossil-fuel-based heating fuels was compensated for by measures that provided temporary aid for moving to lower-emission alternatives. In other words, some of the revenue from the carbon tax was redistributed through welfare programmes.

The Swedish example is confirmed by other studies that found that a country’s underlying distribution of income will influence the equity of a carbon tax. The more equal the income among citizens, the more likely it is that the carbon tax will not have a disproportionately negative effect on low-income citizens. 

In Italy, a carbon tax on transportation fuels was found to have a progressive impact even in the absence of revenue redistribution. A survey focusing mostly on northern European countries (Norway, Sweden, Finland, UK and Ireland) found that a carbon tax can be progressive if the tax revenues are redistributed. US studies concurred that a carbon tax can have a neutral or progressive effect, depending on how the tax revenue is redistributed.

Conclusion 

A slow and considered increase in carbon pricing, taxing different energy products at different levels, and redistributing carbon tax revenues can eliminate distributional effects and enhance economic efficiency. 

If there is a regressive impact, there are ample opportunities in advanced economies for adjusting tax and benefit schedules to alter the overall impact on lower-income households. 

An important note on assessing the equity of carbon taxes

Determining whether a particular carbon tax is progressive or regressive is no simple task. There are plenty of academic analyses of the impact of a carbon tax at an income, sector, regional and country level. But the parameters and assumptions in the research must be examined closely. For example, studies on North-American data on car fuel taxation will not transfer to Europe, as the geography of urban areas, the distribution of income, the relative importance of public transportation and the prevailing levels of fuel taxes are completely different. A UK study found that simple assumptions such as considering all households or just car-owning households when assessing the impact of a fuel tax will change the distributional outcome completely.

When trying to understand the equity implications of imposing a carbon tax, the key things to look out for in the available literature should include:

  • The level of income equality of the country studied
  • The measure of welfare
  • The wider context in which consumers buy energy and carbon-intensive products (eg available alternatives, energy price regulations)
  • The scope of the households considered (ie all vs car-holding households)
  • Any consideration of the financial benefit of abating climate change or pollution on equity
  • The way the tax revenues are redistributed and whether this redistribution aims to correct any for undesirable distributional outcomes.

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