While countries are struggling to reach an agreement on appropriate emissions reduction targets, from a corporate risk and compliance perspective the issues businesses face related to climate change are substantial. The impacts of increased sea levels, extreme weather events like heatwaves, heavy precipitation, droughts and wildfires reach companies in all corners of the world, impacting supply chains, disrupting commodity prices and creating exposure to both costly regulatory changes and political risk. Governments all over the globe are grappling with climate change issues differently and there are layers of regional and international actions being taken.
Now more than ever is it vital to have a working awareness and sensitivity to global events, decisions and legislation related to climate change. Here are five of the top trends in climate change that impact businesses and their operations.
CLIMATE CHANGE CORPORATE RISK STRATEGIES: STILL A COMPETITIVE ADVANTAGE?
It is logical to assume that many companies, especially global ones, have put in place robust climate change risk strategies as part of their corporate policies. However, this assumption has been proved false. The Carbon Disclosure Project (CDP), a UK-based non-profit organisation that collects climate change data and trends in environmental policies of large companies, recently published its Global 500 Climate Change Report for 2012. Based on responses from 379 of the world’s 500 largest companies (in terms of market capitalisation), CDP found that only 82% of those responding have set emission reduction targets of some sort. Additionally, the targets that have been set are short-term and are ‘well below the ambition needed’.
The conclusion of the CDP in this report was as follows:
‘… those companies that have an awareness of long-term climate change risks and opportunities reflected in their business strategy will gain a strategic advantage over their competitors’.
The implication of this report is that, by ignoring climate change risks in corporate risk policies, companies could be put at a distinct disadvantage.
NEGATIVE UTOPIA? DOING BUSINESS IN THE BRAVE NEW WORLD OF MARKET-BASED MEASURES
When implementing climate change policy and resource independence strategies, it is market-based measures (MBMs) that governments are increasingly turning to as a first-resort solution. This continued growth in popularity is taking place in spite of a general scepticism towards financial markets. The most common example of an MBM is a cap and trade system, but there are a growing number of variations on the theme. The waste electronic and evidence trading directive and the energy companies obligation auction framework for domestic energy efficiency measures are a few examples of MBMs in the UK.
Historically, businesses have embraced the idea of buying permits or credits that offset emissions because MBMs are seen as less intrusive than other forms of regulation. MBMs are meant to be more flexible and responsive to inflation, cost changes and uncertainty. The alternatives to MBMs are rigid laws that put a cost on environmental degradation.
However, there are substantial and valid arguments against the use of MBMs to improve the environment and deal with resource scarcity. The success of the European Union Emissions Trading System (EU ETS) at achieving its basic purpose is in serious question. The Bolivian government aptly summarised common complaints about the Clean Development Mechanism (CDM) (a cap and trade measure under the Kyoto Protocol to the United Nations Framework Convention on Climate Change) when it stated that it converts the ecosystem function to a ‘commercial commodity’, with ‘poor quality control of baselines’, which creates a ‘speculative business’ that results in ‘incongruence between carbon markets and sustainable development’. The media has questioned MBMs by calling them ‘quick and dirty’ solutions.
The difficulty is that MBMs are complicated to structure and implement, and must be monitored on an ongoing basis. They have politically controversial components like baselines, caps and targets that have to be set properly. Additionally, if the targets are set at the level required to make MBMs effective, frameworks that implement the MBM must work efficiently. The economic crisis in 2009 helped to mask the functionality issues with the CDM and the EU ETS.
In spite of the sceptics, there are successful income-generating MBMs. It does, however, depend on how success is defined. The Regional Greenhouse Gas Initiative (in North America) was so successful in raising revenue that in 2009 the state of New York used $90m worth of profits as part of a plan to rescue it from insolvency caused by its mounting deficit. Another argument for MBMs is that they can create a more even playing field in some structures, and have the potential to create jobs and increase trade.
