CBAM and the global climate race – is Europe setting the new standard?

One of the EU’s efforts to address the climate crisis is the Carbon Border Adjustment Mechanism (CBAM) introduced in 2023. The system’s goal is to level the cost of goods from carbon-intensive industries that are produced both inside and outside the EU customs area.

CBAM is a trade measure implementing the well known emission trading scheme to global trade of goods. Consider a steel company doing business in the EU. Environmental regulations are becoming increasingly strict for this company. It has to use the EU Emissions Trading System to buy allowances for each tonne of carbon dioxide it emits. These expenses are high and rising.

Now consider a rival steel producer in a nation with different climate regulations. This foreign producer can manufacture steel more cheaply because they don’t face carbon costs. When both companies try to sell their products in the EU market, the foreign producer has an unfair advantage despite being more polluting.

Economists refer to this situation as ‘carbon leakage’. The phrase refers to a situation in which highly emissive industries migrate to other regions as a result of stringent environmental regulations in one area. Businesses may decide to move their operations to areas with less stringent environmental laws, or consumers may decide to buy less expensive imports from polluting countries. The logic behind the EU’s climate action is undermined by carbon leakage. The process rewards businesses that don’t invest in clean technology while penalising those that do. Voters’ perception of jobs shifting abroad makes it more difficult to sustain domestic political support for climate policies. Above all, it falls short of the ultimate objective of lowering greenhouse gas emissions worldwide.

So far, the EU decided to provide free allotment of EU ETS allowances to mitigate the adverse effects of carbon leakage. This, however, is contrary to the EU Polluter-Pays-Principle, a foundation of the modern European environmental policies. As a result, the EU decided to shift from free allotment of emission allowances to CBAM.

The core idea behind CBAM is that universal carbon pricing is the most effective. A competitive disadvantage puts producers under pressure to relocate production or weaken climate policies if only a subset of producers is subject to carbon costs. However, the dynamics of competition completely shift if the carbon costs for all producers serving a large market are the same. Clean production turns into a real edge over competitors.

CBAM is a trade measure which aims to tackle this problem by ensuring that imported goods bear a carbon cost comparable to what EU producers face. In essence, the mechanism creates what the EU refers to as a ‘level playing field’ by extending Europe’s carbon pricing system (EU ETS) to imports. Similar to the EU manufacturer, a foreign steel manufacturer who wishes to sell in the EU market must account for the carbon emissions that are present in their product.

The architecture behind CBAM
A highly complex regulatory framework governs how CBAM functions. We must go over a few essential elements in order to comprehend this architecture.

Fundamentally, CBAM serves as an import carbon pricing mechanism that is a replica of the EU Emissions Trading System. European producers are required to buy emissions allowances under the EU ETS. Importers will soon have to buy certificates for the emissions contained in the goods they bring into the EU under CBAM. These CBAM certificates’ price is directly correlated with the rolling weekly average of the EU ETS allowance price. In theory, this linkage should enable CBAM to satisfy the WTO’s requirements for trade restrictions since it guarantees that the carbon cost of imports is equal to the carbon cost of domestic production.

The mechanism is applicable to certain industries with significant emissions and the highest risk of carbon leakage. Cement, iron and steel, aluminium, fertilisers, hydrogen, and electricity are all included in the first scope.

The EU soon discovered that certain parts of CBAM were adding needless complexity, especially for small businesses, after the transitional period started. The ‘Omnibus simplification package’, which was unveiled in February 2025 and approved in October of the same year, brought about a number of changes to expedite the CBAM definitive regime.

The biggest modification is a mass-based exemption that takes the place of the per-consignment value threshold. Importers who bring in less than 50 tonnes of CBAM-covered goods annually are fully exempt from the mechanism under the new regulations. This seemingly straightforward modification has significant ramifications. The new threshold will cover roughly 99% of total emissions while exempting over 180,000 small importers from CBAM requirements, according to data from the European Commission.

