1. Introduction

The United Kingdom has moved from participation in the EU Emissions Trading System (EU ETS) to its own UK Emissions Trading Scheme (UK ETS), which began operating on 1 January 2021. The UK ETS is a cap-and-trade system: the regulator establishes a limit on covered emissions, allowances are created within that limit, and regulated entities must surrender allowances corresponding to their emissions. The present scheme covers major sectors including heavy industry, power and aviation, representing roughly 25% of UK territorial emissions. (GOV.UK)

Future reform is likely to focus on five connected objectives:

strengthening the carbon-price signal;

expanding sectoral coverage;

improving market stability;

addressing carbon leakage through border measures; and

developing closer links between the UK and EU carbon markets.

These reforms raise important legal questions concerning administrative law, regulatory discretion, property and economic interests, market integrity, procedural fairness, international trade and climate obligations.

2. Legal Foundation of the UK Carbon Market

The central statutory foundation is the Climate Change Act 2008, particularly the provisions enabling emissions trading schemes. The UK ETS itself was established through the Greenhouse Gas Emissions Trading Scheme Order 2020. The courts have expressly recognised that the Climate Change Act provides powers for establishing trading schemes designed to limit greenhouse-gas emissions or encourage emissions reductions. (Judiciary UK)

The UK ETS operates through several regulatory mechanisms:

emissions caps;

allowance allocation;

auctions;

free allocation for qualifying sectors;

monitoring, reporting and verification (MRV);

allowance surrender obligations;

market-surveillance mechanisms;

penalties for non-compliance; and

mechanisms intended to contain excessive price volatility.

The legal design therefore combines environmental regulation with a financial market mechanism.

3. Why Future Reform Is Necessary

A. Net-zero trajectory

The carbon cap must progressively tighten if the UK ETS is to contribute effectively to the UK's statutory climate objectives.

The UK ETS Authority has already moved toward a net-zero-consistent cap and has stated that the scheme should encourage market-led emissions reductions in covered sectors. The Authority has also planned expansion into areas such as maritime emissions, waste and greenhouse-gas removals. (GOV.UK)

Future reform could therefore involve:

progressively declining caps;

stronger alignment with UK carbon budgets;

adjustment of free allocations;

inclusion of additional greenhouse gases;

greater integration of removals;

treatment of negative emissions; and

potential extension to additional sectors.

The principal legal issue will be ensuring that delegated regulations remain within the authority granted by Parliament.

4. Expansion of the UK ETS

The future carbon market is likely to become broader.

The Authority has already established plans for:

maritime transport;

energy-from-waste and waste incineration;

greenhouse-gas removals; and

potentially other sectors. (GOV.UK)

This expansion raises questions of regulatory proportionality and economic fairness.

For example, bringing a new sector into the ETS requires rules dealing with:

who is the regulated operator;

how emissions are measured;

what constitutes an installation;

which emissions are covered;

how allowances are allocated;

whether free allowances are available;

how compliance is verified; and

what penalties apply.

Future legislation will therefore need increasingly sophisticated sector-specific regulatory architecture.

5. Reform of Free Allocation

Free allocation is one of the most important areas of future carbon-market reform.

Free allowances have historically been used to reduce the risk that carbon-intensive industries relocate production to jurisdictions with weaker carbon constraints—known as carbon leakage.

The UK has already legislated for changes to free allocation for the 2027–2030 allocation period. The 2026 amendment regulations modify the calculation of free allocation for industrial installations. (Legislation.gov.uk)

Future reform could progressively move from traditional free allocation toward:

more targeted protection;

stronger decarbonisation conditions;

benchmarking based on best-performing installations;

conditional free allowances;

greater use of contracts for difference or other industrial policy instruments; and

integration with border-carbon measures.

The legal challenge is to balance environmental effectiveness against competitiveness and carbon-leakage concerns.

