List of acronyms Capital expenditure CAPEX Enterprise resource planning ERP European Union EU Operational expenditure OPEX Small and medium enterprises SMEs Tobacco Products Directive 2014/40/EU TPD Unique identifier UI Value added tax VAT WHO FCTC Protocol to Eliminate Illicit Trade in Tobacco Products FCTC Protocol WHO Framework Convention for Tobacco Control FCTC



Table of Contents List of acronyms 1 INTRODUCTION 1.1 Background 1.2 Broader policy context and reasons to act 2 DEFINITION OF THE ISSUES 2.1 What are the main issues to address? 2.2 How would the main issues evolve, all things being equal? – Baseline scenario 2.3 Does the EU have the right to act and is EU added value evident– Treaty base, ‘necessity test’ (subsidiarity) 2.4 Who is affected, in what ways, and to what extent? 3 OBJECTIVES 3.1 General objective

3.2 Specific objectives 3.3 Operational objectives 4 POLICY OPTIONS 4.1 Marking packages with a unique identifier (Issue 1a) 4.1.1 Policy options for achieving objective 1a: to ensure the marking of packs with a unique identifier whilst guaranteeing independence of the traceability system by appropriate assignment of roles and tasks to relevant parties 4.1.2 Policy option 1a/1: Industry operated solution 4.1.3 Policy option 1a/2: Third party operated solution 4.1.4 Policy option 1a/3: Mixed solution (industry and third party) 4.2 Recording and transmitting of data (Issue 1b) 4.2.1 Policy options for achieving objective 1b: to ensure effective surveillance and monitoring throughout the supply chain by determining the most suitable permitted time lag between an event occurrence and its recording and transmission to the data storage facility 4.2.2 Policy option 1b/1: Near real-time 4.2.3 Policy option 1b/2: One day time lag 4.2.4 Policy option 1b/3: One week time lag 4.3 Processing, storing and accessing data (Issue 1c) 4.3.1 Policy options for achieving objective 1c: To ensure effective surveillance and monitoring throughout the supply chain by identifying a system architecture which guarantees full and timely access by competent authorities and the Commission to the data recorded 4.3.2 Policy option 1c/1: Establishment of a decentralised model as per manufacturer/importer 4.3.3 Policy option 1c/2: Establishment of a decentralised model per Member State 4.3.4 Policy option 1c/3: Establishment of a combined model: decentralised for recording per manufacturer/importer with centralised surveillance 4.4 Compatibility of components of the traceability system (Issue 2) 4.4.1 Policy options for achieving objective 2: To ensure an effective transfer of information throughout the distribution chain by an optimal selection of data carriers

4.4.2 Policy option 2/1: Single data carrier per level 4.4.3 Policy option 2/2: Limited variety of data carriers per level 4.4.4 Policy option 2/3: Free system allowing any existing data carrier 4.5 Security features (Issue 3) 4.5.1 Policy options for achieving objective 3: to facilitate the authentication of tobacco products by an optimal selection of application methods for security features 4.5.2 Policy option 3/1: Printing or affixing 4.5.3 Policy option 3/2: Printing or affixing or a combination of printing and affixing 5 ANALYSIS OF IMPACTS 5.1 Marking packages with a unique identifier (Issue 1a) 5.1.1 Policy options for achieving objective 1a: to ensure the marking of packs with a unique identifier whilst guaranteeing independence of the traceability system by appropriate assignment of roles and tasks to relevant parties 5.1.2 Policy option 1a/1: Industry operated solution 5.1.2.1 Economic impacts 5.1.2.2 Social impacts 5.1.3 Policy option 1a/2: Third party operated solution 5.1.3.1 Economic impacts 5.1.3.2 Social impacts 5.1.4 Policy option 1a/3: Mixed solution (industry and third party) 5.1.4.1 Economic impacts 5.1.4.2 Social impacts 5.2 Recording and transmitting data (Issue 1b)

5.2.1 Policy options for achieving objective 1b: to ensure effective surveillance and monitoring throughout the supply chain by determining the most suitable permitted time lag between an event occurrence and its recording and transmission to the data storage facility 5.2.2 Policy option 1b/1: Near real-time 5.2.2.1 Economic impacts 5.2.2.2 Social impacts 5.2.3 Policy option 1b/2: One day time lag 5.2.3.1 Economic impacts 5.2.3.2 Social impacts 5.2.4 Policy option 1b/3: One week time lag 5.2.4.1 Economic impacts 5.2.4.2 Social benefits 5.3 Processing, storing and accessing data (Issue 1c) 5.3.1 Policy options for achieving objective 1c: To ensure effective surveillance and monitoring throughout the supply chain by identifying a system architecture, which guarantees full and timely access by competent authorities and the Commission to the data recorded 5.3.2 Policy option 1c/1: Decentralised model as per manufacturer/importer 5.3.2.1 Economic impacts 5.3.2.2 Social impacts 5.3.3 Policy option 1c/2: Decentralised model as per Member State 5.3.3.1 Economic impacts 5.3.3.2 Social impacts 5.3.4 Policy option 1c/3: Combined model 5.3.4.1 Economic impacts

5.3.4.2 Social impacts 5.4 Compatibility of components of the traceability system (Issue 2) 5.4.1 Policy options for achieving objective 2: To ensure an effective transfer of information throughout the distribution chain by an optimal selection of data carriers 5.4.2 Policy option 2/1: Single data carrier per level 5.4.2.1 Economic impacts 5.4.2.2 Social impacts 5.4.3 Policy option 2/2: Limited variety of data carriers per level 5.4.3.1 Economic impacts 5.4.3.2 Social impacts 5.4.4 Policy option 2/3: Free system allowing any existing data carrier 5.4.4.1 Economic impacts 5.4.4.2 Social impacts 5.5 Security feature 5.5.1 Policy options for achieving objective 3: to facilitate the authentication of tobacco products by an optimal selection of application methods for security features 5.5.2 Policy option 3/1: Printing or affixing 5.5.2.1 Economic impacts per stakeholder group 5.5.2.2 Social impacts 5.5.3 Policy option 3/2: Printing or affixing or a combination of printing and affixing 5.5.3.1 Economic impacts 5.5.3.2 Social impacts

6 COMPARING THE OPTIONS 6.1 Marking packages with a unique identifier (Issue 1a) 6.2 Recording and transmitting data (Issue 1b) 6.3 Processing, storing and accessing data (Issue 1c) 6.4 Compatibility of components of the traceability system (Issue 2) 6.5 Security features (Issue 3) 6.6 Summary of preferred options 7 MONITORING AND EVALUATION List of Annexes



1INTRODUCTION 1.1Background On 3 April 2014, the European Parliament and the Council adopted the Tobacco Products Directive 2014/40/EU (hereafter: TPD). The overall objective of the TPD is to approximate the laws, regulations and administrative provisions of the Member States concerning rules governing the manufacture, presentation and sale of tobacco and related products. It facilitates the smooth functioning of the internal market for tobacco and related products, taking as a base a high level of protection of human health, especially for young people. In addition, Article 1 of the TPD explicitly refers to the obligations of the European Union (EU) under the WHO Framework Convention for Tobacco Control (FCTC). Articles 15 and 16 of the TPD aim at fighting illicit trade in tobacco products and thus at contributing to reducing the circulation of tobacco products not compliant with the TPD and other tobacco control legislation, as well as reducing artificially cheap supplies of illegal tobacco products that have been found to affect the uptake and general prevalence of smoking. Market statistics indicate an increase in the percentage of the illicit trade in cigarettes for the years 2005-2015 (see Table 1). 2005 2010 2011 2012 2013 2014 2015 Total sales in million sticks 767,748 676,015 645,147 617,695 573,766 555,441 546,208 Illicit trade in million sticks 58,120 69,829 65,323 67,184 63,593 64,179 61,512 % penetration of illicit trade 7.6% 10.3% 10.1% 10.9% 11.1% 11.6% 11.3% Table 1: Illicit trade estimate of cigarettes (in EU25) Articles 15 and 16 of the TPD provide for the establishment of systems of traceability and security features for tobacco products.

