EU ETS review: Key proposed changes to the bloc's carbon market

On 17 July 2026, the European Commission proposed a revision of the EU Emissions Trading System (EU ETS) (the Proposal) for Phases 5 and 6 of the EU ETS post-2030. The Proposal forms part of a broader package of measures under the EU Clean Industrial Deal aimed at strengthening the EU's competitiveness, and accelerating industrial decarbonisation, with further legislative proposals expected in the coming months. The Proposal itself aims to align the system with the EU’s 2040 climate target, incentivise investment in decarbonisation efforts to reduce dependencies and increase industrial competitiveness, and stabilise the carbon price.

The Proposal remains subject to negotiation by the European Parliament and the Council.

For businesses exposed to EU ETS compliance obligations, and for those financing energy transition and industrial decarbonisation projects across the EU, the Proposal could materially affect carbon price expectations. It could also create opportunities for developers of qualifying projects, and for developers of carbon removal projects.

Key elements of the Proposal include:

• a revised cap trajectory to slow annual decline in EU ETS allowance (EUA) issuances from 2031 to 2040;
• the establishment of the Industrial Decarbonisation Bank (IDB) to provide EUR 100 billion to industrial decarbonisation projects;
• the extension of free allocation (subject to certain conditions) for sectors outside the EU Carbon Border Adjustment Mechanism (EU CBAM) post 2031;
• the proposed purchase of 260 million high-quality international credits from 2036;
• the incorporation of 250 million tons of domestic permanent carbon removals;
• the inclusion of municipal waste incineration in the scope of the EU ETS from 2031; and
• extensions to the Innovation Fund and Modernisation Fund.

A revised emissions cap trajectory post-2030

The Commission proposes to revise the rate at which the EU ETS cap declines after 2030. The current Linear Reduction Factor (LRF) is 4.3%, rising to 4.4% from 2028 to 2030. According to the Commission, maintaining that rate after 2030 would reduce the cap to zero around 2040 and would go beyond the trajectory required in order to meet the EU’s 2040 climate target.

The Proposal would instead introduce an LRF of 3.7% from 2031 to 2035, and 1.7% from 2036 to 2040.

Allowances would therefore continue to be issued during the 2040s. The Commission intends to maintain a strong carbon price while providing covered sectors with a more gradual transition (thereby easing cost pressures currently faced by operators).

Increased use of ETS revenues for industrial investment

The Commission considers the EU ETS a key financing mechanism for the green transition. A central element of the Proposal is therefore the creation of additional support for industrial decarbonisation through a new IDB, with an indicated funding envelope of approximately €100 billion. The IDB would support the deployment of decarbonisation technologies in energy-intensive sectors through two phases:

• 2028 to 2030: Allowances would be provided on a ‘first come, first served basis’, with payments linked to independently verified emissions avoidances. It is expected to provide around €30 billion of support, financed through 400 million EUAs. A portion of the resources in this phase is ring-fenced for lower-income Member States.
• 2031 onwards: A competitive bidding process, with Carbon Contracts for Difference or carbon premia awarded to successful bidders.

The Proposal would also require Member States to direct 50% of their national ETS revenues towards investments that decarbonise ETS sectors.

The existing Innovation Fund would continue to support innovative and first-of-a-kind low-carbon technologies, while the Modernisation Fund would continue to assist lower-income Member States in modernising energy systems and industrial infrastructure.

Free allocation would continue, subject to investment conditions

The Proposal would retain benchmark-based free allocation beyond 2030. However, continued access to the full allocation would become dependent on investment in decarbonisation within the EU, as the Commission considers that to date, free allocation has not been conducive to driving transformational change.

From 2031, relevant operators would be required to prepare independently-verified Invest in EU Decarbonisation Plans and invest an amount equivalent to the value of their free allocation in qualifying EU decarbonisation projects. Different requirements would apply in respect of projects selected for support under the IDB’s Investment Booster or the Innovation Fund.

