The package of measures recognises the need to promote energy security and combat rising costs.
By Michael D. Green and James Bee
Key Points:
- The Commission has outlined areas of ETS reform, including updated benchmarks for free allocations and a new €30 billion ETS Investment Booster.
- A medium-term ETS review is expected by July 2026 with the intention to “modernise” the system.
On 11 May 2026, the European Commission (Commission) presented updated EU Emissions Trading System (EU ETS) benchmarks for consultation. This followed an announcement on 19 March 2026 of measures intended to modernise and increase the flexibility of the EU ETS.
The Commission emphasised the success of the EU ETS in reducing greenhouse gas emissions, decreasing dependency on fossil fuel imports, and driving investment in low-carbon energy sources, but acknowledged the need to ensure energy security.
The announcement outlined four key areas of reform: updated benchmarks for free allocations, enhanced Market Stability Reserve powers, a medium-term ETS review, and a new €30 billion ETS Investment Booster.
Background to the EU ETS
Established in 2005, the EU ETS is the world’s first and largest regulatory carbon market. It operates on a “cap and trade” principle, under which total greenhouse gas emissions from covered installations are capped, and companies may trade emission allowances to stay within that limit and generate revenue. Certain sectors receive “free allocations” of emission allowances, calculated using benchmarks which are based on the performance of the cleanest installations in each sector. The volume of free allocations is being phased out over time as part of the EU’s broader decarbonisation strategy. The system covers approximately 40% of EU greenhouse gas emissions, including power generation, energy-intensive industries, and (since 2024) maritime transport.1
Some Member States have expressed concerns about the EU ETS, citing fluctuating carbon prices, insufficient certainty for long-term planning, and exposure to “carbon pricing shocks”. With increasing energy costs sparked by conflict in the Middle East, several Member States (especially those with a greater dependency on fossil fuels) have called for measures to smooth price volatility, while also urging a reconsideration of the pace at which free allocations are phased out for industries exposed to
international competition.
Measures Announced
The Commission President’s statement set out four measures, some of which have already seen further updates. The status of each measure is outlined below.
1. Updated Benchmarks for Free Allocations
On 11 May 2026, the Commission proposed updated EU ETS benchmark values for 2026-2030, which are now open to public and Member State consultation before adoption. The Commission updates the benchmark values every five years under the EU ETS, to ensure that the system remains up to date.
According to the Commission, the proposed benchmarks will, on average, allow industry to continue receiving free allocations covering around 75% of its emissions for the period 2026-2030.
The updated benchmarks are intended to ensure that the EU ETS delivers on its climate objectives, whilst also supporting competitiveness and investment in Europe.
2. Enhanced Market Stability Reserve
The Commission announced plans to increase the “firepower” of the Market Stability Reserve (MSR). The MSR is a mechanism designed to address imbalances between supply and demand in the EU carbon market, by adjusting the volume of allowances in circulation.
On 1 April 2026, the Commission released a proposal to amend the MSR. Under the current system, allowances in the reserve above a certain threshold are invalidated. The proposed amendment would stop the invalidation mechanism, allowing these allowances to be kept as a buffer that can support market stability.
By strengthening the MSR, the Commission aims to reduce price volatility in the carbon market, providing greater certainty for market participants. The proposal will be submitted to the European Parliament and European Council and is subject to the ordinary legislative procedure for adoption.
3. Medium-Term ETS Review
The Commission is undertaking a broader review of the EU ETS, with findings currently expected to be published by July 2026. The review aims to ensure that the ETS remains fit for the future and continues to support European industry in its decarbonisation transition. According to the Commission statement, the review will consider:
- a “more realistic” trajectory for the phase-out of free allowances, particularly for energy-intensive industries; and
- measures to ensure a level playing field for the European maritime sector. The inclusion of maritime transport in the EU ETS has raised concerns about competitive disadvantages for EU operators.
As part of the proposed update to benchmarks, the Commission also noted that it will propose the introduction of sector-specific “fallback benchmarks”. These fallback benchmarks allocate allowances based on energy inputs, rather than measuring emissions per ton of a specific product. Therefore, they can be used to calculate allowances for industrial processes that lack a specific product benchmark.
The Commission has previously set out that the assessment will cover broad themes, including the role of carbon dioxide removals, the potential expansion of the current scope of the EU ETS to additional sectors, new rules on how to account for non-permanent carbon capture and utilisation, and the risk of carbon leakage in sectors not covered by the EU Carbon Border Adjustment Mechanism.2 However, mounting pressure from EU leaders may shift the focus of the review towards measures to reduce energy bills and increase energy security.
The EU ETS review follows the EU’s 2040 target of 90% net greenhouse gas reduction (relative to 1990 levels), which was entered into the Official Journal on 18 March 2026. Carbon credits may contribute up to 5% of the decarbonisation target. The Commission is assessing how carbon removal credits could be integrated into the EU ETS, with findings expected by July 2026, including the role of domestic carbon removals.3
4. ETS Investment Booster
In the March 2026 announcement, the Commission announced a €30 billion decarbonisation fund called the ETS Investment Booster. The fund will be financed through the sale of 400 million ETS allowances to support decarbonisation projects across the EU.
Funding will be awarded on a “first come, first served” basis to projects ready for immediate implementation, though lower-income Member States will have guaranteed access.
Next Steps
Following the four-week public consultation launched on 11 May and scrutiny by EU Member States in the Climate Change Committee, the Commission intends to adopt the benchmarks by the end of June 2026.
The medium-term review, including the trajectory for free allowances, sector-specific fallback benchmarks, and maritime sector measures, will be developed through ongoing engagement with Member States and stakeholders, and is expected by July 2026.
Stakeholders should monitor developments closely, as the benchmark revisions and MSR changes may have near-term implications for carbon pricing and compliance strategies.
This article was prepared with the assistance of Samantha Banfield and James Thompson at Latham & Watkins.
Latham & Watkins will continue to monitor developments relating to the EU ETS and the broader European sustainability regulatory landscape.
- For more information on the EU ETS principles and legislative framework, refer to the Commission webpage. ↩︎
- For background to the EU CBAM and further information on the EU energy transition landscape, refer to this Latham article. ↩︎
- For more information on the 2040 target, refer to this Latham article. ↩︎