The provisions relating to traceability set out in Article 15 TPD require all unit packets of tobacco products manufactured in or imported into the Union to be marked with a unique identifier (i.e. UI, containing defined data elements) and their movements to be recorded throughout the supply chain (up to the last economic operator before the first retail outlet, see Figure 1). This identifier is unique for every unit packet, allowing for its individual identification. The recorded movements are to be transmitted to and stored by an independent data storage provider (with which manufacturers and importers shall conclude data storage contracts, to be approved by the Commission). The storage providers are required to be monitored by an external auditor and the data made accessible to the competent authorities of the Member States and the Commission. The provisions relating to the security feature set out in Article 16 TPD will facilitate the authentication of tobacco products, not only for competent authorities but also for consumers. Article 16 requires all unit packets of tobacco products placed on the EU market to carry a tamper proof security feature composed of visible and invisible elements, in order to facilitate the verification of whether or not they are authentic. The systems for traceability and security features must be in place by 20 May 2019 for cigarettes and roll-your-own tobacco products, and by 20 May 2024 for all other tobacco products. This will enable manufacturers of other tobacco products (which are often small and medium enterprises (SMEs)) a longer period to adapt and to benefit from the experience gained before the system becomes applicable to them. The implementation of the traceability system provided for under Article 15 of the TPD will also enable the EU to fulfil its obligations under Article 8 of the WHO FCTC Protocol to Eliminate Illicit Trade in Tobacco Products (hereafter: FCTC Protocol), a legally binding instrument based on Article 15 of the FCTC. The EU and its 28 Member States are Parties to the FCTC and the EU ratified the FCTC Protocol in June 2016. One of the key measures of the FCTC Protocol is the establishment of a global tracking and tracing regime (Article 8), consisting of national and/or regional systems. In order to ensure international interoperability of the various national/regional systems (which are likely to be developed differently by Parties depending on their national/regional context), the Protocol provides for a 'global information-sharing focal point', to be managed centrally by the FCTC Secretariat. Parties will be obliged to ensure that traceability information is made available to this focal point upon request, thereby enabling enquiries to be made and relevant information to be received. It is Article 15 of the TPD that will implement the traceability system required under the FCTC Protocol in the EU. Due regard must therefore be given to its provisions in the preparation of the implementing legislation provided for under the TPD. It should be borne in mind that the FCTC Protocol requires each tracking and tracing system to be controlled by the Party who establishes it. In all cases, therefore, overall control of the system should be with the authorities, and it is crucial that the structure of the system to be established in the EU ensures this. In order to define key technical specifications necessary for the establishment and operation of the systems of traceability and security features, as well as to ensure interoperability across the EU, Articles 15(11) and 16(2) of the TPD require the Commission to lay down implementing acts determining technical standards: 1)for the establishment and operation of the traceability system, including: a.marking packages with a UI; b.recording and transmitting data; c.processing, storing and accessing data. 2)for ensuring that the systems used for the UI and the related functions are fully compatible with each other across the EU. 3)for the security feature . As the establishment of systems for traceability and security features for tobacco products is required under Articles 15 and 16 of the TPD, the scope of the present Impact Assessment is limited to identifying and assessing a number of alternative policy options available to the Commission to meet its technical implementing obligations. In order to conduct this assessment, the Impact Assessment draws on a variety of sources. These are described in detail in Annex 1 and include external expertise (a Feasibility Study regarding EU systems for tracking and tracing of tobacco products and for security features; an Implementation Study on the technical specifications and other key elements for a future EU system for traceability and security features), consultation with stakeholders (targeted and public consultations; workshops; meetings with Member States), as well as independent technical and legal analysis. It should be noted that an important source for the analysis of impacts set out in section 5 of this document was the second interim report of the above-mentioned Implementation Study. The relevant findings of this study, including a detailed cost-benefit analysis of the policy options, are set out in Annexes 5 and 6. Another key source and starting point for the current analysis was the impact assessment that accompanied the original TPD proposal. The methodology employed in the TPD’s impact assessment has to a large extent been replicated in the current document, in particular in relation to the calculation of social benefits as set out in sections 5 and 6, and with respect to the assumptions made regarding the effectiveness of the future systems of traceability and security features. Such an approach was deemed essential for ensuring consistency and robustness of the current analysis, and allows for gauging the potential contribution of the various policy options under consideration to achieving the overall TPD objectives. In addition to the Commission's obligations under Articles 15(11) and 16(2), Article 15(12) of the TPD empowers the Commission to adopt delegated acts to define the key elements of the data storage contracts that manufacturers and importers of tobacco products should conclude with an independent third party, as required under Article 15(8) of the TPD. Following careful consideration of the regulation guidelines it was concluded that it would not be necessary to include this analysis in the current impact assessment, in particular given that what remains for the Commission to define under this act is unlikely to have significant economic, environmental or social impacts beyond those of the policy options currently under assessment, and certain elements are likely to concern compliance of the contracts with specific Union and national law. Finally, the suitability, independence and technical capacity of the third party selected, as well as of the data storage contract to be signed by it, are required to be approved on a case-by-case basis by the Commission.

1.2Broader policy context and reasons to act Illicit trade is broadly defined as any practice or conduct prohibited by law and which relates to production, shipment, receipt, possession, distribution, sale or purchase, including any practice or conduct intended to facilitate such activity. Illicit trade takes different forms. The main categories of tobacco products traded illicitly are contraband tobacco products (i.e. legally produced products which have been diverted into illicit trade, not respecting the legal requirements in the jurisdiction of destination), counterfeit tobacco products (i.e. brand protected products which have been falsified without consent of the brand owner and are not in compliance with the legal requirements in the destination jurisdiction) and illicit/“cheap” whites (i.e. products produced [often legitimately] in their country of origin at very low cost, destined to be smuggled into other jurisdictions and not in compliance with requirements in the destination jurisdiction). Illicit products may be also sourced from illicit manufacturing within a given jurisdiction. The availability of illicit tobacco products strongly undermines the objectives of the TPD, as well as of EU tobacco control policy more generally. Firstly, illicit tobacco products are less likely to be in compliance with product regulation provisions, meaning that consumers do not benefit from key public health measures such as those provided for in the TPD. Secondly, illicit tobacco products contribute to smoking initiation and facilitate tobacco consumption, in particular for young people, by providing a cheaper and more affordable source of tobacco products than the legal supply chain. The implementation of Articles 15 and 16 of the TPD aims at reducing the availability of illicit supplies by increasing the security of the legal supply chain. The traceability system provided for under Article 15 will enable the movement of legal tobacco products to be monitored (tracking) and allow the public authorities to determine at which point a product was diverted into the illicit market (tracing). The security feature system provided for under Article 16 will facilitate authentication of unit packs of tobacco products, not only by competent authorities but also by consumers. In thus exercising a control function on the legal supply chain, the traceability and security features systems will contribute first and foremost to addressing the issue of contraband tobacco products, i.e. those legally produced but diverted into illicit trade. It should nevertheless be underlined that the systems may play a role in addressing other forms of illicit tobacco trade (counterfeit and illicit white tobacco trade), including by enabling authorities to recognise and identify normal and abnormal product flows and fluctuations. Given that an abrupt fluctuation (e.g. a sudden decrease in legal sales of certain tobacco products in a given area) may indicate that significant quantities of illicit products have begun to circulate (whether contraband, counterfeit or 'illicit whites'), such information will be a useful tool for Member States and will enable them to take appropriate investigative measures where necessary. The below case studies provide examples of how the systems provided for under Articles 15 and 16 of the TPD may contribute in practice to addressing the various forms of illicit tobacco trade. Traceability and security feature case studies: contraband, counterfeit and illicit white ·Case study 1: A dispatch truck fails to arrive at its next expected destination along the supply chain. By accessing the stored traceability information, authorities will be in a position to determine where the last recorded movements of the products in question took place. This will help to pinpoint the exact point of diversion (contraband). ·Case study 2: Regular dispatches to a specific retail outlet are suddenly cancelled or significantly reduced at the request of the retailer, due to reduced demand. By accessing the stored traceability information, authorities will be able to monitor such unexpected fluctuations and investigate whether they are due to increased circulation of illicit products in the area concerned (for example sale of counterfeit or illicit white products in a certain area/by a certain retailer). ·Case study 3: Tobacco products which do not carry security features, or whose security features have been tampered with, compromised or are otherwise non-compliant, are identified by consumers and/or owners of retail outlets in which they are placed on the market. The consumers and/or retailer outlet have been alerted to the fact that these products are likely to have emanated from illicit trade and are in a position to take appropriate action and inform authorities. It is recalled that the consumption of tobacco products is related to serious negative consequences (health risks such as various cancer types, cardiovascular problems, increased risk of blindness, impotence, lower fertility, impact on the unborn child etc.). Their treatment costs more than EUR 25 billion a year. The associated further productivity loss is estimated at EUR 8 billion a year. Last but not least, tobacco is the most significant cause of premature death in the EU, responsible for almost 700,000 deaths every year. Reducing illicit trade will contribute to strengthening the internal market in lawful tobacco products, and ensure lawful trade occurs within a regulatory framework that takes account of the objective of ensuring a high level of public health, thus alleviating the burden on health budgets for Member States. In addition, a side effect of the reduction of illicit trade will be an increase in budget revenues from the taxes on tobacco products. A 2012 study estimated the amount of duty that EU tax administrations lose to illicit trade at about EUR 11.1 billion a year. Were illicit trade to be eliminated, it has been estimated that tax revenues would increase in the range of EUR 6.1 billion to EUR 7.2 billion a year (after discounting for decreases in the tobacco consumption of artificially cheaper illicit products, according to the principles of price elasticity).

