What is the EU ETS?
Launched in 2005, the Emissions Trading System (EU ETS) is considered the bloc's main climate policy tool. It currently sets an overall cap on greenhouse gas emissions from power generation, energy-intensive industry, and parts of aviation and maritime transport, which together account for about 40 percent of the EU's total emissions. Companies must surrender one allowance for every tonne of CO2 they emit, while the cap falls over time to drive emissions down and encourage investment in cleaner technologies. It is the world’s first and largest carbon market.
Why is the EU reforming the system?
For three reasons: a review is required under the scheme's legal mandate, emissions must keep falling after 2030, and a potential connection with UN carbon mechanisms requires more scrutiny.
The ETS Directive obliges the European Commission to report on progress by July 2026, and to accompany the report, “where appropriate, by a legislative proposal and impact assessment”.
The current ETS was designed to help deliver the EU's goal of reducing its net emissions by at least 55 percent by 2030, compared to 1990 levels. Following the latest revision in 2023, the cap was tightened to bring emissions down by 62 percent by 2030, compared to 2005 levels. It must now be updated for the decade after, in line with the new EU target of cutting emissions by 90 percent by 2040, compared to 1990 levels. The next reform will therefore determine how quickly emissions should continue to fall between 2031 and 2040, while ensuring the carbon market continues to provide a predictable investment signal for low-carbon technologies.
Moreover, EU heads of state have agreed to allow UN-approved international carbon credits (issued under Article 6 of the Paris Agreement) to cover up to five percentage points of the 2040 goal. Although the Commission has ruled out using those credits for ETS compliance, the decision ultimately will lie in the hands of the European Parliament and the Council of EU member states, acting as co-legislators.
What is the European Commission expected to propose?
The final package remains closely guarded, but several elements have already been signalled by Commission officials and political leaders.
The biggest expected change concerns the pace at which the emissions cap declines after 2030. The annual reduction in the ETS cap, known as the Linear Reduction Factor (LRF), was raised to 4.3 percent annually for 2024-27 and is set to tighten further to 4.4 percent for 2028-30, in line with the EU’s goal of cutting net emissions 55 percent below 1990 levels by 2030. It is now likely to be made less steep, with allowances remaining available further into the 2040s. Many member states have backed a slower trajectory, while senior Commission officials have indicated the annual reduction rate will be "relaxed a little bit".
The Commission is also expected to propose changes to the Market Stability Reserve (MSR), a balancing mechanism that adjusts the supply of allowances in the market. The aim is to improve the system's ability to respond not only to an oversupply of allowances, as it does today, but also to shortages that could trigger sharp price increases.
Another major focus will be investment: Climate commissioner Wopke Hoekstra has repeatedly argued that more ETS revenues should be used to finance Europe's industrial transition. The Commission is expected to introduce stricter conditions on how governments spend ETS revenues and on companies receiving free allowances, linking both more closely to investments in decarbonisation. It is also considering an "Investment Booster" to bring forward ETS funding for clean industrial projects before 2030.
Finally, the proposal is expected to revisit the phase-out of free allowances under the Carbon Border Adjustment Mechanism (CBAM), examine how permanent carbon removals could interact with the ETS for the first time, and assess possible changes to aviation, shipping, and waste incineration rules. Some of these measures remain subject to discussion and may change before the proposal is published.
Despite pressure from parts of industry and several governments, the Commission has repeatedly insisted that the ETS will remain the EU's central climate policy instrument rather than being fundamentally weakened.
What are the main demands of stakeholders?
The review comes at a time when Europe's political priorities have shifted. Concerns about industrial competitiveness and high energy costs have become more prominent, putting pressure on the Commission to ensure the ETS supports decarbonisation without undermining European manufacturing.
Most stakeholders agree the ETS should remain the backbone of EU climate policy. The disagreement is over how much flexibility should be introduced as Europe pursues deeper emissions cuts.
Many governments want a less abrupt decline in emissions allowances after 2030. Germany has called for a "more realistic" decarbonisation pathway, while France has proposed "smoothing the curve" of the carbon market, and Poland has argued for greater flexibility in the use of international carbon credits.
Energy-intensive industries argue that the ETS must better reflect today's economic realities. Steel, chemicals and other manufacturers are seeking a slower phase-out of free allowances and stronger financial support for low-carbon investments. In particular, they are calling for less stringent rules on benchmarks, standard emissions-intensity values used to calculate how many free carbon allowances are distributed to industrial installations.
Polls have found that citizens mostly welcome Commission plans to recycle more ETS revenues into industrial decarbonisation.
Environmental organisations are instead noting that weakening the ETS would undermine Europe's climate goals. They oppose using international carbon credits for compliance, want free allowances to continue being phased out and favour integrating carbon removals in a way that preserves the overall emissions cap.
Researchers and carbon market experts generally stress the importance of predictability. They warn that frequent political intervention in the carbon market could weaken investment signals and reduce confidence in the ETS over the long term.
What is the timeline of the process?
The European Commission is now expected to publish its legislative proposal on 17 July.
On the same day, the Commission will put forward the bloc’s Electrification Action Plan, its assessment of the UN’s international aviation offsetting scheme CORSIA, and new sector-specific benchmarks that will extend free allowances to an additional set of industries for 2026-30.
Ireland, which holds the Council of EU member states’ rotating six-month presidency, is aiming to secure an agreement between the national governments in the first half of December. According to a presidency calendar, the objective is to reach a “general approach” (Brussels speak for a joint position) on both the ETS revision and the amendment of the market stability reserve at the meeting of member state environment ministers on 11 December.
The European Parliament is also expected to fast-track its work, so that the so-called “trilogue” negotiations between Parliament, Council and the Commission can begin in early 2027.
EU leaders have called for a final agreement by the end of the first quarter of 2027, an unusually ambitious timetable for one of the bloc's most technically complex pieces of climate legislation.
What is the political backdrop?
The reform will be negotiated in a very different political environment from the last ETS overhaul under the European Green Deal.
Industrial competitiveness, affordable energy and economic security have moved higher up on the EU agenda, while governments are increasingly concerned about maintaining support for climate policies that impose additional costs on businesses. The Commission has responded by presenting climate action and industrial policy as increasingly intertwined.
The political calendar also raises the stakes. EU leaders want negotiations wrapped up before campaigning intensifies ahead of France's 2027 presidential election and Italy's expected general election, when governments are typically less willing to endorse politically sensitive climate legislation.
The result is likely to become a difficult balancing act. The Commission has repeatedly described the ETS as the EU's most powerful tool for reducing emissions, but it is also under growing pressure to ensure the system supports investment, protects industrial competitiveness and maintains public acceptance as Europe moves towards its 2040 climate target.