Official Report: Minutes of Evidence

The Deputy Chairperson (Mr McAleer): I welcome Richard Coey, the deputy director of the emissions trading scheme, carbon pricing and Windsor framework; Anna McMahon, the head of the UK emissions trading scheme (ETS) branch; and Mairead O'Connor, a principal scientific officer with emissions trading and business support at the NI Environment Agency (NIEA). I invite you to brief the Committee, after which members will have an opportunity to ask questions.

Ms Anna McMahon (Department of Agriculture, Environment and Rural Affairs): Thank you for the opportunity to speak to the Committee today to give it an overview of the Greenhouse Gas Emissions Trading Scheme (Amendment) Order 2026. The Order, which has been prepared by the Department for Energy Security and Net Zero, must be laid simultaneously before both Houses of the UK Parliament, the NI Assembly, the Scottish Parliament and the Welsh Parliament under paragraph 11 of schedule 3 to the Climate Change Act 2008 as an Order in Council for approval in each of the respective parliaments, before proceeding to His Majesty's Privy Council planned for March 2026 to make the Order.

The Committee will be aware that the draft Order was originally laid before the NI Assembly on 1 December 2025 but was withdrawn following the identification of two minor drafting errors flagged by the Delegated Powers and Law Reform Committee in Scotland. The draft Order has since been corrected and relaid under the draft affirmative resolution procedure. I apologise, however, for any disruption that that process may have caused. No other changes were made to the Order.

If members are content, I will not go over the background to and operation of the scheme, as the Committee will be familiar with its workings from previous ETS briefings. We are, however, happy to clarify any aspect of the scheme, if members so wish. I will instead focus on the free allocation aspect of the scheme and on the changes to free allocation that will be made by the amending Order. Members have received a summary of those changes, which was provided in a letter from the departmental Assembly liaison officer on the amending Order, which the Committee noted on Thursday 4 December 2025. A written briefing has also been provided, of which members also have a copy.

By way of a reminder, the aim of free allocation in the UK ETS is to mitigate the risk of carbon leakage, which is when companies relocate production to countries with less stringent climate laws. That can cause an increase in overall global emissions rather than achieve any net reduction, undermining the climate policy and emissions reduction goals. Free allocation of UK ETS allowances is the main policy instrument through which carbon leakage is addressed in the UK.

The provision of free allowances to operators considered at risk of carbon leakage reduces their carbon price exposure in order to lessen the risk of their relocating.

Following the establishment of the UK ETS, the UK ETS Authority initiated a review of free allocation policy in 2021 to ensure its continued effectiveness as a carbon-leakage mitigation. The proposed changes in the draft Order stem from the second phase of the review, which included the free allocation review consultation run in 2024, focusing on the distribution of free allowance to sectors most at risk of carbon leakage, and a second interim consultation — the free allocation review carbon leakage consultation — that was run in 2025, focusing on methodology for calculating and distributing free allocation. The authority published its combined final response to both consultations on 26 November 2025. In that publication, it announced three main amendments to free allocation methodology.

Currently, the UK ETS runs for 10 scheme years, which are split into two allocation periods: 2021-26 and 2027-2030. The purpose of having allocation periods is to give medium-term certainty to ETS participants about the level of free allocation that they can expect to get to allow for their business and financial planning purposes. The changes that the Order will introduce relate to the calculation of free allocation for the 2027-2030 allocation period.

I will now take the Committee through the specifics of each of the three changes. The first is an adjustment to account for COVID-19 impact. To apply for free allowances, operators must submit a baseline data report to the regulator. In Northern Ireland, that is the NIEA. That report records an installation's historical activity and emissions levels over a specified baseline period. For the purposes of the draft Order, the baseline period is 2019-2023. A calculation is then applied to determine their free allocation entitlement. It uses the data, as well as a sector-specific emissions benchmark and a carbon-leakage exposure factor (CLEF). The CLEF identifies sectors at risk of carbon leakage by assessing their trade and emissions intensities. Data on activity levels from the baseline period is therefore a key component of the calculation to determine free allocation entitlement for the 2027-2030 period. To account for the disruption that COVID-19 caused, the Order will allow applicants the option to exclude activity data for 2020 or for 2020 plus 2021, as reduced levels of activity during those years of COVID disruption could result in activity reports being unrepresentative of normal activity, potentially unfairly affecting free allocation entitlement. That approach aims to ensure fairer representation of typical activity levels for the 2027-2030 allocation period.

The second change relates to the benchmarks used in the free allocation calculation. Benchmarks are set at the average of the top 10% of most efficient operators in each subsector, with operators closer to those benchmarks receiving a higher proportion of free allowances. Efficiency is measured on the basis of emissions generated per unit of product, with lower emissions per unit indicating higher efficiency. That ensures that free allocation continues to reward and incentivise decarbonisation efforts. The draft Order updates the benchmarks used in the free allocation calculation to align them with those adopted by the EU ETS for its next allocation period. I ask the Committee to note that UK ETS benchmark values have been based on EU ETS values since the scheme's implementation in 2021. The updated EU benchmark values were not, however, available in time for the making of the draft Order, so the authority will retain the current values for the 2027 scheme year, with the aim of adopting the updated values for the 2028-2030 scheme years, once those values are available. That approach will provide operators with the necessary certainty to plan for the upcoming allocation period.