The establishment of a traceability system will also support wider EU efforts to fight illicit trade in tobacco. As the key measure to secure the supply chain, it forms part of the comprehensive EU strategy to step up the fight against cigarette smuggling and other forms of illicit trade in tobacco products. In addition, synergies and complementarities with other EU systems can be envisaged, and combined use by authorities of the future traceability system with existing systems such as the Excise Movement and Control System (EMCS) – a computerised system for monitoring the movement of excise goods under duty suspension in the EU – has the potential to improve the overall monitoring capacity of EU authorities, increase the amount of data at their disposal and allow for cross-comparison of information. This in turn will generate positive synergies in combatting illicit trade, given that exchange of information is central to the fight against fraud. As mentioned, one of the principle reasons for action stems from the need to fulfil the EU's legal obligations under the FCTC Protocol, a task which the EU has fully committed to via its 2016 ratification of the Protocol. Related to this is the potential for the EU's implementation to positively influence the FCTC Protocol ratification process in general. Ratification by a total of 40 Parties is required for the Protocol to enter into force. While this process has been completed by more than half of the required number of Parties, there remains a significant way to go. The development of a traceability system by the EU – which will be among the first Parties to implement the Protocol's tracking and tracing requirements (as well as the first to develop a system across multiple countries i.e. all EU Member States) – may encourage further ratifications, not only by remaining EU Member States but by third countries and regions, who will be in a position to draw on the EU's experience. As the EU has been a key player in developing the tracking and tracing obligations under the FCTC it is well placed to continue to play a vital role in this respect. Finally, while in the past the EU and the Member States have concluded legally binding anti-contraband and anti-counterfeit agreements with the four largest tobacco manufacturers, the aims of which were to reduce the number of contraband and counterfeit tobacco products smuggled into the EU, a decision not to renew the first of these agreements – with PMI – following its expiry in 2016 was recently taken by the Commission. This followed a technical assessment by the Commission of the experience with the PMI agreement which found that, though it had made an important contribution to the fight against PMI illicit trade, the market and legislative framework had changed significantly since its entry into force. The assessment concluded that the TPD and the FCTC Protocol were now the best instruments with which to fight against illicit trade in the EU.



2DEFINITION OF THE ISSUES 2.1What are the main issues to address? The purpose of this Impact Assessment is to identify and assess a set of alternative policy options capable of enabling the Commission to meet its implementing obligations relating to the establishment and operation of systems for traceability and security features, as provided for under Articles 15 and 16 of the TPD. The main issues which these options must address can be broken down as follows: 1.The need to determine technical standards for the traceability system, including: a.marking packages with a UI; b.recording and transmitting data; and c.processing, storing and accessing data. 2.The need to determine technical standards to ensure full compatibility of components of the traceability system. 3.The need to determine technical standards for security features. Issues 1 (a. b. and c.) and 2 stem from the traceability system requirements under Article 15 TPD. In a workable traceability system, these issues will be closely interlinked: the marking of a tobacco pack with a UI, which will contain the information required under Article 15(2) TPD, will be the first step in the process (issue 1a). Economic operators will have to read this UI at all subsequent points in the supply chain (until the last point before the first retail outlet) in order to ensure that information on all of the product's movements is recorded and transmitted to a data storage facility (issue 1b), where it will be processed and made accessible to authorities for monitoring and enforcement purposes (issue 1c). (In this way, they will be provided with an overview of all tobacco product movements in the EU, making it possible for them to identify instances of illicit trade and take appropriate action). In order to ensure that the system operates smoothly, key technical compatibility requirements must be put in place (issue 2), in particular to ensure that all economic operators are in a position to record (scan) the required information.

Figure 2 below illustrates how these issues should combine and interact in a functioning traceability system. Issues 3 stems from the security feature requirements under Article 16 TPD. It is important to highlight that this is a separate and distinct issue from those relating to the traceability system under Article 15. The requirement for unit packets of tobacco products to carry security features is intended as an additional means (on top of the traceability system requirements) of verifying whether or not the products are authentic, not only for authorities but also for consumers. It is also the only issue that does not stem from FCTC Protocol requirements. For this reason, it is necessary to treat it independently. Further details relating to the questions to be addressed under each issue are set out below. Issue 1a: Marking packages with a unique identifier (UI) This issue is at the core of the traceability system. In order to track and trace tobacco products, it is necessary to mark each packet with a UI containing defined data elements (such as date and place of manufacturing, intended retail market etc.), as set out in Article 15(2) of the TPD.The marking is the basis for all subsequent steps performed within the traceability system. The process of marking with a UI can be broken down into the following main sub-tasks: -generation of a part of the UI, providing for its uniqueness (i.e. through serialisation) -application of the UI on packs (i.e. printing/affixing), -optical verification of its correct application (i.e. scanning the UI to ensure it is correctly applied). A proper assignment of responsibility for each of these tasks amongst the various parties involved in the operation of the traceability system is central in order to provide for an effective system, ensure the required full control by the competent authorities (as required under the FCTC Protocol) and prevent potential manipulation. Various potential task allocation arrangements are presented under policy options 1a/1, 1a/2 and 1a/3.

Issue 1b: Recording and transmitting data Once products are marked with UI, a key task is the recording and transmission of information on their subsequent movements. Article 15(5) of the TPD specifies that Member States shall ensure that "all economic operators involved in the trade of tobacco products, from the manufacturer to the last economic operator before the first retail outlet, record the entry of all unit packets into their possession, as well as all intermediate movements and the final exit of the unit packets from their possession". Article 15 further clarifies that this information must be transmitted to a data storage facility. A key consideration in this context, given the nature and objectives of the system, as well as the need to avoid the possibility of manipulation, is the time that elapses between the occurrence of a reporting event (e.g. dispatch from facility; arrival at subsequent facility; aggregation of unit packs/disaggregation of unit packs etc.) and the transmission of the related information to the data storage system(s). Article 15 does not define precise modalities in this respect. Alternative maximum permitted time limits are presented under policy options 1b/1, 1b/2 and 1b/3. Issue 1c: Processing, storing and accessing data Following the recording and transmission of product data (issue 1b), the question of how it should be processed, stored and subsequently accessed by competent authorities becomes crucial. A system architecture that is capable of enabling easy upload of data by all relevant economic operators, providing secure storage of that data and offering full accessibility to it for competent authorities, as required under Article 15 of the TPD, is necessary to guarantee effective monitoring and enforcement. Alternative system architectures are presented under policy options 1c/1, 1c/2 and 1c/3. Issue 2: Compatibility of components of the traceability system The Commission is required to determine technical standards to ensure that components of the traceability system are fully compatible with each other (e.g. along the supply chain, across Member States etc.). These standards should facilitate the process of recording and transmission of product data for relevant supply chain actors (who will need to ensure compatibility with external components such as scanning devices) by ensuring that the information contained in the UI is encoded on packs in a pre-defined manner via data carriers (e.g. barcodes). The authorised variety of data carriers should therefore be clearly defined. It should be noted that Article 15(5) of the TPD also provides for the marking and recording of aggregated packaging, such as cartons, mastercases and pallets, provided that the tracking and tracing of unit packs remains possible. As all events entailing aggregation, disaggregation and re-aggregation of unit packs along the supply chain will need to be recorded, and the related information transmitted to the data storage facility, it will be necessary to foresee the placement of UIs also at aggregated packaging levels, as outlined in the figure below: The various alternatives are presented under policy options 2/1, 2/2 and 2/3. Issue 3: Security features

The TPD requires all unit packets of tobacco products placed on the EU market to carry a tamper proof and indelible security feature, composed of visible and invisible elements. In general, security features may be composed of one or a number of authentication elements (e.g. special inks visible in ultraviolet or infra-red, watermarks, high-tech micro-prints, chemical, biological and electronic taggants, holograms, security threads, etc.), which may be combined to generate a complete security feature meeting the requirements of Article 16 TPD. The method of applying security features on packs is important for ensuring that they are able to fulfil their authentication function and meet the requirements of the TPD, in particular the requirement to be irremovable, indelible and tamper-proof. The chosen method should take into account different manufacturing processes and packaging types, the need to allow for future innovation and technological developments capable of enhancing the security feature, as well as the needs of consumers and enforcement authorities. The alternative policy options are presented under options 3/1 and 3/2. 2.2How would the main issues evolve, all things being equal? – Baseline scenario Though exact figures for illicit tobacco trade penetration are difficult to establish, overall levels remain high, as confirmed by a recent progress report. Illicit trade in cigarettes as a percentage of total trade is estimated to have amounted to 11.3 % in the EU in 2015. In addition, there are significant variations across EU countries: some Member States have witnessed decreases while others have witnessed increases in recent years. It has been estimated that in some Member States the illicit market share may exceed one quarter of the entire tobacco market. Concerted efforts to fight illicit trade, in particular by means of tracking and tracing, have been scarce at Member State as well as at international level. The Impact Assessment of the TPD outlined how national legislation to address illicit trade in tobacco products is not harmonised across the EU.Without EU action, it is likely that Member States would adopt different national solutions. This would not only hinder the functioning of the internal market, but lead to different levels of monitoring and enforcement, as well as to interoperability issues, which would be detrimental to the proper functioning of the measures and to the supply chain. Where the marking of tobacco products has taken place in the past, this has most commonly been carried out by tobacco industry, using the system developed, owned and operated by it. This system has not been developed with a view to meeting the specific legal requirements of independence and control set out in the TPD and FCTC Protocol. According to the WHO FCTC Secretariat, the industry system conflicts with the FCTC Protocol and does not meet the requirement of Article 8.2 for the tracking and tracing system to be “controlled by the Party”. At international level, currently three countries (Brazil, Kenya, and Turkey) have implemented specific marking systems for tobacco products intended to comply with the requirements of Article 8 of the FCTC Protocol. The EU closely monitors these developments, notably in the context of information-sharing practices under the FCTC. Further details relating to their operation are set out in Annex 10. The national contexts of these systems, however, differ significantly from that of the EU, which is in many respects unique: not only is the EU's system required to comply with the specific legal framework set out in the TPD, but it must be capable of operating across its multiple Member States. It is therefore necessary for the EU to develop solutions suitable for its specific situation. Traceability requirements have recently been introduced in the EU in the field of pharmaceutical products. This system aims to reduce the number of falsified medicines circulating in the EU and represents a concrete example of traceability from the health sector which, like the traceability system for tobacco products, is enforcement-driven. Nevertheless, important differences between the two exist which make direct comparison difficult: the system envisaged for medicinal products foresees a 'check-in, check-out' (or end-to-end) verification system, rather than the recording of all intermediate supply-chain movements as is the case for tobacco products, and the scanning of aggregated packaging levels is not provided for. Finally, the system for medicinal products is not yet fully operational, making it difficult at this stage to draw on the system's practical experience. The failure of the EU to take action would also lead to a significant regulatory gap, given the recent decision (outlined in section 1.2) not to renew the first of the legally binding anti-contraband and anti-counterfeit agreements with the four largest tobacco manufacturers, following its expiry in 2016. Such a decision was based on a clear presumption of future action on the part of the EU to implement the systems provided for under the TPD and the FCTC Protocol. All of the above further underlines the need for timely implementation of Articles 15 and 16 of the TPD in the EU. In the absence of this, the current high levels of illicit trade of tobacco products are likely to persist or increase. This would negatively affect the free circulation of compliant products and also undermine the objective of a high level of health protection pursued by the TPD. From a legal perspective, the absence of action at EU level would render it very difficult for Member States to meet their obligations under Articles 15 and 16 of the TPD in a workable and interoperable manner, namely to ensure the tracking and tracing of all unit packs of tobacco products and their marking with a security feature. It would in addition significantly increase the difficulty for Member States to meet their obligations under the FCTC Protocol, not least the requirement to make the traceability information of each Party available to the 'global information-sharing focal point' foreseen under Article 8 of the FCTC Protocol. 2.3Does the EU have the right to act and is EU added value evident– Treaty base, ‘necessity test’ (subsidiarity) This initiative implements Articles 15 and 16 of the TPD. The power to adopt implementing acts is conferred upon the Commission by these articles. A subsidiarity check was already carried out in the Impact Assessment of the TPD and compliance with the principle has been confirmed by the Court of Justice of the EU. In the absence of the adoption of these acts, the Commission would not meet its obligations under the above mentioned provisions. In addition, the EU, as Party to both the FCTC and the FCTC Protocol, has committed to establishing a tracking and tracing system for tobacco products. The EU's implementation of its traceability system for tobacco products may encourage ratification by remaining EU Member States as well as third countries, thereby contributing to accelerating the entry into force of the FCTC Protocol.

