As the European Union enters a critical phase in the implementation of its Carbon Border Adjustment Mechanism (CBAM), attention is increasingly shifting from the design of the system to its practical implications. While political scrutiny of the EU’s flagship carbon market, the EU Emissions Trading System (EU ETS), has intensified ahead of its scheduled review this summer, CBAM has now moved into its definitive phase, marking a significant milestone in the EU’s climate and trade agenda.
For policymakers, businesses and development partners alike, the focus is no longer on whether CBAM will be implemented, but on how its rules will affect global trade flows, industrial competitiveness and developing-country exporters. Recent proposals by the European Commission (EC) suggest that the mechanism is likely to become both broader in scope and more complex in its operation.
What is CBAM?
CBAM is designed to ensure a level playing field between EU producers subject to the EU ETS and foreign manufacturers exporting to the EU. It does so by applying an equivalent carbon price to imports, while allowing deductions where a carbon price has already been effectively paid during production in the country of origin.
During the transitional phase (October 2023–December 2025), EU importers were required to report the embedded emissions of covered goods. The definitive phase began on 1 January 2026. Under the Commission’s latest simplification proposal, the first annual CBAM declaration and surrender of certificates would take place in 2027. Certificate prices are linked to the weekly average auction price of EU ETS allowances (EUAs).
Downstream expansion
CBAM currently covers several carbon-intensive sectors, including iron and steel, aluminium, fertilisers, cement, hydrogen and electricity. In its initial form, the mechanism primarily applies to basic materials and certain semi-finished products, such as iron and steel ingots.
Building on lessons learned during the transitional phase and growing concerns about downstream carbon leakage, the EC has proposed extending CBAM to approximately 180 steel- and aluminium-intensive downstream products from 1 January 2028. Potentially affected products include, among others, automotive components, industrial machinery, household appliances, selected electrical goods and certain furniture items.
According to the International Institute for Sustainable Development (IISD), expanding CBAM to downstream products would increase the share of EU imports covered by the mechanism from 4.7% to approximately 7.2%. China would face the greatest exposure, with an estimated €18 billion in additional downstream exports to the EU falling within scope annually — equivalent to approximately €49 million in trade every day.
For developing countries, however, the implications extend beyond trade volumes. Expanding CBAM further down the value chain would require producers to trace emissions embedded in a wider range of products and intermediate inputs, often across highly complex international supply chains. Establishing the necessary monitoring, reporting and verification (MRV) systems may prove particularly challenging for small and medium-sized enterprises (SMEs) with limited technical capacity and financial resources. Industry groups representing India’s steel micro-, small- and medium-sized enterprises (MSMEs), for example, have already highlighted concerns regarding the administrative burden associated with CBAM compliance.
Looking further ahead, should CBAM eventually be extended to all sectors covered by the EU ETS, additional industries such as chemicals, polymers and plastics, refining and petroleum products, glass, ceramics and pulp and paper could also fall within scope.
Figure 1 illustrates the share of EU CBAM-covered imports by country of origin under the current CBAM scope (upper) and under Scenario 2 (lower). Scenario 2 assumes full alignment between CBAM and the sectors covered by the EU ETS, meaning that CBAM would be extended beyond its current product coverage to include all sectors subject to carbon-pricing under the ETS. This expansion would significantly increase the value and composition of imports covered by the mechanism, thereby altering the relative exposure of trading partners.
Figure 1. Share of EU CBAM-covered imports by origin under the current CBAM scope (upper) and under full alignment with the EU ETS (lower)
Source: IISD
Draft implementing act: recognising carbon prices paid abroad
On 13 May 2026, the EC published a draft implementing act — open for public consultation until 10 June 2026 — establishing how carbon prices paid outside the EU may be recognised under CBAM. The rules would apply retrospectively from 1 January 2026.
The proposal establishes a framework for recognising carbon costs arising from foreign carbon-pricing instruments, including ETSs, carbon taxes and fuel levies. It goes considerably further than simply demonstrating participation in an ETS or payment of a carbon tax, as it introduces detailed rules governing the attribution of carbon prices to specific production processes, the treatment of free allowances and rebates, the use of carbon credits, precursor emissions calculations, exchange-rate methodologies, documentation requirements and third-party verification. The objective is to ensure that only carbon costs genuinely incurred by producers are recognised under CBAM, while limiting opportunities for double-counting and circumvention.