The decision across the UK to retain alignment with EU benchmarks was considered in the context of the UK and EU's announcement to work towards linking their respective ETSs, as is set out in the common understanding document published following the UK-EU summit on 19 May 2025. Maintaining alignment with the EU approach should also avoid the creation of competitive distortions between the two schemes on free allocation entitlement and maintain consistency in decarbonisation incentive.

The third amendment allows for the phased reduction of free allocation for sectors covered by the carbon border adjustment mechanism (CBAM). The UK Government have announced that, from January 2027, a UK carbon border adjustment mechanism will be introduced as a further measure to address carbon leakage by placing a carbon price on the import of goods from certain sectors, with the aim of creating a level playing field by ensuring that imported goods face the same carbon price as those produced domestically. The CBAM will eventually replace free allocation as the main carbon leakage mitigation tool for the sectors in scope, with the gradual phasing out of free allocation coinciding with the UK CBAM introduction.

The draft Order enables the reduction of free allocation annually during the period 2027-2030 for UK ETS operators covered by the UK CBAM. Operators will be required to inform their regulator if they produce CBAM goods, and a CBAM reduction factor will be applied to those UK ETS activities in each of the 2027-2030 scheme years. That approach will ensure a gradual transition for UK industries from free allowances to the UK CBAM as the primary carbon-leakage mitigation measure. The EU is planning to take a similar approach to free allocation reduction as part of the implementation of its EU CBAM.

Those are the main elements of the draft legislation. The amendments are of a technical and operational nature and are necessary to ensure the continued effective operation of the scheme. The draft Order does not extend the scope of the scheme to additional industrial sectors.

I thank members for their time and interest in the scheme and in the amending Order. We are happy to take any questions or observations.

The Deputy Chairperson (Mr McAleer): Thank you very much for your presentation.

I just want to delve into the matter a bit more deeply. The draft Order was laid in the NI Assembly originally, and drafting errors were then spotted by the Scottish Parliament. How did that happen? How did we miss the drafting errors?

Mr Richard Coey (Department of Agriculture, Environment and Rural Affairs): It is unfortunate, and I repeat the apology for any concern or inconvenience that it caused. As Anna said, the Department for Energy Security and Net Zero's drafting lawyers prepare the legislation and, as part of that process, robust legal checks are carried out prior to the legislation being presented to legislatures for laying. Three separate legal checks are carried out by different lawyers in the UK Parliament, and the devolved Administrations then also review the legislation from a policy-specific perspective. If we have any concerns about the drafting, we consult the Departmental Solicitor's Office to get them resolved. That having been said, it is unfortunate that those minor drafting errors got through this time, but, thankfully, they were spotted early in the process, and the legislation was amended before it was scrutinised further and came into force. It was a mistake, and, despite the checking done, including by us, the errors slipped through. Again, I apologise, but the changes have now been taken into account.

Members will be aware that we laid another amending statutory instrument (SI) two days ago. We were acutely aware of the need to ensure that the same thing did not happen with that SI. We are not discussing that instrument today; we will brief the Committee on it in the future. We acknowledge that a mistake was made and that we need to make sure that it does not happen again. I can reassure the Committee that checks are now in place, and we are taking extra care to make sure that whatever is presented to the Committee contains no errors. Again, apologies.

The Deputy Chairperson (Mr McAleer): Does the delay have any wider impact on the implementation of the ETS here?

Mr Coey: It does not, because the errors were picked up fairly quickly. For example, we had requested that today's briefing session be scheduled before the original laying of the draft Order, and we appreciate that we have been allowed to keep that slot, so the delay has not affected the timings too much. Subject to the Committee's views, we hope that the draft Order will pass by way of affirmative resolution. The debate has been pencilled in for, I think, 16 February.

There is still a month in which to address any queries or issues that may arise as part of the process. Because the errors were picked up so quickly, the delay has not had any knock-on impacts on implementation, thankfully.

The Deputy Chairperson (Mr McAleer): That is good to hear.

Mr McCrossan: Following on from that, I am glad that the drafting errors were picked up early. Mistakes happen.

Has any assessment been done of the financial impact on Northern Ireland-based firms, particularly on small to medium-sized enterprises (SMEs)?

Mr Coey: Regardless of the mistake that was made?

Mr McCrossan: Yes.

Mr Coey: An impact assessment was developed and published in, I think, November of last year, alongside the government response to the consultation, which set out the positions that the SI proposes to take. On the financial impact, the draft Order does not change anything significantly regarding what has been place for Northern Ireland businesses or UK businesses as a result of the free allocation process. It is a significant cost to businesses. Free allocation is important to installations.

