Growing Importance of Environmental, Social and Governance Provisions in Trade Agreements

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Environmental, social, and governance (“ESG”) issues have always played a role in trade agreement negotiations. Now, climate change initiatives as well as racial and ethnic diversity movements such as the Black Lives Matter movement are pushing ESG issues into new prominence. ESG issues could change the landscape for businesses through new free trade agreements stemming from Brexit. Companies and investors should monitor the growing role of ESG to prepare for the impact on business activities and anticipate new disclosure and compliance requirements.

ESG Issues in Trade Negotiations

ESG considerations have been a key component of bilateral and multilateral trade agreements for many years. Historically, these discussions have focused on environmental and labor considerations driven by concerns of unfair competition from countries that might be subject to less stringent regulations than their trading partners and therefore gain a competitive advantage. For example, during the North American Free Trade Agreement (“NAFTA”) negotiations, the U.S. and Canada were concerned that companies would move their manufacturing operations to Mexico due to the country’s lower environmental and labor standards. These concerns carried into the negotiations for the U.S.-Mexico-Canada Agreement (“USMCA”), which ultimately led to more enforcement provisions to ensure that environmental measures could be enforced in Mexico.1 The USMCA, implemented on July 1, 2020, also established a minimum wage for autoworkers in Mexico and committed Mexico to enacting legislation to protect workers’ rights to collective bargaining.2 Under the USMCA, the U.S. and Canada can establish panels of labor experts to investigate labor complaints at Mexican factories.3 In implementing the USMCA, Mexico revised its labor laws and the U.S. Department of Labor (DOL) issued interim regulations on its administration of the high-wage labor value content requirements for the production of automotive vehicles in Mexico.4

As shown with the USMCA, general cooperation provisions5 are giving way to more robust, substantive requirements, and the EU-UK trade discussions show what changes can come. One of the more contentious issues in EU-UK trade negotiations is attempting to agree to a reference point on “non-regression” on environmental and social standards. The EU has historically embraced strict environmental standards. For example, the EU recently proposed a novel carbon border tax, which would effectively be a tariff on imports from countries with less stringent climate policies.6 The proposed EU tax would initially target goods that produce high levels of greenhouse gases such as steel, aluminum, and cement. Such a measure is designed to influence the carbon policy of EU trading partners and to encourage global investment in clean, low-carbon technologies. This carbon border tax would also level the playing field for EU manufacturers, which have been subject to a carbon levy since 2005 under the EU’s Emissions Trading System (“ETS”), a carbon cap and trade system that requires EU’s energy-intensive companies to purchase allowances when they exceed certain emission caps.

The EU’s proposed carbon border tax is certain to be a point of contention in the ongoing Brexit trade deal negotiations as well as the upcoming U.S.-UK negotiations. The UK has expressed a willingness to align any future UK ETS with the EU ETS. However, the UK is less likely to be supportive of the carbon border tax due to the U.S.’s likely opposition to the EU’s tax. The U.S. government would not look favorably upon a tax on its exports to the EU and UK, and is generally unwilling to support foreign climate initiatives that could hurt U.S. industry. For example, the U.S. regularly imposes countervailing duties on foreign companies that receive government subsidies designed to promote responsible environmental behavior.7 Measures such as the carbon border tax could negatively impact the bottom line of many U.S. companies that export to Europe, and could result in a trade war between the countries. Thus, it will be important for companies and investors to continue to monitor environmental objectives in trade relations. This is especially important in a U.S. election year when the current Administration is focused on wrapping up deals and if there is a new administration, changes in negotiating objectives are likely.

