Carbon border adjustment mechanisms: a tool for global decarbonisation

Our carbon footprint isn’t confined by borders. Picture this: a sleek new smartphone, purchased in London. It contains components sourced from across the globe – rare earth metals mined in the Congo, chips fabricated in Taiwan, and a battery assembled in China. Each step in its creation leaves a trail of carbon emissions that stretches around the world. This smartphone illustrates the complex reality of carbon accounting in a globalised economy. Will a new tool called the carbon border adjustment mechanism (CBAM) finally hold businesses accountable for the true carbon cost of what we consume?

Before we start, let's break down the key terms in carbon accounting:

• Territorial emissions: this takes into account greenhouse gas emissions released within a country’s physical borders and includes exports but omit imports.
• Embodied emissions: also known as embedded carbon emissions, refers to the emissions generated throughout the production of goods from raw material extraction to manufacturing and delivery to the end consumer. This includes transportation emissions throughout the value chain.
• Consumption emissions: this assigns embodied emissions to the place where a product is ultimately consumed. In developed nations, consumption-based emissions are often higher than territorial emissions.

The UK, with its strict environmental regulations, might take pride in the fact it is steadily reducing its territorial emissions, but this apparent progress can be deceptive. As manufacturing shifts to countries with weaker regulations, the overall global carbon emissions may not improve. The UK essentially offshores its pollution, and it is not alone in doing so.

The consequence is that the world is playing a dangerous game of carbon hot potato. Production, driven by consumer demand, simply shifts across borders to find the path of least environmental resistance. This is called "carbon leakage," and it's a major loophole in efforts to combat climate change.

Many countries serve as manufacturing hubs for goods consumed worldwide. Factories in these nations churn out huge volumes of goods, including electronics, clothing, and other carbon-intensive products, that are exported around the world. The emissions from production get counted in the exporting country, even though the demand driving that output comes from consumers elsewhere.

This is where a policy tool like a CBAM comes in. A CBAM is a "carbon tariff" on goods imported from countries with less stringent environmental standards. Generally, the importer of goods will pay the CBAM price.

A CBAM aims to:

• Protect domestic industries by preventing UK businesses (subject to emissions trading schemes) from being undercut by cheaper imports from countries without similar environmental regulations.
• Incentivise global action by encouraging other countries to adopt their own carbon pricing mechanisms. If exporting to CBAM-implementing countries becomes costly due to a product's carbon footprint, nations are more likely to adopt cleaner production methods, or at least face economic consequences for inaction.

While the exact design of a CBAM will vary between the countries implementing it, there are some general principles.

Governments identify carbon-intensive sectors like steel, cement, electricity, and fertiliser that the CBAM should apply to. This will usually align with existing carbon tariffs in that country such as the UK’s emissions trading scheme. Additional products can be included over time.

Importers submit details about the origin, quantity, and embedded emissions of imported goods covered by the CBAM. These emissions might be calculated using a default value provided by the government or based on the actual emissions of the product.

The importer pays any CBAM levy, which is designed to remove the discrepancy between the carbon price within the CBAM country (e.g., the UK) and any carbon taxes already paid in the country of origin on those goods. In this way, the CBAM levels the playing field for domestic producers subject to carbon pricing.

The European Union is leading the way with its CBAM, with a reporting phase in effect since October 2023 and full enforcement expected in 2026. While other countries will likely adopt broadly similar CBAM frameworks, their models may vary based on specific economic needs and trade relationships.

The UK also plans to implement a CBAM, with a proposed date of 1 January 2027, and is currently consulting on its design. The UK is expected to largely align its approach with the EU model initially, though some differences have already emerged, and the two systems may diverge over time.

As an early adopter alongside the EU, the UK has the opportunity to help shape global standards and practices around CBAMs. British businesses exporting carbon-intensive goods like steel, cement, and chemicals should recognise the risk their goods will be subject to CBAM levies in other countries.

CBAMs aren't without challenges: administrative burdens, WTO compliance, and ensuring they don't disproportionately impact developing countries are all valid concerns. There are also concerns around potential trade tensions and retaliation from nations subject to CBAM fees.

However, CBAMs offer a promising tool to incentivise global decarbonisation and create a level playing field for industries facing carbon costs. They could drive investment in green technologies, renewable energy, and more sustainable practices throughout international supply chains.

Ultimately, the success of CBAMs hinges on widespread adoption and harmonisation of standards. If major economies like the US, China, and India implement similar measures, the impact could be transformative. However, even if they don’t introduce their own CBAMs, the introduction of CBAMs in major customers of those countries, such as the EU, might have an impact on how they manufacture their exports. Coupled with growing consumer awareness of carbon footprints, CBAMs could pave the way for a more sustainable and environmentally responsible global economy.

ICAEW members will have a crucial role to play in the implementation of, and ongoing compliance with, CBAMs. They possess essential skills and expertise to support businesses as they navigate the complexities of this new landscape.

• ICAEW members are well-positioned to advise companies on measuring and reporting emissions embedded within their supply chains. Understanding different methodologies and calculation standards will be crucial for accurate CBAM declarations.
• As CBAMs rely on emissions data, ICAEW members' rigorous auditing and verification skills will be vital to ensure accurate reporting, prevent miscalculations, and minimise the risk of non-compliance.
• ICAEW members can provide strategic guidance on identifying and mitigating risks arising from CBAMs. This could include evaluating the financial impact on the business, suggesting supply chain adjustments, and developing decarbonisation plans to reduce future CBAM liability and boost competitiveness.

ICAEW has the potential to shape CBAM policy development, but we will need members’ insights and expertise to ensure the creation of a practical and effective CBAM system. Please ensure you engage with us on our response to the UK’s consultation.

• ICAEW Webinar: The EU Carbon Border Adjustment Mechanism - what does it mean for UK businesses?