The European Union’s Emissions Trading System - EU ETS - serves as the central pillar of the EU’s strategy to combat climate change and achieve climate neutrality by 2050. Launched in 2005 as the world’s first major carbon market, the system operates on a market-based ‘cap-and-trade’ principle. The EU sets a strict upper limit - the cap - on the total volume of greenhouse gases that can be emitted by regulated sectors, which is progressively reduced each year to drive down total emissions over time. To comply with this cap, companies must purchase or receive carbon allowances, where each allowance gives an operator the right to emit one tonne of CO2 or an equivalent amount of other GHGs, forcing heavy polluters to internalise the financial cost of their carbon footprint. Because the EU ETS establishes a tangible financial penalty for pollution, it has successfully cut emissions across the sectors it covers by over 50% relative to 2005 levels.

In its current, fourth phase, the EU ETS has significantly expanded its regulatory scope to accelerate decarbonisation. Although it initially targeted heavy manufacturing and electricity generation, the system as now introduced intra-European aviation and maritime shipping, with a complete phase-out of free emission allowances for airlines. Simultaneously, the EU si preparing for the launch of ETS2, a separate cap-and-trade framework targeting upstream fuel suppliers for road transport and building heating. The revenues generated from EUA auctions are directly funnelled back into national economies, funding the Innovation and Modernisation Funds via the EU ETS, alongside a newly deployed Social Climate Fund funded by the ETS2 to support vulnerable households through the clean energy transition.