2.4Who is affected, in what ways, and to what extent? A list of affected stakeholders and related information is set out in Annex 8.



3OBJECTIVES 3.1General objective The general objective of this initiative is to implement the systems for traceability and security features provided for under Articles 15 and 16 of the TPD, and thereby to address the issue of illicit trade in tobacco products, which undermines the free circulation of products compliant with the TPD and other tobacco control legislation. 3.2Specific objectives The specific objectives of the implementing acts can be summarised as follows: -ensure effective tracking and tracing for tobacco products within the EU. -ensure an effective system of security features for tobacco products. -ensure international interoperability of the EU's traceability system with the future global tracking and tracing regime provided for under Article 8 the FCTC Protocol. In all cases, the assessment of effectiveness must take into account the need to ensure the ability of authorities to oversee the establishment and operation of the systems, and the extent to which national enforcement activities are facilitated. 3.3Operational objectives The operational objectives of this initiative have been identified with the aim of developing appropriate solutions for the five main issues referred to in section 2.1: -Issue 1a: to ensure the marking of packs with a unique identifier whilst guaranteeing independence of the traceability system by appropriate assignment of roles and tasks to relevant parties (objective 1a). -Issue 1b: to ensure effective surveillance and monitoring throughout the supply chain by determining the most suitable permitted time lag between an event occurrence and its recording and transmission to the data storage facility (objective 1b). -Issue 1c: to ensure effective surveillance and monitoring throughout the supply chain by identifying a system architecture which guarantees full and timely access by competent authorities and the Commission to the data recorded (objective 1c). -Issue 2: to ensure an effective transfer of information throughout the distribution chain by an optimal selection of data carriers (objective 2). -Issue 3: to facilitate the authentication of tobacco products by an optimal selection of application methods for security features (objective 3).

A relationship table linking the main issues with the operational objectives and the policy options presented in future sections can be found in Annex 4. It should be recalled that Article 15 of the TPD sets out the key requirements for tobacco products to be tracked and traced throughout the Union, leaving to the Commission the task of developing technical standards related to the practical establishment and operation of the system. This impact assessment identifies and addresses the main issues (listed above) not directly addressed in the basic act but central to achieving full system functionality. 4POLICY OPTIONS In order to ensure that the issues referred to in section 2.1 are properly addressed and achieve the operational objectives set out in section 3.2, several policy options have been identified. These policy options were initially based on input received from external expertise (the Feasibility Study) and further developed by the Commission (Inception Impact Assessment). In parallel, in order to test the policy options, as well as to gain the key views of stakeholders (Member States; economic operators; non-governmental organisations; solution providers; the general public), a series of consultation exercises was undertaken. Further external expertise was also sought (Implementation Study) and legal and independent analysis was carried out. Based on this input, the options have been further adapted, in particular to take into account the realities of the supply chain, the enforcement needs of competent authorities, the burdens that may reasonably be imposed on different operators and the need to make the systems adaptable to future technological developments and innovation. With respect to the latter point, where possible across the policy options the use of open, non-proprietary standards has been included and technical specifications are set out in general terms instead of via specific requirements that may undermine flexibility or favour proprietary technologies. Open standards and generalised technical specifications play an important role in allowing systems to keep up to date with technological advances. This is crucial for their effective functioning over time and for preventing them from being locked into specific or proprietary technologies and solutions. Such an approach also contributes to stimulating competition and innovation in the market. It should be noted that such an approach was widely favoured across stakeholders groups throughout the consultation process and is therefore considered to be beneficial for economic operators and public authorities, as well as for the long-term viability of the systems. In relation to the traceability system provided for under Article 15, it should be noted that all policy options should be capable of enabling it to achieve the basic system functionality illustrated in figure 4 below. A set of options for each of the main issues identified in section 2.1 is presented below. 4.1Marking packages with a unique identifier (Issue 1a) 4.1.1Policy options for achieving objective 1a: to ensure the marking of packs with a unique identifier whilst guaranteeing independence of the traceability system by appropriate assignment of roles and tasks to relevant parties As explained above, the process of marking tobacco packs with a UI consists of: -generation of a part of the UI, providing for its uniqueness (i.e. through serialisation);

-application of the UI; -optical verification of the UI. The TPD remains silent as to the task allocation of these main functions, but reference is made to ensuring the independence of the traceability system. In addition, the FCTC Protocol stipulates that the system must be controlled by the Parties. This means that competent authorities must be able to control, supervise and direct all relevant actions. This approach does not exclude the possibility for other actors to operate and perform a sub-set of activities that are necessary for the effective functioning of the system, as long as competent authorities maintain full control of the system. Against this background, and given the various levels of the supply chain (as illustrated in Figure 3 below), the allocation of roles and tasks concerning the above main functions of marking tobacco packs with a UI must be clearly defined. It should be recalled that UIs will need to be applied not only at unit pack level but also at aggregated packaging levels (see Issue 2, section 2.1), and that in such cases the above sub-tasks – generation, application and optical verification – must also be performed. UIs for aggregated packaging levels should primarily enable identification of the unit packs contained within the aggregation – e.g. by listing or linking to their UIs. The policy options below set out the alternatives for the allocation of roles and tasks. 4.1.2Policy option 1a/1: Industry operated solution Under this option manufacturers and importers of tobacco products are responsible for all three sub-tasks identified above, both at the level of unit packets as well as for any aggregated packaging produced at the manufacturing facility. Where aggregation (or re-aggregation) of unit packs is carried out by subsequent supply chain operators, such as distributors, the operators in question would be allowed to generate UIs themselves, or request them from the manufacturer. These operators would then be responsible for applying and verifying them on the aggregated packaging. Nevertheless, as all three key sub-tasks related to marking with a UI are performed by the industry under this option, it would be necessary to set in place extensive control mechanisms to ensure the independence of the system and its full control by the competent authorities. The execution of these extensive controls would be the responsibility of the competent authorities and may involve their own presence or the presence of an appointed third party in the manufacturing facilities. 4.1.3Policy option 1a/2: Third party operated solution Under this option, independent third parties, with no link to the tobacco industry, are responsible for carrying out all three sub-tasks identified above. The independence and technical capabilities of the third parties would be assessed by the competent authorities. The independent third parties would require permanent access to the production facilities in order to install and operate their equipment on the production lines. Distributors and operators at subsequent points along the supply chain would be allowed to apply and verify UIs on the aggregated packaging themselves, after receiving them from an independent third party. 4.1.4Policy option 1a/3: Mixed solution (industry and third party) This option proposes dividing responsibility for the different sub-tasks between the tobacco industry, supply chain operators and independent third parties. This division of the tasks would be such as to allow competent authorities (via the independent third parties) to control, supervise and direct all relevant actions of the system, whilst permitting sub-tasks of a more technical nature to be carried out by the economic operators. The division of tasks under this option means that, in the case of unmarked packages of genuine products found in circulation, economic operators would remain fully and directly accountable. Based on discussions with experts and relevant stakeholders, the generation of a part of the UI (providing for its uniqueness) has been identified as the sub-task most fundamental to system control, as it provides control over the supply of identifiers, offers the possibility to ensure their uniqueness and best protects against manipulation. Under the mixed solution, independent third parties, with no link to the tobacco industry, would be responsible for the generation of a part of the UIs for all packs (both unit packs and aggregated levels). The independence and technical capabilities of the third parties would be assessed by the competent authorities. Independent third parties would not require permanent access to the production facilities but would be requested to install anti-tampering devices (such as surveillance cameras) on production lines in order to provide for additional checks. The parts of the UIs generated would be transferred by the independent third parties to manufacturers and importers upon request, via secure channels. Manufacturers and importers would be made responsible for sub-tasks of a more technical nature; i.e. application and verification of UIs.