6. Carbon Border Adjustment Mechanism

One of the most significant developments in the UK's future carbon-market architecture is the UK Carbon Border Adjustment Mechanism (CBAM).

The UK government has legislated for CBAM to begin on 1 January 2027. It will apply a carbon price to specified emissions-intensive imported goods, initially covering sectors including:

aluminium;

cement;

fertilisers;

hydrogen; and

iron and steel.

Glass and ceramics are not initially included. (GOV.UK)

The CBAM is closely connected to carbon-market reform because its rate is linked to domestic carbon-pricing measures, including the ETS and the treatment of free allowances. (GOV.UK)

Legal significance

CBAM reform creates several important legal issues:

First, the government must establish reliable rules for calculating embedded emissions.

Second, importers need clear rules concerning registration, records, returns and verification.

Third, the mechanism must interact coherently with the UK ETS.

Fourth, the UK must consider its international trade obligations.

The 2026 legislative programme contains detailed rules concerning registration, record keeping, returns, emissions verification and calculation of carbon-price relief. (GOV.UK)

7. Potential UK–EU ETS Linking

Another major future development is possible linkage between the UK ETS and EU ETS.

At the UK-EU Summit of 19 May 2025, the UK and EU agreed to work toward linking their emissions trading systems. The UK ETS Authority has specifically stated that its standalone market-policy decisions do not prevent changes that may be required if UK-EU linking is ultimately agreed. (GOV.UK)

Linking could require legal coordination concerning:

allowance recognition;

market access;

registry systems;

MRV;

auctioning;

free allocation;

market-abuse controls;

aviation;

maritime emissions;

carbon leakage;

CBAM interaction; and

dispute resolution.

A linked market would therefore require more than administrative cooperation. It would potentially require a high degree of regulatory equivalence.

8. Carbon-Price Stability

A carbon market cannot function effectively if its price signal is excessively unstable.

The UK ETS Authority has retained its Auction Reserve Price (ARP) and Cost Containment Mechanism (CCM). The ARP increased from £22 to £28 in 2026, with annual inflation adjustment from 2027. (GOV.UK)

The CCM provides a mechanism for intervention when carbon prices experience sustained extreme increases.

Future reform could introduce:

stronger price collars;

automatic supply adjustments;

allowance reserves;

enhanced market-surveillance powers;

greater transparency of intervention criteria; and

mechanisms responding to sudden demand shocks.

The Authority considered a quantity-triggered Supply Adjustment Mechanism, but decided not to introduce it for the standalone UK ETS at that stage. (GOV.UK)

9. Market Integrity and Carbon Trading

Carbon allowances have economic value and can be traded in financial markets. Consequently, future reform will need to address:

market manipulation;

insider dealing;

fraud;

registry security;

allowance theft;

money laundering;

market concentration;

excessive speculation; and

misleading emissions information.

This is particularly important because historical carbon-credit markets demonstrated that carbon allowances can become targets for sophisticated financial fraud.

10. Case Law: Elliott-Smith v Secretary of State

Elliott-Smith v Secretary of State for Business, Energy and Industrial Strategy [2021] EWHC 1633 (Admin)

This is one of the most directly relevant UK cases.

The claimant challenged the legality of the government's decision to establish the UK ETS as the replacement for UK participation in the EU ETS following Brexit. The High Court considered the legal basis for establishing the UK ETS and the government's exercise of statutory powers. (BAILII)

Importance

The case demonstrates that carbon-market reform is subject to ordinary principles of public law.

Future UK ETS regulations must therefore be:

authorised by legislation;

procedurally lawful;

rational;

properly reasoned where required; and

within the limits of delegated powers.

This principle becomes particularly important as the government creates increasingly complex carbon-market regulations through secondary legislation.

