Overview of EU “Fit for 55”
The European Union (EU) recently enacted five laws in furtherance of its “Fit for 55” legislative package, which aims to ensure that EU policies are in line with EU’s climate targets of reducing net greenhouse gas (GHG) emissions by 55 percent by 2030 and achieving “net zero” emissions by 2050. The European Commission (EC) presented the “Fit for 55” package in July 2021, and it includes more than a dozen legislative proposals that touch upon a broad set of policies, including carbon pricing, energy efficiency, taxation, land use and forestry, transport, and renewables.
Recent Activity
On April 25, 2023, the following five pieces of legislation were adopted as a part of the “Fit for 55” package:1
- a revision of the Emissions Trading System (ETS) Directive;2
- a revision of the ETS Aviation Directive;3
- an amendment of the Monitoring, Reporting, and Verification (MRV) shipping Regulation;4
- the adoption of a Regulation establishing a Social Climate Fund;5 and
- the adoption of a Regulation establishing a Carbon Border Adjustment Mechanism (CBAM). The European Parliament (the Parliament) formally adopted these laws on April 18, 2023.6
The laws were published in the Official Journal of the EU on May 16, 2023.7 While the CBAM Regulation entered into force on May 17, 2023, the remaining legal acts are expected to become effective on June 5, 2023, 20 days after their official publication.
Revision of the Emissions Trading System (ETS) Directive
The EU’s ETS is a market where certain companies in covered industries can trade emissions allowances for GHGs. Each allowance gives the holder the right to emit one ton of carbon dioxide or its equivalent of another covered gas.8 The ETS is an important policy tool that the EU uses to incentivize emissions reductions. Emissions for covered gases are capped on a sectoral basis, and allowances are distributed to companies within each sector via free grants or through an auction. Companies may then buy and sell allowances to meet their emissions needs. Available allowances have decreased, and will continue to decrease, over time.9
The present revision of the ETS Directive is a sweeping reform of the ETS market and contains updates to three key aspects: 1) the decrease in overall emissions caps; 2) the addition of maritime transport emissions to the ETS; and 3) the establishment of a new ETS mainly for buildings, road transport, and additional—mainly small industry—sectors (ETS II).
First, the revision further decreases the ETS emissions caps that will be in place in 2030. Specifically, energy-intensive sectors subject to the ETS—such as electricity and heat generation, or commercial aviation—will need to reduce their GHG emissions by 62 percent by 2030 compared to their 2005 GHG emissions levels.10 Previously, the goal of the ETS was to reduce net emissions by 55 percent.11 Additionally, the grant of free GHG emissions allowances to companies across all sectors will be phased out completely by 2034.12
Second, the revision adds maritime transport emissions to the ETS. Shipping companies must surrender allowances equal to 40 percent of their verified emissions allowances in 2024, 70 percent in 2025, and 100 percent in 2026.13 For 2024 and 2025, the difference between the amounts of verified emissions and allowances surrendered shall be canceled rather than auctioned.14
Third, the EU established ETS II: a new, stand-alone, emissions trading system for sectors that are not currently covered by the ETS, including buildings, road transport, and additional targeted energy, manufacturing, and construction sectors.15 ETS II is being set up to focus on addressing “the particular challenge of reducing the emissions in the buildings and road transport sectors” and to establish a suite of complementary policies necessary to a functioning emissions market, without disturbing the functioning of the ETS.16 ETS II emissions allowances will be set from an emissions baseline measured over 2024, 2025, and 2026.17 Regulated entities in sectors covered by ETS II will be subject to the new trading system beginning in 2027, except that ETS II trading will be postponed until 2028 if prices of oil and gas are “exceptionally high” as the implementation date approaches.18
Revision of the ETS Aviation Directive
