Working Paper

Beyond non-regression: Mainstreaming climate action into FTAs

emiLydgate, E (2023) 'Beyond non-regression: Mainstreaming climate action into FTAs' CITP Working Paper, 1.

Published 1 February 2023

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CITP Working Paper 1

Emily Lydgate 1

Abstract

While integrating climate objectives into FTAs remains unusual, it is an area of rapid innovation. This chapter focuses on EU and New Zealand, both of whom have used FTAs to support climate-related goals. The EU has increased the enforceability of requirements to uphold the Paris Agreement and domestic climate regulation, while New Zealand has used FTAs to further regulatory cooperation, emphasizing fossil fuel subsidy reform. The UK also features in the analysis as a country that has completed recent FTAs with both. Innovative FTA provisions between countries who self-identify as climate leaders may appear limited in their scope and influence: outliers rather than frontrunners. However there is evidence to suggest they have already contributed to broader climate cooperation, and can do so further, by: propelling discussion other fora, including the WTO and Paris Agreement; addressing technical challenges for climate cooperation across different regulatory systems; breaking down silos between trade and climate agreements; and furthering a learning process about effective models for achieving climate cooperation through trade.

Introduction

As of September 2022, 140 countries, covering 90% of global emissions, have agreed or are considering seriously net-zero CO2 emissions targets.2 Successful implementation of net-zero targets implies significant reform of countries’ trade strategies and patterns. Broadly speaking, countries will need to increase trade and investment in low-carbon goods and services, and decrease trade and investment in high-carbon goods and services. Free Trade Agreements clearly have the potential to play a supporting role in this process. For example, they can remove tariffs between Parties on goods that support climate change mitigation and adaptation, and liberalise services in this area. They can increase regulatory cooperation to overcome trade barriers based on differing regulation and standards, such as energy efficiency standards or approaches to carbon pricing. They can support technology transfer and innovation. Or they can also address concerns about asymmetric costs of climate regulation between countries and the need to level the playing field between producers.3In practice, such opportunities for alignment between FTA and climate objectives remain relatively undeveloped. A 2021 WTO analysis concludes that only 18% of FTAs notified to the WTO refer to climate change, global warming, greenhouse gas emissions or low emissions economy. It concluded that ‘compared to other environmental topics, such as biodiversity or sustainable fishery or forestry management, specific provisions on climate change are relatively fewer and less detailed.’4

Some of the largest FTAs, including the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP), the Agreement between the United States of America, the United Mexican States, and Canada (USMCA) and the Regional Comprehensive Economic Partnership (RCEP), do not mention climate change by name at all. Failure to endorse climate change mitigation or adaptation as an explicit objective does not preclude its inclusion in some form. For example, CPTPP supports climate-related objectives by encouraging Parties to cooperate in support of transition to a low-emissions economy in a way appropriate to their domestic circumstances and capabilities.5 But refusal to identify climate change by name in an FTA clearly limits its ability to support mitigation and adaptation as a core strategic objective.

The lack of widespread integration of climate objectives into FTAs results from several factors. First, trade agreements are traditionally understood as supporting primarily trade and economic objectives, with environment integrated in the form of flanking measures.6 More specifically, environmental goals have been represented in many FTAs, including those of the US and EU, only through broad best endeavours clauses to uphold high levels of environmental protection, agreement to adhere to relevant multilateral environmental agreements and so-called non-regression clauses through which Parties promise to uphold and enforce existing domestic environmental laws (which include by default climate legislation).7 The latter are animated by concerns about preventing competitive deregulation that takes place in order to benefit trade and investment.

