With the European Union’s CBAM set to take full effect by 2026, companies must urgently adapt their supply chains, contracts, and data reporting processes to mitigate financial and legal risks while promoting sustainability
The European Union’s Carbon Border Adjustment Mechanism (CBAM) — with its first reporting deadlines due earlier this year — represents a major step forward in the region’s bold climate change initiatives. CBAM is intended to work alongside the current EU Emissions Trading System (EU ETS), fostering fair competition between EU and non-EU manufacturers by imposing a cost on specific greenhouse gases (GHG) that are released during the production of certain imported goods.
This groundbreaking strategy seeks to counteract the scenario in which businesses move their operations to regions with more lenient carbon pricing regulations.
Initially, the CBAM covers imports of specific products such as cement, iron, steel, aluminum, fertilizers, electricity, and hydrogen. In particular, iron and steel are very energy- and carbon-intensive commodities, accounting for nearly 6% of the EU’s total emissions. They are among the first sectors covered by the CBAM, corresponding to about 4% of the EU’s total imports by value. The EU plans to assess and potentially expand the coverage of the CBAM by 2030, aiming to encompass more than half of the emissions in EU ETS sectors by the full phase-in of CBAM in 10 years.
As the CBAM is implemented, carbon emissions will emerge as a new and significant expense in global trade. The financial impact will be substantial, as the CBAM’s pricing structure will align directly with the allowance rates set by the EU ETS.
On a wider scale, a study conducted by the International Emissions Trading Association (IETA) showed that several nations are in the process of creating their own systems, while others are taking a stance against such measures. How quickly and to what degree these new systems come into force may also depend on the outcome of numerous national elections across the globe.
Guidance for companies and their suppliers
While CBAM’s financial impact isn’t expected to be fully felt until 2026, immediate preparation is crucial. Companies should take the following steps to mitigate potential legal and financial exposure in the future.
1. Determine the scope of impact and map your suppliers
Compliance and corporate functions should collaborate — along with other internal functions, such as tax, operations, finance, and procurement — to identify in-scope activities and then map out the company’s global supply chain. This effort should focus on EU activities and the in-bound flow of goods to identify their country of origin and volumes. (Some goods may be excluded because of their country or territories of origin.)
To assess and pinpoint affected suppliers, conduct a comprehensive mapping of your company’s supply chain to identify suppliers of CBAM goods, analyzing every stage from raw material sourcing to end-product distribution. Check your product records (along with your HS codes) against the regulation as a good starting point to identify those goods and suppliers within its scope.
Also, it’s important to understand what the default values are for your products. This will be important information to know when reviewing the potential cost impact, especially if you should need to use default values because the actual values are not known.
As this is an EU regulation, it is likely that foreign suppliers will not be familiar with CBAM and will need further training on how to capture, calculate, and report the required data to EU importers. Initiating communication with impacted suppliers sooner rather than later will be key as it will take time for them to put in place the required processes. Make sure to emphasize suppliers’ adherence to CBAM regulations and their ability to deliver goods with lower carbon intensity as an important part of their value to your company.
2. Amend terms and conditions in supplier contracts
Update the standard contracts for CBAM suppliers to include clauses that mandate the provision of accurate and timely embedded emissions data for CBAM goods. Require collaboration with them on data improvement efforts, clearly define supplier responsibilities for CBAM compliance, specify which party is responsible for carbon certificate costs, and outline the consequences for non-compliance. Additionally, consider adding clauses regarding confidentiality and data storage.
3. Institute processes for reporting
To optimize CBAM reporting, analyze the reporting infrastructure to identify specific areas of duplication and potential synergies that could be found in data collection, management, and analysis. Set up the process to collect and store data on the embedded emissions, including which parties in the supply chain hold this information, who will reach out to suppliers, and who will work with those suppliers that are new to tracking emissions.
As part of this step, set up the reporting process in the EU by determining which internal business function within your organization will be responsible for the compliance requirements of the CBAM and verifying under whose name the goods are imported into the EU to determine the declarant. Using global trade supply chain compliance solutions at this point, may be wise if it is feasible to do so.
4. Partner and codify collaboration cadence
Implementing CBAM will necessitate collaboration across various internal departments, including sustainability, procurement, tax, finance, trade compliance, supply chain operations, and legal. At an early stage, be sure to establish and communicate clear roles, responsibilities, and expectations, particularly regarding data requirements. Additionally, explore possibilities for partnerships with industry experts or specialized carbon-pricing organizations to better facilitate knowledge sharing, exchange best practices, and gain valuable insights.
5. Identify products with lower embedded emissions
Evaluate and analyze your supply chain to find additional sourcing options for products that may contain lower embedded carbon emissions, if necessary. Technology tools can help drive efficiency in this process as well.
6. Exporters to the EU should take steps as well
Exporters should be proactive in identifying any products covered under CBAM for which they will be responsible to report. Additionally, they should review the methodology for calculating emissions and ensure they have a method to collect the necessary data points. It would also be helpful to review the default values for impacted products to understand the possible cost impact to an EU client if you are unable to capture actual emissions data. Finally, make sure there is a process to collect, store, calculate, and share the required data.
Establishing CBAM marks a significant step by the EU towards reducing carbon emissions and promoting fair competition in the global market. Companies must take immediate action to prepare for the implementation of CBAM, including amending supplier contracts and identifying, evaluating, and educating impacted suppliers.
By taking these steps, companies can minimize the financial and legal risks associated with CBAM, while also capitalizing on opportunities to reduce their carbon footprint and promote their own commitment to sustainability.
You can find more information about ESG-related climate change regulation here.