The Department of Energy and Climate Change (DECC) in the UK published a study last year that considered whether or not the EU ETS was in fact effective. Their findings were almost entirely inconclusive due to a lack of data available and the anomaly of the economic recession. However, the study did prove the difficulty in measuring and defining what effectiveness looks like in practice. DECC found that there was no negative impact of the EU ETS, and that it is clear that for true abatement of emissions to work, incentives for innovations in clean technologies must be implemented simultaneously.
Concerns over whether or not MBMs can be effectively structured and implemented are heightened by the number of jurisdictions that have emissions trading schemes based on MBMs now in place. ICAP has recently introduced eye-opening interactive maps to track jurisdictions creating emissions trading schemes based on MBMs to regulate climate change. These maps can be found at icapcarbonaction.com/index.php?option=com_wrapper&view=wrapper&Itemid=147. There are currently nine schemes in force, eight scheduled to be implemented, and 13 under construction. These governments are in ongoing discussions to link the regional systems to make one global emissions trading market. Concerns for complications to businesses are magnified further by the growing number of sectors and activities that are being included in compliance regimes implemented by MBMs. If the current momentum is sustained, many companies will have compliance obligations implemented through MBMs, and potentially the market inefficiencies and risks that have been associated with them, to manage.
AVIATION EMISSIONS REGULATION: THE SIGN OF A COMING TRADE WAR?
The EU Commission announced in November of last year that a draft decision was being put forward to the European Parliament that would defer the obligations under the Aviation Directive (2008/101/EC) on commercial aircraft operators to monitor, report and surrender emission credits for flights in and out of Europe for one year. This draft decision is still on its way through the parliament, but it has been widely publicised in the media. It is the first time the EU has backed down on the issue in the face of significant pressure and trade boycotts from China and the US. Some are calling it the first crack in the EU – signalling its downfall as a global leader in climate change initiatives.
This EU directive requires that carriers from outside of the EU pay for their carbon emissions in the same way that EU-based airlines have to for flights that originate in or leave from the EU. Otherwise, EU carriers will be at a significant disadvantage. The law equates to a carbon border adjustment measure and was put in place because the ICA (International Civil Aviation Organisation) failed to take the action necessary to come to an international agreement on how to regulate the emissions of the aviation sector.
This has been an ongoing battle for several years. In December 2011, Air Transport Association of America & ors v Secretary of State for Energy and Climate Change [2011] was brought to the European Court of Justice. The validity of the directive under international law was reviewed, and the Court ruled in favour of the EU scheme. In February 2012, Russia led a meeting of a number of nations (including China and the US) and industry sector representatives that resulted in the Moscow Declaration, in which the EU’s aviation directive was denounced. The group threatened a range of measures in response to the directive, including litigation under Article 84 of the Chicago Convention, and alleging possible violation of World Trade Organization (WTO) obligations.
Public international law academics are questioning whether the regulations implementing the EU ETS properly account for conflicts between regional and international laws, and whether recent actions by the EU on climate change conflict with the General Agreement on Tariffs and Trade (GATT). In December 2012, the WTO ruled that Ontario’s requirement for local content in its renewable energy feed-in tariff (FIT) programme violates GATT free trade rules. The case is seen as a landmark precedent, and the importance should not be overlooked. New sustainable sources of energy clearly need local governmental support, which may be very difficult in light of the precedent set in the Ontario FIT ruling.
This case brings into question whether domestic public law forums implementing MBMs are capable of dealing with complicated issues of international trade law. It is clearly not in the interest of the WTO to become a battleground for environmental disputes. However, more WTO cases like the one on Ontario’s FIT programme could cause governments to begin to question whether or not they want to continue to implement certain types of regimes due to the complications of the GATT and other international free trade rules. If cases such as this are brought to the WTO or even if sufficient threats to do so are made, going forward the landscape of climate change regulations could change drastically.
THE BLUE ECONOMY: MBMS GO OUT TO SEA.
