Last updated: 5 August 2026.
Quick answer. The EU Emissions Trading System (EU ETS) is a cornerstone of the European Union’s climate policy. It sets a cap on total greenhouse gas emissions from certain economic sectors, progressively reduced in line with the EU’s reduction targets, and puts a price on carbon that incentivises companies to invest in clean technologies: those with surplus allowances may sell them, while those exceeding their cap must purchase more. The system promotes innovation, implements the polluter-pays principle of Article 191(2) TFEU, generates auction revenue for climate policies, and guards against carbon leakage through free allocation to at-risk sectors and the Carbon Border Adjustment Mechanism (CBAM). The carbon price also serves as a reference signal for investment decisions across the wider economy.
The EU Emissions Trading System (EU ETS) is a cornerstone instrument of the European Union’s climate policy.
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The main functions of the Emissions Trading Scheme are:
- Reduction of greenhouse gas emissions: The EU ETS sets a cap on the total emissions from certain economic sectors, which is progressively reduced to achieve the EU’s emission reduction targets.
- Creation of economic incentives: By putting a price on carbon, it incentivizes companies to invest in clean technologies and reduce their emissions. Companies can sell their surplus allowances, while those exceeding their cap must purchase additional allowances.
- Promotion of innovation: The system encourages investment in low-carbon technologies and energy efficiency.
- Implementation of the “polluter pays” principle, as outlined in Article 191(2) of the TFEU: The Union’s environmental policy aims to achieve a high level of protection, considering the diverse situations in different regions of the Union. It is based on the principles of precaution and preventive action, the principle of rectifying environmental damage at the source, and the “polluter pays” principle.
- Generation of revenue for climate policies: Revenue from the auctioning of emission allowances can be used to fund climate change mitigation and adaptation policies.
- Prevention of carbon leakage: Through mechanisms such as the free allocation of allowances to at-risk sectors and the future Carbon Border Adjustment Mechanism (CBAM), it aims to prevent the relocation of industries to countries with less stringent climate policies.
- Price signal for the entire economy: The carbon price established under the EU ETS serves as a reference for other sectors and policies, influencing investment decisions beyond the directly covered sectors.
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Frequently asked questions
Its core function is the reduction of greenhouse gas emissions: the system sets a cap on the total emissions from certain economic sectors, and that cap is progressively reduced in order to achieve the European Union’s emission reduction targets. It is regarded as a cornerstone instrument of the EU’s climate policy.
By putting a price on carbon, the system incentivises companies to invest in clean technologies and reduce their emissions. Companies that emit less than their allocation can sell their surplus allowances, while those exceeding their cap must purchase additional allowances, so cutting emissions becomes financially rewarding and polluting becomes costly.
The system gives practical effect to the polluter pays principle set out in Article 191(2) of the TFEU, under which the Union’s environmental policy pursues a high level of protection based on precaution, preventive action and rectifying environmental damage at source. Under the EU ETS, those who emit must bear the cost of their emissions through the allowances they surrender or purchase.
Carbon leakage is the relocation of industries to countries with less stringent climate policies in order to avoid carbon costs. The EU ETS addresses this risk through mechanisms such as the free allocation of allowances to at-risk sectors and the future Carbon Border Adjustment Mechanism (CBAM), which extends carbon pricing to certain imports.
Revenue from the auctioning of emission allowances can be used to fund climate change mitigation and adaptation policies. In addition, the carbon price established under the system serves as a reference for other sectors and policies, influencing investment decisions well beyond the sectors directly covered by the scheme.
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