The implications of the proposal can be illustrated with a simple example. Consider a steel producer operating under a domestic emissions trading system with a carbon price of €20/tCO₂ and a compliance obligation of 1,000 tonnes of emissions. If the producer purchases and surrenders allowances or eligible compliance credits to meet this obligation, it incurs a carbon cost of €20,000, which could be recognised under CBAM and deducted from its CBAM liability, subject to the applicable rules and verification requirements.
By contrast, if the producer receives free allowances covering its entire compliance obligation, it incurs no actual carbon cost under the domestic system. Even if it subsequently spends €200,000 on voluntary carbon credits to support corporate climate commitments, these expenditures would not qualify for recognition under CBAM.
The draft implementing act is also likely to increase reporting and verification requirements for importers and their suppliers, who may need to provide significantly more granular emissions, pricing and accounting data than previously anticipated.
For developing countries, the implications could be substantial. Exporters operating under emerging carbon-pricing systems may face additional administrative and verification requirements in order to demonstrate that a carbon price has been effectively paid and can therefore be deducted from CBAM obligations. These requirements may prove challenging for smaller firms and for countries where carbon-pricing systems and emissions-reporting frameworks are still under development.
The proposal also establishes separate methodologies for recognising foreign carbon prices, based either on actual carbon costs incurred or on Commission-determined default values. Claims based on actual carbon prices would need to be supported by detailed documentation demonstrating that the carbon cost was effectively incurred and paid.
A fragmented global carbon-pricing landscape
According to World Bank data, around 80 carbon-pricing instruments—including emissions trading systems and carbon taxes—are currently in operation worldwide. However, these mechanisms vary significantly in terms of carbon prices, sectoral coverage and emissions-reporting requirements. Many also incorporate free allowance allocations, tax exemptions, rebates or other forms of compensation that reduce the effective carbon cost borne by producers.
Because CBAM is designed to recognise only the effective carbon price actually paid, exporters will need to demonstrate not merely the existence of a carbon-pricing mechanism but also the net carbon cost incurred after exemptions and compensation measures have been taken into account. In practice, this may limit the extent to which CBAM liabilities can be reduced through recognition of foreign carbon prices.
For exporters located in jurisdictions without explicit carbon-pricing mechanisms, opportunities to reduce CBAM liabilities through recognition of carbon costs may remain limited, regardless of their actual emissions performance.
The role of carbon credits
A differentiated approach is proposed for carbon credits. Where a mandatory carbon-pricing regime allows the use of domestic credits, the associated costs may be recognised as part of the effective carbon price for CBAM purposes. However, the recognition of international Article 6 credits—including internationally transferred mitigation outcomes (ITMOs) under the Paris Agreement’s framework — would be limited to 10% of reported emissions. Any use beyond this threshold would not count towards reducing CBAM obligations.
The distinction could have important implications for developing countries. Broader recognition of Article 6.2 credits could stimulate demand for ITMOs and help mobilise additional investment in emissions-reduction activities across developing economies. The proposed limitation suggests that the EC is seeking to balance these potential benefits against concerns over environmental integrity while maintaining consistency with the EU ETS, under which industrial installations cannot use offsets to meet compliance obligations.
Looking ahead
The global carbon-pricing landscape is expected to continue evolving as more countries introduce or expand emissions trading systems and carbon taxes, strengthening carbon price signals across their economies. While carbon prices are expected to increase in many jurisdictions over time, significant differences in design, coverage and price levels will remain. At the same time, the recognition of carbon credits is expected to remain subject to close scrutiny.
From a development cooperation perspective, the draft implementing act presents a challenge not only of compliance but also of capacity. Many developing countries are still in the process of establishing carbon-pricing instruments, emissions-accounting systems and verification frameworks. As CBAM expands and its rules become more sophisticated, exporters’ ability to demonstrate compliance may increasingly depend on access to technical assistance, institutional support and investment in emissions-monitoring and reporting infrastructure.
Addressing these capacity gaps could become an important area for international cooperation. Support for carbon accounting, MRV systems, industrial decarbonisation and regulatory capacity-building could help developing-country exporters maintain access to EU markets while advancing domestic climate objectives.
