The European Commission on July 17 tabled a proposal to overhaul the EU Emissions Trading System, the bloc’s flagship carbon market and the central pillar of its climate policy, setting the legal framework for the next phase of the programme covering 2031 to 2040. The proposal is designed to align the trading system with the EU’s target of a 90 percent net reduction in greenhouse gas emissions by 2040, compared with 1990 levels.
At the heart of the review is a recalibration of the Linear Reduction Factor, the rate at which the overall cap on emissions allowances shrinks each year. The Commission has proposed lowering that factor to 3.7 percent for 2031 to 2035 and to 1.7 percent from 2036 onward, down from the current 4.3 percent. Analysts who reviewed the proposal noted that the change would push back the point at which the cap effectively reaches zero, the so-called “ETS Endgame,” from around 2039 under current rules to roughly 2048, giving industry a longer runway to adapt even as the pace of reductions increases in the near term.
The reform package also proposes expanding the system’s coverage, including bringing municipal waste incineration gradually under carbon pricing, and introducing a new financing mechanism to support industrial decarbonisation. That mechanism, described as a 100 billion euro Industrial Decarbonisation Bank, would launch its first phase in 2028 through an “Investment Booster” of 400 million allowances, equivalent to roughly 30 billion euros in support for decarbonisation projects across European industry.
On free allocation, the proposal sets out a more conditional system from 2031 onward: 80 percent of free allowances would go to companies that have submitted credible investment plans for decarbonisation, while the remaining 20 percent would only be released to companies that can demonstrate they actually followed through on those plans and achieved the emissions cuts they had outlined.
The review also touches the Carbon Border Adjustment Mechanism, the EU’s tool for taxing the carbon content of imported goods to prevent European industry from being undercut by producers in countries with weaker climate rules. The Commission proposed slowing the phase-out of free ETS allowances for CBAM-covered sectors and extending it to 2038, with 15 percent of previously phased-out free allocation reintroduced starting in 2028, a move officials said was intended to manage lingering carbon leakage risk while the border mechanism matures.
Commission officials framed the changes as a response to updated scientific advice indicating that steeper emissions cuts are required this decade to keep the bloc’s 2040 target within reach, while also acknowledging industry concerns that an overly aggressive tightening of the cap could accelerate the relocation of manufacturing outside Europe.
The proposal is a legislative starting point rather than a final rule. It now goes to the European Parliament and the Council of the EU for negotiation, with political agreement targeted by the first quarter of 2027 and implementation expected from 2028. Analysts expect intense debate to begin in earnest from September 2026, as industry groups, environmental organisations and member states stake out positions on the cap trajectory, the new decarbonisation bank and the CBAM timeline.
Sources: International Carbon Action Partnership, Carbon Brief, ERCST
Author: Pulse Of Nations Wire Desk
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