New EU Commission emission proposal comes at a time when tier 2 and 3 suppliers already face tough financial challenges.
Negotiations are currently underway on the EU Commission’s proposed Euro 7 emissions standard, which is intended to ensure cleaner vehicles and better air quality.
The EU has been tightening the rules on air pollution from traffic since the original Euro 1 standards in 1992. Nevertheless, according to the EU Commission it’s estimated that traffic pollution caused around 70,000 premature deaths in the EU and UK in 2018.
Euro 7 aims to reduce nitrogen oxide emissions from cars by 35% by 2035, and by over 50% for buses and trucks. The standard covers exhaust emissions and also particulate matter pollution, produced by braking and tyre abrasion.
Euro 7 also extends the implementation of standards to more journeys and more cars. Vehicles will have to comply with the pollution limits for longer, for 200,000 km or ten years.
This, at least, is the proposal. But it faces concerted pushback from vehicle manufacturers, component suppliers and some national governments. Some experts expect the proposals to be significantly changed between now and July 2025, when the rules for passenger cars and light commercial vehicles are due to come into force.
Why is Euro 7 controversial?
Euro 7 has united the automotive industry in opposition. Mercedes and Volkswagen have both criticised the timeframe for implementation, which they regard as unrealistic.
The industry is also unhappy that the new standards are likely to lead to higher vehicle prices. There are fears that the new rules could make smaller cars, in particular, disproportionately expensive. This could be counterproductive if consumers are pushed towards larger cars with higher emissions.
Many of them may give up on petrol and diesel cars altogether. Industry representatives talk of a "ban on combustion cars through the back door" and warn that up to 300,000 jobs could be at risk.
All these issues are compounded by the transition to electrical vehicles (EVs), with sales of carbon-emitting cars due to end in 2035.
The industry is committing significant amounts of money and resources to the development of all EV fleets. They argue that strict new emissions targets, which relate mostly to petrol and diesel models, will take investment and expertise away from EV projects.
The potential impact on suppliers
All of this is a challenge for vehicle manufacturers, but it could have even more serious consequences for suppliers. For smaller tier 2 and tier 3 suppliers in particular, the need to meet Euro 7 standards in a short time frame could put them in serious financial peril.
In some cases, they already are. Higher input costs in terms of commodities and labour, a tighter lending environment and the need to invest in the shift to EV has already created fragility in the sector.
Euro 7 could push tier 2 and 3 towards insolvency, as they run out of funds to cover both new emissions standards and the transition to EV. Reduced sales of smaller and relatively more expensive combustion engine cars would also hit original equipment manufacturers (OEMs) and their supplier network.
The situation around Europe
These fears are consistent across the continent. The potential for stricter emissions standards are creating uncertainty. There are concerted demands for the proposal to be changed.
“It’s not clear whether the proposal can continue in its current form, as there will be massive objections by the industry and certain affected countries,” says Jens Stobbe, Risk Services Manager for Atradius Germany. “They will demand compromise and for the proposal to loosen its very tight timeframe.”
Some suppliers may consider Euro 7 a step too far, and focus instead on the transition to EV components. “The implementation of Euro 7 will take place when suppliers in tiers 2 and 3 are transforming their business model for electric vehicles,” says Hanane Saber, Risk Services Manager for Atradius France. “They simply may not be able to do both.”
The new regulations create additional financial burden, which impacts credit risk. “New Euro 7 standards are extremely burdensome for the supply chain,” says Laura Balestrazzi, Risk Services Manager for Atradius Italy. “As a consequence we assume a higher credit risk among supply chain players.”
Euro 7 adds to supply chain fears
The consensus is that Euro 7 standards, if they are implemented in anything like current form, could create unsustainable pressure in the automotive supply chain.
Across the continent, firms are already coping with high energy and labour costs, rising interest rates and disruption caused by the war in Ukraine. In Italy, Laura says the consequences could be severe.
“In such a challenging environment, we assume an increase in insolvencies in the sector of about 10% year-on-year in the coming 12 months,” she adds.
In France, too, margins have fallen as costs have increased. Many suppliers are highly leveraged. Covid-related government support kept insolvencies at a historically low level in 2022, but that has ended. Hanane believes insolvencies in the sector could rise by as much as 50% in the next 12 months.
Similarly, some Czech-based suppliers will be forced to leave the market if they can’t transition to EV supply, according to Lenka Hermankova, Risk Services Manager at Atradius Czech Republic.
That transition requires finance, which can be difficult to access on favourable terms, especially for tier 2 and 3 suppliers.
“Although banks are in general open to financing the sector, lending conditions are often not that favourable and credit risk increases,” she says. Insolvencies among smaller suppliers are likely to increase over the next 12 to 24 months, as manufacturers switch to suppliers that can satisfy new green vehicle standards.
In Germany, Jens also foresees a ‘survival of the fittest’ scenario. Larger tier 1 suppliers can still access finance at reasonable rates. But banks are already tightening lending criteria to smaller tier 2 and 3 counterparts.
This is a concern for the supply chain across the continent. Finance is becoming harder and more expensive to access just as suppliers need to invest in the development of new, greener product lines. They will be watching the negotiations around Euro 7 nervously. If the proposals are passed in their current form, smaller suppliers in particular may struggle to remain in business.