In a nutshell: Revised Effort Sharing and LULUCF Regulations


Reducing emissions from sources other than industrial or transport sources is essential to reach climate neutrality.

The European Union’s (EU) revised land use, land use change and forestry (LULUCF) Regulation, which came into force on 16 May 2023, intends to reverse the declining net greenhouse gas (GHG) removals by the EU’s agricultural and forestry sectors by expanding the scope to cover the entire land sector from 2031 and setting a net GHG removal target of at least 310 million tons of CO2e by 2030, thereby bolstering the LULUCF’s contribution to the EU‘s increased climate ambition. It also introduces additional efforts to decrease use of forestry biomass in the energy sector.

The revisions introduced will likely increase the speed of transition to nature-based solutions which can mitigate climate and nature issues while increasing resilience and creating wider societal benefits. Increasing importance of not only forests but as well as all other land uses (including wetlands) can provide a development boost to bio-economy products.

With a greater focus on enhancing net sinking capacity, the integration of the non-CO2 agricultural emissions, and the goal of having a net zero land sector by 2035, companies and land managers in the EU may need to accelerate the uptake of nature- based solutions. New opportunities to mobilize Common Agriculture Policy (CAP) funds and generate carbon farming certificates at EU level are emerging. To keep pace, businesses should begin mapping their dependencies and impacts on nature and identify their potential to generate emission reductions and removals.

The revised Effort Sharing Regulation (ESR), which came into force on 11 May 2023, sets a collective climate target for Member States to reduce emissions by setting national limits for GHG emissions for Member States. 

Fit for 55

It covers sectors that were, until now, excluded from the EU ETS and LULUCF Regulation, that is: road transport, heating of buildings, agriculture, small industrial installations and waste management. (Road transport and buildings are being singled out for further climate ambition via a dedicated emissions trading system.) The revised Regulation raises national binding reduction targets for each Member State to achieve an EU-wide GHG emissions reduction of 40 percent by 2030 over 2005 emissions levels in the ESR sectors.

Although the revisions to the LULUCF Regulation and ESR only create direct obligations for Member States, countries will need to take action through the implementation of concrete national policies and measures that will have a direct impact on the private sector. Different Member States will have different individual targets and apply distinct domestic levers to reduce their respective emissions. Understanding the specific national plans and strategies that each Member State is willing to apply to the covered sectors, including the use of any specific market or regulatory incentives is critical for companies.

Unpacking the specifics

A climate crisis, combined with the implementation of the EU’s Nationally Determined Contribution commitments under the 2015 Paris Agreement, 2050 climate-neutrality ambitions, and the need for a socially fair European transition towards a climate-neutral economy, set the EU climate policy into motion.

In 2020, the EU adopted the European Green Deal which is the core EU strategy to fight climate change and achieve climate neutrality and consists of dedicated regulations, strategies and funding mechanisms that address eight major policy areas. Embedded into the European Green Deal targets, the Fit for 55 policy package, containing 15 legislative proposals designed to align and update EU legislation to ensure consistency with its climate ambitions, is the EU’s most ambitious initiative to reduce its impact on the environment by transforming the workings of the EU’s economy, industry and society.

First presented by the European Commission (Commission) in 2021, only one proposal remains under negotiation in the legislative process at the end of 2023 – the revision of the Energy Taxation Directive. Of the 14 other proposals, the first legislation that entered into force were the strengthening of the contribution of the LULUCF sector to the EU’s overall climate ambitions through the LULUCF Regulation, and stronger emission reduction targets for European Union (EU) Member States under the ESR. These Regulations entered into force on 16 and 11 May 2023 respectively.

Effort Sharing Regulation

The ESR sets national limits for greenhouse gas (GHG) emissions for Member States. It covers sectors that were, until now, excluded from the EU Emission Trading System (EU ETS1) and LULUCF Regulation, that is: road transport, heating of buildings, agriculture, small industrial installations and waste management. Together, these sectors account for around 60% of total EU domestic emissions.

