EU Emissions Trading System (ETS )
2026 Guide for Companies
What Is the EU Emissions Trading System (ETS)?
The EU emissions trading system is the European Union’s flagship policy for reducing greenhouse gas emissions from high-polluting sectors through a cap-and-trade mechanism. Launched in 2005, it covers electricity and heat generation, energy-intensive industries, commercial aviation, and maritime transport, accounting for approximately 40% of total EU greenhouse gas emissions.
In July 2026, the European Commission published a proposal to revise the EU emissions trading system for Phase V (2031–2040), balancing industrial competitiveness with the EU’s 2040 climate target of 90% net emissions reduction.
How Does the EU Emissions Trading System Work?
The EU emissions trading system operates by setting a declining cap on total emissions from covered sectors, converting this cap into tradable allowances. Each allowance permits the holder to emit one tonne of CO₂ (or equivalent) during a specified period.
Key principles:
- Companies must monitor and report their emissions annually
- They must surrender enough allowances to cover their verified emissions
- Companies can buy or sell allowances on the carbon market
- The cap decreases over time, creating a carbon price signal that incentivises emission reductions
What Sectors Are Covered by the EU Emissions Trading System?
The EU emissions trading system currently covers the following sectors:
Stationary installations:
- Power and heat generation plants
- Energy-intensive industries (steel, aluminium, cement, chemicals, refineries, paper, glass, ceramics)
- Municipal waste incineration (from 2031, phased to 100% by 2034)
Aviation:
- Commercial flights within the European Economic Area (EEA)
- From 2029: flights departing from the EEA to destinations within 5,000 km of Frankfurt
- All incoming and outgoing flights operated by business jets
Maritime transport:
- Ships above 5,000 GT (since 2024)
- From 2029: certain categories of smaller ships (400–5,000 GT)
What Are the Key Changes in the 2026 EU Emissions Trading System Proposal?
Important: The July 2026 proposal is a legislative draft, not yet law. It will enter negotiations between the European Parliament and the Council, with implementation targeted for 2028.
How Will the Emissions Cap Change?
The Commission proposes to adjust the Linear Reduction Factor (LRF), which determines how fast the emissions cap declines each year.
Current LRF:
- 4.3% per year (2024–2027)
- 4.4% per year (from 2028)
Proposed LRF:
- 3.7% per year (2031–2035)
- 1.7% per year (2036–2040)
This slower trajectory means the cap will reach zero in the 2040s rather than around 2039, providing more time for industrial transition while still aligning with the 90% net emissions reduction target by 2040.
Will Free Allocation Continue After 2030?
Yes. The proposal extends benchmark-based free allocation beyond 2030, but with new conditions.
From 2031 onwards:
- Operators must establish verified “Invest in EU Decarbonisation Plans”
- Companies must invest 100% of their free allocation value in decarbonisation activities within the EU
- Free allocation for CBAM-covered sectors will phase out more slowly, extending to 2038 (subject to decarbonisation plan compliance)
A companion benchmarks proposal would add EUR 6 billion in free allocation for 2026–2030.
Can International Carbon Credits Be Used?
From 2036 onwards, the proposal allows for high-quality international carbon credits to contribute to ETS-sector ambition, but not as direct operator-level compliance units.
Key limits:
- 260 million tonnes total over the 2036–2040 period
- Subject to a 2% ceiling of the EU’s 1990 emissions baseline
- Credits must meet strict integrity criteria under forthcoming EU legislation
What Should Companies Do Now to Prepare
How Can You Ensure Compliance with Current Rules?
Immediate actions:
- Continue monitoring and reporting emissions under current EU emissions trading system requirements
- Verify that your emissions data is accurate and submitted on time
- Track allowance prices and market developments
How Should You Plan for Free Allocation Changes?
If your business currently receives free allowances, start preparing for the new requirements.
Action required by 2031:
- Develop a verified “Invest in EU Decarbonisation Plan”
- Document planned decarbonisation investments in the EU
- Ensure investments are verifiable and EU-based
What the Proposal Means for Your Business?
The 2026 proposal positions the EU emissions trading system as both a decarbonisation driver and an investment engine for European industry.
Climate impact:
- Aligns the cap with the 90% net emissions reduction target by 2040
- Integrates 250 Mt of permanent carbon removals (BioCCS and DACCS)
- Allows up to 260 Mt of international credits from 2036, complementing domestic action
Industrial competitiveness:
- Slower LRF reduction provides more time for industrial transition
- EUR 100 billion Industrial Decarbonisation Bank supports clean technology investment
- Extended free allocation beyond 2030 maintains competitiveness while ensuring reinvestment
What Is the Current Status of the Reform?
Current status:
- The Commission’s proposal from July 2026 is a legislative draft, not yet law
- It will now enter co-decision negotiations between the European Parliament and the Council
- Expected timeline: negotiations through 2026 and into 2027, with implementation targeted for 2028
What remains fixed:
- Current EU emissions trading system rules continue to apply until amendments are adopted
- CBAM obligations (including the 30 September 2027 certificate surrender deadline) remain unchanged regardless of ETS reform negotiations
Preparing for the Changes
As the EU emissions trading system continues to evolve, businesses should review their compliance and decarbonisation strategies. At Carbon Complete, we provide practical support to help organisations assess the impact of regulatory changes and prepare for upcoming requirements.
Contact us to discuss how these changes may affect your business.
