This article first appeared in Forum, The Edge Malaysia Weekly on July 18, 2022 - July 24, 2022
Carbon pricing is fast becoming a contemporary buzzword, with the adoption of carbon pricing instruments (CPIs) having grown significantly since 2010. While these instruments were confined, mostly, to European nations back then, today some 46 national jurisdictions operate in the presence of some form of carbon pricing regime. Developing countries are also showing an interest in their implementation; the World Bank indicates that Brazil, Indonesia, Morocco, Thailand, Turkey, Vietnam — and indeed Malaysia — have announced that either a carbon tax or emissions trading scheme (or in some cases, a combination of both) is on the policy horizon.
The proliferation of CPIs is the result of numerous pressures, some more significant than others. First, the continuous nature of scientific discovery in the realm of climate change necessitates a stronger response to the issues of emissions growth and environmental degradation. Recognition of the need for policymakers to act is quite possibly at an all-time high; so is public pressure on policymakers to act.
A second factor is the need for governments to find alternative sources of financing to both pay back for Covid-related fiscal outgoings (including record-setting stimulus packages) as well as fund further climate change mitigation and adaptation efforts.
And third, the atmosphere of global climate regulation is changing, not least through the potential effects of the European Union’s Carbon Border Adjustment Mechanism (CBAM), which, once enacted, will likely have significant and tangible financial impacts on high-carbon exporters to the EU. In a 2021 report, the United Nations Conference on Trade and Development noted that Malaysia was among the 20 nations likely to be most affected by the EU’s CBAM, with close to US$1 billion (RM4.42 billion) worth of exports subject to looming carbon regulation. Importantly, one way to curtail this bill is for Malaysia to implement its own CPI.
Therein lies one of the more benevolent ambitions of the EU’s CBAM; indeed, an in-depth assessment of the economics of carbon pricing would yield that if all economic actors (or, in this context, nations) act in accordance to their own self-interest, the best policy outcome to address the market failures causing climate change (carbon pricing) requires a second-best approach. In an ideal world, all countries would agree to a uniform global tax on emissions — or, if ambition ran high, a global emissions trading scheme. In such a scenario, there would be no need for border carbon adjustments (the category of tax to which the CBAM belongs) in the first place. That emissions are the responsibility of a single country is irrelevant given the global nature of the atmosphere; for this reason, a global solution is required to address climate change. Yet, in the absence of such global policy uniformity, the next best alternative for climate leaders who have adopted CPIs would be to protect their domestic industries from competitors operating in jurisdictions where emissions remain unpriced.
It is likely that by the end of the decade, the EU’s CBAM will be seen as just the first of its kind; other markets that have implemented CPIs face the same incentives to adopt border carbon adjustment taxes. Carbon pricing is fortifying its position as an almost inescapable reality.
A second, modern-day buzzword, to which climate change is both a subset and a risk factor, is “ESG” (environmental, social and governance). And where climate change is involved, carbon pricing is too, and so ESG and climate change are inextricably entwined. But the relationship runs deeper than the superficial — and the superficial is in itself of significant economic, financial and even moral relevance in the first place.
Let us start with the superficial. Carbon pricing opens the door to a host of action and investment on the part of corporations and other such entities in the name of sustainability; it makes for a tangible and monetised way to put a value on committing to projects that beget reductions in emissions. It spells out the financial benefits of environmentalism, in contrast to the long-established custom that environmental protection is a cost and an unnecessary financial burden that, when regulation is lax, is worth circumventing entirely.
For Malaysia, this remains a present-day issue. Now, addressing climate change is profitable. A reduced climate footprint increasingly makes financial sense; economics is beginning to favour it, customers want it, and striving to be seen as the most climate-friendly enterprise has the potential to become a cut-throat race-to-the-top-type battle that has already led to allegations of fraud and “greenwashing”.
What made this possible was acceptance of the need to price carbon in the first place. This need was first considered by economists — as far back as the 1920s. It has since transformed into the economic textbook’s staple definition of market failure and the past 30 years of UN Framework Convention on Climate Change negotiations have coincided with a rapid rise in the proliferation of carbon pricing instruments (bear in mind that correlation is not causation) globally. The economic case for carbon pricing has long been clear and it took governments the best part of a hundred years to take advantage of it — in large part because fossil fuels were an even bigger business. But the world is changing; in some parts, it already has — witness power markets where renewables are more profitable as an investment than coal and natural gas.
It won’t take anywhere near as long for the private sector to take advantage of the economic promise of carbon pricing. We are likely to see — as Malaysia enacts a voluntary carbon market and contemplates the implementation of its own national CPI(s) — domestic and multinational corporations take advantage of the opportunity to cash in on the climate and environmental promise of their low-carbon investments, as well as increase their interest in procuring the “carbon rights” to a whole host of natural capital assets, depending on where the most attractive bang-to-buck ratios are.
But when the conversation moves from projects contributing to emissions reductions towards a class of assets as natural capital, there is value beyond that of, say, a forest’s role as a carbon sink and therefore a route to achieving emissions reductions. This is where the relationship between carbon pricing and ESG moves beyond the “superficial”. Forests are priceless ecosystems that do regulate temperatures, rainfall and the climate, but have a myriad other functions that are usually obscenely difficult to measure — much like carbon emissions once were and indeed, to a degree, still are; best estimates of the “social cost of carbon” are precisely estimates, with wide standard errors.
Putting a monetary value on societal utility associated with a “plot” of natural capital through employment, recreation, tourism and others; the biodiversity it supports; the roles it plays as a watershed and custodian and provider of other key resources (like water and energy, and indirectly food); its role as a carbon sink, and so on, is an arduous task, but one that matters significantly. It could mean the difference between conservation and exploitation; it could provide the economic case for environmental protection just as much as carbon pricing is for addressing climate change.
For Malaysia, much research is still required to establish the monetary value of its natural capital with significant scientific rigour. To illustrate this fact, albeit roughly, consider that the Ecosystem Services Valuation Database (ESVD), an open-source data repository, contains information covering only four different forest ecosystems across Malaysia. As a megadiverse nation, this is indicative of a lack of research into the topic; ecosystems in Indonesia and Thailand, for example, are covered more extensively by the ESVD. With biodiversity and broader ecosystems increasingly considered a “new frontier” and even the “elephant in the room” in the context of ESG and other sustainability efforts, the onus is on Malaysia to start making the right moves so that its corporations — and society — can reap the economic benefits of environmental conservation and protection.
In March 2022, Bank Negara Malaysia and the World Bank launched an exploration into nature-related financial risks; this is a step in the right direction, as would be the establishment of a task force on nature-related financial disclosures (parallel to but distinct from the already-established Task Force on Climate-related Financial Disclosures, or TCFD) as they apply to Malaysian companies and institutions. The remit of the environmental aspect of ESG may for now be focused on the generation of emissions reductions and efficient resource exploitation, but this narrow scope will inevitably broaden. Malaysia needs to ready itself for these changes, and put in place the foundations for domestic actors to participate in and benefit from the protection of our natural capital.
Darshan Joshi is affiliated with the Malaysian hubs of the Asia Foundation as a climate consultant, and the World Bank, as a consultant and programme coordinator. Robin Bush is the Asia Foundation’s country representative in Malaysia, where she oversees programmes in support of Malaysia’s development as an advanced middle-income country.
This column is part of a series coordinated by Climate Governance Malaysia, the national chapter of the World Economic Forum’s Climate Governance Initiative (CGI). The CGI is an effort to support boards of directors in discharging their duty of care as long-term stewards of the companies they oversee, specifically to ensure that climate risks and opportunities are adequately addressed.
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