The European Commission has unveiled a new proposal aimed at strengthening the European Union’s carbon market, marking the first concrete step in updating the EU

Emissions Trading System (ETS) following commitments made earlier this year.

Announced in the wake of President Ursula von der Leyen’s remarks at the March European Council, the reform focuses on adjusting the Market Stability Reserve (MSR) — a key mechanism designed to regulate the supply of carbon allowances and maintain price stability within the ETS.

A shift in market intervention strategy

At the heart of the proposal is a significant change to how surplus carbon allowances are handled. Under current rules, any allowances held in the MSR above 400 million are automatically cancelled. The Commission now wants to halt this invalidation mechanism, allowing excess permits to remain in reserve as a strategic buffer.

This shift is intended to make the system more flexible. Instead of permanently removing surplus allowances, the MSR would retain them and deploy them when the market faces shortages, helping to smooth price volatility and prevent sudden spikes in carbon costs.

The MSR already plays a balancing role in the system: it withdraws allowances from the market when there is an oversupply and reintroduces them when scarcity emerges. The proposed reform aims to strengthen this function, making the carbon market more predictable for businesses and investors.

ETS: a cornerstone of EU climate policy

The EU ETS remains the bloc’s flagship climate policy tool and one of the world’s largest carbon markets. It operates on a “cap-and-trade” principle, setting a limit on total greenhouse gas emissions while allowing companies to buy and sell emission allowances.

Since its introduction, the system has delivered measurable results. EU domestic emissions have fallen by 39% compared to 1990 levels, even as the economy expanded by 71% over the same period. Policymakers point to the ETS as a major driver behind the decline in fossil fuel use and the rapid growth of renewable energy investments.

Beyond emissions reductions, the ETS has also contributed to energy security. By incentivising locally produced renewable energy and low-carbon technologies, it has reduced the EU’s dependence on imported fossil fuels — a priority that has become more urgent amid geopolitical tensions and volatile energy prices.

Why reform is needed now

Despite its success, the ETS is facing new pressures. Energy market instability, global competition, and long-term decarbonisation targets are testing the system’s ability to remain both effective and predictable.

The Commission argues that modernising the MSR is essential to ensure the carbon market can respond to future challenges, including potential supply shortages as emission caps tighten in the coming decades.

By preserving allowances instead of cancelling them, the EU aims to avoid situations where the market becomes too constrained, which could drive up costs for industries and consumers.

Broader EU emissions policy context

The proposed reform fits within the EU’s wider climate framework, particularly the European Green Deal and the “Fit for 55” package, which aims to cut greenhouse gas emissions by at least 55% by 2030.

The ETS has already been expanded to cover more sectors, including aviation and maritime transport, with a separate system being introduced for buildings and road transport. At the same time, complementary policies such as the Carbon Border Adjustment Mechanism (CBAM) are being rolled out to prevent carbon leakage and ensure fair competition with non-EU producers.

Together, these policies are designed to align the EU with its long-term goal of achieving climate neutrality by 2050.

What happens next

The proposal will now be submitted to the European Parliament and EU Member States for negotiation under the ordinary legislative procedure.

A broader review of the ETS is scheduled for July 2026, when further adjustments to the system — including the role of the MSR — are expected to be considered to ensure it remains fit for the next decade of climate policy.