Do not weaken Europe’s carbon market just when it starts to matter most

Europe is again debating whether climate ambition and industrial competitiveness can coexist. The answer will shape not only the continent’s decarbonisation pathway, but also its economic resilience, strategic autonomy, and attractiveness to long-term investors. At the centre of this debate stands the EU Emissions Trading System (ETS) – the carbon market that, since 2005, has translated climate objectives into an economic signal for companies and investors. EU climate commissioner Hoekstra is expected to present his proposal for a revision of the ETS this week.

The EU ETS is not a symbolic climate instrument. It is one of the world’s largest and most established carbon pricing systems, covering power generation, energy-intensive industry, intra-EEA aviation and, since 2024, maritime transport. Together, these sectors account for roughly 35-40% of EU greenhouse gas emissions. Since its launch, the system has delivered material reductions: emissions under the ETS are now around 50% below 2005 levels, with stationary installations alone down 51% by 2024.

This is why the ETS has rightly been described as the cornerstone of Europe’s climate policy.

Yet precisely at the moment when the system is becoming economically meaningful, calls are growing to dilute, delay, or redesign it in ways that could weaken its core function. Some argue that the ETS has become a drag on competitiveness and a driver of high energy prices. Yet this argument risks confusing cause and effect. Europe’s dependence on imported fossil fuels is not a reason to weaken the ETS; it is one of the strongest reasons to preserve and improve it.

That matters to us as long-term institutional investors. We invest on behalf of pension fund participants whose financial interests extend far into the future. A predictable transition is not an abstract policy preference – it is a condition for sound capital allocation.

This, however, does not mean the EU ETS should remain unchanged.

Predictability, strategic revenue use

The first priority is to safeguard the integrity and predictability of the carbon market. The Market Stability Reserve (MSR) plays a central role in doing this and it is imperative that rules-based governance be maintained, free from ad hoc political intervention. Furthermore, in a tighter ETS environment, it makes sense to review whether the MSR is responsive enough. Some market participants argue that narrower thresholds for the Total Number of Allowances in Circulation (TNAC) and more proportionate allowance releases would make the system more effective.

“The carbon market generates substantial public revenue that should be recycled into the transition it is designed to accelerate”

Lars Dijkstra and Andres van der Linden at PGGM

A credible market signal, however, is only useful if companies have the means to respond to it. That is why the second priority should be to use ETS revenues more strategically. The carbon market generates substantial public revenue that should be recycled into the transition it is designed to accelerate. This means strengthening instruments such as the Innovation Fund to support and scale innovative technologies, enabling industrial electrification, and financing the infrastructure needed for large-scale decarbonisation. The Commission has already acknowledged the need to combine ETS reform with stronger industrial support, such as by proposing updated benchmarks for free allocation and an ETS Investment Booster for industrial decarbonisation. The objective should not be to compensate for inaction, but to accelerate transformation.

That distinction is important. If ETS revenues are used simply to offset carbon costs, the system’s incentive effect is weakened. But if they are used to unlock capital investment – in clean electricity, grids, storage, low-carbon fuels, carbon transport and storage, and industrial process innovation – they can make the carbon price more politically durable and economically productive. In other words, revenue recycling should help companies reduce exposure to the carbon price, not shield them from it indefinitely.

Carbon removals

The third priority should be to clarify the role of carbon removals. Achieving climate neutrality will require deep emissions cuts first and foremost, but also high-quality permanent removals for residual emissions. Action on this front needs to start now, including developing robust accounting rules for the different types of removals, which differ in permanence, additionality, and verification requirements. This would unlock investment decisions and accelerate technology development, while ensuring that removals do not become a substitute for reducing emissions at source.

The fourth priority is to make carbon leakage protection compatible with a stronger carbon price. European industry cannot be expected to decarbonise while competing against imports that face no equivalent carbon cost. That is why the Carbon Border Adjustment Mechanism (CBAM) is so important. If implemented well, CBAM can help preserve a level playing field while restoring a stronger carbon price signal for domestic producers. But CBAM will only work if it is credible in practice. That requires robust anti-circumvention rules, reliable embedded-emissions data, workable verification, and close attention to leakage risks in downstream sectors.

Competitiveness and climate policy should not be treated as opposing objectives. A credible ETS can reinforce Europe’s competitiveness by reducing fossil fuel dependence, stimulating innovation, and providing the investment certainty needed for low-carbon industries to scale. Europe will not strengthen its strategic autonomy by clinging to imported fossil fuels or by shielding legacy business models from transition pressure. It will do so by building the technologies, infrastructure, and markets that define the next industrial era.

Lars Dijkstra is chief investment officer at the Dutch pension administrator and asset manager PGGM, and Andres van der Linden is a senior stewardship specialist