The revision to the ETS Aviation Directive introduces a number of changes to the existing regulatory framework.19 First, free emissions allowances in the aviation sector will be phased out by 2026, meaning that all emissions allowances in the aviation sector will then be allocated by auction.20 Second, the EU will also reserve up to 20 million allowances, to be allocated between 2024 and 2030, to incentivize commercial aircraft operators to use sustainable aviation fuels (SAF) and other aviation fuels that are not derived from fossil fuels.21 Third, the reforms clarify that, subject to certain limited exceptions, targets set under the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), established by the International Civil Aviation Organization, apply to flights that depart from or are destined for jurisdictions outside the European Economic Area (EEA) that participate in CORSIA, while the ETS applies to flights that depart from the EEA and arrive in the EEA, the United Kingdom, or Switzerland.22 Finally, the reforms require aircraft operators to annually report on non-carbon dioxide aviation effects beginning after January 1, 2025.23 The EC is obligated to adopt implementing legislation by August 2024, which will set the framework to be used by aircraft operators to satisfy this new reporting obligation.24
Relatedly, on April 26, 2023, the EC announced a political agreement between the EU’s co-legislators on the ReFuelEU Aviation proposal.25 The proposal contemplates mandating that: 1) aviation fuel suppliers use at least 2 percent SAF by 2025, increasing to 70 percent by 2050; 2) aircraft operators refuel with only the fuel necessary for their upcoming flight; and 3) airports ensure that they have the infrastructure for SAF distribution.26
Amendment of the MRV Shipping Regulation
The MRV operates as a monitoring, reporting, and verification system for emissions produced by ships.27 The MRV outlines the scope of these emissions as well as reporting requirements for shipping companies.28 Amendments to the MRV system included several key updates.29 Beginning in 2024, the MRV will regulate methane and nitrous oxide emissions from maritime transport in addition to current regulations on carbon dioxide emissions.30 Additionally, the MRV is expanded to include general cargo ships between 400 and 5,000 gross tonnage beginning in 2025.31 The EC will assess, by December 31, 2024, the experience of including general cargo ships between 400 and 5,000 gross tonnage in the MRV to assess whether they should be included in the ETS or other climate-focused regulatory schemes.32
Following the amendments, companies are required to submit company level aggregate emissions data to the member state whose flag the ship flies or the agency empowered by that state.33 Additionally, beginning in 2025, companies will be required to submit an emissions report for the previous year’s reporting period for each ship for which they are responsible by March 31st of each year.34 Companies will be required to use a standard “monitoring plan” using templates set by the EC.35 By April 1, 2024, companies will also have to submit a monitoring plan which includes methane and nitrous oxide emissions, although companies that are not subject to the MRV until after January 1, 2024, will have three months to submit their monitoring plans after “each ship’s first call in a port under the jurisdiction of a Member State.”36 Ships that are not in compliance with reporting requirements may be denied entry into ports or may be detained in ports until they meet the reporting requirements.37
Regulation Establishing a Social Climate Fund
The Council has established an investment vehicle called the Social Climate Fund (the Fund) to provide economic incentives for the reduction of fossil fuels consumption.38 Since the economic and social cost of reducing GHG emissions is difficult to measure before implementation, the Fund will serve to mitigate such costs by investing in climate transition “energy efficiency measures, as well as renewable energy-based heating systems, such as heating with electric heat pumps, heating and cooling at district level and participation in renewable energy communities” for vulnerable households, micro-enterprises, and transport users.39 The Fund will be financed with revenue generated from the auctioning of more than 200 million emissions allowances, such that a maximum amount of EUR 65 billion will be available for use by the Fund between 2026 and 2032.40
The funds will be dispersed to each Member State according to their respective Social Climate Plans that should promote “the long-term solution of reducing fossil fuels reliance and could envisage other measures, including temporary direct income support, to mitigate adverse effects on income in the shorter term.”41 Ultimately, the Social Climate Plans should pursue two objectives: 1) provide vulnerable populations and micro-enterprises with the resources necessary to carry out decarbonization of heating and cooling; and 2) mitigate the impact of increasing costs of fossil fuels on the most vulnerable, preventing energy and transportation poverty during the transitional period.42