Second, elevating the importance of climate objectives in an FTA beyond the status of non-regression obligations, or exceptions to the rules, requires consensual commitment by FTA partners. While almost all countries have agreed in principle on the need to limit global warming to 1.5 degrees C in the context of the Paris Agreement, the speed and the means by which they contribute to this objective vary, and are informed by countries’ level of development, their domestic political leadership, and other factors. Third, global recognition of the climate crisis is an emerging norm, and many FTAs were negotiated before countries agreed to their current levels of commitment to climate action. This also means that the inclusion of climate provisions in FTAs is an area of relatively rapid innovation. Distinct features are emerging of an EU-led and New Zealand-led approach. The EU’s approach emphasizes ‘mainstreaming’ sustainability objectives, including climate objectives, throughout FTAs, and introducing stronger enforcement mechanisms to reinforce commitment to climate action. New Zealand’s approach has focused on regulatory cooperation, particularly through commitments to phasing out harmful fossil fuel subsidies.  Both have moved to increase the prominence of climate objectives in Free Trade Agreements. The chapter foregrounds recent FTAs which showcase these new strategies: the UK-EU Trade and Cooperation Agreement (2020), UK-New Zealand FTA (2022) and EU-New Zealand FTA (2022) and the ACCTS (in negotiation). The UK features prominently as a country which been active in its FTA negotiations after leaving the EU, and which shares a relatively ambitious approach to domestic climate action. In the conclusion, I argue that the innovations that they introduce have larger relevance for international climate and trade cooperation.

The EU approach: embedding the ‘fight against climate change’ in FTAs

Background and context

In its regional integration, the EU has increasingly emphasized the need to ensure that market opening does not create competitive disadvantages for EU producers stemming from non-traded inputs, including low environmental standards.9 To achieve a level playing field, the EU-Ukraine DCFTA, for example, requires Ukraine to align not only with EU product standards, but also regulations covering air quality, climate change and environmental impact assessment, among others.10 The EU’s approach to more distant trade partners with which regulatory harmonization remains minimal has differed, but is animated by a similar concern: securing a favourable climate for EU producers by preventing competitive deregulation. Since 2009, the EU has negotiated dedicated Sustainable Development chapters which include obligations not to reduce levels of protection, often referred to as non-regression or non-derogation clauses. For example, Article 13.7(2) of the EU-Korea FTA states that:

A Party shall not weaken or reduce the environmental or labour protections afforded in its laws to encourage trade or investment, by waiving or otherwise derogating from, or offering to waive or otherwise derogate from, its laws, regulations or standards, in a manner affecting trade or investment between the Parties.11

Not all environmental regulation is equally likely to provide a competitive advantage. The requirement not to lower environmental standards is bounded in scope to regression that results from, or affects, trade or investment. Article 1:2(a) of the EU-Korea FTA also identifies one of the objectives of the agreement as: ‘to promote foreign direct investment without lowering or reducing environmental, labour or occupational health and safety standards in the application and enforcement of environmental and labour laws of the Parties’. [emphasis added]

TSD chapters also often include best endeavours clauses; in the EU-Canada Comprehensive Economic and Trade Agreement (‘CETA’), Parties ‘…shall seek to ensure [their] laws and policies provide for and encourage high levels of environmental protection and shall strive to continue to improve such laws and policies and their underlying levels of protection.12 Such commitments are self-evidently broad and aspirational. Core components include affirmation of both Parties’ intention to effectively implement existing Multilateral Environmental Agreements to which both are Parties, and to guarantee public participation in environmental regulatory and decision-making processes and access to environmental remedies.13

Reforms to EU strategy

The EU has indicated that it will strengthen the role of sustainability in its FTAs, including stronger integration of climate aims. In June 2022 the Commission produced a Communication, ‘The power of trade partnership: together for green and just economic growth’, which presents a new FTA strategy.17 The EU’s strategy elevates the importance of climate action. Most significantly, it further develops the proposal set out in the Commission’s Green Deal18 to impose sanctions on FTA parties for non-compliance with the Paris Agreement:

The Commission now proposes the possibility of trade sanctions as a matter of last resort, in instances of serious violations of core TSD commitments, namely the ILO fundamental principles and rights at work, and of the Paris Agreement on Climate Change. In such instances, trade sanctions would be appropriate as a means to foster
compliance. In the case of the Paris Agreement, the intention would be to capture failure to comply with obligations that materially defeats the object and purpose of the agreement….This approach will build on and reinforce the respect of core labour rights and of the Paris Agreement as essential elements of our trade agreements.