The ESR that is currently in force was adopted in 2018 and sets a collective climate target for Member States to reduce emissions by 29% for the 2021-2030 period (compared to 2005 levels). This collective target is shared between Member States, with national binding GHG reduction targets varying in accordance with their GDP per capita2 and decreasing annually in line with a set linear trajectory. Annual emissions levels are then translated into Annual Emissions Allocations (AEAs) or “annual caps” that must be observed by Member States. Member States have considerable discretion in selecting the policies and measures that they put in place to reach their individual targets. In addition, to ease the burden of achieving the annual caps and promote cost-effectiveness, the ESR allows for certain market-based flexibilities for Member States, including banking and borrowing of AEAs in limited quantities, trading of AEAs between Member States, and using a limited amount of ETS allowances and LULUCF removals (for certain Member States).

To align with the EU’s amplified climate ambitions and increase coherence with other complementary legislation and strategies under the EU Green Deal, the EU is updating and strengthening its Effort Sharing approach for the 2021-2030 period. The most notable changes relate to stricter collective and national Member States’ targets: EU-level emissions reduction will be increased from 29% to 40% by 2030, compared with 2005 emissions levels (this is up from the 30% EU-level target initially proposed by the Commission). As a result, the national reduction targets assigned to Member States will also increase. Targets will range from -10% (Bulgaria) to -50% (Denmark, Finland, Germany, Luxembourg and Sweden)3.

While the scope of the ESR remains unchanged, two important sectors – road transport and buildings – are being singled out for further climate ambition via a dedicated emissions trading system. This new ETS is set to kick-start in 2025 and will assist the EU in achieving the new EU-wide Effort Sharing target by directly tapping into private sector action and incentivizing consumer behavioral change. The new ETS will pursue reductions of 43% by 2030.4

The flexibilities made available to Member States will also be adjusted and further restricted in some cases to close existing loopholes. Member States will be able trade up to 10% of their AEAs each year during 2021-2025 and 15% for the period 2026-2030. When national emissions are lower than annual caps, Member States can bank up to 70% for 2021 and up to 25% for the years 2022-2029 (to be used until 2030). In turn, when emissions in a given year exceed the annual cap, Member States can borrow up to 7.5% of their AEAs for 2021-2025 and up to 5% for 2026-2030. Furthermore, to comply with their national targets, countries can also rely on limited quantities of LULUCF credits (with limits divided up into two periods: 2021-2025 and 2026-2030) and of EU ETS allowances (in this case, limited to nine specific Member States whose targets are above national average).5

Land Use, Land Use Change and Forestry (LULUCF)

Adopted in 2018, the existing LULUCF6 Regulation requires each Member State to ensure that emissions in the forest sector are compensated by at least an equivalent amount of removals in the period 2021-2030 (the “no debit” rule). This no-debit rule currently translates into a target of -225 million tons of CO2e and covers activities related to conversion, use and management of forests, grasslands, croplands and wetlands in the EU.7 Member States need to ensure sector emissions do not exceed removals, with GHG accounting for forested land done against a projected reference level that sets the baseline for existing forest management practices. 

However, to meet the ambitious Fit for 55 target of at least 55% reduction in GHG emissions by 2030, the EU needs more than just balancing out emissions and removals from forests. It requires a greater focus on increasing EU net sinking capacity with enhanced absolute targets for Member States, streamlined accounting, and clear incentives for forest and landowners.8 As a result, under the provisional changes agreed by the European Commission, the Council and the Parliament on 8 November 2022, the LULUCF Regulation will be amended to:


Set absolute net-negative targets: An overall EU carbon absorption target of -310 MtCO2 by 2030 is introduced9. Until 2025, the current "no debit rule" will continue to apply. Thereafter, between 2026 and 2030, this EU target will be distributed as annual (absolute) binding targets between Member States, which will be determined using a linear trajectory and based on recent levels of removals and emissions and the potential for increased removals. If progress towards these targets is not sufficient, EU countries will be obliged to take corrective action10.






