Negotiations over the reform of the EU Emissions Trading System (EU ETS) are gathering pace following the European Commission’s long-awaited overhaul proposal unveiled earlier this year.

The European Parliament, the Council and the Commission are now working towards a common position on the future of the bloc’s flagship carbon market, with the three EU institutions having jointly set the first quarter of 2027 as the target for reaching an agreement on the ETS review.

As negotiations started, significant differences are emerging over some of the reform’s most consequential provisions, not least the future of the Market Stability Reserve (MSR) and the fate of hundreds of millions of allowances held within it.

Under the current rules, when the total number of allowances in circulation (TNAC) exceeds 1,096 million, 24% of the TNAC is withdrawn from auction volumes and placed in the Market Stability Reserve (MSR). In addition, allowances held in the MSR above 400 million are invalidated and cease to be valid. Consequently, as of 1 January 2026, the MSR contained exactly 400 million valid allowances.

However, on 1 April 2026, the European Commission proposed an amendment to the Market Stability Reserve (MSR) Decision that would end the automatic invalidation of allowances held in the reserve above the current threshold. 

Instead of being permanently cancelled, these allowances would be retained in the MSR as a buffer that could be released back into the market in the future if the supply of allowances becomes scarce. The Commission’s proposal therefore aims to preserve additional allowances that could be used to support market stability and mitigate potential supply shortages in the EU ETS.

However, the European Parliament’s Committee on the Environment, Climate and Food Safety (ENVI) has taken a different position. Rather than abolishing the MSR invalidation mechanism, as proposed by the Commission, MEPs voted with a large majority to retain the mechanism while increasing the threshold from 400 million to 650 million allowances from 2027. This would allow a larger volume of allowances to remain in the MSR as a potential buffer, while allowances exceeding the new 650 million threshold would continue to be invalidated.

From a price perspective, both proposals are bearish compared with the current rules, as they preserve allowances that would otherwise be cancelled. However, Parliament’s approach is less bearish than the Commission’s, as allowances above 650 million would still be permanently invalidated. 

Different views have also emerged within the Council. According to S&P Global, Germany supports suspending MSR invalidation until 2030 to build an additional buffer, while the Netherlands proposes keeping the 400 million threshold until March 2027 before raising it to 650 million EUAs.

The diverging positions leave the future size and role of the MSR as a key issue in the upcoming negotiations as the volume of allowances preserved in the MSR could have important implications for future EUA supply, scarcity expectations and prices.