Carbon border adjustment mechanisms – climate and trade policy issues

February 2026 | SPOTLIGHT | GLOBAL TRADE

Financier Worldwide Magazine

February 2026 Issue

Over the past two decades, carbon pricing – through carbon taxes or emissions trading systems – has become a central tool in the global effort to reduce greenhouse gas emissions. Seventy-five carbon taxes and emissions trading systems are currently in place worldwide. Along with carbon pricing, and around the same time, a concept of carbon leakage emerged in academic literature on trade and pollution and in economic analysis of environmental and trade policies. Researchers studied how unilateral climate policies could shift emissions to countries with weaker regulations. To address carbon leakage, a domestic carbon pricing regime was proposed to be augmented by a border adjustment mechanism that imposes a carbon cost on imports to match the domestic carbon price.

In theory, a border adjustment mechanism is intended to level the playing field: imported goods from countries without equivalent carbon constraints should face a carbon levy, making them cost competitive with domestic goods that bear carbon costs. In practice, a border adjustment mechanism is a departure from multilateral approaches to climate governance, which has already created tensions in international trade and is risking industrial and economic distortions and disruptions in global supply chains.

One of the central questions about border adjustment mechanisms is whether they meaningfully reduce global emissions or merely reshape production and trade flows. Several studies have assessed the effectiveness and impact of carbon border adjustment mechanisms (CBAM) on global emissions and international trade. Findings suggest that CBAM’s global environmental impact, while directionally positive, is limited. The gains stem largely from redirecting trade flows to more carbon efficient producers rather than meaningful decarbonisation. With negligible impact on global emissions, CBAM is argued to deliver critical policy spillovers, by creating incentives for exporters to adopt carbon pricing or cleaner technology and turning European carbon tariffs into a driver of global decarbonisation. This article is testing whether the EU CBAM is likely to achieve such policy spillovers and drive proliferation of border adjustment mechanisms.

EU – the first mover

The EU Carbon Border Adjustment Mechanism is the first implementation of a border adjustment mechanism. Adopted in 2023 as part of the EU’s broader decarbonisation agenda, including the strengthening of EU Emissions Trading System (ETS), CBAM’s declared aims are to mitigate carbon leakage, protect European heavy industry competitiveness and foster a global decarbonisation push.

Rolled out gradually, CBAM requires importers of certain carbon-intensive commodities deemed most vulnerable to carbon leakage – iron and steel, cement, aluminium, fertilisers, hydrogen and electricity – to report the embedded emissions of their imports and, starting in 2026, to purchase certificates equal to the embedded carbon emissions — priced equivalently to allowances under the ETS.

In October 2025, amendments to the CBAM were made under the EU’s “Omnibus” simplification package to reduce the regulatory burden on small businesses. The updated regulation introduced a de minimis threshold: importers whose annual imports of CBAM-covered commodities (other than hydrogen and electricity) are below 50 tonnes will be exempt from obligations.

The European Commission is currently preparing further secondary legislation in view of the start of the CBAM definitive phase in 2026. Several key operational elements remain under development, including aspects of the methodology for determining embedded emissions in CBAM-covered goods and the level of the default values to be applied where actual emissions data is unavailable. According to recent informal disclosures, the default values under consideration appear to be set at relatively high levels, which could, depending on the final parameters adopted, increase the risk that CBAM is perceived and experienced in practice as a trade-restrictive measure rather than a purely decarbonisation-driven instrument.

In parallel, a further legislative initiative is expected in the near term to assess a possible extension of CBAM to additional sectors covered by the EU ETS and to selected downstream goods. Any such expansion would raise additional legal and trade-policy considerations, notably in relation to international trade relations and the potential impact on global value chains and internationally active businesses.

UK and Norway – the followers

While the EU is the frontrunner, the UK and Norway are progressing their versions of a carbon tariff. Norway’s Ministry of Climate and Environment official response to the European Commission’s consultation on CBAM positioned Norway firmly in defence of CBAM’s environmental integrity. Norway is integrated into the EU’s single market, is a participant in the EU ETS as a European Economic Area member and plans to introduce its own CBAM from 2027. Norway’s CBAM mirrors the EU regime in order to maintain regulatory alignment. Norway’s CBAM will not impact trade between Norway and the EU but, for outside trade partners, it means the EU’s carbon regime will expand to cover Norway, including the same reporting standards and compliance costs.

The UK government announced, at Budget 2025, it will legislate in Finance Bill 2025-26 to introduce a CBAM from 1 January 2027. The UK will not adopt the EU CBAM wholesale. Key differences in the UK CBAM design include: the scope (UK CBAM covers iron, steel, aluminium, fertiliser and cement, but not electricity), application to both direct and indirect emissions (although indirect emissions will be delayed until 2029 at the earliest), the method of assessment of default emissions values, and the payment method (the UK system will operate as a tax at a rate set by the government to match the effective carbon price paid by domestic producers). The UK still lacks a clear agreement with the EU on how UK exporters should be treated.

That said, it is also relevant to note that the EU and the UK issued a joint political declaration in May 2025 expressing their intention to explore the possible linking of their respective ETSs. This political commitment was followed by the adoption of a formal Council Recommendation authorising the European Commission to open negotiations with the UK on behalf of the EU. If such negotiations were to result in a binding agreement linking the two ETSs, goods originating in the UK and imported into the EU could become exempt from CBAM obligations, with a reciprocal exemption potentially applying to EU-origin goods entering the UK.

