Measuring Sustainability & ESG Through Trade: A Wake-up Call for Policy Makers All Around the World

June 2022

What happened to the ambitions of COP26? In December 2021 analysts and commentators alike were talking about 2022 as though it was likely to be the most important year for sustainability since the Paris Climate Accord. Policymakers set ambitious net-zero goals, there were further bans on deforestation and targets to reduce the amount of methane produced by cattle.

Alongside this, regulators in the EU in particular introduced stringent mandatory reporting requirements in the form of the Sustainability Financial Disclosures Regulation and the EU taxonomy, as well as in the form of the imminent Supply Chain Act, and the “Ecodesign for sustainability” regulations. All of these measures will be introduced during the course of 2022 and by 2023/4 there will be requirements to report on both the “E” (environment) and “S” (social) aspects of ESG (Environment, Social and Governance) criteria. The Security and Exchange Commission has similarly announced its intention to make mandatory sustainability reporting. It opens an avenue for further collaboration between the EU and the US under the Trade and Tech Council, some working groups addressing “climate and clean tech” and “global trade challenges” issues.

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Even though the crisis in Ukraine initially diverted attention away from this focus on sustainability, the EU’s reliance on Russia for oil and gas in particular has put a spotlight on the need to source energy from alternative suppliers as well as from alternative means. The requirement to limit financial transactions with Russia because of sanctions is now affecting the types of goods traded as well as individuals and entities. As a result of all this, the “G” (governance) in ESG has increased in importance as well.

Yet the “how” of all of this remains vague. At present, the problem for financial services organisations and for businesses alike is the same: what to measure is clear but exactly how to do this in a consistent and 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, in order to avoid inevitable accusations of “Greenwash” as well as the compliance quagmire that was experienced with Anti-Money Laundering and Know Your Client legislation, it is imperative that the definition of how to measure sustainability in a standardised way has itself become a regulatory pre-requisite. This latter issue is a well-known weakness of current practice – of some 115 of the largest banks in the euro area, none is currrently adequately reporting their exposure to climate-related and environmental risks, according to the ECB.

In the current climate, where there is an imperative for the EU in particular and the West, in general, to move away from its reliance on fossil fuels for geopolitical as well as climate reasons, the imperative to report ESG in all its guises cannot be understated. This is particularly relevant to trade, as highlighted in the European Council conclusions which point to the critical role that trade plays in the implementation of the 2030 agenda. It argues that open and rules-based trade contributes to achieving the SDGs and focuses in particular on trade agreements as a mechanism for promoting socially and environmentally sustainable development and inclusive and sustainable trade entirely consistent with the goals of the World Trade Organsiation.

This paper is an initial contribution to the process of creating an automated and consistent mechanism for measuring sustainability. It builds on 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 Sustainable Development Goals (SDGs) as a framework for the approach to financial reporting. This is a useful framework, yet there is little guidance on exactly what needs to be measured, how it aligns with the SDGs and most importantly of all, the base unit of measurement. It looks first at the challenges of measurement and then looks at how to measure trade flows between countries, within the EU and between the EU and the rest of the world in a consistent way using the match of product HS codes (used in international customs and excise records) to Sustainable Development Goals as illustrated in the 17 SDG icons (Figure 1).

The approach taken here is developed from the United Nations ESCAP matching of SDGs to the HS codes first published in 2019 and the subsequently released “R” code that provides a schema for matching SDGs to Non Tariff Measures (NTMs). The research conducted by the UN ESCAP both highlights the materiality of trade to the broader sustainability agenda, but similarly provides an excellent baseline for improving the matching. In particular, Coriolis Technologies has taken this paper and added to the number of products, as represented by their HS code, by undertaking an analysis for each product not covered in the paper, and using Python code to conduct a global discourse analysis of how these products are reported in relation to the key words contained in the SDGs positively or negatively. This approach maintains the objectivity of matching SDGs to HS codes and means that around 90% of traded products are now covered in this approach which is significantly more than the coverage in the original concordance. The remaining proportion of trade is classified as neutral and, for the sake of clarity, omitted from this paper.

The approach reveals some interesting findings.

First, trade generally across the world creates more negative contributions to SDGs than it does positive ones. On a scale of -1 to +1 where -1 is all trade makes negative contributions, zero is neutral and +1 is all trade makes positive contributions, world trade comes out at a score of -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. The EU, and nations within the EU, perform particularly badly: intra EU trade scores -0.68 and extra EU trade scores -0.71 due to the heavy reliance on fossil fuels, automotives, electronics, machinery and components and aerospace in the trade profile of the region.

Second, if we break down the SDGs into their “Environmental”, “Social” and “Governance” elements, again using the trade profile of a country as the proxy, then 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 for its social balance against SDGs. However on Governance, measured largely from positive contributions to decent work and economic growth, and good health and well-being, the score is a positive one 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 provisions of basic health, but the price for the environment and for social equality and justice is over-whelmingly high. Particularly high negative contributions of exports and imports are attributable to SDGs 12, 16, 7, 11 and 6 from the icons above suggesting that trade policy can do significantly more to promote the basic human rights of trade as represented by the commitment to fair and open trade to promote sustainable cities and communities, responsible consumption, and to shore up the institutions of trade that help peace and justice.

Creating a sustainability trade profile like this is a useful conceptual first step along the way to creating a fully-fledged country ESG risk trade profile. HS codes in themselves are not products, they are product categories and matching them beyond the category to sector and activity levels so that the EU taxonomy’s activity-based approach is potentially over-aggregating in the interests of creating a stylised picture. The risks of false positives, or false negatives at a company level using this approach needs to be balanced against the imperative for finding a quick and simple measurement that creates an effective call to action. This is what we hope to have achieved here and the paper concludes with some areas where further research would be helpful in building out from this starting point.

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