The writer is professor of law at City University of Hong Kong and president of the Asia-Pacific FDI Network. X: @jchaisse

The EU’s recent introduction of the Carbon Border Adjustment Mechanism (CBAM) is a significant step in global environmental policy, with significant legal implications for foreign direct investment (FDI). This mechanism, which is being phased in with full implementation by 2026, targets carbon-intensive imports such as cement, iron, aluminium, fertilisers, electricity, hydrogen and steel. 

CBAM essentially extends the EU’s internal carbon pricing system to external producers. By requiring importers to purchase carbon certificates that mirror the EU’s carbon price, the mechanism seeks to equalise the cost of carbon for both domestic and foreign producers. This innovative regulatory approach aims to prevent so-called carbon leakage — or the shifting of production to countries with laxer emission standards. 

From an FDI perspective, CBAM introduces new dynamics. Economies that heavily rely on exports to the EU in targeted sectors may face increased production costs, potentially diminishing their attractiveness for FDI. At the same time, there may be a surge in investments in green technologies and cleaner production methods as companies adapt to meet the EU’s carbon standards. This could spur innovation and the global transition towards greener manufacturing practices.

CBAM’s phased implementation allows for a gradual adaptation period, which provides a buffer against abrupt market disruptions. Initially, only the reporting of carbon emissions is mandated, with financial obligations such as the purchase of carbon certificates, commencing later. This gives international businesses time to align their operations with new requirements, thus reducing the risk of legal challenges sparked by sudden market access restrictions that could violate fair and equitable treatment provisions in investment treaties.

Moreover, CBAM could set a global precedent, influencing other major economies, such as the US and Japan, to adopt similar measures. This potential ripple effect necessitates a re-evaluation of global FDI strategies, focusing on sustainability and compliance with emerging environmental standards. Countries with existing carbon pricing mechanisms may find themselves better positioned in this changing legal scenario, possibly attracting more FDI because of their alignment with these emerging norms.

The EU defends CBAM as a measure to prevent carbon leakage and protect ambitious climate goals. However, it also invites wider consideration of the role of trade policy in global environmental governance. CBAM’s full legal and economic impact will become clearer as its implementation unfolds. However, it undoubtedly marks a turning point in how environmental considerations are integrated into international trade and investment law.

The introduction of CBAM is a major development at the intersection of environmental policy and international trade law. Its legal impact requires the monitoring of several areas, including: domestic investment law adjustments to accommodate new carbon pricing models; shifts in cross-border FDI, particularly towards sustainable and green technologies; and potential revisions in international investment agreements to reflect evolving environmental standards. 

Moreover, the mechanism could instigate changes in the legal framework of dispute resolution, as countries align their trade and investment policies with global climate objectives. As such, CBAM not only symbolises a legal milestone in global trade and investment, it also serves as incentive for broader legal changes in international economic policy, fostering a greener and more sustainable future.

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This article first appeared in the April/May 2024 print edition of fDi Intelligence.