Member states push back against Brussels' ETS reform ahead of lawmaker response

EU member states have voiced sharp concerns about the Commission's proposal to overhaul the bloc's carbon market, with supply-balancing rules and free allocations emerging as major points of contention while governments and lawmakers begin staking out their positions ahead of negotiations.

Documents submitted to the Working Party on the Environment, the Council's preparatory body for environmental rules, showed that delegations from multiple member states held significant reservations about the Commission's July proposal to reform the EU Emissions Trading System, the world's most mature carbon market and the centerpiece of Europe's climate architecture.

At the heart of the dispute lie three interlocking questions: how to manage the supply of allowances through the Market Stability Reserve, whether to attach conditions to free allocations, and how to distribute funding. None has a simple answer, and on each, the divisions run deep.

MSR faultlines

The MSR, the mechanism designed to absorb surplus allowances and anchor market stability has become the most technically complex and politically charged battleground of the reform.

The Commission had proposed halting the automatic invalidation of allowances held in the reserve, allowing unlimited accumulation as a buffer against future price shocks. Member states are far from united on how to respond.

Germany staked out a detailed and carefully calibrated position. The German delegation vouched for keeping the Linear Reduction Factor at 4.4% until 2035, while agreeing to temporarily suspend MSR invalidation until 2030 to create an additional buffer.

"We consider it necessary to introduce a new limit on the MSR volume of 800 million allowances," the German delegation said, adding that the limit should be reduced to 4% starting in 2028 to allow any surplus through 2030 to be absorbed.

EU lawmakers, meanwhile, voted to keep the MSR invalidation in place, with MEPs pushing to raise the threshold from 400 to 650 million allowances in 2027, a position that sets up a direct confrontation with the Commission's original proposal when trilogue begins.

Seeking to bridge the divide, the Netherlands proposed what it dubbed a "compromise combining elements of both approaches": maintaining the invalidation threshold at 400 million EUAs until March 1, 2027, raising it to 650 million from the same date, and introducing an annual 4% decrease from 2028.

The MSR is a pool that holds surplus allowances and has operated since January 2019 to address supply-and-demand imbalances in the EU ETS.

According to the ETS review proposal, the linear reduction factor will fall to 3.7% for 2031-2035 and 1.7% for 2036-2040, down from the current 4.3% rate, providing what the Commission called "breathing space" for European industry. The LRF is the annual fixed percentage by which the total number of emission allowances is reduced in the EU ETS.

Conditionality

If the MSR debate is technical, the row over free allocation conditionality is anything but. The Commission's proposal to tie a portion of free allowances to verified emissions reductions has drawn fire from several of Europe's industrial heavyweights, who argue it penalizes manufacturers already operating at the frontier of decarbonization.

France said that "should the conditionality of free allowances be adopted, it should remain simple to implement and aim to limit the administrative burden," while Poland held a firmer opposing view, stating that the "mechanism seems to be illogical and counterproductive." Paris also questioned the absence of provisions to improve the gradualness and predictability of benchmark reductions for the 2031-2035 and 2036-2040 periods, a concern that speaks to the broader anxiety among member states about long-term investment certainty.

Italy raised concerns about whether the implementation timetable gives investments enough time to generate measurable reductions during the 2031-2035 reference period, warning of risks to the effectiveness of carbon leakage protections.

"The conditions set out for the allocation of the remaining 20% of free allowances are particularly challenging," the Italian delegation said, pointing out that "significant time in technical, financial and regulatory terms" was needed to achieve meaningful emissions reductions.

Poland adopted the most uncompromising stance, arguing that conditionality is unjustified because free allocations are not state aid measures.

"Free allocation is meant to simply level the playing field between EU producers bearing the ETS cost and non-EU producers, and to help avoid carbon leakage. Therefore, there is no systemic reason for the free allocation to be based on conditionality," the Polish delegation said.

Similar concerns were echoed by Estonia, whose delegation argues that linking allocations to investments is challenging and may prove difficult for several installations.

Price pressure

The stakes are significant. The EU ETS sets the price signal that drives decarbonization investment across power generation, heavy industry and aviation, and in 2026, that signal has been far from steady.

EU Allowance prices have been volatile this year, ranging from lows of about €60/mt to highs approaching €90/mt, buffeted by relentless political pressure on the carbon market and a sharply higher energy complex driven by the US-Israel war with Iran.

The outcome of this reform will shape the trajectory of European carbon prices for the next decade and also the investment decisions of some of the continent's most energy-intensive industries.

Platts, part of S&P Global Energy, last assessed EU Allowances at €85.67/metric tons of CO2 equivalent ($99.71/mtCO2e) on Sept. 9, the highest since July 22.

With Parliament set to adopt its formal negotiating mandate at the September 2026 plenary, the distance between the institutions and within the Council itself suggests the path to a final agreement will be long, hard-fought, and consequential for the future of European climate policy.