The Paris Agreement relies upon participating countries to define their own contribution to reducing emissions. In this sense, the likelihood of being able to establish that either Party took actions that would ‘materially defeat the object and purpose of the Paris Agreement’, short of withdrawal from the Agreement itself, seems unlikely. However, at least symbolically, the elevation of climate change to an essential element is significant. With reference to the Vienna Convention on the Law of Treaties (VCLT), it means that either Party can partly or fully suspend the agreement if it is breached.19 In sum, the proposal positions climate change inaction as a basis for unilateral FTA suspension, elevating its status to accompany traditional EU FTA ‘essential elements’ of democratic principles, the rule of law and human rights.

The UK-EU TCA [TCA]

Though negotiated before the Commission’s new FTA strategy was published, the TCA, which came into force in May 2021, has already put into practice some of the recommendations above. Like past FTAs, the TCA relies upon non-regression as a mechanism to guarantee that Parties will maintain environmental protection. But it departs from existing FTA non-regression requirements, which remain thematically open-ended. Instead, it specifies quantitative climate-related regulatory commitments which must be maintained, and which take reference in shared domestic (rather than international) commitments. It also has much stronger enforcement mechanisms, which uphold the non-regression commitments, but also a shared commitment to the Paris Agreement. These changes take the form of five distinct innovations.

Innovation 1: ‘Fight against climate change’: an essential element of the Agreement

In keeping with the new EU FTA strategy, the very first sentence in the TCA Preamble affirms that the ‘fight against climate change’ is an essential element of the agreement, acting as a guiding principle for the whole agreement. The chapter establishing the ‘Basis for Cooperation’ for the TCA also affirms that ‘climate change represents an existential threat to humanity’, and gives this ‘fight’ a material form as a requirement to ‘respect the Paris Agreement and the process set up by the UNFCCC and refrain from acts or omissions that would materially defeat the object and purpose of the Paris Agreement.’21

The TCA reaffirms both Parties’ ambition for ‘economy-wide climate neutrality by 2050,’22
the first time that a shared net-zero emissions commitment was integrated into an FTA. This commitment is phrased as an ‘ambition’ rather than a target or objective, and there is no specific outcome duty attached to it. While either Party can initiate a dispute for non-compliance with this requirement, there is no option for sanctions.23 Instead, the enforcement process parallels the EU’s standard FTA enforcement model, as described above in the example of CETA However, it establishes an expectation for climate planning and action that is quantitative, measurable and long term as one of the ‘principles and objectives’ of the Level Playing Field requirements of the TCA.

Innovation 3: the inclusion of interim climate reduction targets

As well as the general objective of maintaining a climate neutrality ambition, the TCA includes a commitment to uphold both Parties’ ‘climate level of protection’ as set out in interim greenhouse gas reduction targets. This includes specific quantitative interim targets that both Parties have committed to in domestic legislation. These targets do not reflect both sides’ increased climate ambition after committing to net-zero targets. Thus the 40% reduction by 2030 target has been revised up to 55% in EU and 68% in UK. However integrating quantitative climate benchmarks into an FTA is novel, and the targets are covered by the non-regression requirement, such that, if an arbitral tribunal agrees that regression has occurred, either Party can apply sanctions.24

Innovation 4: commitment to effective carbon pricing

The Parties also commit to non-regression on upholding an ‘effective system of carbon pricing’. This requirement is also linked to binding dispute settlement. Parties shall ‘give serious consideration’ to pursuing linked ETS schemes.25 This situates dialogue on carbon pricing effectiveness within the institutional framework of an FTA and its implementing committees, notably the Trade Specialised Committee on Level Playing Field for Open and Fair Competition and Sustainable Development.