Asia Pacific and North America in disarray

Australia does not have a universal carbon tax, but its Safeguard Mechanism places emissions limits on its largest industrial facilities, creating potential carbon leakage. The Australian government launched a Carbon Leakage Review in July 2023 to consider policy options to address carbon leakage, particularly for steel and cement. The review was expected deliver its advice to the government by the end of 2025.

An independent Australian think tank Climate Energy Finance (CEF) is advocating for the harmonisation and integration of carbon pricing mechanisms in Asia Pacific for the steel, aluminium and cement value chains. CEF calls for coordinated, targeted government intervention from key industrial economies across Asia Pacific to correct “the persistent global market failure of unpriced emissions in fossil fuel intensive commodity processing”, arguing that this should take the form of an Asian CBAM and that Australia should take a leading role in its development. Outcomes of the Carbon Leakage Review may indicate whether such initiative is viable.

Canada, having considered a border carbon adjustment in 2021, did not move forward with it. In the April 2024 joint report of the Canada-EU Comprehensive Economic and Trade Agreement Committee on Trade, trade integration with the US, which does not have a national carbon price, and the high export intensity of Canada’s emissions-intensive industries were cited among reasons for Canada to abandon efforts to develop a border carbon adjustment mechanism.

Prospects of the US looking into carbon pricing and a border carbon adjustment mechanism under the current administration are slim. The closest the US came to a carbon tariff is the Foreign Pollution Fee Act first introduced in 2023 and again in the 2025 Congress. Rather than pricing carbon directly, the proposal is a traditional tariff assessed on the value of high-emissions imports. The US National Security Strategy released in November 2025, gives an insight into the Trump administration’s view of the EU’s climate agenda, broader regulatory landscape and its impact on the EU economy. Citing Europe’s significant loss of share of the global GDP since 1990 “partly owing to national and transnational regulations”, the Strategy declares that the US “want Europe…to abandon its failed focus on regulatory suffocation” and reject the “disastrous ‘climate change’ and ‘Net Zero’ ideologies that have so greatly harmed Europe [and] threaten the United States”. It is difficult to foresee any productive dialogue between the US and EU in relation to emission reductions, at least under the current administration.

Against the US’ scathing view of the European economic and regulatory landscape sits the EU’s own recent commitment to buy $750bn worth of US energy products, which casts a shadow on the credibility of the EU in its pursuit of global leadership in climate action.

Russia, China and the global south

While the EU finds little support among its key allies and trading partners, reactions from the rest of the world are even less favourable. Concerns are raised over trade fairness and equity between developed and developing economies. At COP30 in Belém in November 2025, trade emerged as one of the hottest issues, with border carbon adjustments featuring prominently among unilateral trade measures, viewed as disadvantaging developing economies and creating imbalances in decarbonising the global economy.

CBAM-induced trade frictions are triggering retaliation, WTO trade disputes and a risk of fragmentation of global trade standards. Russia was the first country to request consultations with the EU pursuant to the WTO Dispute Settlement Understanding in May 2025. India, China and Brazil have not yet brought claims under the WTO dispute settlement system, but have also been critical of CBAM, expressing concerns that such measures place disproportionate burden on developing countries because of embedded emissions in their export products. India, China and Brazil have each repeatedly submitted to the WTO’s Council for Trade in Goods that CBAM may violate the basic principles of the Common but Differentiated Responsibilities and Respective Capabilities of the United Nations Framework Convention on Climate Change. India has emerged as a prominent critic of the EU’s CBAM, repeatedly expressing its concerns that principles and rules of both international trade law and international environmental law should have been followed in designing CBAM. Brazil also has repeatedly submitted that CBAM is not fully consistent with the EU’s international obligations, disregards the Paris Agreement, and shifts the costs faced by developed nations in meeting their nationally determined contributions onto developing countries. China has also submitted that CBAM may violate the Paris Agreement and the non-discrimination principle of the WTO rules. China has urged the EU to improve the transparency of its CBAM in the implementation process and ensure its WTO consistency.

Indonesia has also repeatedly expressed before the WTO’s Trade in Goods Council that CBAM constitutes a discriminatory policy that violates the General Agreement on Tariffs and Trade’s most favoured nation and national treatment provisions. Japan, Paraguay, South Korea, Taiwan and Türkiye are among other WTO members that have expressed their scepticism about CBAM consistency with WTO rules.

Conclusion

As geopolitical tensions put rules-based order in international trade under unprecedented strain, international law academia are acknowledging that there is a deep intellectual disagreement about how global affairs should be organised. If the era of globalisation is over, according to the new rationale, governments are bound first by the democratic will of their people, not by international rules. In an environment where non-compliance with international law is presented as a democratic duty, fostering dialogue and cooperation toward a multilateral coordination framework based on common but differentiated responsibilities seems elusive. CBAMs are furthering international trade frictions and have potential to reshape global trade, supply chains and investment flows.

Tatiana Hermann and Thomas Delille are partners and Valerio Giovannini is an associate at Squire Patton Boggs. Ms Hermann can be contacted on +61 2 8248 7814 or by email: tatiana.hermann@squirepb.com. Mr Delille can be contacted on +32 2 627 1104 or by email: thomas.delille@squirepb.com. Mr Giovannini can be contacted on +32 2 627 1108 or by email: valerio.giovannini@squirepb.com.

Tatiana Hermann, Thomas Delille and Valerio Giovannini

Squire Patton Boggs