11. Case Law: Bilta (UK) Ltd v Tradition Financial Services

Bilta (UK) Ltd v Tradition Financial Services Ltd [2025] UKSC 18

The Supreme Court considered litigation arising from historic missing-trader fraud involving EU Emissions Trading Scheme allowances. The underlying transactions involved EU carbon allowances and VAT fraud. (BAILII)

An earlier Supreme Court decision, Jetivia SA v Bilta (UK) Ltd [2015] UKSC 23, likewise concerned transactions involving European emissions allowances. (BAILII)

Importance for future reform

These cases demonstrate that carbon allowances have a substantial commercial and financial character.

Future UK carbon-market legislation therefore needs strong:

registry controls;

identity verification;

financial supervision;

anti-fraud measures;

taxation rules;

transaction monitoring; and

enforcement mechanisms.

The legal lesson is that environmental markets cannot be regulated solely as environmental programmes; they also require financial and commercial safeguards.

12. Case Law: SSE Generation

Commissioners for HMRC v SSE Generation Ltd [2023] UKSC 17

The Supreme Court dealt with questions concerning the taxation treatment of certain expenditure and the interaction of tax law with emissions-related allowances. The case illustrates the broader importance of accurately determining the legal and economic character of environmental allowances. (Supreme Court)

For future reform, this reinforces the need for coordination between:

carbon-market regulation;

corporation tax;

VAT;

environmental taxation; and

accounting treatment.

A carbon allowance may simultaneously have environmental, regulatory and financial consequences.

13. Relevant EU Case Law

Although the UK is no longer governed by the EU ETS in the same way, EU case law remains relevant for comparative analysis and any future UK-EU linkage.

Billerud Karlsborg AB v Naturvårdsverket — Case C-203/12

The CJEU considered penalties for failure to surrender sufficient emissions allowances within the prescribed period.

The Court treated the surrender obligation as fundamental to the functioning of the ETS and rejected an approach that would allow the statutory penalty to be avoided simply because the operator possessed allowances but failed to surrender them properly. (InfoCuria)

Relevance

The case supports a strict approach to:

annual compliance;

surrender deadlines;

verification;

penalties; and

regulatory certainty.

A future UK ETS should therefore maintain clear compliance rules while providing appropriate procedural mechanisms for genuine disputes.

14. Nitrogénművek: Free Allocation and Carbon Leakage

Nitrogénművek — Case C-519/24, judgment 16 April 2026

This recent CJEU case is particularly significant for future carbon-market design.

The Court held that EU law can preclude a national tax on freely allocated carbon allowances where the tax neutralises the compensatory effect of free allocation and undermines the objectives of preventing carbon leakage and preserving the incentives created by the ETS. (curia)

Importance for UK reform

Although the decision concerns EU law rather than the UK ETS, it provides an important comparative principle:

Free allowances are not simply economic subsidies; they form part of the architecture of an emissions-trading system.

Consequently, future UK legislation should carefully examine how taxation or other charges affecting allowances influence:

carbon prices;

investment incentives;

competitiveness;

carbon leakage; and

emissions-reduction incentives.

15. Procedural Fairness and Regulatory Reform

Future carbon-market reform will increasingly depend upon delegated legislation and regulatory decisions.

Important administrative-law principles include:

Consultation

Major reforms should generally be developed through transparent consultation where the governing legislation or public-law principles require it.

Legitimate expectations

Businesses making long-term investments based on regulatory frameworks may challenge abrupt changes in certain circumstances.

Reasonableness and rationality

Regulatory decisions must remain within the lawful boundaries of administrative discretion.

Equality and consistency

Comparable operators should not be treated differently without a legally relevant justification.

Reasons

Where legislation or public-law principles require reasons, authorities must explain the basis for important regulatory decisions.

These principles become increasingly important as carbon prices influence billions of pounds of investment.

16. Carbon Removals and Negative Emissions

Future UK carbon-market reform may also incorporate greenhouse-gas removals (GGRs).

The Authority has already indicated that GGRs will be included in the UK ETS architecture. (GOV.UK)

This creates difficult legal questions.

For example:

When does a removal legally qualify as permanent?