Broaden its scope and reach: For the period 2031-2035, the LULUCF sector should be merged with the non-CO2 agricultural sector (e.g., livestock, manure management, fertilizer use) that is currently covered by the ESR to form a newly regulated climate pillar with one Agriculture, Forestry and Other Land Use (AFOLU) policy instrument. This newly defined land sector should reach climate-neutrality by 2035 and become a carbon sink (i.e., have negative emissions) thereafter. Post-2035, the scope should be further extended to include GHG emissions and removals from additional sectors, such as the marine and freshwater environment.



Simplify and harmonize accounting: To optimize existing carbon accounting and reporting procedures, the accounting approach for the LULUCF sector will be aligned with other sectors starting from 2026. Accounting practices and periods will be harmonized, which will notably ease the integration of the AFOLU sector within the LULUCF regulation in 2030. Moreover, greater use of geographical data and remote sensing will help increase accuracy in data collection. The Commission aims at accurate, dynamic and granular results to determine if action is on track to meet policy objectives in each Member State and to provide global assurance of the progress towards meeting the EU's target transparently11.


While the trading of net removals between Member States and the possibility to use surplus AEAs will remain, other flexibility rules may be adjusted to maintain ambition levels. Net removals from the LULUCF sector will no longer be accepted for ESR compliance. Similarly, banking of surplus net removals from the first accounting period (2021-2025) will also be no longer be authorized under the new regulation. Additionally, a land-use flexibility mechanism will be set up, allowing allocations to Member States experiencing unexpected decreases of removals related to natural disturbances (such as wildfires, pests and the effects of climate change), provided that the EU as a whole meets its 2030 target.

Complementary regulatory frameworks

To achieve its target of cutting greenhouse-gas emissions by at least 55% by 2030, the EU does not rely solely on the ESR and LULUCF regulations. Synergies, supporting instruments and links with other directives and regulations must be considered to obtain a global view of the transformation pathway underway within the EU. Additionally, key to attaining climate neutrality by 2050 is not only the inclusion of all sectors within the Fit for 55 framework, but the complementary nature of the individual proposals. For instance, the sectors that are not covered by the EU ETS are captured by the ESR, thereby ensuring that all sectors contribute to the climate target; the EU ETS provides a flexibility mechanism for the ESR; and provisions within the ESR allows for Member States to use limited AEAs to meet LULUCF targets.

To ensure that Member States not only reach their ESR and LULUCF targets, but that they, together with businesses, are pulling in the same direction and consistently working towards a common goal, some of the complimentary Fit for 55 Package proposals include, amongst others:

  • The recast of the Energy Efficiency Directive12, which raises the level of ambition of the EU’s energy efficiency target and requires all EU Member States to use energy more efficiently at all stages of the energy chain to achieve binding end-use energy savings obligations.
  • The revised Renewable Energy Directive6, which sets a common target of 45% of renewable energy in the EU’s energy consumption by 2030 and contains revised sustainability criteria for energy biomass.
  • The amendment to Regulation 2019/631, which requires all new cars or vans placed on the market in the EU from 2035, whether manufactured in the EU or imported, to be zero-emission vehicles will work towards ensuring that Member States.

Looking beyond the EU’s 2030 milestone target and the Fit for 55 Package to its 2050 net-zero ambition and the European Green Deal, various other plans, strategies and legislation are also in place that are closely related to the LULUCF sector:

  • The new Common Agriculture Policy (CAP) Strategic Plans, which incentivizes land managers to restore and expand carbon sinks and implement measures to reduce CH4 and N2O emissions from agriculture.
  • The new EU Forest Strategy for 2030, adopted by the Commission in 2021, that focuses on the protection, restoration and sustainable management of EU forests and aims to ensure healthy & resilient forests that contribute to biodiversity, climate objectives and livelihood security.
  • The EU Biodiversity Strategy for 2030 contains plans to protect nature and reverse the degradation of ecosystems. It includes EU’s first ever Nature Restoration Law, with binding restoration targets for specific habitats and species.
  • The EU Farm to Fork Strategy aims to accelerate the transition to a sustainable food system that has a neutral or positive impact on the environment, contributes to mitigating and adapting to the effects of climate change, and reverses biodiversity loss.