International reactions to CBAM
The rise of CBAM has had an impact on international trade and climate diplomacy, with reactions ranging from imitation to resistance.

Major emerging economies, especially China and India, have been the most vocal in their criticism. These countries are some of the biggest exporters of goods that are covered by CBAM to the EU, so their economies will be greatly affected. Chinese officials have called CBAM a form of trade protectionism that is pretending to be climate policy[1]. They say it unfairly punishes developing countries that have only recently become industrialised and used carbon-heavy processes. Indian leaders have said they will fight CBAM at the World Trade Organization because they say it goes against the ideas of non-discrimination and common but differentiated responsibilities in climate action.

The EU says CBAM works within WTO rules, treating every country the same. No matter where goods come from, they’re covered – foreign businesses aren’t hit harder than local ones, just held to similar carbon fees. Officials stress that if another nation already puts a price on emissions, those costs can count under CBAM. That way, places acting on climate don’t end up penalised twice.

Even though there’s tension, CBAM is pushing others to follow. The UK said it’ll roll out a similar setup by 2027[2], hitting many of the same industries under similar terms. Their model might allow joint acceptance with the EU’s if both carbon markets connect, which could expand the overall reach across Europe.

A variety of proposals for carbon border adjustments have been put forward in the US, though none to date has been enacted into law[3]. Discussion in Congress has considered how such a mechanism would fit with the US system of state and federal regulations. Canada has also expressed interest, not least as it ramps up its own carbon pricing policies[4]. The prospect of a transatlantic carbon border adjustment regime opens some fascinating possibilities for establishing a large zone of harmonised carbon pricing.

If CBAM-like policies proliferate globally, the effects could be far-reaching. If all major economies adopt similar mechanisms, there will be powerful incentives for universal carbon pricing. It is also possible that a new multilateral carbon-pricing treaty could be negotiated as early as in the next decade. It would certainly become increasingly difficult for producers to avoid carbon costs by shifting production to unregulated jurisdictions. This might accelerate the global energy transition but also runs the risk of fragmenting international trade where countries implement incompatible systems.

Conclusion
CBAM is a far-reaching climate policy experiment that seeks to square environmental ambition with economic realism in an open, interdependent world economy. It embodies the principle that trade policy and climate policy must be integrated if either is to be effective.

Its success will be multidimensional: legal resilience in the face of international challenges, practical implementability for businesses of different sizes, the economic impact on EU importers and foreign exporters, and actual effectiveness in preventing carbon leakage and encouraging global decarbonisation. Early evidence is mixed, with administrative challenges and international tensions weighed against signs of emerging compliance systems and even climate policy emulation.

One thing is for sure – CBAM has already altered the climate-trade narrative. It proves that large economies will utilise trade measures for the attainment of environmental objectives, even at the risk of friction in diplomacy. It shows that carbon leakage concerns, which have long constrained climate policy ambition, can potentially be addressed through mechanisms other than free allowances or regulatory forbearance.

Whether CBAM becomes the template for a new era of climate-trade policy or proves a cautionary tale about overreach remains to be seen. Its emergence, however, does mark a real point of inflection in how the world thinks about the relationship between trade, competition, and climate action. Europe has placed a consequential bet that carbon borders can work, and the rest of the world is watching to see how this experiment unfolds.

[1] https://www.scmp.com/economy/china-economy/article/3227326/eus-trade-focused-climate-policy-seen-new-tariff-barrier-china-economic-circles [17-11-2025].

[2] https://www.gov.uk/government/publications/factsheet-carbon-border-adjustment-mechanism-cbam/factsheet-carbon-border-adjustment-mechanism [17-11-2025].

[3] https://www.congress.gov/bill/119th-congress/senate-bill/1325/text [17-11-2025].

[4] https://www.canada.ca/en/department-finance/programs/consultations/2021/border-carbon-adjustments/exploring-border-carbon-adjustments-canada.html [17-11-2025].