Who owns the carbon-removal credit?

Who bears liability if stored carbon later returns to the atmosphere?

What monitoring period is necessary?

How should reversal risk be addressed?

Can one tonne removed permanently offset one tonne emitted?

What verification standards should apply?

Future legislation may therefore need a carbon-removal liability regime alongside conventional emissions regulation.

17. MRV Reform

Monitoring, reporting and verification is the foundation of any carbon market.

A future UK system will likely require increasingly sophisticated:

digital monitoring;

automated reporting;

satellite-based verification;

continuous emissions monitoring;

third-party verification;

data-sharing mechanisms; and

anti-fraud controls.

This is particularly important for CBAM because imported goods may be produced under different monitoring standards abroad.

The UK's 2026 CBAM regulations already devote substantial attention to emissions and verification arrangements. (GOV.UK)

18. International Trade Law

The UK's carbon-market reforms increasingly intersect with international trade.

CBAM creates potential questions under:

WTO law;

GATT principles;

non-discrimination;

national treatment;

most-favoured-nation treatment;

subsidies law; and

international environmental agreements.

The central legal challenge is to design carbon-border measures so that they pursue legitimate environmental objectives while avoiding unjustified discrimination between domestic and foreign products.

This will become particularly important if UK CBAM interacts with the EU CBAM and other national carbon-pricing systems.

19. Future Regulatory Architecture

A mature UK carbon market is likely to consist of several interconnected instruments:

Climate Change Act 2008
↓
UK Carbon Budgets
↓
UK ETS cap
↓
Allowance allocation and auctions
↓
Carbon-price mechanisms
↓
Industrial decarbonisation incentives
↓
UK CBAM
↓
International carbon-market cooperation
↓
Possible UK-EU ETS linkage

This represents a transition from a relatively discrete emissions-trading scheme toward an integrated carbon-pricing governance system.

20. Key Legal Issues for Future Reform

21. Future Direction

The future UK carbon market is likely to develop along six major legal directions.

1. From standalone ETS to integrated carbon-pricing system

The ETS will increasingly operate alongside CBAM, industrial policy, carbon budgets and other decarbonisation measures.

2. From broad free allocation to targeted carbon-leakage protection

Free allowances are likely to become more closely connected with competitiveness and decarbonisation objectives.

3. From domestic market to interconnected market

Potential UK-EU ETS linkage could substantially increase the importance of regulatory equivalence.

4. From conventional emissions to removals

Carbon-removal activities could become part of the regulated market, requiring new rules concerning permanence and liability.

5. From manual MRV to digital verification

Technology will increasingly become part of legal compliance.

6. From environmental regulation to environmental-financial regulation

Cases involving carbon-credit fraud demonstrate why carbon markets require strong financial-market governance as well as environmental rules.

Conclusion

Future carbon-market reform in the UK is likely to transform the UK ETS from a relatively self-contained cap-and-trade mechanism into a broader legal architecture integrating emissions trading, industrial decarbonisation, carbon-border regulation, market stability, carbon removals and international cooperation.

The most significant current developments are the expansion of the UK ETS, changes to free allocation, the UK CBAM scheduled from 1 January 2027, and the work toward possible UK-EU ETS linkage. (GOV.UK)

The case law demonstrates three particularly important legal principles. Elliott-Smith shows that creation and reform of the UK ETS remains subject to judicial review and statutory limits. Bilta demonstrates the need for strong anti-fraud and financial controls in carbon-allowance markets. Billerud illustrates the importance of strict compliance with allowance-surrender requirements. Comparative EU jurisprudence, including Nitrogénművek, further demonstrates that the legal treatment of free allowances must preserve the fundamental incentives and carbon-leakage functions of an emissions-trading system. (BAILII)

Accordingly, the central legal challenge for the UK's next generation of carbon-market reform will be to combine environmental ambition, market integrity, industrial competitiveness, administrative legality and international compatibility within a single coherent regulatory framework.