It is, therefore, important to analyze the interplay of the individual proposals in the context of the overarching ambitions when determining companies’ future strategies and decarbonization journeys.

Impact & next steps

Although the revisions to the ESR and LULUCF Regulation only create direct obligations for Member States, countries will likely take action through the implementation of concrete national policies and measures that can have a direct impact on the private sector. Different Member States will have different individual targets and apply distinct domestic levers to reduce their respective emissions. Understanding the specific national plans and strategies that each Member State is willing to apply to the covered sectors, including the use of any specific market or regulatory incentives is critical for companies and land managers. For instance, if subsidies are not driving sufficient reductions, governments may turn to supplementing these policies with taxes to combat undesirable behavior, or even remove these subsidies in favor of various forms of environmental taxes13.

Undertaking such country-level analyses are important for business as they start to future-proof their operations in a world that is increasingly placing importance on companies’ sustainability strategies, decarbonization efforts and environmental footprint. It is up to, and advisable for, each company to anticipate and adapt to these changes to limit the regulatory risks, seize the associated opportunities, and avoid future costs of inaction, such as higher investment costs and stranded assets. In particular, achieving individual Member States’ binding targets will require companies and land managers to strengthen their own emissions reduction efforts. Such emissions reduction starts with measurement of emissions to determine the current state of play for an appropriate low carbon strategy to be developed.

Specific to the construction industry, low-carbon material for new buildings, building renovation, energy efficiency and the replacement of fossil fuels in heating systems are key solutions that should be considered when developing such strategies. For buildings, road transport and smaller industries, the new ETS that will co-exist with the ESR after 2025 will also require the private entities to understand how these instruments will intersect and interact with national policies and reflect on business operations in each Member State. The carbon price from this second ETS will be applied at fuel distribution level based on the carbon intensity of fuels sold on the market.   

The revision of the LULUCF Regulation is not lacking in terms of business impact either. With a greater focus on enhancing net sinking capacity, the integration of the non-CO2 agricultural emissions, and the goal of having a net zero land sector by 2035, companies and land managers in the EU will need to accelerate the uptake of nature- based solutions, such as regenerative agriculture. New opportunities to mobilize CAP funds and generate carbon farming certificates at EU level are emerging14. To keep pace, businesses need to begin mapping their dependencies and impacts on nature and identify their potential to generate emission reductions and removals. It is estimated that, by 2050, carbon farming practices can remove almost 200 million tons of CO2.15 Companies with land holdings of any size should thus consider what they can do to improve carbon sequestration, conserve biodiversity, and restore nature.

The regulatory path to net zero is changing rapidly, and businesses should already be putting clear and implementable transition strategies in place to prepare for and adapt to these upcoming changes. As an immediate step, clients both within and outside the EU should first assess whether, and how, the new and revised regulations impact them and, if necessary, start preparing for the significant changes that we are seeing as global climate actions continue to intensify. This may include analyzing existing supply chains, entering into new partnership agreements, investigating available grants and incentives and determining future funding requirements.

How KPMG professionals can help

KPMG has developed a leading global Climate Change and Decarbonization practice. Working alongside KPMGs' ESG Tax and Legal teams, KPMG professionals deliver leading  services and solutions and work collaboratively with clients on the journey to a low carbon future.

KPMG ESG professionals can assist you with a climate risk and decarbonization strategy that includes helping you gain strategic foresight and operational value in your decarbonization journey, from emissions measurement to implementation, monitoring and reporting. All of this is supported by an array of options, such as renewable energy procurement, energy efficiency, circular economy, supply chain management, and includes assessing and understanding the underlying tax and legal impacts.

Through KPMG Climate Risk Advisory services, KPMG firms can help you measure, quantify and assess risks and opportunities across business operations and supply chains under a wide range of scenarios, and understand the impact on business performance.