Regulation Establishing a Carbon Border Adjustment Mechanism (CBAM)
The CBAM sets up a carbon border tax, pursuant to which the carbon price of imports will be made equivalent to the carbon price of intra-EU production.43 It seeks to address so-called “carbon leakage,” i.e., a concern that companies based in the EU could move carbon-intensive production abroad to take advantage of lax standards, or EU made products could be replaced by more carbon-intensive imports.44 The CBAM will be phased in gradually, starting with a reporting system45 that applies to goods at high risk of carbon leakage—such as iron and steel, cement, fertilizer, aluminum, and electricity generation—and developing into a system whereby importers would pay a financial penalty to for submitting incomplete CBAM reports.46 By imposing an EU-equivalent carbon price on the imports of covered goods, the EU aims to level the playing field for EU producers and EU importers of carbon-intensive goods and promote decarbonization in the production processes of partner countries.47
EU companies may face higher import prices of covered goods (e.g.,steel) and increased prices of secondary goods that include components of covered goods (e.g., vehicle manufacturers buying parts from another EU manufacturer that contain imported higher-priced steel / aluminum). Also, to sell covered goods to the EU, non-EU companies will have to implement carbon accounting to track the embedded emissions associated with these products (and have these emissions independently verified).48
Going Forward
As noted in the introduction, the “Fit for 55” package encompasses a suite of legislative proposals, some of which are still progressing through the legislative process and are the subject of intense negotiations. These include, among others, new energy-related decarbonization directives, such as the Recast Renewable Energy Directive (RED II),49 which is the legal framework for the development of renewable energy across all sectors of the EU economy, and the revision of the Energy Taxation Directive,50 which aims to align the taxation of energy products with EU energy and climate policies by promoting clean technologies.
The “Fit for 55” legislative package, aimed primarily at helping the EU achieve its climate goals, is itself part of a broader policy initiative called the European Green Deal. Within it are a number of EU sustainability-related measures worth monitoring, including the REPowerEU Plan,51 the recently enacted Corporate Sustainability Reporting Directive (see our previous client alert here), the proposed Corporate Sustainability Due Diligence Directive,52 the proposed rules on Deforestation Regulation,53 and the EC proposal on banning products linked to forced labor.54
As shown by the legislation discussed above, and the suite of legislative and policy items under consideration, the EU continues to develop and expand its climate change and sustainability-related policies in areas that will significantly impact how companies do business, even if they are not located in the EU.
[1] Council of EU, Press Release ‘Fit For 55’: Council adopts key pieces of legislation delivering on 2030 targets, April 25, 2023, https://www.consilium.europa.eu/en/press/press-releases/2023/04/25/fit-for-55-council-adopts-key-pieces-of-legislation-delivering-on-2030-climate-targets/.
[2] Directive (EU) 2023/959 of the European Parliament and of the Council of May 10, 2023, amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union and Decision (EU) 2015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading system, (ETS). Available here.
[3] Directive (EU) 2023/958 of the European Parliament and of the Council of May 10, 2023, amending Directive 2003/87/EC as regards aviation’s contribution to the Union’s economy-wide emission reduction target and the appropriate implementation of a global market-based measure, (ETS Aviation Directive). Available here.
[4] Regulation (EU) 2023/957 of the European Parliament and of the Council of May 10, 2023, amending Regulation (EU) 2015/757 in order to provide for the inclusion of maritime transport activities in the EU Emissions Trading System and for the monitoring, reporting, and verification of emissions of additional greenhouse gases and emissions from additional ship types, (MRV). Available here.
[5] Regulation (EU) 2023/955 of the European Parliament and of the Council of May 10, 2023, establishing a Social Climate Fund and amending Regulation (EU) 2021/1060, (Social Climate Fund). Available here.
[6] Regulation (EU) 2023/956 of the European Parliament and of the Council of May 10, 2023, establishing a carbon border adjustment mechanism, (CBAM). Available here.
[7] See Official Journal of the European Union, L 130, May 16, 2023. Available here.
