Following the Government’s recent launch of a consultation on its proposed Zero Emission Vehicle mandate and CO2 emissions regulation, James Roberts (Senior Associate), Georgina Bayly (Associate) and Emma Franck-Gwinnell (Associate) at law firm Freshfields Bruckhaus Deringer LLP set out the key points of the consultation for automotive businesses to bear in mind.

On 30 March 2023, the UK Government announced a range of new and updated energy security and net zero transition policies through its ‘Powering Up Britain’ policy papers.

Alongside these policy papers, it also launched a consultation seeking views on its proposed Zero Emission Vehicle (ZEV) mandate and framework for regulating CO2 emissions of cars and vans. This blog considers the key proposals and outlines the next steps for industry and the Government.

ZEV mandate

In its 2021 Net Zero Strategy (which was successfully challenged last year by non-profit and climate groups on the basis that the proposals were too vague and the Strategy did not contain enough detail), the Government introduced plans for a new ZEV mandate which would require manufacturers’ sales to be made up of an increasing proportion of ZEVs each year from 1 January 2024.

The 2021 Net Zero Strategy did not indicate what proportion of a manufacturer’s sales would need to be made up of ZEVs. However, the consultation document published in March now provides this information, and also introduces two mechanisms designed to introduce flexibility into the scheme: (i) if a manufacturer exceeds its ZEV targets, it will be permitted to trade the excess ZEV mandate allowances to other manufacturers; and (ii) a manufacturer may, from 2024-2026, borrow ZEV allowances from future periods in the event that they are unable to meet the ZEV mandate for the relevant year.

ZEV sales

The Government notes that zero-emission car sales in the UK are already strong (12% in 2021) and will be required to make up 100% of car sales in the UK from 2035. Based on feedback from stakeholders, its suggested targets for ZEV car sales shares, as explained in an earlier technical consultation, have now been set at 22% in 2024, rising to 38% in 2027, 80% in 2030, 92% in 2033 and 100% in 2035 (though the targets for 2031 onwards have not yet been fixed by legislation).

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The consultation describes the market for zero emission vans as “less mature” and states that the proposed trajectory for mandating ZEV van sales in the UK will initially be lower than that for ZEV car sales, before rapidly increasing from 2026. Its suggested targets for ZEV van sales shares have now been set at 10% in 2024, rising to 22% in 2026, 34% in 2027, 70% in 2030, 88% in 2033 and 100% in 2035 (again, the targets for 2031 onwards have not yet been fixed by legislation).

Manufacturers who form part of larger “connected entities” within the meaning of the Income Tax Act 2007 and the Corporation Tax Act 2010 may choose to form a “closed pool” and be treated as a single participant within the ZEV mandate, allowing ZEV allowances to be pooled together.

In the event that a manufacturer is unable to comply with the ZEV mandate in a particular year (through sales of ZEVs, buying excess ZEV mandate allowances and/or deferring its ZEV compliance requirements), it will be required to pay a penalty to the government of £15,000 per excess activity (ie non-ZEV sale) in the car scheme and of £18,000 per excess activity in the van scheme.

Trading of excess ZEV mandate allowances

The consultation indicates that manufacturers will be able to trade ZEV allowances on a permissive basis: there will be no restrictions on the price of allowances (though the Government has indicated that, in practice, it anticipates that allowances will not be sold for an amount which is greater than the penalty price to be paid to the government in the event of non-compliance with the ZEV mandate).

Manufacturers will be required to notify the scheme administrator of ZEV mandate allowance trades, including the number of allowances purchased and the price paid per allowance. However, when the scheme administrator publishes information on the net number of allowances each participant in the scheme has added or lost throughout a particular trading period, it will not publish details of the amounts paid in relation to the trades, nor the number of allowances traded in each transaction.

Deferring ZEV compliance requirements

The consultation recognises that “some vehicle manufacturers face challenges meeting targets” as their business model shifts towards ZEVs. It states that, therefore, manufacturers which are unable to comply with the ZEV mandate in the 2024-2026 trading periods will be able to “borrow” allowances from future trading periods.

The number of allowances which can be borrowed will be subject to a cap of 75% of the ZEV target in 2024, 50% in 2025 and 25% in 2026 and, to “reflect the lost environmental benefit to society of delaying the deployment of a ZEV in a given year”, a 3.5% compounding interest rate will be applied to a manufacturer’s allowance deficit for each year that it is not repaid.

Any allowance deficit carried forward from 2026 must be repaid with allowances from the 2027 trading period (including through trading), otherwise the manufacturer will be required to make a payment to the government.

Industry reaction

The reaction from industry bodies has so far been mixed. Whilst some have welcomed the setting of ambitious ZEV targets, others have criticised the continuing uncertainty concerning the categorisation of hybrid technology and noted that the relatively late publication of the mandate has made planning extremely challenging for manufacturers.

