Shannon Manders speaks to Ricardo Meléndez-Ortiz, chief executive of the International Centre for Trade and Sustainable Development (ICTSD), about aligning trade and investment frameworks for sustainable development outcomes and the role that financiers play in supporting these initiatives.
GTR: What headway are we seeing with the Environmental Goods Agreement (EGA) and UN climate talks? And once agreements are successfully in place, what will this eventually mean for financiers that back the trade of goods and climate-affecting projects?
Meléndez-Ortiz: The Paris Agreement secured last December will soon come into force [November 4], following ratifications by major emitters including the US, China, India, and the EU. The EGA has a window of opportunity to be concluded this year.
From an investment perspective, the Paris Agreement sends important market signals for the types of projects that both need support and are viable. The Paris Agreement’s climate goals require a major energy transformation, given that fossil fuels account for around 81% of the world’s energy mix and generate roughly two-thirds of anthropogenic greenhouse gas emissions. Bloomberg New Energy Finance (BNEF) and Ceres estimate that around US$12.1tn must be invested in new renewable power generation over the next 25 years to stay within a 2-degree Celsius temperature rise from pre-industrial levels. This amounts to US$5.2tn above business-as-usual projections over the period or US$208bn per year.
Conversely, there is increasing recognition of climate-related investment risk due to the shifting value of assets as the world moves to a low-carbon economy (stranded assets) – noting that the total stock market capitalisation of fossil fuel companies is around US$5tn – as well as the risks to assets presented by climate impacts.
As evident from these figures, the capital needed to move to a global clean energy system is ultimately not that significant for global financial markets to absorb, but supportive policies will be needed to align and scale up sustainable investment flows. Climate Investment Funds (CIFs) led by the World Bank are already providing support to tackle barriers to such investment. The E15Initiative – a joint trade policy, expert-led process by ICTSD and the World Economic Forum – also recommends establishing an international support programme for sustainable investment facilitation more generally, including by strengthening the capacity of least developing countries to compete in world FDI markets. The programme could focus on improving national regulatory frameworks in order to create attractive and enabling environments for investors.
The Environmental Goods Agreement (EGA) talks were launched in July 2014 by a group of 44 countries, including significant trading players such as the US, China, Japan and the EU.
The talks are geared towards eliminating trade tariffs on a select list of environmental products. Negotiators have met regularly in Geneva, Switzerland to identify which products will be included, timeframes for liberalisation and other operative aspects of the deal. Although trade tariffs generally have fallen over the years with global and regional liberalisation efforts, these can still be a nuisance in a world of international production networks, where parts and components cross borders multiple times before resulting in an end product. Environmental products under discussion in the EGA include those related to clean energy, energy efficiency, air pollution control, water and wastewater treatment, environmental monitoring and analysis, among others.
Negotiators are nearing what is hopefully the end game for hammering out the EGA. All participants have submitted lists of products for consideration and there is now a collective draft list that will be used for final bargaining in the coming weeks. Through the G20, select participants have signalled plans to conclude the agreement by the end of this year, a goal also endorsed by non-G20 economies.
The EGA should have positive cost-cutting impacts for certain climate-related projects as a result of tariff reductions for key inputs among the 44 participating countries. This may help to spur increased demand for clean energy-related projects in domestic markets, for example, or prompt producers elsewhere to seek out new export markets in those countries. These impacts can contribute to competitive, innovative and scaled-up clean energy solutions, particularly in a world characterised by economies with different resources and factors of production.
It will be important, however, for other countries to look at joining the agreement further down the line – tariffs on some clean energy products remain very high in some non-participating countries – and for governments to work on environmental services liberalisation and non-tariff barriers.
Although this agreement will focus on goods, some participants have also called for the inclusion of a work programme on liberalising trade in accompanying environmental services and addressing non-tariff barriers to trade, both critical areas to boosting deployment of environmental goods. Non-tariff barriers (NTBs) can include diverse standards for various types of clean energy equipment, or limitations in access to energy transport or distribution services, for example. Services trade barriers and NTBs may be equally, if not more, prohibitive than tariffs to trade and global diffusion of environmental goods.
GTR: What role can financiers play in promoting and incentivising such policies?
Meléndez-Ortiz: The role of financiers is absolutely critical. From an investor’s perspective, policy signals by governments around transformational steps towards a low-carbon economy can prompt changes in levels of support for the kind of goods and services that we want to see playing an important role going forward.
At the UN climate talks in December 2015, Michael Bloomberg launched a task force on climate-related financial disclosures under the remit of the international Financial Stability Board (FSB). The task force will develop voluntary climate-related financial risk disclosures for companies to provide information to investors, lenders, insurers and other stakeholders. The information relates to physical, liability and transition asset risks associated with climate change. This transparency and exercise can be helpful in sending market signals to investors and re-aligning business models for sustainable development.
The Bank of England’s governor and FSB chairman, Mark Carney, has outlined the nature of these risks for the global financial system: “Shifts in our climate bring potentially profound implications for insurers, financial stability and the economy,” he said in a speech at a Lloyd’s of London event in September last year. Further (paraphrased): “First, physical risks: insurance liabilities and value of financial assets that arise from climate property damage or disrupted trade. Second, liability risks: likely to hit carbon extractors and emitters and their insurers the hardest. Finally, transition risks: the financial risks which could result from the process of adjustment towards a lower-carbon economy.”