Distributors and operators at subsequent points along the supply chain would be required to request UIs for aggregated packaging levels from the third parties and to subsequently apply and verify them. It should be pointed out that, as independent third parties will not be in a position, time wise, to obtain from the manufacturers all the information necessary to form the UI (as set out in Article 15(2) of the TPD), such as time of manufacture, the remaining information would need to be completed on site by the manufacturer (or distributor/operator). These parts should be clearly defined. It should be noted that although this option presents a more complex division of tasks than the previous options outlined, its technical feasibility has been confirmed in analysis by experts. 4.2Recording and transmitting of data (Issue 1b) 4.2.1Policy options for achieving objective 1b: to ensure effective surveillance and monitoring throughout the supply chain by determining the most suitable permitted time lag between an event occurrence and its recording and transmission to the data storage facility The TPD requires all economic operators involved in the tobacco product supply chain (from the manufacturer to the last economic operator before the first retail outlet) to record all movements relating to unit packets of tobacco products – including the entry into possession, intermediate movements and final exit from possession – and transmit this data to the relevant data storage facility. In order to enable competent authorities to carry out their surveillance and enforcement activities effectively, in particular in cases in which it is necessary to take rapid action, up-to-date information relating to product movements should be available to them. In order to ensure this, it is necessary for information on the movement of products (or 'events') to be recorded and transmitted to the data storage facility in as timely a manner as possible. Maximum permitted time lags between the occurrence of an event (e.g. the scanning of a UI upon application; the dispatch of products from a facility; the arrival of products at a subsequent facility; aggregations performed by economic operators etc.) and its transmission to the data storage by economic operators should therefore be defined. Three possible options have been identified: a near real-time, once daily or once weekly time lag. A longer time lag would not allow for attainment of the policy objective identified as it would no longer be possible to effectively monitor the movements of products. 4.2.2Policy option 1b/1: Near real-time This option proposes a minimum permitted (near real-time) time lag between a supply chain event and its recording and transmission to the relevant data storage by an economic operator. Real-time reporting requirements are often in the order of several seconds. However, in order to provide some margin for the internal processes of economic operators, this policy option foresees a near real-time requirement (e.g. transmission to data storage facility up to a number of hours after an event occurrence). Economic operators would be allowed to process the event in their internal systems and would then be required to transmit the related information to the data storage facility by the elapse of the set time lag. Competent authorities would receive regular reports containing smaller data volumes. 4.2.3Policy option 1b/2: One day time lag This option proposes a maximum permitted time lag of 24 hours between a supply chain event and its recording and transmission to the data storage facility by an economic operator. Relevant processing of the event data by the economic operator’s internal system could take place during this time and competent authorities would expect to see once-daily transmissions to the data storage. This would result in the need for economic operators making use of the 24 hour permitted time lag to locally store and later transmit a larger amount of data (compared to option 1b/1), which could be transmitted in batches. 4.2.4Policy option 1b/3: One week time lag This option proposes a maximum permitted time lag of 7 days between a supply chain event and its recording and transmission to the data storage by an economic operator. Relevant processing of the event data by an economic operator’s internal system could take place during this time and competent authorities would expect to see once-weekly transmissions to the data storage. This would result in the need for economic operators making use of the 7 day permitted time lag to locally store and later transmit a larger amount of data (compared to option 1b/1 and 1b/2), which could be transmitted in batches. 4.3Processing, storing and accessing data (Issue 1c) 4.3.1Policy options for achieving objective 1c: To ensure effective surveillance and monitoring throughout the supply chain by identifying a system architecture which guarantees full and timely access by competent authorities and the Commission to the data recorded In order to ensure effective surveillance and enforcement activities, the TPD stipulates that the Commission, the national competent authorities and the external auditor shall have full access to the data which is recorded, transmitted to and subsequently stored within the facilities of an independent third party. By accessing the data stored, competent authorities will have the possibility to systematically monitor the movement of tobacco products throughout the supply chain ("tracking”). In addition, at the time of any inspection it will be possible to recreate the route taken by the product and to determine at what point it was diverted into illicit trade ("tracing"). In this context, the architecture of the storage system, the means by which data can be processed and stored by it and the ease with which competent authorities can access it are key aspects to be defined. Three policy options have been identified in this respect: a decentralised model per manufacturer/importer, a decentralised model per Member State and a combined model that is decentralised for recording (per manufacturer/importer) but which comprises a common copy of data providing for read access by the competent authorities of the Member States, at centralised level.

It should be pointed out that both the Inception Impact Assessment and the Feasibility Study had identified the establishment of a single centralised data storage as an additional alternative option. Following further scrutiny of the relevant legal provisions, as well as careful consideration of the input received from stakeholders, a decision not to retain the option of a single centralized data storage was taken. The current impact assessment instead adopts an approach based on the establishment of technical standards to ensure that the data storage contracts effectively serve the purpose for which they are intended – namely to ensure an effective and independent system for the traceability of tobacco products – but are nevertheless capable of providing authorities with the global overview and ease of access to the stored data necessary. It should be noted that the above approach does not exclude the possibility for manufacturers to freely opt for one single data storage provider for the EU. 4.3.2Policy option 1c/1: Establishment of a decentralised model as per manufacturer/importer This policy option provides for the establishment of multiple independent data storage repositories organised per manufacturer or importer (i.e. decentralised). It leaves the choice of independent data storage provider to each manufacturer or importer. In all cases the suitability of the third party must be approved by the Commission. In order to ensure that information recorded by economic operators is correctly processed, this option provides for a data router service run by an independent third party and responsible for ensuring the transmission of data to the correct data storage facility. Furthermore, to ensure that the required access to the stored data is granted to the Commission, the competent authorities of the Member States and the external auditor, as provided for in Article 15(8), this option includes the creation of a central query tool (called ‘discovery service’ in Figure 4 below) run by an independent third party and linked with all decentralised repositories. This would allow authorities to address queries relating to the data stored in all individual repositories (e.g. similar to using a system with access to all libraries in the EU to identify the location of a particular book). The query tool would not permanently store any traceability data but would facilitate data searches (in contrast to option 1c/3 below). 4.3.3Policy option 1c/2: Establishment of a decentralised model per Member State This policy option proposes the establishment of one data storage repository per Member State. Each repository would host data exclusively related to the Member State in question, i.e. related to tobacco products manufactured and/or placed on the market in that Member State, and/or imported into the EU on its territory. For this purpose, each Member State would be responsible for the identification of an independent data storage provider which would host data related to it, and with which each (relevant) manufacturer or importer would sign a contract. To ensure the required access to the stored data by the Commission, the competent authorities of the Member States and the external auditor, as provided for in Article 15(8), this option provides for the creation of a central query tool run by an independent third party and linked with the national repositories, similar to that described under policy option 1c/1. Such a central query tool would allow competent authorities to analyse data hosted in the repository of other Member States (thereby allowing Member States to, inter alia, verify products merely in transit across their territory). To ensure the transmission of data to the correct data storage facility, this option provides for a router service, similar to that described under the policy option 1c/1. 4.3.4Policy option 1c/3: Establishment of a combined model: decentralised for recording per manufacturer/importer with centralised surveillance This policy option provides for the establishment of a data storage system which is composed of multiple decentralised repositories, organised per manufacturer/importer, as well as for a central surveillance solution, including a single centralised data storage repository, run by an independent third party, which can be commonly accessed and viewed by Member States. The main difference as compared to policy options 1c/1 and 1c/2 is that the central element stores a copy of all data transmitted to the individual decentralised repositories in one common data repository (see Figure 5). The presence of this single central data repository, managed by an independent third party and made accessible to all Member States, would provide competent authorities with a global overview of the supply chain, not limited to the specific "search question" necessary under the central query tool system in the options above. This would enable Member States to ensure full access according to Article 15(8) of the TPD. To ensure the transmission of data to the correct data storage facility, this option provides for a router service, similar to that described under the previous policy options. 4.4Compatibility of components of the traceability system (Issue 2)

