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To reach climate neutrality, carbon emissions from the production of basic materials need to be significantly reduced. For governments' support measures to be consistent with their World Trade Organization obligations, they need to be compatible with the WTO's Agreement on Subsidies and Countervailing Measures (ASCM). This paper analyzes the ASCM consistency of three selected support schemes, namely: (1) free allocation under emissions trading systems such as the European Union Emissions Trading System (EU ETS) to operators of installations deemed to be at significant risk of carbon leakage; (2) a combination of a charge on carbon-intensive materials with free allocation; and (3) carbon contracts for differences (CCfDs) for operators of climate-neutral installations, in which governments pay out the incremental costs of climate neutral-production processes relative to the costs of conventional primary material production. The analysis reveals that the current system of carbon leakage protection through free allocation is vulnerable to challenges under the ASCM. By contrast, a transition to a combination of free allocation and a charge on carbon-intensive materials would implement consistent carbon-pricing and thus would very likely not amount to a subsidy under the ASCM. In a similar vein, support for climate-neutral installations through CCfDs could be designed in such a way that it confers no benefit, so that it would also not constitute a subsidy.

As part of its Green Deal, the European Commission is considering the introduction of border carbon adjustments and alternative measures. The measures, which would primarily apply to basic materials like steel and cement, pursue a double objective: they are aimed at enhancing the effectiveness of carbon pricing for the transition to climate neutrality but also at avoiding carbon leakage risks. When implementing carbon adjustment mechanisms and alternative measures, various design options might be considered to reform the EU Emissions Trading Scheme (EU ETS). In this paper, we have decided to focus on three main models, which help to highlight the main differences between the available options. Under the first model, importers of basic materials would be required to surrender carbon allowances at the level of a product benchmark or, where lower, at the verified level of foreign carbon intensity. In parallel, allocation of free allowances would be phased out. Under the second model, a symmetric adjustment mechanism for exports and imports would be adopted, including refund to exporters for the carbon costs incurred on basic materials embodied in products. Finally, under the third model, the EU ETS would be complemented with a climate contribution charged for materials sold in the European Union (EU) at the product benchmark level related to the carbon intensity of each material. The free allowance allocation regime would then be modified to be directly linked to the volume of material production at the product benchmark level. In order to contribute to the current policy debate, we evaluate for each of these three models, their legality, coherence with EU climate objectives, effectiveness in carbon leakage prevention, potential international implications, as well as their administrative complexity and compliance costs.