On December 21st 2015, the United Nations announced the Paris Agreement, outlining the stark warning that emissions need to be cut by 50% by 2030 to stay below 1.5 °C of global warming. The UN followed this announcement by publishing 17 Sustainable Development Goals (SDGs), giving clear, global ambitions to policymakers, regulators, banks, businesses and investors to emphasise the symbiosis between the planet, economic activity and economic development.
In December 2021, analysts and commentators were talking about 2022 as likely to be the most critical year for sustainability since the Paris Climate Accord. Policymakers set ambitious net-zero goals, and there were further bans on deforestation and targets to reduce the amount of methane produced by cattle. What happened?
Since then, the US Securities and Exchange Commission has proposed amendments to require specific disclosure of funds’ and investment advisers’ use of Environmental, Social and Governance (ESG) factors as part of their investment decisions and strategies. Meanwhile, the Sustainability Accounting Standards Board have laid out an ESG guidance framework that sets standards for the disclosure of financial material by companies to their investors to collect sustainability information. The EU has also introduced stringent mandatory reporting requirements in the form of the Sustainability Financial Disclosures Regulation and the EU taxonomy.
Yet the “how” of all of this remains vague. What to measure is clear, but how to do this consistently and in a standardised way is not. There is a heavy reliance on self-reporting at a company level which means that the whole move towards making business and trade comply with sustainability standards will be at risk from incomparable, incomplete, or simply missing data. Thus, to avoid inevitable accusations of “Greenwash” and the compliance quagmire experienced with Anti-Money Laundering and Know Your Client legislation, the definition of how to measure sustainability in a standardised way must become a regulatory pre-requisite.
An automated solution:
Building from the approach taken by the International Chamber of Commerce’s joint position paper on measuring sustainable trade, which puts forward a proposal to use the SDGs as a framework for the approach to financial reporting, we can create an automated and consistent mechanism for measuring sustainability. This initial framework is helpful, yet there is little guidance on exactly what needs to be measured and, most importantly, what is the base unit of measurement.
The solution is to use an approach developed by the United Nations Economic and Social Commission for Asia and the Pacific, first published in 2019, by matching product HS codes (used in international customs and excise records) to Sustainable Development Goals. By consistently focusing on trade flows between countries, we can build a picture of the sustainability of global activity and cross-reference this against all regulations mentioned above while also creating a scalable framework that can incorporate any potential future regulations.
The approach reveals some interesting findings.
First, trade generally across the world creates more negative contributions to SDGs than positive ones. On a scale of -1 to +1, where -1 is all trade contributes negatively, zero is neutral, and +1 is all trade contributes positively, world trade comes out at -0.58. In other words, the balance between positive and negative contributions to SDGs is tipped predominantly towards negative SDGs: some 80% of the value of world trade is unsustainable in this sense. Emerging economies on a simple match like this are slightly more “sustainable”, although still largely negative, simply because of the fewer consumer products they trade.
Second, suppose we break down the SDGs into their “Environmental”, “Social”, and “Governance” elements, again using the trade profile of a country as the proxy. In that case, the picture shows potentially where the macro policy levers may be. For example, world trade scores -0.73 on its environmental balance against SDGs and -0.91 on its social balance against SDGs. However, on Governance, measured primarily from positive contributions to decent work, economic growth, and good health and well-being, the score is a positive of 0.43. In other words, the world of trade and trade finance, alongside regulators, has put in place the governance structures to minimise economic risks in the form of employment, economic growth and basic health provisions, but the price for the environment and social equality and justice is overwhelmingly high.
Creating a sustainability trade profile like this is a practical conceptual first step to building a fully-fledged country ESG risk trade profile. HS codes in themselves are not products; they are product categories. Matching them beyond the category to sector and activity levels is potentially over-aggregating, creating a stylised picture. The system must balance the risks of false positives or negatives at a company level, but using this approach against the imperative for finding a quick and straightforward measurement creates a compelling call to action from which the industry can grow.
This scoring system is a wake-up call for world trade and policymakers worldwide. Some of the most advanced economies have the least sustainable trade accounting for some $18.5tn in value terms in negative contributions to responsible consumption and production. If we are to meet the ambitious targets laid out at COP 26, we cannot afford to ignore these messages. Most world trade is unsustainable; where it is not, it is a symptom of under-development.
There are further advantages to this process. First, since we know where the most significant negative contributions are likely across world trade, we know the levers we should pull. Second, we also know the sectors to blame for the low scores of some countries: automotive, consumer electronics, machinery and components, plastics, iron and steel, and oil and gas. Suppose Governments can implement policy incentives toward using electric cars and clean energy. In that case, this may address some of the current negative roles that automotive and fossil-fuel trade play.
These are age-old challenges, and addressing them will be neither quick nor easy. However, if we know how to measure them, we can also measure progress towards addressing them.
This feels like progress.