4.4.1Policy options for achieving objective 2: To ensure an effective transfer of information throughout the distribution chain by an optimal selection of data carriers Marking with data carriers (which contain the UIs), such as barcodes, will take place at unit packet as well as aggregated packaging level. To assure effective identification of products, a data carrier must be able to hold a UI containing all the required information. Technical specifications relating to data carriers are central for ensuring readability of all information required under Article 15 of the TPD across the supply chain and by all actors. This further guarantees the interoperability of the system. Three alternative policy options have been identified. It should be noted that in order to ensure full compatibility, it will be essential for data carriers to use open standards based on non-proprietary solutions, so that they are available to all operators. 4.4.2Policy option 2/1: Single data carrier per level This option proposes a single authorised data carrier per packaging level, i.e. one data carrier for unit pack level, and one separate data carrier for carton, mastercase and pallet level respectively. Manufacturers and importers would need to adjust their machinery to apply and read the authorised data carrier, depending on the packaging levels being produced/imported. Wholesalers and distributors would have to make use of scanners that are capable of reading the authorised data carrier for aggregation levels, and competent authorities carrying out inspections would have to do likewise for all packaging levels. 4.4.3Policy option 2/2: Limited variety of data carriers per level Under this option, economic operators may choose from a limited number of authorised data carriers per packaging level, i.e. a limited number of data carriers for unit pack level, and a separate limited number for carton, mastercase and pallet levels respectively (overlaps in the authorised data carriers per level are likely). Manufacturers would need to adjust their machinery to at least one data carrier from the limited authorised list. Wholesalers and distributors would have to make use of scanning devices that are capable of reading all the authorised data carriers for aggregation levels, and competent authorities carrying out inspections would have to do likewise for all packaging levels. 4.4.4Policy option 2/3: Free system allowing any existing data carrier This option proposes that any data carrier may be placed on the unit pack and at aggregation levels, as long as it is able to hold a UI containing all the required information. Manufacturers would therefore need to select at least one type of data carrier meeting the necessary requirements and adjust their machinery accordingly. Conversely, wholesalers and distributors, as well as competent authorities carrying out inspections, would need to ensure that they use scanners capable of reading all data carriers available on the market. 4.5Security features (Issue 3) 4.5.1Policy options for achieving objective 3: to facilitate the authentication of tobacco products by an optimal selection of application methods for security features The method of applying security features on packs is important, in particular given that different packaging types (e.g. paper, wood etc.) may require different application methods. An important additional consideration is that Article 16 of the TPD permits Member States to allow the use of tax stamps or fiscal markings for the security feature, provided they meet the requirements of that article (including those to be laid down via implementing acts). It is important to ensure that future developments and innovation in the field of security feature technology, which may provide enhanced protection, are capable of being incorporated. The chosen method of applying security features to packs can play an important role in achieving this by widening the potential variety of authentication elements that may be used to form security features. Further information relating to the two methods of adding security features provided for under Article 16 (printing or affixing) has therefore been sought via external expertise and consultation. The latter provided competent authorities, economic stakeholders and consumers with an opportunity to provide targeted input. The Commission was provided with a useful overview of existing methods as well as insight into their feasibility and expected impact for different production lines. The needs of enforcement authorities were also clarified and potential future evolutions in the field of security feature technology were indicated. It emerged as important that the technical standards to be laid down by the Commission ensure flexibility and avoid prescribing the use of specific authentication elements to form the security feature, an approach which would favour proprietary solutions and exclude the incorporation of technologies yet to be developed. Taking this into account, two policy options were identified in line with Article 16: the first would allow a choice between printing and affixing of security features on unit packs. The second would extend this choice to permit, in addition to the above, a combination of the two methods, i.e. a security feature applied to unit packs via a combination of printing and affixing.

4.5.2Policy option 3/1: Printing or affixing Under this option there would be two possible methods for adding a security feature to unit packs. Printing is the first of these, provided it is performed in a way that renders the feature irremovable. This requires the printing to take place directly on the unit pack (i.e. before it is wrapped in surrounding material such as cellophane). Under this method, it may be possible for the printing to be performed either on the manufacturers’ production lines or at a previous stage (such as by the suppliers of packaging material). Affixing is the other method by which security features could be placed on unit packs, provided it is performed in a way that renders the feature irremovable. This is likely to involve placing the security feature in an area where it is impossible to tamper with it without breaking or damaging the unit pack and/or the use of specific technologies (e.g. frangible papers). Affixing must take place directly on the unit pack and before it is wrapped in surrounding material such as cellophane. Affixing is currently the most common method by which Member States’ tax stamps or fiscal markings are applied to packs. 4.5.3Policy option 3/2: Printing or affixing or a combination of printing and affixing Under this option there would be three possible methods for adding a security feature to unit packs. In addition to the two above-mentioned methods, the placing of security features on unit packs via a combination of both printing and affixing would be allowed. Under this third option, individual elements would be printed and affixed. A combined set of these elements would therefore form the security feature in the sense of Article 16 of the TPD.



5ANALYSIS OF IMPACTS The impact assessment analyses social and economic impacts of the policy options under evaluation. No particular environmental impacts have been identified. Impacts on fundamental rights (in particular the right to conduct a business) were already assessed in the Impact Assessment for the TPD, which constitutes the legal base for the establishment and implementation of systems of traceability and security features. Likewise, the Impact Assessment of the TPD already included an assessment of trade impacts with respect to the implementation of the systems in question. Each of the discussed policy options differs not only in terms of costs, but also as regards their potential for attaining the reference level of social and economic benefits. The analysis set out in the following sections takes these differences into account, most importantly by assessing the extent to which the individual policy options and their measures -are suitable to achieve the operational objectives set out in section 3; -are necessary to achieve these objectives; -allow these objectives to be achieved at maximum benefit and minimum costs. All the positive impacts brought about by this initiative rely on the same explanatory variable, i.e. a decrease in the size of the illicit tobacco market. As to the negative impacts, the initiative is considered not to have adverse impacts in social terms since, as it will be explained, it has relatively low overall costs (estimated at a fraction of the expected benefits), a minimal impact on the unit costs and hence is not expected to affect employment in the legal supply chain. The negative economic effects are dependent on the costs of establishing and operating the system. The figures provided are estimates and rely on the underlying assumptions of the key sources outlined in section 1.1 as well as on other available data. They should not be presumed to be exact but rather provide an indication of the order of magnitude expected for the various categories of costs and benefits. The clandestine nature of the illicit market makes it particularly difficult to make accurate predictions relating to its future trends or composition. The relative novelty of the traceability system may in turn affect the precision of cost estimates. Even if the individual aspects of the system are pre-dominantly based on currently used and tested technologies, the system will be the first of its kind to operate amongst such a broad range of economic operators in a multi-national regulatory context. Reference level of social and economic benefits The analysis estimates the reference level of social and economic benefits expected to be delivered with this initiative at EUR 3.8 billion a year. This level serves as a reference point in the subsequent analysis of individual policy options, since the different options are not likely to attain the same level of benefits. The initiative could generate a reduction in illicit trade equal to 2.45% of the total tobacco products market, which translates into 674 million cigarette packs per year. It is assumed that the initiative could result in an increase of the licit sales by 510 million cigarette packs per year and a decrease of the total consumption by 164 million cigarette packs per year.