Blue may in fact be the new green – at least there is a substantial amount of buzz about the recent focus on sustainable development and emission reduction in the maritime sector. This is partly due to the European Commission publishing a number of reports and communications to the EU Parliament in 2012. In December 2012 the EU Council officially endorsed the blue growth agenda with a view that the maritime sector is an area of real development potential to create new jobs and to help ‘retrigger’ the EU economy. The movement is being referred to as the ‘blue economy’, or the ‘blue agenda’. This blue agenda is nothing new. The EU Commission launched a study back in 2007 on maritime activity to connect sectors which had previously been treated separately – fisheries, shipbuilding, port activities, tourism, coastal management, environmental protection and maritime safety. The maritime sector is very important to the EU because sea-based coastal activities make up about 40% of the EU’s income.
The aim is to create seven million jobs and generate an annual gross income of €600bn by 2020. The Council also stated that the growth will not just be focused on traditional sectors like fisheries and port activities, but also on the development of offshore wind farms, renewable energy from wave and tidal technologies, as well as the development and use of biotechnologies. As part of this agenda, the EU is looking to implement an MBM emissions trading scheme regulating the shipping sector, which is intended to raise revenue to finance the growth of the blue economy.
The IMO (the International Maritime Organisation) has actually been looking into using an MBM to regulate global shipping emissions since July 2006. The IMO is still conducting impact assessments of the MBM proposals and considering further what methodology and criteria should be used in such a framework. It is not entirely clear that the global shipping sector is willing to submit to emissions targets and if it is in fact able to garner the support required to create a framework for a MBM.
It will be interesting to see if the EU can influence the IMO to move on the implementation of an international MBM framework and what this will mean to companies in the blue sector.
CARBON TRADING: NOT THE WILD WEST THAT IT USED TO BE.
It is no surprise, given the price of carbon and the state of the EU ETS, that many carbon trading desks have disappeared. The view is especially grim if we flash back to 2008 when trading carbon was experiencing an explosive boom.
Beyond the financial bubble itself, carbon trading desks expanded dramatically because the carbon commodity sector had very little regulation. Anyone could hold registry accounts to trade carbon, traders themselves were not regulated and carbon certificates were not sufficiently documented. This created a Wild West of sorts for the carbon commodities market that began to crumble in 2009 with a number of market-shaking fraudulent events on the EU ETS. The aftermath of the carousel fraud, VAT fraud and stolen emissions credits on the carbon trading desks of non-financial institutions was to slow it to nearly a halt. The level of fraud in this sector is still being investigated. As recently as December 2012, four staff members from Deutsche Bank were reportedly jailed in connection with investigations into European carbon trading fraud.
However, given the popularity of MBMs with governments as a method to regulate emissions, the momentum of linking regional emissions trading schemes, and the large number of new industries and types of emissions on the verge of being regulated – many companies may again consider whether to add a carbon trading operation to their business. Today, companies looking to establish a carbon trading operation on the secondary market will now have to consider new regulations that are currently being enacted on both regional and domestic levels. One example is the legislation that was adopted by the European Commission for the Markets in Financial Instruments Directive that reclassifies emission credits on the EU ETS as financial instruments. The impact of this proposed legislation, among other things, is that traders will need to hold licenses and most companies conducting trading activities will need to have authorisations. This should make buying carbon on the secondary market more reliable, and is more favourable to global financial institutions and large power companies that already hold the required licences.
CONCLUSION
In addition to the trends discussed here, investors are requiring companies to take actions in relation to climate change. This is evidenced by the fact that 722 investors representing $87 trillion, that’s more than half the world’s invested capital, request corporate climate data. Additionally, it is becoming common practice to require data on climate change and sustainability policies during a tender process. Many corporations, as part of their sustainability and energy efficiency polices, are requiring that contracts with suppliers of both services and goods contain representations and warranties on sustainability practices and environmental degradation prevention. The accounting and reporting of emissions is becoming a requirement for a growing number of business sectors. Climate change management is reaching nearly all aspects of modern businesses. For lawyers, it is no longer sufficient to deal solely with environmental compliance risks. Consideration also needs to be given to the growing requirements from both the private and public sectors in order to proactively manage corporate climate change issues.