The 2026 EU ETS Revision: A New Framework for Industrial Decarbonisation

In July 2026, the European Commission tabled a long-awaited proposal to revise the EU Emissions Trading System (EU ETS). The ETS is one of the most important pillars of the European Green Deal and aims to reduce greenhouse gas emissions. The current EU ETS was designed in 2003 (EU ETS Directive) to deliver the 2030 climate target reduction of at least 55 % net GHG emissions, and become climate neutral by 2050 (net-zero GHG emissions). The revision aims to update the ETS to align with the new climate target the 2040 of -90%. 

The ETS is based on a cap-and-trade system for emission allowances. The cap is the limit of the total amount of GHG that can be emitted by installations and operators covered under the scope of the system. Companies in key sectors such as steel, chemicals, and glass are required to obtain sufficient allowances each year to cover all their greenhouse gas emissions. While most allowances are sold at auction, some are allocated free of charge, particularly to energy-intensive industries that face international competition. This mechanism aims to reduce carbon leakage, and therefore, the carbon leakage list was implemented, where sectors considered at significant risk of production/emissions are included. Those companies receive free allowances.

What new revision change?

1. The Linear Reduction Factor (LRF) 

LRF determines how fast the allowances are reduced every year, driving up the cost of polluting as supply shrinks. The current LRF is around 4.3% per year and was designed mainly to help the EU reach its 2030 climate target. The Commission proposed a different trajectory after 2030. For  2031-2035- 3.7%, and for  2036-2040- 1.7%.

2. Free allocation 

Free allocation would continue beyond 2030 in some form, with stronger conditions linking support to decarbonisation investment. From 2031, all free allocation is made fully conditional upon operators submitting a verified decarbonisation investment plan, with 80% of allowances released upon plan approval and the remaining 20% contingent on demonstrated emissions reductions by the end of each five-year period.

3. Market Stability Reserve (MSR)

   
   

MSR is the ETS’s automatic mechanism for managing the number of allowances available in the market. The revision will make MSR more dynamic, and will be adjusted for a much smaller post-2030 carbon market and to improve liquidity and price stability.

4. Industrial Decarbonisation Bank 

   
   

The proposal includes an Industrial Decarbonisation Bank of around EUR 100 billion from 2028, as a new EU-level entity to support the scale-up and deployment of emissions reduction technologies in stationary installations. Additionally, the Innovation Fund would be expanded/strengthened and complemented by additional industrial support mechanisms.

5. Use of ETS revenues 

   
   

ETS revenues primarily flow to the national budgets of Member States. Member States receive auction revenue and are required to use significant amounts for climate-related purposes like Industrial and Transport Decarbonisation, Climate adaptation, Energy transition.

The proposal sets a requirement for Member States to allocate at least 50% of ETS auction revenues to defined priority areas - including clean energy and grids, low-carbon transport, industrial decarbonization, waste management, and research and innovation. Investments incompatible with climate neutrality, including fossil fuel lock-in are explicitly prohibited.

Overall, the proposed revision marks an important shift in the EU ETS as the EU moves from its 2030 climate target towards the more ambitious 2040 target. While the reform would continue to tighten emissions constraints, it also places greater emphasis on supporting industrial decarbonisation through conditional free allocation, targeted ETS revenues and new financing mechanisms. The key challenge will be balancing faster emissions reductions with the competitiveness of European industry and the risk of carbon leakage. The proposal is only the beginning of the legislative process, and negotiations in the European Parliament and Council will determine how this balance is ultimately reflected in the post-2030 EU ETS.