Carbonomics

There are obvious changes we have all had to contend with within our physical environment when it comes to pollution and adverse weather effects caused by climate change. Yet have we considered how climate change will affect wealth creation and preservation?

The 2015 Paris Agreement saw countries make a commitment to transition to net-zero greenhouse gas emissions by 2050 (or earlier in some cases), with the aim of limiting further global warming to 1.5–2°C. Despite these commitments, many countries have had to be prompted by the OECD, the UN and the World Bank.

In 2021, the International Monetary Fund (IMF) and the OECD produced a report (the Report) that provided guidelines to countries on how they could meet these commitments.[1] Carbon taxes, emissions trading systems, fuel excise taxes and carbon pricing are some of the initiatives already being implemented by countries. Whatever system is used currently or is being considered, doing business that is not carbon friendly is poised to become prohibitively expensive, whether it be another layer of costs and/or taxes.

Changes are coming

In the Report, the OECD says that carbon pricing, which charges emitters a fee based on their level of emissions or incentivises emitters to emit less, should apply to all greenhouse gas emissions and not just carbon dioxide. The Report says that carbon pricing should be reflective of the most harm caused, incentivising businesses and households to make production and consumption decisions that support lower emissions. Pricing should apply to cheap fossil fuel and process emissions across the power, industry, transport and building sectors. It should also include ‘fugitive emissions’ from extractive industries, and net emissions from land use change and agriculture.

The Report further states that fossil fuel subsidies should be phased out and that forms of emissions monitoring will be developed or be based on output and default emission rates. Consequently, rising carbon pricing should incentivise innovation in low-carbon or alternative energy sources and processes, as well as providing a source of revenue. Governments are encouraged to widen the class of carbon emitters as well as increase carbon pricing to meet targets.

The IMF and the OECD have said that carbon prices do not currently match policy ambitions and are too low. At the same time, they acknowledge that such policies will only work if there is energy affordability for lower-income households and if carbon ‘leakage’ and competitiveness in countries can be managed.

To prevent carbon leakage, where countries pursue less ambitious carbon pricing with the aim of encouraging production to move to their countries, the OECD recommends border carbon adjustments. This would be an internationally coordinated effort where a measure will be applied to traded products, making their prices in destination markets reflect the costs they would have incurred under that destination country’s greenhouse gas emission regime. Sound familiar? Like a double-taxation regime, perhaps? An alternative mechanism is the international carbon price floor, which would cover all emissions from the 195 participating countries rather than only those involved in trade flow.

Measures undertaken by countries

In a 2021 article, BloombergNEF analysed practices that have been adopted by countries and how they have been working.[2] These included carbon taxes, cap-and-trade market-based mechanisms and credit schemes. Interestingly, the US (as with its state tax system) has adopted individual state schemes.

Directors’ obligations

The Commonwealth Climate and Law Initiative report Primer on Climate Change: Directors’ Duties and Obligations (the Primer)[3] provides a jurisdictional review of legal opinions from around the world on how climate change will affect directors’ duties and corporations.

According to the Primer, as at the end of 2020, there were at least 1,550 litigation cases globally involving climate change brought in 38 countries. The Primer warned that ‘while only a few of these cases to date involve fiduciary duty or securities claims, this is likely to change as this field of litigation expands. Those fiduciary duty and securities claims that have been brought clearly show the risks to companies, and their directors and officers, from failing to incorporate climate change into strategy, oversight, risk management and disclosure’.[4]

Japan, Malaysia, Singapore and the US have adopted more of a detailed approach in their approved laws and regulations, whereas the EU (in conjunction with additional measures adopted by each Member State) and Switzerland only require disclosure obligations on the impact of corporate activity on environmental matters, if any, from large organisations.

Consistent themes acknowledged in the Primer were that climate change is a systemic risk that could have a major impact on the future financial performance or prospect of an entity; that this risk is foreseeable and therefore relevant to directors and companies taking positive action; and that regulators have increasingly become empathic to companies and directors needing to adopt climate resilience in governance and disclosure. Recommendations for each jurisdiction are provided in the Primer.

Conclusion

Wealth creators and family offices will now have to consider how they can become more efficient and proactive when it comes to asset management. Climate change is a risk that is now unpredictably predictable.