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🚢 If end-of-year news is any omen, 2023 will be a big one for green trade politics. On Tuesday, the European Parliament reached a preliminary agreement on the world’s first carbon tax on imported goods. Under the Carbon Border Adjustment Mechanism (CBAM), overseas companies importing carbon-intensive iron and steel, cement, fertilisers, aluminium and electricity will be required to buy emissions permits to cover the emissions generated during production. The tariff is designed to mitigate carbon leakage and level the playing field for domestic European industries already subject to the rules under the EU’s (evolving) Emissions Trading System (ETS). Meanwhile, the G7 agreed to the terms of an international climate club for countries seeking to cooperate on climate action, with particular focus on decarbonising heavy industries and commodities. Even the US is entering the fray, with proposals for a US-EU ‘green steel club’ that would levy tariffs on steel and aluminium from countries with higher-polluting industrial processes. To join, countries would need to improve production standards and limit output to below a certain threshold: a requirement that would, in all likelihood, prevent China from joining.

🗺️ Is all of this about national/economic or global/environmental security? Depends on who you ask. EU officials contend the fight against global warming depends on coordinated efforts to (a) fix carbon leakage, particularly by (b) decarbonising global heavy industries, which account for a substantive slice of global emissions and yet—unlike transport or power—have no clear path to net zero via electrification. That may be true (we’ve long argued it makes no sense to talk about domestic emissions without factoring in imports), but it’s hard to deny accusations of “green protectionism” from the higher-emitting developing nations whose economic development is at stake. Especially when they come on the heels of a COP27 and COP15 that threw into sharp relief—and exacerbated—tensions between rich and poor countries. CBAM aims to incentivise trading partners to decarbonise, but plenty of disgruntled trading partners don’t want to decarbonise. They want the same shot at economic growth afforded by the developed world. It’s a dilemma the IEA (and de facto authority on industrial decarbonisation) attempts to address, but there’s no easy answer amid increasingly fractured international politics and geopolitical realignment.

💸 Once asked to describe his threshold test for obscenity, Supreme Court Justice Potter Stewart replied, infamously, “I know it when I see it.” If only it were that easy for sustainability. As ESMA takes aim at sustainable investment standards, asset managers are bracing for (more) corrections to the tune of $4T. Speaking to Bloomberg, Util CEO Patrick Wood Uribe characterises glaring misclassifications as either “intentional, or poorly thought through.” Article 9 exposure to, say, Uyghur genocide should, surely, pass the “I know it when I see it” test for greenwash. Still, as even thematic and green bond funds fall victim to the green reaper, ETF Stream asks whether any funds can be classified as Article 9. A closer look at the holdings of certain ‘green standard’ funds may provide clues. For e.g.: One whole quarter of green bond issuance in 2022 was, uh, not actually green because there wasn’t enough information about the issuer, according to the Climate Bonds Initiative. The EU isn’t the only body trying to clear things up. Under Swiss proposals, only products contributing to the UN SDGs would qualify as ‘sustainable’. Something for the SEC to think about as it reviews feedback (read: pushback) on its expanded names rule?

Catch-2022: Util’s year in review

For a year characterised by moral relativism, 2022 ends on an appropriate note.

Historic deals emerged from COP27 and—just today—COP15, where international tensions, too, hit new highs. They may be a critical lever to decarbonise the world economy, but fresh green trade tariffs have been rebuked for threatening the socioeconomic progress of developing countries. The EU and UK signed an offshore clean energy agreement on the heels of booming jobs data and ambitious new targets, yet the IEA reports global coal consumption hit a new record in 2022.

On the finer details of fund names and company disclosure rules, is it any surprise that regulators and investors are struggling to define ‘sustainable’?

Reality check

If sustainable finance were a well-promoted private company, this would have been its IPO year.

On the one hand, all of those “into the mainstream?” predictions came true. Catalysts included the regulatory and anticipated (August: MifID II updates require fund providers and advisors to take into account client sustainability preferences; also August: ISSB and EFRAG close their consulting periods on standardised disclosure frameworks; November: The FCA publishes its proposal UK Sustainable Disclosure Requirements), as well as the political and unexpected (February: Russia’s invasion of Ukraine forces a reevaluation of international energy markets and security).