That is probably one of the most important signals that has been given to investors in connection with the Paris Agreement and is a very important reason why financiers should be looking into these issues.
Another critical market signal is carbon pricing. In a section on non-state actors, the Paris Agreement recognises the important role of providing incentives for emission reduction activities, including tools such as domestic policies and carbon pricing. Carbon taxes are now being established in several economies at various levels of jurisdiction. Increasing numbers of emissions-trading schemes are coming online as each year passes.
Carbon pricing helps to capture the external cost of fossil fuel use, sending a strong signal to companies and investors to shift from high to low emission practices and investments. It is a powerful means of spurring innovation and modernisation, and altering competitive advantages in favour of low-carbon economies. And fossil fuel subsidies are being phased out, even if not at the scale and pace that would be desirable so as not to counteract the effect of carbon pricing.
GTR: Should financiers care whether or not they are financing sustainable trade? What responsibilities do they bear?
Meléndez-Ortiz: I think that financiers are an absolutely critical piece in the economy, and if we are going to move the world towards a low-carbon economy, they bear a huge responsibility in doing so.
There are both financial and normative reasons to care. Some estimates suggest that an average of US$2.5tn, or 1.8%, of the world’s financial assets are at risk from climate impacts if global temperatures rise by 2.5 degrees Celsius above pre-industrial levels by 2100. A new report from BlackRock – the world’s largest asset manager, responsible for more than US$4.9tn in assets – details how climate change presents asset risks and opportunities through four channels, including physical (extreme weather), technological (advances in batteries, electric vehicles, etc), regulatory (subsidies, taxes and energy efficiency) and social (changing consumer and corporate preferences). The report says that all asset owners should take advantage of a growing array of climate-related investment tools and strategies to manage risk, search for excess returns, or improve market exposure. The report adds that carbon pricing is the most cost-effective way for governments to meet emissions-reduction targets.
Formal initiatives have encouraged investors to incorporate sustainable development criteria into their portfolios. They include the UN-backed Principles for Responsible Investment (PRI). Launched in 2006, the PRI supports international investors in reflecting and accounting for environmental, social and governance (ESG) issues, acknowledging that these can affect the performance of investment portfolios and investors’ fiduciary (or equivalent) duty. It is supported by the United Nations Environment Programme (UNEP) Finance Initiative and the UN Global Compact.
There are also the Organisation for Economic Co-operation and Development (OECD) Guidelines for multinational enterprises (MNE Guidelines). These are voluntary recommendations from adhering governments on principles and standards for responsible business conduct across international production networks. The guidelines relate to areas such as employment and industrial relations, human rights, environment, information disclosure, combating bribery, consumer interests, science and technology, competition and taxation.
In June 2015, the G7 group of major economies pledged to encourage enterprises active or headquartered in their countries to implement procedures to enhance supply chain transparency and accountability, for example through voluntary due diligence plans. Liability regimes and other forms of formal accountability are being developed as a result that can help augment investor and corporate responsibility in the transition towards sustainable trade and low-carbon economies. Similar efforts on labour conditions in international supply chains are underway through the G20.
What we are saying in very simple words is that if you are an investor today and you don’t care about these things, it is no longer a question of 20 years’
time but in two, three, five years’ time, you are going to see your investments rendered without value.
GTR: What key issues is the ICTSD championing when it comes to sustainable trade?
Meléndez-Ortiz: ICTSD’s work on trade and investment policy governance is driven by the understanding that the frameworks and incentives put in place by governments shape outcomes in the global economy. Ensuring international trade and investment frameworks to support sustainable development outcomes has been at the core of the organisation’s mission for the last 20 years. [It is celebrating its 20th anniversary this year.] ICTSD champions sustainable development outcomes by acting as a knowledge provider and knowledge broker for policymakers and stakeholders around trade and investment.
Policy research undertaken by ICTSD relates to areas such as farm trade (agriculture products and food security), supportive trade policies for tackling climate change and boosting clean energy and energy efficiency, conserving oceans and fisheries resources, trade and development, trade and environment, innovation and intellectual property, services trade such as finance, logistics, insurance and so on, and
the digital trade agenda.
Since 2011 ICTSD has also convened – in partnership with the World Economic Forum – the E15Initiative as a dialogue process designed to come up with options for strengthening and improving the global trade and investment system for sustainable development outcomes. So far this has involved 16 partnering institutions, around 400 leading experts, hundreds of think pieces, and a series of concrete policy proposals that could be taken forward in various international contexts, whether multilateral or regional, as well as by private sector initiatives.
GTR: Do you know of any financial institutions that are leading the way when it comes to backing sustainable trade?
Meléndez-Ortiz: Among other things, business is engaged in the UN Sustainable Development Goals Fund (SDG-F), an international multi-donor and multi-agency development mechanism bringing together a range of actors to address the challenges set out by the goals. SDG-F has a Private Sector Advisory Group formed by business leaders of major companies from various industries worldwide. This group is helping to build a roadmap for public-private alliances that can scale up solutions to SDG challenges.
I am a member of the research advisory group of the new Business and Sustainable Development Commission (BSDC) launched in January 2016 by Unilever’s CEO Paul Polman. The commission will make a case for why business leaders should seize sustainable development as a significant opportunity. The aim is to mobilise a growing number of business leaders to align their companies with social and environmental impact. The commissioners and advisory group members bring a wide array of expertise to the research and include representatives from the private and public sectors, as well as civil society.