It may be worthwhile for me to provide a wee bit of context on the amount of money that the UK ETS raises. Since the UK ETS came into force on 1 January 2021, it has raised in the region of £19 billion for the UK Treasury. The most recent auction of ETS allowances yesterday raised in the region of £140 million for the UK Treasury, so the scheme has a significant financial impact. It is hard to pinpoint the exact cost to NI businesses, because it all depends on when and where they buy their allowances, but it could be in the region of £15 million a year, depending on the price of carbon. That is very much a ballpark figure, however. It is based on the number of emissions generated in NI in 2024 times the average carbon price for that year. It is a significant financial — I do not want to say "burden", because it is a decarbonisation policy, so the incentive is there to

is supposed to encourage decarbonisation. The financial impact is very much at the forefront of our minds, given the significant costs associated with the UK ETS.

Mr McCrossan: Finally, given that a mistake was made that, thankfully, was caught early, what assurances can the Committee be given that future climate SIs will be procedurally robust?

Mr Coey: For the ones that we are working on with the UK Government to implement the UK ETS, because of the financial impact, we have robust legal checks in place at the minute. We will make sure that we double down on the legal checks. This is of no comfort at all, but it is probably worth highlighting the fact that the mistakes that were picked up were not of a significant nature and did not change the legal intent of the SI. They were presentational. For example, one of the mistakes was that the labelling for one of the tables in one of the annexes did not reflect the content of the column that it was heading. Yes, that was unfortunate, and we want to make sure that it does not happen again. I do not want to be here again explaining to you —.

Mr McCrossan: We are not that bad.

Mr Coey: No. [Laughter.]

I want to be here again, but I do not want to be here having to explain why another mistake has been made. As I say, thankfully, they were minor in nature and were picked up quickly.

Mr McCrossan: OK. Thank you.

Ms Finnegan: Thanks very much for your oral briefing. What role, if any, does the NIEA have?

Ms Mairead O'Connor (Department of Agriculture, Environment and Rural Affairs): In what context? Do you mean in the laying of the draft Order?

Ms Finnegan: Yes. I am just wondering whether the NIEA has a role to play in what has been discussed this morning. My next question was going to be this: does the NIEA have the necessary staff and resources to regulate and reinforce the ETS properly, and, if not, what risks does that pose to compliance, credibility and fairness, particularly for ensuring that the costs fall to the big polluters and not to ordinary working people?

Ms O'Connor: We work closely with the UK regulators. We have weekly meetings based on the baseline data report that Anna mentioned. Work is therefore ongoing weekly to ensure that it is ready in time for the deadlines, when it will go out to the operators. We have support outside of the NIEA. We have a small number of sites, for which there is a lot of regulation, but, again, we have a lot of support from the Environment Agency (EA), the Scottish Environment Protection Agency (SEPA) and Natural Resources Wales (NRW).

Mr Coey: It is worth mentioning that we engaged heavily with the NIEA throughout the policy development process, because we wanted to make sure that, when we develop policy, the NIEA has the capacity and resources to deliver it. The NIEA is in fairly regular contact with each of the installations about what they need to do and when they need to do it by. If it becomes clear that they will not meet the deadline for, say, applying for a free allocation, the NIEA will chase that up with the industry. I think that it is safe to say that NIEA has the resource to deliver the ETS effectively.

Ms O'Connor: Yes, we do at the minute. There are more regimes coming in: in maritime and whatever else may be coming down the line. There is a potential risk at a point, but, at the moment, we are OK to cover the installations in aviation.

Mr Coey: The question not only of whether it is deliverable but of whether it is deliverable in each of the Administrations is factored into the policy development process. There are therefore conversations between policy officials and regulators about whether they have the resources to do that and about what support mechanisms there are in the regulator community through NRW, SEPA and the EA in England so that, if there are, say, gaps in knowledge or expertise, there are people in other regulatory bodies who can provide support. I reassure the Committee that the resource is there to deliver the free allocation regime effectively.

Mr T Buchanan: What support is there for SMEs that may struggle with compliance costs?

Ms McMahon: Do we have SMEs in the scheme?

Mr Coey: There are not really SMEs in the scheme. It is mainly for the bigger industries.

Mr T Buchanan: The bigger industries.

Mr Coey: Yes, but the whole point of free allocation is to make sure that the industries do not face the full cost of their carbon allowances. They are allowed that level of free allocation so that they are not disproportionately affected or so that there is no unfair competition from imports from jurisdictions that do not necessarily have those carbon prices. That is what free allocation is all about. It is, in effect, a financial support scheme.

Mr T Buchanan: OK.

The Deputy Chairperson (Mr McAleer): Thank you very much, Richard, Anna and Mairead.

Mr Coey: Thanks for your time.