What role for trade and investment in the new climate regime?

10 March 2016

A landmark universal emissions-cutting deal offers both hope and challenges as stakeholders move to implementation.

In a historic move, parties to the UN Framework Convention on Climate Change (UNFCCC) successfully landed the first multilateral climate treaty since the 1997 Kyoto Protocol during the Twenty-first Conference of the Parties (COP21) held in Paris, France, last December. However, while the adoption of the Paris Agreement and the decisions giving it effect mark a significant achievement for the climate community, the world must now get to the business of implementation.

The Paris Agreement charts a path towards a climate regime capable of moving the global economy off a carbon-intensive growth model that is responsible for driving planetary warming. Parties agreed to hold the increase in global average temperature to “well below 2 °C above pre-industrial levels” and to “pursue efforts” for a 1.5 degrees Celsius limit. The aim is to peak global emissions “as soon as possible” and to achieve net-zero emissions in the second half of the century. In order to do so, the deal requires parties to submit so-called “nationally determined contributions” (NDCs) every five years, which should at the minimum outline best-effort mitigation pledges, with increasing ambition over time.

The new deal represents a significant break from previous UN climate arrangements. It provides for universal participation through bottom-up climate action, on the basis of “common but differentiated responsibilities and respective capabilities” (CBDR-RC), in contrast to previous top-down mandated emissions cuts for developed countries only. Under a binding transparency framework, all parties will have to monitor and report on emissions and track progress on achieving their NDCs regularly, which will be subject to a technical expert review and a facilitative, multilateral consideration of progress.

A series of principles, arrangements, and guidelines need to be developed in order to operationalise the Paris Agreement, and these will govern international cooperation across many climate policy areas for decades to come. Deadlines for implementing various features of the Paris deal vary, ranging from consideration at the first meeting of the parties to the Agreement ­– to be held at the relevant UNFCCC COP following the deal’s entry into force – to specific dates, such as a one-off facilitative dialogue on progress in 2018 to inform the 2020 NDC submissions; the 2023 start of a binding five-yearly  “global stocktake” to assess progress towards achieving the Agreement’s objective and targets; and the establishment of a new collective quantified climate finance goal from a floor of US$100 billion per year prior to 2025.

Building the new climate regime will undoubtedly face many technical, financial, and political challenges. Among the more systemic concerns is whether the deal does enough to galvanise the action needed to avoid the worst impacts of climate change. This will ultimately depend on whether political will is maintained and supportive policies are put in place.

Among these, trade and investment both directly relate to various parts of the Paris deal, and need to be harnessed for the much-needed low-carbon economic transition. The remainder of this article will focus on key details and next steps that matter from a trade and investment perspective.

A boost for carbon markets

COP21 has sent a clear and strong message that carbon pricing will be an integral part of the global mitigation effort under the new climate regime. The Carbon Pricing Leadership Coalition (CPLC) ­– launched by 21 governments and over 70 businesses and organisations in December ­– will undoubtedly contribute to the uptake of carbon pricing policies.

In addition to an expansion of domestic carbon pricing, such as the planned introduction of China’s national carbon market next year, international cooperation in this area will be of significant interest as countries will likely find themselves in an increasingly ambitious and asymmetric climate regime. Linking carbon markets creates a more harmonised carbon price, thus lowering concerns around competitiveness distortions and fears industry may relocate to countries with less stringent climate regulations, referred to as “carbon leakage.” Linking can also incentivise the uptake of new carbon markets and encourage the reduction of potentially trade-distortive and often sub-optimal support measures in existing schemes. The first carbon market linkages have already been formed by California and Québec, by the EU and Switzerland, and more may soon join rank with interest signalled for EU-China, EU-Korea, and China-Korea linkages.

Article 6 in the Paris Agreement lays the multilateral foundation for such cooperation. Paragraph 1 broadly recognises voluntary cooperation between parties in the implementation of their NDCs, while paragraph two specifically refers to cooperation involving “internationally transferred mitigation outcomes.” It gives countries flexibility to work out different cooperation arrangements outside, yet in parallel to, the multilateral process. Article 6 simply recognises countries’ ability to engage in transfers but does not impose COP procedures to this end beyond applying emissions accounting rules that are consistent with those developed under the Paris Agreement.

Through this language the deal provides a hook for the formation of carbon market clubs, an arrangement where groups of countries agree to rules and standards, in exchange for the exclusive right to trade emissions units between themselves. The club’s value lies in its ability to scale up climate action by increasing ambition among members and incentivising the adoption of markets by non-members.

New Zealand, supported by 17 countries, also released a ministerial declaration after the COP stating the signatories’ intention to develop standards and guidelines for international market mechanisms in the post-2020 regime and inviting others to support and apply these. This could provide an additional stepping stone for the formation of carbon market clubs.

Another promising avenue is the Carbon Market Platform, launched by Germany on behalf of the Group of Seven (G7) industrialised countries, with the aim of supporting the spread of carbon pricing policies. The initiative was opened to non-G7 countries during COP21. Together with the CPLC, these processes create significant impetus for the increasing mobilisation of market mechanisms, and sends important signals to business and investor communities.