A lower level of tobacco consumption is equal to a higher level of public health, increased number of healthy life-years and less suffering from tobacco related diseases affecting both smokers and their families. First and foremost, health must be considered a value in itself, both for the individual and for society as a whole. Following the methodology adopted in the TPD Impact Assessment, the main categories of social effects can also be monetised. It is expected that the initiative may generate savings in healthcare expenditure in the range of EUR 165 million per year and a gain of EUR 54 million per year in social productivity (i.e. reduction in smoking induced early retirements and work absenteeism). It is also expected that the initiative may lead to an increase of the discounted monetary value of saved lives by EUR 1.5 billion. The expected increase of the licit sales may provide EUR 2 billion per year in collected taxes (i.e. VAT and excise duties) and EUR 59 million per year in additional profits for the economic operators involved in the value chain of the tobacco products. An increase in the quantities of legally traded tobacco products should have a positive effect in terms of employment within the tobacco sector. However, this effect is difficult to account for as it can also be expected that the traceability system will induce further automation in the production and logistic chain. Table 2 summarises the reference level of expected direct economic and social benefits. It can be assumed that the full potential benefit will be achieved gradually over six years from the launch of the system, i.e. over the period 2019 to 2024. Benefit Type Affected stakeholders Value (in EUR million per year) Savings in healthcare expenditures Social Competent authorities 165 Social productivity gains Social Competent authorities 54 Saved lives Social General public 1497 Higher collection of taxes Economic Competent authorities 2029 Increased revenues of the economic operators Economic Manufacturers, importers, distributors, wholesalers and retailers 59 Total 3804 The expected economic and social benefits vary across Member States. Their magnitude depends on several factors. These are: (a) the estimated size of the national markets for illicit products, (b) their composition in terms of different types of illicit products (i.e. contraband, counterfeit and illicit whites) and (c) differences in the assumed elasticity of demand reflecting income disparities across Member States. Together these factors translate into different relative and absolute changes in the consumption of legal products as well as in the reduction of the overall consumption at the national level. The magnitude of economic impacts is further affected by differences in prices and taxation across Member States. Table 3 shows the expected distribution of economic and social benefits per Member State. SB EB SB EB SB EB SB EB AT 30 104 EL 65 93 IE 20 74 PL 197 81 BE 31 37 ES 98 144 IT 85 122 PT 24 22 BG 33 18 ET 7 6 LT 16 7 RO 142 71 CY na 7 FI 10 17 LU 1 5 SK 9 7 CZ 23 27 FR 346 508 LV 20 10 SL 6 9 DE 184 316 HR na 10 MT 1 2 SV 18 38 DK 3 4 HU 68 12 NL 37 43 UK 241 293 In terms of other effects, it is recalled that the illicit tobacco trade has been identified as a primary source of revenue for organised crime, and, in some case, terrorist groups. The European Agenda on Security adopted by the European Commission in April 2015 recognises the need to cut off criminal groups from this revenue source. The present initiative has a potential of reducing such revenues by EUR 1671 million per year. The initiative is also likely to create positive unintended consequences in terms of competitiveness, innovation and job creation in the sector for traceability and security feature technologies. For track and trace solutions and security features to be effective in meeting their objectives, they must rely on the latest technological developments. Modern technologies (such as digitalisation of data, state-of-the-art developments in two-dimensional bar codes, modern printing technologies, encryption techniques and forensic technologies) will be further customised to match the specific needs of the tobacco sector. It is likely that the technologies developed during the EU deployment of the system will be to a certain extent taken over by non-EU countries, in particular in the context of the global implementation of the FCTC Protocol. These effects are not directly dependent on the policy options discussed below. However, they can be expected to positively correlate with the maximisation of the initiative's benefits, which will serve as a proof of concept and promote the technologies developed during the EU deployment. Nature of costs Given the nature of the traceability system, all the costs indicated under main issues 1-3 (section 5.1-5.4) and allocated to the economic operators should be considered as compliance costs, and in particular, as administrative burdens. The traceability system established under Article 15 of the TPD obliges economic operators until the last economic operator before the first retailer to report the entry of all unit packets into their possession, as well as all intermediate movements and the final exit of the unit packets from their possession. The recording and transmitting of data clearly constitutes an information obligation. All the elements of the system serve this purpose. Regarding the system for security features (Article 16 of the TPD) all costs discussed under the policy options proposed for main issue 4 (section 5.5) should be considered as substantive compliance costs. Cost analysis Each of the below policy options is evaluated by looking at its various impacts in terms of economic costs. The costs are divided into capital expenditure (CAPEX) and operational expenditure (OPEX). Apart from the equipment, CAPEX also includes the costs of installation, installation support and implementation. In order to annualise the initial capital investment, CAPEX is depreciated over the period of six years. The depreciation allows for jointly reporting CAPEX and OPEX in terms of an annualised total cost for each of the options. The relevant costs are analysed per stakeholder group. However, it must be recalled that the majority of the costs will be eventually covered by manufacturers of tobacco products. Article 15(7) of the TPD stipulates that manufacturers provide all other economic operators with the equipment that is necessary for the recording of the tobacco products purchased, sold, stored, transported or otherwise handled. The costs allocated to service providers are also to be covered by the manufacturers who will be required to conclude contracts with service providers whenever certain tasks are allocated to a third party, e.g. data storage. Each instance of the cost redistribution is indicated in the below analysis. 5.1Marking packages with a unique identifier (Issue 1a) 5.1.1Policy options for achieving objective 1a: to ensure the marking of packs with a unique identifier whilst guaranteeing independence of the traceability system by appropriate assignment of roles and tasks to relevant parties

The analysis of the policy options identified under objective 1a covers the following tasks: -generation of UIs for unit packets and higher aggregation levels, i.e. cartons (10 packets), master cases (50 cartons) and pallets (50 master cases); -application of UIs (encoded in a data carrier (e.g. barcode) to unit packets and higher aggregation levels; -verification if the UIs have been correctly applied; -audits and additional controls. 5.1.2Policy option 1a/1: Industry operated solution 5.1.2.1Economic impacts Economic costs In terms of economic costs, policy option 1a/1 affects (a) manufacturers and importers, (b) distributors and wholesalers and (c) competent authorities. Manufacturers and importers CAPEX: EUR 69 million OPEX: EUR 23 million Annualised cost: 34 EUR million During the consultations, this option was clearly preferred by the economic operators involved in tobacco trade as the most cost-efficient in terms of operations. SMEs, in particular representing the cigar sector, argued that their unit costs are considerably higher due to the small scale of operations. However, no calculations were provided to substantiate this claim. The technical evaluation shows that this option could involve potential problems at the level of system interoperability, if multiple manufacturers are involved in the generation of UIs. Distributors and wholesalers CAPEX: EUR 21 million OPEX: 1 EUR million Annualised cost: 5 EUR million It must be noted that these costs are applicable only insofar distributors and wholesalers need to re-aggregate products at higher packaging levels. The CAPEX element will be transferrable to manufacturers under Article 15(7) of the TPD. During the consultations, many respondents underlined the importance of open standards for a cost-efficient roll-out and operations of the future system. As regards SMEs, it seems plausible to assume that their costs will be alleviated if there is a competitive market of providers offering solutions tailored for smaller operations, such as off-the-shelf software packages or external generation of UIs. Competent authorities

CAPEX: n/a OPEX: EUR 16 million Annualised cost: EUR 16 million During the consultations, non-industry respondents often recalled that competent authorities are obliged to be in control of the future system (under Article 8(2) of the FCTC Protocol) and stressed the importance of the system’s independence from the industry as required by the TPD. For competent authorities to be able to control the system, this option includes a quasi-permanent presence of competent authorities at the manufacturing sites. Economic benefits The attainment of the reference level of economic benefits referred to above within the industry operated system is less probable given the nature of economic incentives faced by economic operators and their employees. High profitability of illicit trade creates immediate economic incentives for misusing the traceability system, e.g. by duplicating identifiers or misreporting logistic events. In addition, the strong addictiveness of tobacco means that illicit trade may contribute to creating new demand for legal products. Consumers initially prevented by their age or economic status from purchasing the legal tobacco products can be initiated with illicit products. But it is also likely that such consumers will eventually turn to the legal tobacco products. The consulted health NGOs have cited instances where the industry has been investigated for facilitating the supply of illicit tobacco. Consequently, they stressed that the schemes designed or promoted by industry, or in which the industry takes a major role in implementation, should be regarded as inadequate. The affected stakeholder groups are: competent authorities and economic operators along the supply chain, i.e. manufacturers, importers, distributors, wholesalers and retailer. The economic benefits for each stakeholder group should be adjusted downwards in a proportionate manner to their share in the reference level of benefits. 5.1.2.2Social impacts For the same reasons as indicated in the above section on economic benefits, the attainment of the reference level of social benefits within the industry operated system is less probable. The affected stakeholder groups are: competent authorities and general public. The social benefits for each stakeholder group should be adjusted downwards in a proportionate manner to their share in the reference level of benefits. 5.1.3Policy option 1a/2: Third party operated solution 5.1.3.1Economic impacts Economic costs In terms of economic costs, policy option 1a/2 directly affects (a) independent service providers and (b) competent authorities. Subsequently independent service providers charge their costs to (c) manufacturers and importers and (d) distributors and wholesalers. As far as the CAPEX element is charged to distributors and wholesalers, they can in turn require manufacturers to reimburse this part of the costs under Article 15(7) of the TPD. Independent service providers CAPEX: EUR 100 million OPEX: EUR 25 million Annualised cost: EUR 42 million Independent service providers will charge their costs to the industry. The estimates are based on the same cost calculations as in option 1a/1 – i.e. the costs of manufacturers, importers and those of distributors/wholesalers – but increased with a 10% margin of independent service providers. Several respondents also drew attention to potential liability issues (e.g. costs of production stoppage) related to the presence of third parties (independent service providers) at the industry facilities. The technical evaluation further indicates that the presence of a third party may negatively affect the manufacturing process. Competent authorities

CAPEX: n/a OPEX: EUR 2 million Annualised cost: EUR 2 million Under option 1a/2, competent authorities are not required to implement extensive control measures, regular audits are deemed sufficient. The audits cover both manufacturing facilities and activities of independent service providers. The selection of independent service providers will call for an organisational effort limited to the initial phase of establishing the system. As a strict minimum, competent authorities will have to verify providers' independence. Economic benefits The attainment of the reference level of benefits within the third party operated solution is highly probable. In this policy option, the presence of an independent service provider at the industry facilities provides for a high level of assurance against potential misuses of the system, which in turn could affect the system's overall performance. The affected stakeholder groups are the same as in option 1a/1. 5.1.3.2Social impacts For the same reasons as indicated in the above section on economic benefits, the attainment of the reference level of social benefits within the third party operated solution is highly probable. The affected stakeholder groups are the same as in option 1a/1. 5.1.4Policy option 1a/3: Mixed solution (industry and third party) 5.1.4.1Economic impacts Economic costs In terms of economic costs, policy option 1a/3 affects (a) manufacturers and importers, (b) distributors and wholesalers, (c) independent service providers and (d) competent authorities. As in policy option 1a/2, independent service providers charge their costs to the economic operators involved in tobacco trade. Manufacturers and importers CAPEX: EUR 76 million OPEX: EUR 9 million Annualised cost: 22 EUR million The costs include the installation of anti-tampering devices for verification of UIs. These costs were assumed to be a part of the overall installation and configuration costs allocated to manufacturers and importers. During the consultations, it was noted that this policy option does not affect the operations of hardware equipment on the production lines. The operations of hardware equipment alone are believed not to pose a risk to the system’s integrity, while being highly prone to liability questions if they become dependent on third party actions. This option also excludes the need for extensive integration of economic operators' hardware with that of the third party, and hence is less technically complex than option 1a/2. On the basis of the proposed allocation of tasks, the experts from Member States confirmed that this option represents a compromise that can ensure effective control, while respecting legal requirements. The technical evaluation indicates that this option should have no negative impacts on the operational processes of manufacturers. Distributors and wholesalers