CO2 emissions regulation

Until now, the regulation of CO2 emissions produced by cars and vans in the UK has largely mirrored the EU scheme. Average CO2 emissions allowances relating to vehicles sold in the UK are set by the Vehicle Certification Agency (VCA) and, in order to avoid exceeding the allowance (and incurring a fine), manufacturers are permitted to pool – ie share – their CO2 emissions allowances. Such pools could be “closed”, meaning members of the pool are all connected entities within the same corporate group, or they could be “open”, and so include members from different corporate groups.

Under the Government’s new proposals, CO2 emissions allowances for cars and vans which do not meet the criteria to be considered exempt ZEVs will still be set by the regulator, and the same fine for exceeding the allowance is proposed to apply (£86 per gram of CO2 above the allowance, multiplied by the total number of non-ZEV cars or vans sold). However, some key divergences from the EU scheme have now been proposed as part of the consultation (although we note that regulation of vehicle CO2 emissions in the EU is also evolving, with the latest European Regulation available here).

Allowances to be tailored to individual manufacturers

Firstly, CO2 emissions allowances will be set for each manufacturer individually, by reference to the average CO2 emissions of their vehicles sold in previous periods. The baseline targets to be used from 2024, the first year of the new scheme, are intended to be calculated by reference to manufacturers’ vehicles sold in 2021. Specifically, the consultation notes that this would be the average of the CO2 emissions (using the WLTP test cycle and subtracting any CO2 savings from approved eco-innovations) of all cars or vans sold by that manufacturer in 2021, excluding any vehicle with a WLTP CO2 rating of 0g. However, if a manufacturer exceeded their CO2 emissions target in 2021 and therefore incurred a penalty, their baseline target for 2024 would be the target that applied in 2021, rather than their actual fleetwide average.

Manufacturers who sell both cars and vans in the UK market will have separate targets for each segment.

Allowances to be fixed between 2024-2030

Secondly, the Government proposes to maintain the same CO2 emissions allowance between 2024 and 2030, rather than gradually adjust targets year-on-year as under the current system. The Government’s approach here is intended to recognise that manufacturers have limited R&D budgets and that the overall objective of the legislation will be for manufacturers to shift their production to ZEVs, rather than invest in increasing the efficiency of the non-ZEV fleet.

CO2 pools to be replaced by allowance trading scheme

Thirdly, under the new scheme, manufacturers will be allowed to trade their CO2 allowances. As such, the consultation notes that open pooling is no longer necessary and would be duplicative of this new trading system. This means that 2023 will be the final year in which open CO2 pools will operate in the UK.

The proposal notes that there will be no conditions on the price for which allowances may be sold, however, trade details, including price, must be notified to the regulator. The regulator will publish information concerning the net amount of CO2 allowance which has been added or disposed of during a particular trading period by each manufacturer, however, the amounts paid and the details of specific trades will be kept confidential.

Both the CO2 emissions allowance and the ZEV mandate allowance can be traded in this way, and allowances earned under the ZEV mandate can be converted to become CO2 allowances. The consultation proposes that the rate of conversion should reflect the average CO2 emissions of non-ZEV new cars and vans, as measured in the WLTP cycle, in 2021. For example, if all new non-ZEV cars sold in 2021 had average CO2 emissions of 135 g CO2/km, then a ZEV mandate allowance earnt in 2024 could be exchanged for allowances for 135 g CO2/km for new non-ZEV cars sold in 2024.

The Government has also proposed to offer increased flexibility by counting ongoing improvements in non-ZEV emissions toward ZEV mandate targets, to be applied only in the first three years of the scheme (until the end of 2026). This proposal is made alongside an acknowledgement that manufacturers will have made multi-year investments targeting improvements in internal combustion engine efficiency, hybrid vehicles and plug-in hybrid vehicles as a way to meet CO2 targets, which may yield additional improvements in non-ZEV efficiency in the near future. The proposed 2026 cut-off can be seen as an effort to direct future investment toward ZEVs, rather than improvements in non-ZEV efficiency.

Specifically, the consultation proposes that manufacturers will be able to convert unused CO2 emissions allowances into credits in the ZEV mandate scheme, at a rate of 167 non-ZEV CO2 allowances per ZEV mandate credit in the car scheme, and 216 non-ZEV CO2 allowances per ZEV mandate credit in the van scheme. The consultation explains that these exchange rates are based on real-world differences in CO2 emissions from an average non-ZEV car or van, compared to a ZEV.

Should manufacturers choose to operate closed pools for the purpose of the ZEV mandate, they will also be required to participate as a pool for the purpose of the non-ZEV CO2 emissions standard.

Next steps

The consultation will close on 24 May 2023. Affected businesses, in particular those which contemplate making use of the ZEV and/or CO2 allowance trading schemes or ZEV mandate deferral scheme, should consider participating in the consultation. After the consultation closes, the Government will take the feedback into account when finalising the design of the ZEV mandate and CO2 emissions regulation. Once the Government has considered the feedback, it intends to put in place legislation to support the finalised policies, which are scheduled to take effect from 1 January 2024.