Fit for 55: Effort Sharing & LULUCF Regulations

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.

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.

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.

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.

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