CAPEX: EUR 21 million OPEX: EUR 1 million Annualised cost: EUR 5 million The same impacts are expected as in policy option 1a/1. Independent service providers CAPEX: n/a OPEX: EUR 14 million Annualised cost: EUR 14 million Under policy option 1a/3, independent service providers are made responsible for the generation of UIs. Independent service providers will charge their costs to the industry. The estimates are based on the same cost calculations as in option 1/1 for the generation of UIs, but increased by a 10% margin of service providers. During the consultations, manufacturers and certain solution providers argued that due to efficiency and security reasons, the generation of UIs should take place at the manufacturing line. The technical evaluation does not confirm this opinion. The security risks related to the generation of UIs do not vary whether performed by the industry or a third party. The key issue is whether adequate security is in place to protect the generating server. Competent authorities CAPEX: n/a OPEX: EUR 2 million Annualised cost: EUR 2 million Under policy option 1a/3, competent authorities are not required to implement extensive control measures as in option 1a/1, regular audits are deemed sufficient. The audits cover both manufacturing facilities and activities of independent service providers. The selection of independent service providers will call for an organisational effort limited to the initial phase of establishing the system. As a strict minimum, competent authorities will have to verify providers' independence. Economic benefits The attainment of the reference level of benefits in the mixed solution is highly probable. In this policy option, the involvement of an independent third party provides for a high level of control over the supplies of essential inputs, i.e. UIs, as well as for additional controls over outputs through the anti-tampering devices securing the process of optical verification of UIs. The proposed control measures provide for a high level of assurance against potential misuses of the system, which in turn could affect the system's overall performance. At the same time, the operation of hardware equipment (used in marking) by the economic operators keeps them fully and directly accountable for any potential instances of unmarked packages of genuine products found in circulation. The affected stakeholder groups are the same as in option 1a/1. Option 1a/3 also represents the most beneficial option in terms of unintended positive consequences for research and innovation as it promotes dynamic market competition for providing a range of services. There are numerous suppliers interested in this market as could be observed during the stakeholder workshops organised by the Commission. In return, this can drive innovation, for example by stimulating further improvements in UI application and verification. 5.1.4.2Social impacts For the same reasons as indicated in the above section on economic benefits, the attainment of the reference level of social benefits in the mixed solution is highly probable. The affected stakeholder groups are the same as in option 1a/1. 5.2Recording and transmitting data (Issue 1b)

5.2.1Policy options for achieving objective 1b: to ensure effective surveillance and monitoring throughout the supply chain by determining the most suitable permitted time lag between an event occurrence and its recording and transmission to the data storage facility The cost benefit analysis of the policy options identified under objective 1b reflects the system's requirements as to the recording and transmitting of data concerning the tracking and tracing events. Although the main parameter is timeliness of data transmissions, the cost calculations include the total costs of hardware and software development required for the recording and transmitting of data that take place under any scenario. In all policy options, the affected stakeholders are economic operators obliged to report the movements of tobacco products, notably (a) manufacturers and importers and (b) distributors and wholesalers. 5.2.2Policy option 1b/1: Near real-time 5.2.2.1Economic impacts Economic costs Manufacturers and importers CAPEX: EUR 4 million OPEX: EUR 2 million Annualised cost: EUR 3 million During the consultations, several stakeholders observed that real-time recording and transmitting of data is highly complex and its costs are very difficult to estimate. It requires automated synchronisation and data integrity checks of several sources of information, e.g. internal enterprise resource planning (ERP) systems, which are required to meet the reporting obligations introduced by Article 15 of the TPD. However, larger manufacturers admitted to already working in near real time except in situations of network failures. A few stakeholders pointed out that the real time solutions avoid potential problems with network congestion caused by upload of daily data batches. A distinction was made between data acquisition and data transmission, the former requires interoperability with company's other systems and hence may be costly to be performed in real time. Member States and several stakeholders stressed that in this option particular regard must be given to the needs of SMEs for which near real time compliance may be difficult to achieve. The technical assessment confirmed the opinions expressed by the stakeholders that the implementation and operational complexity of this option needs to be considered. Distributors and wholesalers CAPEX: EUR 35 million OPEX: 40 EUR million Annualised cost: EUR 46 million During the consultations, very similar comments concerning technical aspects were made as for manufacturers and importers. It was highlighted that many SMEs use the scanning equipment based on docking stations, which transfers information only once docked for synchronisation, i.e. not in real time. It will be very demanding for SMEs to introduce this option in time. Economic benefits Assuming that economic operators manage to introduce the near real time recording and transmitting of data, the attainment of the reference level of benefits in this option is highly probable. Several non-industry stakeholders pointed out that only the real time option can guarantee to achieve the objectives of the traceability system. Any other option puts the ability to effectively fight carrousel frauds, frauds in transit and diversion points at risk by allowing for time gaps. Member States also agree that the shorter the timespan the more effective the ability of enforcement bodies to react to possible anomalies. The technical evaluation further highlights the ability of a near real time solution to integrate most effectively with other related systems at national level (e.g. customs systems). The affected stakeholder groups are: competent authorities and economic operators along the supply chain, i.e. manufacturers, importers, distributors, wholesalers and retailer.

5.2.2.2Social impacts For the same reasons as indicated in the above section on economic benefits, the attainment of the reference level of social benefits in this option is highly probable. The affected stakeholder groups are: competent authorities and general public. 5.2.3Policy option 1b/2: One day time lag 5.2.3.1Economic impacts Economic costs Manufacturers and importers CAPEX: EUR 2 million OPEX: EUR 1 million Annualised cost: EUR 1 million During the consultations, most of the economic operators involved in tobacco trade expressed their preference for this option. Distributors and wholesalers CAPEX: EUR 18 million OPEX: EUR 12 million Annualised cost: EUR 15 million During the consultations, several stakeholders noted that daily uploads better reflect the current business practice geared to daily dispatches of goods. It was also suggested to have clear and timely requirements defining until when recording and transmitting have to take place instead of setting fixed-time intervals. Economic benefits The attainment of the reference level of benefits in the option of one day time lag reports is less probable as the technical evaluation has highlighted that it could cause potential delays in enforcement action. The attainment of the reference level of benefits could be more likely if this option is combined with additional requirements. During the consultations, it was suggested that the focus should be on when the shipment happens and not on the timing of pre-shipment scans. Therefore, it was proposed to introduce an obligation to record any shipment of goods, i.e. movements between facilities, before the dispatch. The affected stakeholder groups are the same as in option 1b/1. The economic benefits for each stakeholder group should be adjusted downwards in a proportionate manner to their share in the reference level of benefits. 5.2.3.2Social impacts For the same reasons as indicated in the above section on economic benefits, the attainment of the reference level of social benefits in the option of one day time lag reports is less probable. The affected stakeholder groups are the same as in option 1b/1. The social benefits for each stakeholder group should be adjusted downwards in a proportionate manner to their share in the reference level of benefits. 5.2.4Policy option 1b/3: One week time lag

5.2.4.1Economic impacts Economic costs Manufacturers and importers CAPEX: EUR 2 million OPEX: EUR 1 million Annualised cost: EUR 1 million Even if the costs are estimated at the same level as in option 1b/2, during the consultations, many respondents disagreed with this option as creating far too long time lags in the recording and transmitting of data concerning the tracking and tracing events. Economic operators among others claimed that such a long time lag may lead to additional costs of data buffering and is not economically viable. No savings were expected as compared to the policy option of one day time lag. Distributors and wholesalers CAPEX: EUR 18 million OPEX: EUR 12 million Annualised cost: EUR 15 million The same comments as made above for manufacturers and importers are also relevant for distributors and wholesalers. Economic benefits The attainment of the reference level of benefits in the option of one week time lag reports may be seriously compromised. According to Member States and many stakeholders, the recording and transmitting of data with such a long time lag defeats the objective of tracking and tracing. The affected stakeholder groups are the same as in option 1b/1. The economic benefits for each stakeholder group should be adjusted downwards in a proportionate manner to their share in the reference level of benefits. 5.2.4.2Social benefits For the same reasons as indicated in the above section on economic benefits, the attainment of the reference level of social benefits in the option of one week time lag reports may be seriously compromised. The affected stakeholder groups are the same as in option 1b/1. The social benefits for each stakeholder group should be adjusted downwards in a proportionate manner to their share in the reference level of benefits. 5.3Processing, storing and accessing data (Issue 1c) 5.3.1Policy options for achieving objective 1c: To ensure effective surveillance and monitoring throughout the supply chain by identifying a system architecture, which guarantees full and timely access by competent authorities and the Commission to the data recorded The cost benefit analysis of the policy options identified under objective 1c covers the establishment and operations of the data storage under the traceability system. Article 15(8) of the TPD requires that the data storage is provided by an independent third party contracted by manufacturers and importers. The third party's activities shall be monitored by an external auditor paid for by manufacturers. All these costs are fully attributable to manufacturers and importers. The external auditor will submit its annual report to the competent authorities and the Commission. The policy options under objective 1c have also a direct impact on the Commission, which under Article 15(8) of the TPD is obliged to approve the suitability of the third party, the data storage contract and the external auditor. 5.3.2Policy option 1c/1: Decentralised model as per manufact