Made for each other: How the Industrial Decarbonisation Bank can complement the ETS

In this article, Jannis Schneider, Willem Dil and Lukas Bertram from our economics of a green and just transition team examine the proposed new EU Industrial Decarbonisation Bank. With information about its design still sketchy, they look at how making it complementary to the Emissions Trading System can give it a reliable funding base. 

High energy costs and global competitiveness pressures are being cited by carbon intensive industries and some EU Member States to make the case for weakening the EU’s flagship decarbonisation policy, the Emissions Trading System (ETS). In recent months – notably since the start of the Iran conflict – a trade-off is being presented to policymakers; sticking to climate goals on the one hand, and strengthening economic security and competitiveness on the other

The updated ETS benchmarks presented last month, under which industry will continue to receive free carbon allowances covering 75% of emissions, are a worrying sign that the Commission is listening to these arguments.  

A decarbonisation-competitiveness trade-off? 

Of course, some degree of relief is necessary to alleviate the pressures on European industry. Europe’s energy intensive industries are facing competition from countries with lower energy prices, more lenient climate legislation, and interventionist subsidy and state support frameworks. So far, the EU’s answer to this has mainly consisted of generous exemptions from carbon pricing in the form of free allowances for affected industries. These allowances partly explain the limited success of incentivising decarbonisation investments. Less than 10% emissions reduction were achieved by Europe’s energy intensive industries between 2013 and 2022.

Now, carbon intensive industries are pushing back against the phase-out of free allowances and their replacement with the Carbon Border Adjustment Mechanism (CBAM) which would apply carbon pricing also to imported goods.

Despite the valid critiques of CBAM that were already summed up in the Draghi Report (not leveling the playing field in third markets, lack of coverage for downstream sectors, bureaucratic workload), delaying or abandoning a phase-out of free allowances and deflating the carbon price is no long-term solution to Europe’s economic woes – quite the opposite.

Over half of European industries’ final energy consumption comes from fossil fuels, which are predominantly imported. Until energy demands change, this structural dependence will continue to make the EU vulnerable to price shocks and foreign political pressure. Weakening the ETS does not help companies to push ahead with the green transition when they still face fundamental bankability issues including high up-front capital expenditure, unproven technologies, and first-mover risks. Such a move also creates fundamental uncertainties for any business that has already made decarbonisation investments or is planning them.

Keeping this in mind, how should the EU handle its energy price and competitiveness issues without undermining decarbonisation efforts?

The Industrial Decarbonisation Bank

The Clean Industrial Deal, proposed by the Commission back in February 2025 offers a solution by extending the ETS architecture with the Industrial Decarbonisation Bank (IDB). The purpose of this €100 billion instrument with a 10-year runtime is to “use ETS allowances […] to support projects with carbon emission reduction as a metric to enable technology-neutral support across industrial sectors”. The IDB will work in stages: an ‘investment booster’ worth €30 billion, will probably be rolled out in 2027; and the other €70 billion likely along with the next EU budget in 2028.

The fundamental idea of the IDB can solve the long-term ETS dilemma. Public money for decarbonisation can bridge funding gaps for the deployment and scale-up of green production. The IDB aims to disburse direct public support as a positive incentive to complement the negative incentives of carbon pricing. It thus creates a balance of ‘carrots and sticks’ for industrial decarbonisation.

By funding this public decarbonisation support through ETS revenues, the EU can provide financial assistance for industry to deliver decarbonisation goals without undermining the carbon pricing incentives – the system essentially redistributes funds from polluters to green transition leaders. This reinvestment (or recycling) would turn the EU’s carbon pricing system from a ‘cap-and-trade’ into a ‘cap-and-invest’ system.

However, at an average capacity of €10 billion per year, the IDB falls way short of the projected €34 billion of annual industrial investment needed to achieve EU climate targets. To maximize the impact of the IDB, it needs to use its funds as effectively as possible, while also increasing said funds through a strong recycling of ETS revenues.

Design: how the IDB can complement the ETS

An effective use of funds means delivering decarbonisation. The IDB must make sure that public support directly creates public value (in this case decarbonisation) and not mainly private profits. This is ideally achieved by reciprocal deals between the public and private sector through strong decarbonisation conditionalities.

So far there is very little confirmed information about the IDB’s design. The first phase ‘investment booster’ will support projects on a ‘first-come, first-served’ basis, according to their verified emissions abatement. Considering the language of the Clean Industrial Deal and the experience of the €1 billion pilot auction, the final IDB will likely be disbursed mainly through competitive bidding procedures, with carbon abatement as a main target, in the form of Carbon Contracts for Difference (CCfDs) or fixed carbon premiums.

Judging from the limited information available to date, the approach to funding is promising and can ensure the effective use of public money. Both the booster and the core IDB will disburse funding upon verified emissions reduction. The competitive bidding design can ensure proportionality of support to the decarbonisation needs of industry without relying on complex ex-ante assessments. Such an outcome-oriented, competitive, and simple support scheme comes close to the ideal conditionality design. The Commission should, therefore, aim to preserve as many of these features as possible when it publishes the legal proposal for the Bank.

• Further reading: Progress over promises – Rethinking direct public support through a progress-dependent conditionalities regime

Funding: how the IDB can complement the ETS

On the funding side, much remains uncertain. Based on the information leaked around the release of the Clean Industrial Deal, €45 billion of the budget will come from the ETS, including reassignments from the Innovation Fund. A further €25 billion is expected from a revision of the InvestEU programme with the remaining €30 billion to be raised through “voluntary top-ups […] by member states”. Yet, the political pressure on the ETS combined with Member States’ unwillingness to commit more funding in a time of fiscal stress, means that the €100 billion headline target is in jeopardy. 

This is especially worrisome given Member States’ investments in industrial decarbonisation are already insufficient. The ETS directive stipulates that Member States’ ETS revenues need to be reinvested into ‘climate action’, explicitly including industrial decarbonisation. Yet, in 2024, less than 5% of these revenues were spent on industry decarbonisation projects. Recently, Commission President Von der Leyen explicitly called on national governments to reinvest a larger share of their ETS revenues into industrial decarbonisation. Increasing recycling in this way will be essential to for an effective cap-and-invest system. 

Crucially, the IDB offers an attractive mechanism for channelling Member State contributions into industrial decarbonisation via Auctions-as-a-service (AaaS). Through such auctions, States can provide top-ups for any IDB funding call to support their domestic companies that submitted bids but were not competitive enough to be selected for funding under the core budget. AaaS is designed to be state aid compliant which makes it an attractive option for Member States to use to support industrial decarbonisation in their own country without setting up and administering their own support schemes. Encouraging Member States to recycle their ETS revenues as AaaS contributions for the IDB will be an important step to close the cap-and-invest loop and ensure it has financial firepower.

The upcoming ETS revision must lay the foundation for the IDB’s access to ETS revenues. It should include an industrial decarbonisation spending target for Member States and explicitly name the IDB’s Auctions-as-a-service as an approved use for this goal. It can also strengthen the IDB’s funding base through the reassignment of EU ETS revenues from freed-up allowances under CBAM.

Conclusion

The Industrial Decarbonisation Bank is the most credible policy proposal to complement the ETS by mobilising funding for industrial decarbonisation at scale. To succeed, the IDB needs a simple, competitive and performance-based design paired with a reliable funding base from increased ETS revenue recycling to effectively redistribute funds from polluters to clean transition leaders.