Article 6 also creates a new UNFCCC mechanism to generate tradeable offset credits. Contrary to the Kyoto Protocol’s Clean Development Mechanism (CDM), it will be universal in nature, meaning that all countries will be able to generate credits and use these to meet their NDCs. 

Gearing up for a massive energy shift

One of the most discussed elements of the Paris deal is its global temperature goals, with the aspirational 1.5 degrees Celsius warming ceiling representing a considerable increase in ambition, compared to the previous two degrees Celsius target that has alone guided climate policy thus far. Long advocated for by those most vulnerable to the impacts of climate change, the lower temperature reference was incorporated into the text after receiving support from a “High Ambition Coalition” of countries formed in secrecy six months prior to the COP, including almost 80 African, Caribbean, and Pacific countries, all EU members, and the US.

Keeping the temperature rise to well below two degrees Celsius will require tremendous efforts by all nations to scale up emissions mitigation efforts and to do so fast. A massive energy shift away from climate-warming fossil fuels and to clean energy will be key in this respect. In addition, negative emissions technologies like carbon capture and storage (CCS) will play an increasingly important role, given that all scientific scenarios under the 1.5 degrees Celsius limit reviewed by the Intergovernmental Panel on Climate Change (IPCC) to date include assumptions about the use of such technologies.

The role of clean energy and energy efficiency are clearly recognised in many of the current NDCs as key areas for climate action. Although the Paris Agreement itself does not include any energy-related provisions, the decisions contain a noteworthy reference acknowledging “the need to promote universal access to sustainable energy in developing countries, in particular in Africa, through the enhanced deployment of renewable energy.”

Trade and investment both directly relate to various parts of the Paris deal and will be critical to harness for the much-needed low-carbon economic transition.

Trade policy has an important role to play in securing the necessary energy shift and thus helping countries achieve their mitigation pledges. Removing traditional trade barriers like tariffs and restrictions to trade in services would help decrease the cost of clean energy technologies, thereby making them more affordable for all, and a viable alternative to fossil fuels. Border obstacle reductions can largely be done on a unilateral basis. This option should also be particularly considered by African countries to help enhance access to renewable energy technologies.

Collaboration between countries is, however, needed to address more complex issues such as cumbersome and uncoordinated standards and their associated testing and certification requirements, or various energy subsidy schemes, many of which are far more trade restrictive than tariffs. The trade talks for an Environmental Goods Agreement (EGA) by 17 WTO members could play a role on this front, despite current limitations in scope and ambition.

Regional trade agreements (RTAs) offer another promising avenue to tackle these issues. Whereas the recently concluded Trans-Pacific Partnership (TPP) could have done more to promote clean energy, other agreements such as the EU-Singapore free trade agreement are more proactive on this matter, and could serve as an inspiration for future RTAs. Ongoing negotiations like the one for the Transatlantic Trade and Investment Partnership (TTIP) have the opportunity to make a big difference, not only by facilitating trade in climate-friendly technologies between the US and the EU, but also by strengthening environmental laws and enforcement, or promoting additional opportunities for collaboration on climate related issues like fossil-fuel subsidy reform, which can inform future multilateral trade policymaking.

Technology for climate action

Technology development and transfer is a key building block for effective climate action in the context of sustainable development. Technologies for mitigation include those related to energy efficiency, clean energy, carbon capture and storage, hybrid vehicles, or animal waste management, while examples of adaptation technologies include those needed to tackle sea-level rise such as improved drainage; crop varieties resistant to drought or heat; and improved irrigation systems.

Technology development and transfer is enshrined in Article 4.5 of the 1992 UNFCCC founding document as a tool to enable climate action. To this end, a Technology Mechanism (TM) was established in 2010 at COP16, with the task of enhancing climate technology development and transfer. However, as is well documented, technology development and transfer can prove difficult to harness in practice due to a range of challenges, including access, finance, institutional, and innovation constraints.  

It is nevertheless an encouraging sign that COP21 decided to strengthen the TM to serve the Paris Agreement’s aims, and provided it with instructions to undertake further work on technology research, development and demonstration, as well as the development and enhancement of endogenous capacities and technologies.

The UNFCCC’s subsidiary bodies will additionally elaborate a new “technology framework” to provide “overarching guidance” on the TM’s work in the new climate regime. This framework should facilitate the updating of technology needs assessments and the enhanced implementation of their results; the provision of enhanced financial and technical support in this context; the assessment of technologies that are ready for transfer; and the enhancement of enabling environments for and the addressing of barriers to the development, and transfer of socially and environmentally sound technologies.

There will also be a periodic assessment to evaluate the effectiveness and adequacy of the support provided to the TM following modalities to be developed and adopted by 2019. The Paris Agreement further creates a link between the TM and the UNFCCC’s financial instruments, responding to concerns that technology-based activities have so far been restrained by insufficient funds.