KPMG firms also advise clients on the financing and investment aspects of the low carbon agenda, including fundraising and identifying investment partners and merger and acquisition opportunities, which includes both debt and equity solutions.

For more information, please contact one of our team.

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Mike Hayes

Climate Change and Decarbonization Leader, Global Head of Renewable Energy
KPMG International

Ruth Guerra

Partner, Co-Head of International trade and Green taxation, Lawyer
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Senior Tax Manager – Global ESG Tax (EU Green Deal & Decarbonization)
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Related insights

1 The EU ETS, which currently applies to limited energy-intensive, high emitting industries, is a cap-and-trade system that sets an annual cap on the amount of greenhouse gases that companies in covered sectors may emit. This amount is covered by allowances, which are tradeable. Within the cap, companies either receive emission allowances for free or buy them, and unused allowances can be sold or used the following year. The cap decreases every year, ensuring that total emissions fall. Substantial penalties are levied when these caps are exceeded or where the number of allowances held do not cover the emissions generated.

2 The use of GDP per capita is based on the need to reflect different Member States’ financial and technical capacities and ensure fairness of the Effort Sharing approach. Currently, national reductions targets vary between 0% and -40%. https://climate.ec.europa.eu/eu-action/effort-sharing-member-states-emission-targets_en

3 The 2030 Member State targets range between 10% and 50% below 2005 levels and will be translated into binding annual targets at the Member State level. See annex: https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52021PC0555&from=FR

4 See EU Parliament briefing paper (February 2023), available here: https://www.europarl.europa.eu/RegData/etudes/BRIE/2021/698812/EPRS_BRI(2021)698812_EN.pdf

5 See the Council of Europe press release (November 2022) for detailed information on ESR flexibilities: https://www.consilium.europa.eu/en/press/press-releases/2022/11/08/fit-for-55-eu-strengthens-emission-reduction-targets-for-member-states/

6 The LULUCF sector covers the use of soils, trees, plants, biomass and timber.

7 Although the EU forest sector is currently a net sink and achieved net removals of -264 million tonnes CO2e in 2019, the EU’s forest and land sector’s ability to sequester carbon has been declining since 2013, where net removals from the sector were at -316 million tonnes. The decrease in absorption capacity is due to ageing forests, climate impacts and increased harvesting for bioenergy production, among other factors. (Refer: https://www.europarl.europa.eu/cmsdata/233827/Background_paper_LULUCF_Regulation_2030_Climate_target.pdf).    

8 The Policy Department for Economic, Scientific and Quality of Life Policies for the Committee on the Environment, Public Health and Food Safety (ENVI) explored options for improving carbon sinks in the EU and strengthening the LULUCF Regulation. The summary of the expert discussions is available here: https://www.europarl.europa.eu/RegData/etudes/STUD/2021/662929/IPOL_STU(2021)662929_EN.pdf

9 This represents an increase of removals of about 15% compared to today. The current LULUCF Regulation does not include an EU-wide carbon absorption target; instead, it operates under the “no-debit” rule.

10 EU countries will be obliged to take corrective action if progress towards their target is not sufficient. There will also be a penalty for non-compliance: 108% of the GHG above their 2026-2029 budget will be added to their 2030 target. https://greenfiscalpolicy.org/fit-for-55-deal-on-carbon-sinks-goal-will-increase-eu-2030-climate-target/

11 These results will be used to conduct a comprehensive review of national inventory data in 2025, to properly set out the Member States' national annual targets for 2026-2030.

12 Renewable Energy and Energy Efficiency Directives - KPMG Global (home.kpmg)

13 KPMG's ESG Tax Tracker provides a high-level overview of the global ESG and sustainability landscape as it relates to taxes, incentives and grants.

14 The proposal for a EU Carbon Removal Certification Framework can be found here: https://climate.ec.europa.eu/document/fad4a049-ff98-476f-b626-b46c6afdded3_en

15 Simon Kay, DG CLIMA, European Commission, LULUCF: The path forward on climate policy monitoring for land,  CLUE22_Kay_LULUCF.pdf