Legal Response International » Use of EU ETS Revenues to fund climate action in developing countries

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The EU has established a number of schemes to reinvest proceeds from the EU ETS (NER 300 programme, the Innovation Fund, the Modernisation Fund). Their legal basis is contained in the attached EU directive. The EU is currently in the process of reviewing its climate legislation.

Would it be possible to create a new scheme that allows the EU to directly support the financial mechanism of the UNFCCC (e.g. the Green Climate Fund) with funds generated through the monetisation (auctioning) of emission allowances? Are there any legal constraints or concerns, in particular with regard to the division of competencies and responsibilities between the EU and its member states?

Advice

The query pertains to the interpretation of EU law.

EU law derives from the Treaty on the Functioning of the European Union (the “TFEU“) and the Treaty on European Union (collectively, the “EU Treaties“). The EU Treaties are themselves a part of, and governed by, international law. However, the corpus of EU law contains within it rules that are applicable as international law and also those that operate only within the internal legal order of the EU and, at least arguably, do not form part of international law. It is the EU’s institutions, such as the European Commission (“EC“), that play a crucial role in upholding and implementing the EU Treaties.

The EU Emissions Trading Directive (“ETS Directive“) is an EU legislative instrument adopted in 2003 under the EU Treaties.[1] The ETS Directive is a cornerstone of the EU’s climate policy and constitutes its key tool for reducing greenhouse gas emissions in a cost-effective way.[2]

Under the ETS system, EU Member States (the “Member States“) are authorised to determine the use of revenues generated from the auction of emission allowances (“ETS Revenues“).[3] ETS Revenues must be spent in a manner that is coherent with the long-term objectives expressed in the Paris Agreement, the objectives of the EU’s 2030 climate and energy policy framework, as well as other EU funding programmes, so as to ensure the effectiveness of public spending in the EU.[4]

At present, Member States are required to spend at least half of their ETS Revenues to support greenhouse gas emissions reductions, to deploy renewables and carbon capture and storage, and to improve energy efficiency and district heating.[5] Whilst Member States do not receive the entirety of the ETS Revenues, and remain obliged to inform the EC how they use ETS Revenues, their exclusive competence in determining the use of any ETS Revenues does not appear to be in doubt.[6]

As ETS Revenues may not currently be considered the EU’s own resource, a constraint appears to exist under the EU legal framework to the creation of a new scheme, that would prevent the EU from directly supporting the financial mechanism of the UNFCCC (e.g. the Green Climate Fund) by transferring funds without the involvement of any Member State.[7] Thus, in accordance with the principle of subsidiarity set out in Article 5 of the TFEU,[8] the proposed scheme could only be achieved through a legislative instrument at EU level (i.e. an EU Directive), by amending the ETS Directive.[9]

In contrast, the envisaged direction of travel of the ETS Directive would appear to allow the EU to directly support multilateral financial institutions and programmes, such as the proposed new scheme.

On 14 July 2021, the EC adopted a series of legislative proposals detailing how it intends to achieve climate neutrality in the EU by 2050, including revising several pieces of EU climate legislation, such as the ETS Directive.[10] For example, under the existing EU ETS, a portion of allowances is auctioned for the Innovation Fund and the Modernisation Fund, which respectively support innovations towards climate neutrality across the EU and power sector modernisation in lower-income Member States.

The EC proposes to increase both funds to help overcome the low-carbon innovation investment gap and to address distributional effects between Member States, specifically the proportionally greater challenge in meeting the EU’s climate target in Member States that rely more on fossil fuels for power generation. Further, based on the EC’s proposals, Member States will be required to spend their ETS Revenues on climate and energy-related projects, including decarbonisation in the road transport and buildings sectors. [11]

The EC also proposes to set up a new Social Climate Fund, to address social impacts of emissions trading in road transport and buildings sectors on vulnerable households, micro-enterprises and transport users. The Social Climate Fund would be financed by the EU budget, using an amount equivalent to 25% of the expected revenues of emissions trading for building and road transport fuels.[12]

[1] EU Directive, 2003/87.

[2] EU Regulation, 2021/1119.

[3] Article 10(3), ETS Directive.

[4] EU Directive, 2018/410.

[5] For an overview of the use of ETS Revenues towards multilateral financial institutions and programmes over the period 2013-2015 by Member States, see Figure 4, Analysis of the use of Auction Revenues by the Member States (Final Report), which shows that the main recipient of the ETS Revenues committed and disbursed by Member States is the Green Climate Fund.

[6] ETS Handbook, p. 35.

[7] Ecologic, Smart Cash for the Climate: Maximising Auctioning Revenues from the EU Emissions Trading System, p. 48, “The EU Parliament’s Committee on Industry, Research and Energy also suggested altering the text of the ETS Directive as concerns use of auctioning revenue…It also specifically adds the Green Climate Fund as a recipient of auction revenues (Committee on Industry, Research and Energy 2016, page 19).” For an overview of the status of pledges and contributions to the Green Climate Fund, as at 31 October 2020, see the latest Pledge Tracker: https://www.greenclimate.fund/sites/default/files/document/status-pledges-irm-gcf1_0.pdf.

[8] Article 5(3), TFEU, “Under the principle of subsidiarity, in areas which do not fall within its exclusive competence, the Union shall act only if and in so far as the objectives of the proposed action cannot be sufficiently achieved by the Member States, either at central level or at regional and local level, but can rather, by reason of the scale or effects of the proposed action, be better achieved at Union level.

[9] EC, Staff Working Document, Subsidiarity Grid, SWD(2021) 557 final, pp. 7 and 59. See further, inter-institutional agreement of 16 December 2020, EU Official Journal, L 433I , 22 December 2020, pp. 28 – 46.

[10] EU Emissions Trading System, https://ec.europa.eu/clima/policies/ets_en.

[11] See Questions and Answers – Emissions Trading – Putting a Price on carbon, Question 7.

[12] Ibid.