To: Canadian Trade, Competition and Environment Watchers
From: Neil Campbell, William Pellerin and Tayler Farrell
Date: June 10, 2022
Re: A Roadmap for Trade Law Compliant Border Carbon Adjustments
Interest in Border Carbon Adjustments (BCAs) is accelerating. The European Union proposed a Carbon Border Adjustment Mechanism (CBAM) last July, Canada concluded consultations on BCAs last February, the recent US-EU sustainable steel announcement indicates carbon content may be incorporated into trade measures, and BCAs are expected to be discussed at the World Trade Organization’s Ministerial Conference that begins Sunday. Positive comments in the concluding statement would be an important step for global climate protection.
BCAs are taxes or charges imposed on goods from nations that have less rigorous emission requirements.
They are complex, and must comply with the General Agreement on Tariffs and Trade or risk being challenged at the WTO. A trade law-compliant BCA must provide national treatment (imports treated no less favourably than domestic goods), and most favoured nation (MFN) treatment (equal treatment of imports from all WTO countries), or meet the criteria for an exception from these GATT requirements.
Here are some pathways to a compliant BCA.
1. Domestic Carbon Regulation is the Point of Departure
Countries that regulate carbon emissions risk placing their producers at a disadvantage. A tax or charge can ensure that imported products include a cost of carbon that is comparable to domestic producers’ costs, creating a level playing field. Any nation implementing a BCA needs a domestic regulatory framework against which to adjust the price of carbon-intensive products as they cross the border. BCAs will be most feasible where there is a clear domestic cost for carbon (e.g., a price per tonne of CO2 emissions).
For example, the EU’s emissions trading system has a market-determined CO2 emission price. Its CBAM imposes a charge on imports linked to their embedded carbon emissions and trading system prices.
2. Regulatory Framework
A BCA must meet national treatment and other GATT requirements for taxes or regulatory charges. Two key challenges are the treatment of exporters’ home country carbon costs and any free allocations provided to domestic producers.
BCAs will likely need to account for foreign climate regimes by reducing charges on imports based on carbon payments made in the country of export, to ensure exporters aren’t paying twice for the same emissions.
Many climate regimes provide free emission allowances to reduce “carbon leakage” (migration of production to low-emission jurisdictions). Where this occurs, charging imported products at the full carbon price would raise national treatment issues, an issue the EU is addressing by phasing out free allocations.
3. Most-Favoured Nation Treatment
The GATT requires a country imposing taxes or regulatory charges on imports to treat the products of all exporting countries as favourably as it treats the goods from its most favoured nation.
This obligation poses an issue for products originating from countries with different climate policies.
If a BCA is set without regard to exporters’ home country carbon charges, there would be no formal discrimination in the charge itself; however, there would be substantive discrimination against countries that already impose carbon regulatory costs on their exporters. Conversely, if a BCA accounts for exporters’ home-country carbon costs, this would avoid discrimination on total CO2 emission charges between WTO members, but would result in exporters from low carbon cost countries paying higher BCA amounts than those with high carbon costs.
While BCA charges that vary based on the embedded carbon content of imports from different countries may be challenged based on some historical jurisprudence, we believe they should be defensible under a purposive application of the MFN obligation because the combination of the charges imposed in the home jurisdiction plus the BCA would be the same for all exporting countries.
4. The Article XX Exceptions
BCAs that do not meet national treatment or MFN treatment requirements might be defended using general exceptions in GATT Article XX: measures “necessary for the protection of human, animal or plant life or health,” or “relating to the conservation of exhaustible natural resources.”
The implementation of the measure must not operate in a way that unfairly restricts international trade. Any discrimination must also be rationally related to the policy objective. For example, if adjustments for home-country carbon pricing were found to contravene the MFN obligation, they would be good candidates for an exception because consideration of home-country carbon costs would be consistent with the objective of reducing carbon emissions globally.
5. Concluding Observations
Export-oriented countries with weak commitment to greenhouse gas reduction may well challenge BCAs at the WTO, where the Multi-Party Interim Appeal Arrangement is available for such disputes.
In our view, WTO-compliant BCAs are achievable without, or if need be with, recourse to the Article XX exceptions. As more countries enact BCAs, the incentives for remaining jurisdictions to address emissions will increase as the number of markets in which they benefit from an unlevel playing field decline.
Neil Campbell is a partner in the competition and international trade groups at McMillan LLP in Toronto. William Pellerin is a partner in the firm’s international trade group in Ottawa, where Tayler Farrell is an associate.
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The views expressed here are those of the authors. The C.D. Howe Institute does not take corporate positions on policy matters.