New ESG Issues for Ongoing and Upcoming Negotiations

ESG and trade agreements are intertwined and can have a long-term impact on global trade and investment. ESG issues to follow during the ongoing EU-UK Brexit negotiations, the upcoming U.S.-UK trade negotiations, and other trade discussions include:

  • Sustainable investment disclosure rules: The United Kingdom and European Union have adopted rules requiring certain financial institutions and other companies to disclose their approach to climate-related and other ESG risks.8 There is no single global standard regarding the scope of such disclosures, and requirements can vary significantly depending on the nature and materiality of the risk at issue.9 Countries may seek to impose their own ESG disclosure requirements on trade agreement partners through future negotiations.
  • Gender diversity for corporate boards and management: Global companies are facing growing pressure to improve diversity among their management and director ranks. This pressure primarily is from investors and potential employees and customers. Many jurisdictions, such as the state of California and European countries such as France, Italy, Belgium, Germany, Austria, and Portugal, are imposing quotas to require improved participation of women in corporate boards and senior management.10 As these measures evolve, they could become a point of contention for future trade negotiations.
  • Worker representation on corporate boards: Global companies similarly are facing pressure to increase the participation of company employees on corporate boards. In a number of countries in the EU, such as Germany, France, Luxembourg, Norway and Sweden, workers are represented by a certain number or percentage of representatives on the board.11 Many countries, including the United States, have considered legislation to require corporate boards of certain companies (such as companies over a certain size or that are publicly-listed) to include a certain percentage of directors elected by employees.12 Due to the increased attention on income disparity and worker representation, these issues could become relevant in trade negotiations.

Conclusion

In light of the impact that trade agreements can have on their operations, companies and investors should set up a task force to monitor trade agreement negotiations and periodically evaluate their ESG risks and opportunities. In the current political atmosphere, there may be rapid changes to business requirements to achieve ESG goals. As such, companies that maintain a strong ESG profile and awareness will be best prepared for future changes in the global trade environment. In particular, ESG-related risks in the EU-UK and U.S.-UK negotiations could set new parameters for ESG requirements.

Footnotes

1) E.g., see USMCA, Environment Cooperation and Customs Verification Agreement between the United States and Mexico.

2) See USMCA Chapter 4 (Rules of Origin) and Chapter 23 (Labor).

3) See USMCA Chapter 23 (Labor).

4) See High-Wage Components of the Labor Value Content Requirements under the United States-Mexico-Canada Agreement Implementation Act, 85 Fed. Reg. 39782 (Dep’t of Labor July 1, 2020).

5) A recent example of the general cooperation provisions is the 2019 EU-Japan Trade Agreement, in which the parties reaffirmed their commitments to implement the United Nations Framework Convention on Climate Change (“UNFCCC”) and the Paris Agreement and agreed to strive to facilitate trade and investment in goods and services of particular relevance to climate change mitigation.

6) See European Commission, EU Green Deal (carbon border adjustment mechanism).

7) For example, Canadian companies have paid countervailing duties on their exports of softwood lumber to the U.S. for receiving government funds from the following programs which are designed to promote renewable energy sources and energy conservation: New Brunswick Large Industrial Renewable Energy Purchase Program, BC Hydro Power Smart Program, and Hydro Quebec’s Energy Efficiency Program. See U.S. Department of Commerce, Softwood Lumber Subsidies Report to the Congress, dated December 2019.

8) See European Council, Sustainable Finance: Council Adopts a Unified EU Classification System (April 15, 2020), see also HM Government, Green Finance Strategy (July 2019).

9) E.g., the U.S. Department of Labor has recently proposed regulations under which ERISA Plan fiduciaries may not invest in ESG vehicles when they understand an underlying investment strategy of the vehicle is to subordinate return or increase risk for the purpose of non-financial objectives. See Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 39113 (Dep’t of Labor June 30, 2020).

10) See California Secretary of State, Women on Boards. see also European Commission, 2019 Report on Equality Between Women and Men in the EU.

11) See European Commission, Board Level Employee Representation in Europe: An Overview (March 2018).

12) E.g., in 2018, U.S. Senator Elizabeth Warren proposed the Accountable Capitalism Act, which would require U.S. corporations to ensure that no fewer than 40% of its directors are selected by the corporation’s employees. See Warren Introduces Accountable Capitalism Act (August 15, 2018).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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