Tilting the Playing Field

“Levelling the playing field” has been one of the buzzwords of the European Union (EU)’s external economic policy over the last few years. In essence, through various instruments including free trade agreements, the EU has been trying to ensure that foreign entities, goods and services are subject to similar regulatory burdens as their EU counterparts when engaging in the EU single market. While many of these instruments do so adequately, several recent measures do not, in fact, create a level playing field. Rather, they tilt the playing field in favour of EU entities, goods and services.

This is notably so for the EU’s Carbon Border Adjustment Mechanism (CBAM). The CBAM seeks to reduce carbon leakage by requiring European importers of iron and steel, aluminium, cement, fertilisers, electricity and hydrogen to buy certificates for the emissions embedded in the imported products corresponding to the carbon price that would have been paid, had the goods been subject to the EU’s Emission Trading Scheme (ETS). The CBAM thus intends to mirror the EU’s ETS obligations imposed on European producers to imported goods. While the final text of the CBAM is not yet available, foreign producers might be subject to more stringent pricing and administrative requirements than the European producers under the ETS. For instance, importers would not be able to freely trade their CBAM certificates or even resell the entirety of their surplus purchased CBAM certificates while, under the ETS, emission allowances can be freely traded. Similarly, the proposed CBAM would potentially make it more difficult for third-country producers to have their emissions verified than European producers under the ETS since only European verifiers would be allowed to verify emissions. This could result in the use of benchmarks instead of actual data, leading to a higher financial burden. Moreover, foreign goods are subject to more burdensome reporting obligations than their European counterparts because the CBAM requires them to report emissions emitted directly during the production of exported products as well as account for indirect emissions (that is the carbon emitted to produce the energy necessary to manufacture the imported product), whereas the ETS covers only direct emissions by manufacturing plants as a whole and certificates for indirect emissions are paid for by EU energy producers themselves.

The EU’s Foreign Subsidy Regulation also tilts the playing field in favour of EU entities, goods and services. The Foreign Subsidy Regulation seeks to extend the EU State aid regime vis-à-vis third countries by allowing the European Commission to investigate whether entities engaging in an economic activity in the EU have received subsidies from third-country governments that distort the internal market and to impose redressive measures against the recipient. However, it might impose stricter conditions on foreign subsidies than those overseeing the granting of State aid under EU law. For example, the Foreign Subsidy Regulation does not provide for any exemptions similar to those provided under EU law, such as the General Block Exemption Regulation. Furthermore, while financial assistance provided by EU bodies is not regulated under EU State aid law, the Foreign Subsidy Regulation covers foreign subsidies granted at any level of government in third countries. In addition, entities that have received foreign subsidies might be put at a disadvantage when attempting to invest in the EU because the Foreign Subsidy Regulation imposes administrative burdens on these entities directly, while the EU’s State aid regime imposes administrative burdens on EU Member States.

As such, these initiatives do not create a level playing field, but rather tilt the regulatory playing field in favour of EU entities, goods and services. The main reason for this is that these measures do not set out rules applicable to both domestic and third countries’ entities, goods and services alike, but, instead, attempt to create a separate external regulatory regime to mirror the domestic one. However, these external regulatory regimes appear more burdensome than the domestic regimes they attempt to replicate. This might be so partly because of inherent administrative difficulties in administering measures towards third countries’ entities, goods and services.

Yet, under international economic law, this separation between domestic and external regimes is likely to lead to a violation of the national treatment principle enshrined in World Trade Organization (WTO) rules and Free Trade Agreements as the assessment of whether this principle is respected would centre on the external regime on its own, to the exclusion of the domestic one (see, for example, WTO Appellate Body Report, US–Tuna II (Article 21.5 DSU), para. 7.13). However, such a violation of the national treatment principle could be justified under the general exceptions found in WTO rules or under Free Trade Agreements if the external regime mirroring the domestic one does not put foreign entities, goods and services at a competitive disadvantage vis-à-vis domestic entities, good or services subject to the domestic regime or if such a disadvantage relates to the legitimate objective pursued by the measure or is due to practical limitations in administering the external measure. This does not seem to be the case for certain elements of the CBAM and Foreign Subsidy Regulation. For example, the more stringent pricing and certificate mechanism under the CBAM does not relate to its legitimate objective and is not due to any practical administrative limitation. The same goes with regard to the lack of exemptions in the Foreign Subsidy Regulation similar to those under the General Block Exemption Regulation for EU State aid.

Thus, while international economic law does not prohibit external measures that tilt the playing field, they do impose limitations to avoid such measures serving as a tool to give domestic entities, goods and services an undue advantage over their competitors. However, any adverse ruling against these measures, be it by the WTO or under a Free Trade Agreement, which finds a violation of the national treatment principle and that the measure does not meet the requirement of the general exceptions, would not require the removal of the measure. It would, instead, require that the measure be amended to adequately level the playing field or tilt it in the favour of domestic entities, goods or services only insofar as necessary to reach the legitimate goal pursued by the measure or to make it practically feasible to administer.

In this regard, other recent EU economic initiatives are different to the CBAM and Foreign Subsidy Regulation as they encompass both domestic and foreign goods, services and entities within the same set of rules. The EU has recently proposed several measures of this kind, such as the Deforestation Regulation, Corporate Sustainability Due Diligence Directive, Forced Labour Ban, Batteries Regulation and has already adopted the Corporate Sustainability Reporting Directive, Digital Markets and Digital Services Acts. It also has more in the pipeline, such as the Critical Raw Materials Act initiative. While these measures may have been designed to target specific issues arising in certain third countries (such as China for the proposed Forced Labour Ban or the United States of America for the Digital Markets Act) and may contain a few discriminatory elements (for example, the Corporate Sustainability Due Diligence Directive applies to EU companies meeting certain employee thresholds, whereas there is no such employee threshold applicable to non-EU companies), they generally do not impose more stringent or burdensome regulatory regimes on foreign entities, goods and services. This mode of regulation is thus better apt to create a “level playing field”.

Yet, with the current international situation and the (re)emergence of protectionist industrial policies, tilting the playing field through economic measures might become increasingly pronounced and persist. Indeed, EU industries may find themselves at a disadvantage when faced with the sheer amounts of green and industrial incentives being provided by third countries, such as the United States of America and China, to their own domestic industries. In this context, using its regulatory clout to tilt the playing field in favour of EU industries might be a clever way for the EU to help its industries remain competitive.