Bracing for the CBAM impact

IN Europe, going green is increasingly a compulsion. Besides intense, and sometimes radical, efforts to promote public awareness of environmental issues, new regulations are continuously introduced to enforce sustainability standards across industries and incentivise the adoption of eco-friendly practices.

Take the Carbon Border Adjustment Mechanism (CBAM).

Representing the European Union’s (EU) ambitious climate agenda, the new policy is a carbon-pricing system designed to address carbon leakage and ensure fair competition in international trade by levelling the playing field between domestically produced goods in the 27-nation region and imported goods from non-EU producers.

Under this policy, importers will be required to pay an additional charge or tax for selling carbon-intensive goods such as cement and iron, among others, to the EU.

Indirectly, through CBAM, the EU is also encouraging other countries to adopt similar climate initiatives to promote higher environmental standards worldwide.

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The CBAM framework is currently in a transitional phase from Oct 1, 2023 to Dec 31, 2025.

By Jan 1, 2026 CBAM will be fully enforced, requiring companies exporting to the EU to buy carbon certificates according to the region’s carbon pricing rules.

This framework has huge implications for Malaysia, as the EU is one of the country’s major export destinations.

Data from the Economy Ministry show the 27-nation region accounted for about 8% to 9% of Malaysia’s total exports annually from 2019 to 2023. Last year, the country’s total exports to the EU were valued at RM84.3bil, down from a record-high of RM126.1bil in 2022.

The Securities Commission (SC), in its Capital Market Stability Review 2023 released in March this year, estimated that about 75% of Malaysia’s exports to the EU would be impacted by CBAM.

Urging Malaysian companies to be ready, the SC stressed in the report that more climate and environmental, social, and governance (ESG)-related policies, like CBAM, particularly from advanced economies such as the EU, have the potential to affect Malaysian firms through multiple channels.

“There is an increasing proliferation of disclosure standards and ESG requirements being imposed at an international and domestic level, all of which require compliance and attention from corporates,” it said.

In the current transitional phase, the CBAM framework applies only to certain sectors that are particularly carbon-intensive, or pose the most significant risk of carbon leakage such as cement, iron and steel, aluminium, fertilisers, electricity and hydrogen (see chart).

During this period, importers of goods in the scope of the new rules will only have to report greenhouse gas (GHG) emissions embedded in their imports directly and indirectly.

The scope of products under CBAM will be reviewed or expanded over time, as the EU adjusts the coverage to align with its climate goals, including cutting GHG emissions by up to 55% by 2030 from the 1990 levels and reaching net-zero by 2050.

At present, there is no legal obligation for Malaysian exporters to comply, as UOB Global Economics & Markets Research (UOB Group Research) notes, but they are required to report the price of embedded carbon emissions generated in the production of the goods exported to the EU.

“The direct impact for Malaysia’s businesses and exporters that fall within the scope of CBAM are additional reporting requirements to facilitate this mechanism. This would incur potential additional costs to local companies to enhance data collection practices and process,” the research institution explains.

“If a Malaysian exporter is unable to provide this information in compliance to the EU methodology, then there is a risk of losing the business and market share, given the competitive macro landscape,” it adds.

Assuming that EU importers pass through additional CBAM costs, Malaysia’s producers could face a higher price for their raw materials, UOB Group Research points out.

“As companies enhance their emissions reporting capabilities within their supply chains, EU importers may favour lower emitting suppliers to reduce CBAM-related costs,” it explains.

“As suppliers implement processes and technologies to accurately measure emissions within their supply chain, the increased transparency could spur innovation to reduce emissions and mitigate potential transition risks,” it adds.

Undoubtedly, CBAM could potentially raise the cost of exporting goods to the EU due to the potential imposition of carbon border tax charges when the new policy takes full effect in 2026. This could also place affected companies at a comparative disadvantage, MIDF Research points out in its report on CBAM last year.

“We expect this may likely affect Malaysian exporters to the EU and this may have negative implications,” it says.

“Further down the line, the CBAM could also impact the supply chain as companies in the EU seek to reduce their exposure to carbon taxes, resulting in changes to sourcing practices and other adjustments that could impact Malaysian exporters,” it adds.

For small and medium enterprises (SMEs), in particular, challenges could arise from the need to adapt their production processes to be more carbon-efficient when most of them already lack the resources and technical expertise to make significant changes, MIDF Research says.

This is on top of having to face increased costs associated with compliance and carbon taxes could place a burden on already-strained budgets, it adds.

On the flip side, companies that already incorporate carbon-efficient production processes may be able to benefit from new market opportunities as companies in the EU seek lower-carbon products, it says.

Essentially, MIDF Research points out, understanding the impact of CBAM is key for Malaysian businesses, policymakers and stakeholders to prepare for potential changes in trade dynamics, and assess the competitiveness of Malaysian exports in the EU market.

“Strategies and policies can be developed to navigate the changing trade landscape, enhance competitiveness and potentially leverage opportunities arising from the CBAM implementation,” it adds.