By Urszula Szalkowska, Managing Director, Europe, EcoEngineers

In a landmark move for climate policy and international carbon markets, the European Union (EU) and the United Kingdom (UK) recently announced their commitment to Emissions Trading Systems (ETS). 

The decision, announced at the EU-UK Summit in May, marks a significant step toward greater regulatory alignment and climate cooperation post-Brexit. For companies and stakeholders engaged in hard-to-abate heavy industries like cement, steel, aluminum, and paper, the agreement seeks to enhance market efficiency, reduce compliance costs, and strengthen climate ambition through coordinated emissions caps and mutual recognition of allowances.

The EU’s ETS, launched in 2005, is the world’s largest carbon market and a cornerstone of the EU’s climate strategy. Following Brexit, the UK established its own ETS in 2021, closely modeled on the EU’s framework but operating independently. 

This linkage of an ETS between different jurisdictions is not without precedent. The EU previously linked its ETS with Switzerland’s in 2020, demonstrating the feasibility and benefits of cross-border carbon market integration. However, the EU–UK linkage is far more consequential due to the scale and economic interdependence of the two regions.

The technical and legal work to operationalize the EU-UK ETS linkage is expected to begin immediately, with a target implementation date in 2026. 

Key Objectives and Provisions

The primary goal of linking the EU and UK ETS is to enhance the cost-effectiveness and efficiency of emissions reductions. By allowing mutual recognition of allowances, companies in both jurisdictions can trade emissions permits across borders, increasing market liquidity and price stability. The agreement also aims to:

• Ensure a level playing field for businesses operating in both markets.
• Strengthen climate ambition through coordinated cap-setting and compliance mechanisms.
• Facilitate long-term investment in low-carbon technologies by providing regulatory certainty.

Both parties have committed to respecting each other’s regulatory autonomy while aligning key design features such as cap trajectories, auctioning rules, and monitoring, reporting, and verification (MRV) standards.

Implications for Industry and Stakeholders

For regulated entities, the linkage offers several advantages. First, it expands the pool of available allowances, potentially reducing compliance costs. Second, it harmonizes carbon pricing signals, reducing the risk of carbon leakage and competitive distortions. Third, it simplifies compliance for multinational firms operating in both the EU and the UK.

However, the integration also introduces new complexities. Companies will need to stay informed of evolving rules and ensure their internal compliance systems can accommodate cross-border trading. Market participants should also anticipate increased scrutiny from regulators as the linked system will require robust oversight to maintain environmental integrity and prevent fraud.

Impacts on the EU’s Carbon Border Adjustment Mechanism (CBAM)

The EU’s Carbon Border Adjustment Mechanism (CBAM), which entered its transitional phase in October 2023 and will last until the end of 2025, is designed to prevent carbon leakage by imposing a carbon price on imports of certain goods from countries with less stringent climate policies. Once fully implemented in 2026, CBAM will require importers to purchase certificates reflecting the carbon price that would have been paid had the goods been produced under the EU ETS.

The planned linkage between the EU and UK ETS could exempt UK exporters from CBAM obligations, assuming the UK’s carbon pricing is deemed equivalent to the EU’s. This would streamline trade between the two regions and reduce administrative burdens for businesses operating across borders. 

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However, such an exemption is not certain. The EU will need to assess the UK ETS’s alignment with EU standards, including cap stringency, MRV protocols, and enforcement mechanisms. If the linkage is successfully implemented and maintained, UK exporters of CBAM-covered goods—such as steel, cement, and aluminum—could avoid double carbon pricing and maintain competitiveness in the EU market.

For companies in both jurisdictions, this underscores the importance of staying informed on both ETS and CBAM developments. The intersection of these policies will shape compliance strategies, supply chain decisions, and long-term investment planning.

Opportunities for Innovation and Leadership

The EU-UK ETS linkage opens the door for innovation in carbon finance, digital MRV (dMRV) solutions, and cross-border emissions accounting. Companies that proactively invest in emissions reductions and carbon market intelligence will be better positioned to capitalize on arbitrage opportunities and demonstrate climate leadership. 

Moreover, the linkage could serve as a model for future international cooperation. As more jurisdictions consider carbon pricing, the EU-UK framework may inform global efforts to create a network of interoperable carbon markets. 

Reform of the EU ETS

The linkage of the EU and UK cap-and-trade systems coincides with the announced review of the EU ETS. A review of some of the system’s elements is due by 2026 and will include an assessment of whether additional policies are needed to reach those targets. The Market Stability Reserve (MSR), which helps regulate the structural supply and demand of allowances, is also due for review by 2026. Both the EU ETS and the MSR are currently being evaluated to inform these reviews.

As part of the 2023 revisions of the ETS Directive, the monitoring and reporting of emissions was launched in 2025. Throughout 2027, a 30% higher volume of allowances will be auctioned to provide market liquidity. As in the existing EU ETS, the ETS2 will operate with a dedicated, rule-based MSR to mitigate insufficient or excessive supply of allowances to the market. 

The proposed reforms are part of the broader “Fit for 55” legislative package, aligning the ETS with the EU’s legally binding target to cut net greenhouse gas (GHG) emissions by at least 55% by 2030 under the European Climate Law. 

Climate Removals and Carbon Farming 

In 2024, the EU created a separate system of Carbon Removals and Carbon Farming (CRCF) (i.e., industrial and nature-based permanent storage and utilization of biogenic carbon dioxide (CO₂)), which has led to industrial carbon removal projects being developed in both regions. The CRCF is currently excluded from the EU ETS and, therefore, cannot be used by EU ETS obligated parties as a compliance mechanism. 

There are, however, discussions taking place in the EU about the inclusion of carbon removals within the EU ETS system, an approach the UK has been considering for some time. The ability to use carbon removal as a compliance mechanism would ease compliance and operability for the majority of the industry. 

Summary

The announced intent between the EU and UK to link their respective ETSs represents a pivotal moment in climate policy and carbon market evolution. The recent agreement underscores the importance of international cooperation in addressing global emissions and sets a precedent for future market integration. However, while broader integration of carbon markets across jurisdictions may benefit market players and industries by improving efficiency and liquidity, it must not come at the expense of traceability and compliance requirements. Maintaining environmental integrity and robust oversight remains essential to the credibility and effectiveness of the system.

About the Expert

Urszula Szalkowska is the Managing Director, European Markets, and leads EcoEngineers’ European practice, supporting both European-based clients and international clients doing business in the EU. Ms. Szalkowska has more than two decades of experience working in renewable energy, fuels, climate change, and transportation. She has a deep understanding of regulations, business impact, and strategic communications in the EU. She advises businesses on compliance with national regulations in EU Member States and helps navigate the highly regulated renewable energy markets. 

For more information about how we can help you navigate the UK or EU carbon market landscape, contact: 

Urszula Szalkowska, Managing Director, Europe | uszalkowska@ecoengineers.us   

About EcoEngineers

EcoEngineers, an LRQA company, is a consulting, auditing, and advisory firm exclusively focused on the energy transition and decarbonization. From innovation to impact, EcoEngineers helps its clients navigate the disruption caused by carbon emissions and climate change. Its team of engineers, scientists, auditors, consultants, and researchers live and work at the intersection of low-carbon fuel policy, innovative technologies, and the carbon marketplace. For more information, visit www.ecoengineers.us.