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ETS 2 and CBAM represent powerful climate tools and climate policies for cutting emissions and strengthening Europe’s climate leadership but without careful design their distributional consequences risk undermining support for the transition.

The European Union (EU) has consistently presented itself as a global leader in climate governance, committing to reach climate neutrality by 2050 first through the European Green Deal and subsequent policy package it for 55, and now through the 2040 Climate Target. At the heart of its climate policies lies the EU Emissions Trading System (ETS), launched in 2005 as one of the world’s largest carbon markets. The ETS employs a cap-and-trade system to limit emissions while permitting allowances to be traded, thus creating an incentive for industries to decarbonise at the lowest possible cost. .

Parallel to its domestic climate efforts, the EU also faces the challenge of carbon leakage, which is the  relocation of carbon intensive industries to jurisdictions with weaker climate policies outside the EU. This undermines global emissions reductions and threatens European competitiveness.

To address this, the EU has introduced the Carbon Border Adjustment Mechanism (CBAM), which levies a carbon price on imports in highly emission-intensive sectors such as steel, aluminium, cement, fertilisers, electricity, and hydrogen. CBAM is designed to ensure a level playing field for EU industries and to encourage trading partners to adopt their own carbon pricing schemes. However, while it has been hailed as a landmark policy in aligning trade with climate goals, it has also raised political, legal, and diplomatic concerns.

ETS 2 and CBAM mark a new phase in European climate policies and governance, extending carbon pricing. Their success will depend on their ability to embrace social fairness and international equity. Without robust redistribution at home and solidarity abroad, these measures risk undermining the EU’s climate ambitions.

Policy Recommendations

1. Strengthen the Social Climate Fund for ETS 2.

The EU and Member States should reinforce the Social Climate Fund (SCF) as the main tool to offset the regressive impacts of ETS 2, with a focus on vulnerable households. Following the regulation, Member States should prioritise in their Social Climate Plans structural investments such as home renovation, affordable renewable heating, and affordable available public transport, as well as strengthened social protection systems, including adequate minimum income schemes, and avoid temporary income support that is not targeted to vulnerable households. By combining targeted short-term protection with long-term transformation, the SCF can prevent energy and transport poverty while enabling households to adapt to a low-carbon economy. To ensure adequacy, its budget should be expanded by pooling resources from both ETS and ETS 2 revenues and other national resources and managed with transparency to secure trust of people across Europe.

2. Make CBAM a driver of fairness and cooperation.

CBAM should become a vehicle for climate solidarity and not framed as a mere trade instrument. At the EU level, support should be offered to SMEs through simplified reporting rules, technical assistance, and targeted financial help. Internationally, a portion of CBAM revenues should be allocated to assist developing countries via technology transfer, climate finance, and capacity building. This would align CBAM with principles of climate justice and reduce risks of trade tensions. By better embedding fairness at home and abroad, the mechanism can protect and support the EU industry while encouraging global convergence on climate action.

3. Introduce flexibility and exemptions for the most vulnerable partners.

To strengthen CBAM’s legitimacy and reduce risks of economic harm, the EU should adopt a differentiated approach in its application to partner economies. Critical subsectors with low emission intensity, as well as small-scale enterprises in low-income and vulnerable regions of the Global South, should be either exempted from CBAM or subject to reduced carbon tax rates. This would demonstrate the EU’s commitment to the principle of common but differentiated responsibilities and prevent disproportionate impacts on fragile economies. Coupled with transparent criteria for exemptions, such an approach would reinforce global trust, avoid retaliation, and enhance the EU’s credibility as a leader in climate diplomacy.

4. Build institutional and technical capacity in trade partners.

EU trading partners should strengthen their institutional and technical systems to better align with the EU’s ambitious climate goals and avoid higher CBAM costs. This involves improving emissions data collection, developing transparent monitoring and reporting frameworks, and investing in skills and expertise to manage compliance effectively. By doing so, countries cannreduce their vulnerability to CBAM charges and demonstrate progress toward lowcarbon pathways. International partnerships, including technical and financial support from the EU, can facilitate this transition. Enhancing institutional and technical capacity will help trading partners integrate smoothly into global low-carbon markets while reinforcing the EU’s push for a fair and ambitious climate agenda.

4. Safeguard the integrity of the European Green Deal and long-term climate ambition.

The EU should avoid weakening core elements of the European Green Deal. Recent moves to introduce flexibilities in the 2040 climate target, roll back parts of the Common Agricultural Policy, water down the Nature Restoration Law, and ease corporate sustainability reporting risk undermining progress. Protecting these frameworks is essential to keep climate ambition on track, give people confidence in the transition, and uphold Europe’s credibility as a global leader in climate action.

These Policy Recommendations are part of the sixth Policy Brief delivered by the SPES Consortium