Calling to mind that Winston Churchill quote (“you can always count on the Americans to do the right thing after they have tried everything else”), the most powerful catalysts—expected and unexpected—came out of the world’s largest economy (May: the SEC proposes extending its Names Rule to cover sustainable funds; August: The Biden administration passes its Inflation Reduction Act, directing federal spending towards decarbonisation).

Supportive monetary policy made clean energy attractive. Supportive fiscal policy made it inevitable. But one consequence of something going from a “nice to have” to a “must have” is that it looks less, well, nice.

For years, ESG and sustainable investing have been dogged by chronic wishful thinking, or the idea that financial and ethical outcomes, invariably, will come about because they should come about: clean energy will deliver above-average returns, diverse boards will manage above-average companies. Over the long term, of course, policy and sentiment are driving currents in the right direction. In the immediate term, however, the tide of easy money is pulling comfortable narratives out from under every industry.

That shouldn’t detract from the value of sustainable finance, which lies in structural net—not cyclical or short-term—benefit. And market volatility certainly hasn’t stymied demand (April: AGM season invites a record number of shareholder proposals and engagement; October: The impact investment market hits $1T; November: Data show sustainable fund flows outstripped those into the broader market). Supply, however, has been challenged by wishful thinking of a different type.

Idealism arbitrage

Recent months have changed perceptions about what qualifies as ‘green’, if it exists at all (February: The European Commission adds oil & gas and nuclear to its green taxonomy; March: In light of the Russo-Ukraine war, debate ignites as to whether weapons qualify as sustainable). In retrospect, the writing was on the letter (January: BlackRock goes for wish-wash in Larry Fink’s annual missive to CEOs).

To reiterate, sustainable policies, investments, and transitions have vital, if not existential, net benefits. Broad consensus has crystallised into acceptance that long-term gains—even those not priced traditionally—outweigh shorter-term pain. But it’s difficult to mitigate negative costs entirely (June: Reports emerge that solar panel supply chains, mostly originating in China, rely on slave labour; November: Developing nations tell COP 27 they need fossil fuels to fuel economic growth). In reality, almost every sector, company, and product has effects both good and bad.

The trouble with ‘green’ and ‘brown’ labels is that they confer ‘goodness’ and ‘badness’ onto activities that are rarely so binary, undermining valuable debate and promoting greenwash—and backlash (April: Elon Musk brands ESG ratings a “scam,” after Tesla is dropped from the S&P 500 ESG Index; May onwards: The GOP takes aim at sustainable finance).

It’s grown painfully obvious that a company’s PR activity is a poor measure of its social and environmental performance (October: COP 27 organisers defend their decision to welcome Coca-Cola, the world’s largest plastic polluter, to sponsor the world’s largest environmental conference; November: On FTX fraud, CEO and ‘effective altruist’ Sam Bankman-Fried explains: “I had to be [good at talking about ethics]. It’s what reputations are made of.”). But even data that reveal the impact of one company on one metric is an incomplete pixel in a vast economic web (August: Util publishes a whitepaper, covered by the FT and Bloomberg, unpacking the realities of SDG investment impact).

If, in 2022, ‘polycrisis’ were the no.1 adjective with which to describe the economy (October: IMF and World Bank meetings address on “causally entangled” social, environmental, and economic crises), perhaps ‘complexity’ can be taken as read in 2023 and beyond. The global economy is an ecosystem, not a jigsaw puzzle: Effecting social, environmental, and economic change calls for a systems-level approach. There’s only so much that can be achieved by shifting emissions off your trading bloc, securities out of your portfolio, or projects away from your company (December: Carbon tariffs enter the chat). Equally, the social and environmental consequences of systemic capital reallocation—both good and bad—are far-reaching, confusing, and deserving of attention.

For politicians as for portfolio managers, the last 12 months have underscored just how complicated this transition is and has yet to become. They may be missed, but the easy financial and ethical wins were never the central attraction. On both scores, real long-term progress is now underway.

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