While technology development, diffusion, commercialisation, and transfer ultimately remains a complex and multifaceted process, getting trade and investment policy settings right is an important, although not an easy task. For example, lowering tariffs on clean energy goods, as discussed above, would likely increase their competitiveness and uptake in the global market place.

More generally, trade liberalisation can help to boost the supply of intermediate goods needed for technology innovation in any given economy, and competition in an open market should spur innovation. Indeed, a key feature of the TM is its focus on domestic innovation capacities, although the role of intellectual property rights (IPRs) will likely continue to be a tricky subject in the climate talks. The TM has identified the need for further clarity on IPRs in relation to climate technology development and transfer. Earlier draft versions of the Paris Agreement had included several options on this front, but the final text does not directly address the subject.

Climate action in a global economy

Implementing the Paris Agreement will have effects beyond the climate world due its fundamental ties with economic activity. Under a climate regime marked by universal action on the one hand, driven by self-determined and increasingly ambitious domestic measures on the other, mitigation efforts and policies will vary greatly between countries.

This asymmetry can have impacts on the global economy beyond emissions, both positive and negative, intended and unintended. Carbon pricing instruments or subsidies for low-carbon technologies may, for example, affect relative prices and competitiveness; alter demand and supply; and ultimately impact trade. The link between trade – itself a key driver of growth and development – and climate change will therefore be of increasing relevance. A good understanding and careful consideration of the impacts of so-called climate “response measures” will be crucial to ensure that climate action contributes to, rather than undermines, sustainable development.

Building on some existing general references in the Convention, the Paris Agreement and decisions refer to the impact of response measures in several places. COP21 also decided to continue a response measures forum, formerly initiated at COP17 in an attempt to host a more substantive discussion on the issue, but which had become largely paralysed following the expiry of its two year mandate in 2013. Parties agreed to improve the forum and adopted a work programme and technical modalities to this end. The forum will continue once the Paris Agreement takes over from the current regime, though for this purpose the modalities, work programme, and functions remain to be developed by the UNFCCC’s subsidiary bodies over the coming years.

These developments are a positive sign for an issue where a more specific conceptual discussion has long proven difficult due to its sensitivity and controversy, not least the perception that it serves the interests of fossil fuel-dependent economies, and may raise compensation obligations. Parties now have an opportunity to pick up and deepen much-needed dialogue and exchange on response measures, including on trade and climate change interactions. However, discussions should also take place within the trade world, as well as between the climate and trade communities.

International transport emissions

The final Paris Agreement contains no references to tackling emissions from international aviation and shipping. Given that these together account for around five percent of global emissions, and are forecast to grow by two to five percent per year if no further abatement actions are taken, this decision was criticised by many stakeholders. The close link between trade and international transport means that, from a trade policy perspective, tackling transport emissions will be key to making trade more sustainable.

Work on international transport emissions is on the docket for other multilateral bodies. Members of the International Civil Aviation Organization (ICAO) have pledged to develop a proposal for the first-ever global market-based measure (MBM) for aviation emissions by September, to come into effect at the end of the decade, as part of an aspirational goal to achieve carbon neutral growth from that time onwards.

Meanwhile, the International Maritime Organization (IMO) is in the process of elaborating a global data collection system to analyse energy efficiency, including guidelines on fuel use information. This will be considered at a meeting in April along with revisiting last year’s proposal from the Marshall Islands for a sector-wide emissions reduction target.

The Paris outcome could provide important stimulus for action in both arenas. Failure to make meaningful progress might, meanwhile, see parties such as the EU resort to unilateral solutions to address international transport emissions.

Opportunities and challenges

The new climate regime presents both opportunities and challenges. Through the universal commitment to ambitious targets there is unprecedented momentum to transition from our current high-emission trajectory to a truly low-carbon society. In addition to avoiding the worst impacts of global warming, this could result in a host of other benefits, from new economic opportunities to improved health. At the same time, the transition will not be simple. The bottom-up nature of the new climate regime raises doubts about countries’ ability to collectively achieve the necessary level of ambition, while the absence of a strong enforcement mechanism poses a challenge for ensuring compliance.

Implementing the Paris Agreement must also look to increase interactions between the climate and trade regimes. Climate measures under the asymmetric regime will likely test the limits of existing trade rules, something that policymakers will need to consider and deal with.

However, more than anything, climate efforts should actively mobilise trade policy, including liberalising trade in clean energy technologies, fostering innovation and technology transfer, as well as informing and facilitating club-like governance arrangements in the area of carbon markets. A proactive use of trade and trade policy can help the world achieve our low-carbon transformation imperative.

Authors: Ingrid Jegou, Senior Programme Manager of the Global Platform on Climate Change, Trade and Sustainable Energy at the International Centre for Trade and Sustainable Development (ICTSD). Sonja Hawkins, Junior Programme Officer, Climate and Energy, ICTSD. Kimberley Botwright, Managing Editor, Bridges Trade BioRes, ICTSD.

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