[8] European Commission, EU Emissions Trading System (EU ETS): Development of EU ETS (2005-2020), https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets/development-eu-ets-2005-2020_en.
[9] See European Commission, Guidance Document no1 on the harmonized free allocation methodology for the EU ETS post 2020. Available here.
[10] See ETS, Recital (39), supra note 2.
[11] European Commission, EU Emissions Trading System (EU ETS): Delivering emissions reductions, https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets_en#:~:text=Under%20the%20European%20Climate%20Law,contribute%20to%20delivering%20this%20target.
[12] European Parliament Press Release, Climate Change: Deal on a more ambitious Emissions Trading System (ETS), December 18, 2022, https://www.europarl.europa.eu/news/en/press-room/20221212IPR64527/climate-change-deal-on-a-more-ambitious-emissions-trading-system-ets.
[13] See ETS, Article 3gb, supra note 2.
[14] Id.
[15] Id. at Recital (75).
[16] Id.
[17] Id. at Article 30c.
[18] Climate Change: Deal on a more ambitious Emissions Trading System (ETS), supra note 12.
[19] See ETS Aviation Directive, supra note 3; see also Reducing Emissions from Aviation, European Commission, https://climate.ec.europa.eu/eu-action/transport-emissions/reducing-emissions-aviation_en (explaining the staggered withdrawal of aviation emissions from the ETS in favor of a global regulatory scheme to offset aviation emissions).
[20] ETS Aviation Directive, Amendment to Article 3d, supra note 3.
[21] Id. at amendment to Article 3c.
[22] Id.
[23] Id. at amendment to Article 14.
[24] Id.
[25] European Commission Press Release, European Green Deal: new law agreed to cut aviation emissions by promoting sustainable aviation fuels, April 26, 2023. Available here.
[26] Id.
[27] See Regulation (EU) 2015/757 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 29 April 2015 on the monitoring, reporting and verification of carbon dioxide emissions from maritime transport, and amending Directive 2009/16/EC, https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32015R0757&from=EL (this text is the MRV regulation prior to the release of the below amendments).
[28] Id.
[29] See MRV, supra note 4.
[30] Id., amendment to Article 2.
[31] Id.
[32] Id. at insertion of Article 22(a).
[33] Id. at amendment to Article 11(a).
[34] Id. at amendment to Article 11, paragraph 1.
[35] Id. at amendment to Article 6 (5).
[36] Id. at amendment to Article 6.
[37] Id. at amendment to Article 20, paragraph 3.
[38] See Social Climate Fund, supra note 5.
[39] Id. at Recital (10).
[40] Id. at Recital (30).
[41] Id. at Recital (17).
[42] Id.
[43] See CBAM Recital (12), supra note 6.
[44] See EC, Carbon Border Adjustment Mechanism: Questions and Answers, July 14, 2021, https://ec.europa.eu/commission/presscorner/detail/en/qanda_21_3661.
[45] See CBAM Article 32, supra note 6.
[46] Id. at Article 35.
[47] Id. at Recitals (9)-(12).
[48] Id. at Article 8.
[49] See European Commission, Reference Regulatory Framework: Renewable Energy – Recast to 2030 (RED II). Available here.
[50] See European Commission, Revision of the Energy Taxation Directive (ETD): Questions and Answers, July 14, 2023. Available here.
[51] See European Commission Press Release, REPowerEU: A plan to rapidly reduce dependence on Russian fossil fuels and fast forward the green transition, May 18, 2022. Available here.
[52] See Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937, February 22, 2022. Available here.
[53] See European Commission Proposal for a Regulation on the making available on the Union market as well as export from the Union of certain commodities and products associated with deforestation and forest degradation and repealing Regulation (EU) No 995/2010, November 17, 2021. Available here. The regulation was recently adopted by the European Parliament. See European Parliament Press Release, Parliament adopts new law to fight global deforestation, April 19, 2023. Available here.
[54] See European Commission Press Release, Commission moves to ban products made with forced labour on the EU market, September 14, 2022. Available here.