This would make free allocation a more conditional form of support:

• 80% of the free allocation for each five-year period would be allocated upon the submission, verification and approval by the competent authority of the investment plan; and
• the remaining 20% would be allocated at the end of the five-year period, subject to the relevant conditions having been met (e.g. decarbonisation investments implemented in the EU, and significant emissions reductions were achieved at the installation during that period).

In addition, under the Proposal, operators would be required to return allowances if they relocate or transfer in-scope activities outside the EU.

For sectors covered by the EU CBAM, the Commission proposes slowing the reduction of free allocation and extending its phase-out until 2038. Although CBAM is intended to replace fee allocation by subjecting imports to an equivalent carbon cost, industry has argued that a more gradual transition is needed.

By contrast, EU ETS sectors that remain outside the scope of CBAM would continue to rely on the existing carbon leakage framework, under which eligible sectors receive benchmark-based free allocation to mitigate the risk of production relocating outside the EU because of carbon pricing.

A separate benchmarks proposal is expected to provide approximately €6 billion in additional free allocation between 2026 and 2030.

Integration of permanent carbon removals

The Commission proposes to integrate up to 250 million tonnes of eligible permanent domestic carbon removals into the EU ETS, and the EU ETS cap would be increased by a corresponding number of EUAs.

Only permanent removals (BioCCS and DACCS) certified under the EU Carbon Removal Certification Framework would qualify (for more on this framework, see our post here), and they would remain subject to monitoring, reporting, verification and liability requirements.

The Proposal also anticipates the inclusion of removals to carbon storage sites in third countries from 2031, if such third countries have an ETS linked to the EU ETS. This could pose an opportunity for UK CCS developers if the UK ETS and EU ETS are linked. An announcement is expected on this in September.

The Proposal is intended to create demand for permanent removals and provide a degree of flexibility for sectors with residual emissions that are difficult to eliminate. The detailed rules on eligibility, liability and reversal risk will be important for developers of removals projects and operators of assets with hard-to-abate emissions.

International credits

From 2036, the Proposal would also allow the purchase of high-integrity international credits to contribute up to 5% of the EU’s target of reducing net emissions by 90% by 2040 compared to 1990 levels. The LRF from 2036 takes such credits into account. Should high-quality international credits not be available, the LRF will revert to 2.7% (rather than 1.7%)

This would not amount to an unrestricted return to the previous international offset model.

Reduced intake into the Market Stability Reserve

The Commission also proposes adjustments to the MSR (which absorbs or releases a proportion of allowances depending on the total number of EUAs in circulation) to reflect the expected reduction in the size of the ETS market after 2030: the annual intake rate would fall from 24% to 12%, allowing more allowances to remain in circulation.

The proposed changes are intended to maintain liquidity and reduce excessive price volatility, while preserving the carbon-price signal to incentivize investment in decarbonisation.

Sector-specific changes

Aviation

For aviation, the Commission proposes extending ETS coverage – from 2029 – to certain flights departing from the EEA to third-country destinations within 5,000 kilometres, while continuing to implement CORSIA and introducing measures intended to avoid double carbon pricing.

Maritime

For maritime transport, the ETS would be extended to certain vessels between 400 and 5,000 gross tonnage. The Proposal also includes measures intended to address evasion risks and improve coordination with any future global carbon-pricing mechanism adopted by the International Maritime Organization.

Municipal waste

The Commission proposes to include municipal waste incineration in the EU ETS via a phased approach between 2031 and 2034:

• 25% of verified emissions in 2031;
• 50% in 2032;
• 75% in 2033; and
• 100% from 2034.

Limited national opt-outs would be available until 2035 where specified conditions are met.

Implications and next steps

The Proposal will now be considered by the European Parliament and the Council under the ordinary legislative procedure, and changes are likely during that process. If adopted a number of key elements of the revised framework – including the detailed design of the IDB, the new conditions for free allocation, eligibility criteria and the treatment of removals and international credits – will require further implementing measures and secondary legislation before they become fully operational. Companies potentially affected should therefore monitor both the legislative negotiations and the subsequent implementation process and assess at an early stage whether the proposed framework could require changes to existing compliance, investment or financing strategies.