European Commission proposes sweeping EU ETS reform, slows emissions cap decline to ease industry costs

The European Commission has proposed a wide-ranging revision of the EU Emissions Trading System, the bloc’s flagship carbon pricing instrument, slowing the pace at which the overall emissions cap will shrink and extending free allocation of allowances for industry in a package designed to align climate policy more closely with the EU’s competitiveness agenda.

The proposal was published in Brussels on 17 July 2026, more than a month ahead of the legal deadline for the ETS’s mandatory review following adoption of the EU’s 2040 climate target of a 90% net reduction in greenhouse gas emissions. The Commission said the reform reinforces the EU ETS as a driver of investment while modernising the carbon market and strengthening incentives for companies to decarbonise within Europe.

At the heart of the proposal is a recalibration of the Linear Reduction Factor, the annual rate at which the EU ETS emissions cap declines. The Commission proposed lowering the factor to 3.7% per year for the 2031–2035 period and 1.7% per year for 2036–2040, down from the current rate of 4.3% applied for 2024–2027. The change would slow the pace at which the overall pool of available allowances shrinks, giving covered installations more time to cut emissions. The proposal also halves the trigger threshold for the Market Stability Reserve, the mechanism that adds or withdraws allowances from the market to manage supply and demand imbalances, to 12% of allowances in circulation from the current 24%.

On free allocation, the Commission proposed reducing the annual “benchmark” rate that cuts free allowances to installations each year to 2% from 2030, down from 2.5% under current rules, effectively slowing the phase-out of free permits for industry. The ten most efficient installations in each sector, out of every hundred, would be exempted from conditions attached to free allocation as a reward for early decarbonisation investment. For the aviation sector, free allocation of allowances will be removed entirely from 2026.

The reform is paired with substantial new financial support for industrial decarbonisation. The Commission is proposing an Industrial Decarbonisation Bank designed to mobilise €100 billion for large-scale industrial decarbonisation projects across Europe, with a first phase expected to launch before 2030, financed through the Innovation Fund, ETS revenues and InvestEU. An existing fund that channels ETS revenue into clean energy investment in the EU’s lower-income member states will continue past 2030, with 280 million allowances earmarked for the purpose.

The proposal would also expand the EU ETS to cover flights departing Europe for destinations up to 5,000 kilometres away, a change that would bring routes to cities such as Dubai and Istanbul into scope, though not intercontinental flights to the United States or China. The package was published alongside a separate Electrification Action Plan, which sets an indicative target for electricity to reach 46% of the EU’s final energy consumption by 2040, roughly double today’s share.

European Commission President Ursula von der Leyen said the proposal would provide relief to industry while supporting the clean transition, describing it as an investment and independence plan spanning electricity prices and the adaptation of the carbon market to changing global realities.

The proposal follows weeks of intense lobbying ahead of publication. A coalition of ten member states, including Italy, Poland, Bulgaria, Cyprus, Czechia, Estonia, Greece, Hungary, Romania and Slovakia, wrote to the Commission calling for the ETS emissions cap to be extended closer to 2050, for the phase-out of free allowances in sectors covered by the Carbon Border Adjustment Mechanism to be paused, and for greater flexibility for national circumstances. Six European steelmakers, including ArcelorMittal, Outokumpu, SSAB and thyssenkrupp, had separately urged the Commission to defend the integrity of the carbon market and avoid measures that would artificially depress the carbon price, warning that weakening the ETS would penalise early movers and delay industrial transformation.

Environmental groups criticised the proposal following its publication. The Greens–European Free Alliance group in the European Parliament said the reform would allow polluting industries to emit more, for longer, at a cheaper price, and argued the changes to free allocation ran counter to the carbon market’s function as an incentive for renewable energy investment. Campaign group Bellona Europa said the combination of a slower cap decline and changes to the Market Stability Reserve risked weakening green investment signals.

The proposal will now enter negotiations between the European Parliament and the Council of the EU under the ordinary legislative procedure, a process expected to continue into 2027, with implementation targeted for 2028.