Innovation 5: Rebalancing mechanism

The TCA outlines a so-called ‘rebalancing’ mechanism, which specifies that ‘significant divergences in [climate protection] can be capable of impacting trade or investment between the Parties in a manner that changes the circumstances that have formed the basis for the conclusion of this Agreement….If material impacts on trade or investment between the Parties are arising as a result of significant divergences … either Party may take appropriate rebalancing measures to address the situation.26 Like the essential elements clause, this invokes VCLT, under which a fundamental change of circumstances is a ground for terminating or withdrawing from a treaty.27The mechanism defines two processes, one dealing only with the areas of subsidy control, labour and social standards and environment and climate, and a second dealing with any issue arising from any trade provision.

This mechanism is accompanied by a bespoke fast-tracked dispute settlement process. The rebalancing mechanism also provides for reviews of the whole of the trade provision in the TCA that could end in its termination. These can be triggered by either party every four years if it feels the arrangement has become unbalanced or more frequently if “measures [on subsidies, labour or environment, including climate protection] … have been taken frequently by either or both Parties, or if a measure that has a material impact on the trade or investment between the Parties has been applied for a period of 12 months.”

Analysis: Convergence without harmonisation: an outcome benchmarking approach

The overall approach of the TCA might be described as outcome benchmarking.28 It combines high-level ambitions with specific quantitative targets underpinned by strong enforcement mechanisms, with the potential for sanctions from to the failure to keep pace with future levels of climate protection. This provides a hybrid between the alignment with environmental legislation required in ‘deep’ EU Association Agreements and the EEA Agreement, and non-regression requirements that the EU has negotiated in its ‘shallow’ trade agreements with countries such as Canada and Korea.

The inclusion of a keeping pace requirement is also innovative, both from an international trade perspective and also an international environmental law one. Broadly defined, non-regression in international law encompasses any commitment not to lower existing levels of protection. It is not a widely-recognized principle of international law.

However, based on its inclusion in the Paris Agreement and the Rio + 20 Declaration, a growing movement of academics and international lawyers have argued that there is a sufficient basis for it to comprise an emerging principle of international environmental law.29One critique of non-regression is that it fixes expectations of environmental protection at the point where a treaty was agreed. The TCA addresses this issue through its inclusion of the rebalancing mechanism which includes the expectation that Parties will dynamically update.

The contentious nature of negotiations is evident through the many enforcement mechanisms that underpin agreed climate benchmarks. The novel nature of these provisions makes their interpretation highly unpredictable. The Rebalancing mechanism relies upon the interpretation of several concepts which have no precise equivalents in existing EU treaties, such as whether ‘significant divergence’ has had a ‘material impact on trade and investment.’ In its justification of rebalancing measures, a party is required to show that a proposed response is ‘strictly necessary and proportionate in order to remedy the situation’, and the tribunal would need to decide what the situation was that required ‘remedy.’ Rebalancing measures are not defined. In practice, this means that an arbitral tribunal required to interpret them would hold significant influence.

New Zealand: Climate and trade agreements, and fossil fuel subsidies

The ACCTS

Like the EU, New Zealand has also elevated the importance of climate objectives in recent FTAs. Indeed, New Zealand has gone further than the EU, by leading negotiations for the first FTA that explicitly defines its objective as climate-related: the Agreement on Climate Change, Trade and Sustainability (ACCTS), announced in September 2019, in partnership with Fiji, Iceland, Norway and Costa Rica.

The centrality of climate-related objectives is clear not only from the name of the FTA itself, but also in the Joint Leaders’ Statement on its launch, in which the Prime Ministers of ACCTS countries made clear that its purpose is to aid in achieving the aims of the Paris Agreement.30 In subordinating trade aims to climate aims, the ACCTS has flipped the hierarchy of traditional FTAs, in which climate or environmental aims are included as flanking measures. In so doing, regardless of its ultimate success in facilitating the low-carbon transition, the ACCTS has provided an innovative model which goes beyond any existing FTA in mainstreaming climate objectives into a trade agreement. Uniquely among the FTAs considered in this chapter, the ACCTS also includes signatories from both developed and developing countries.
The ACCTS aims to support the Paris Agreement through identifying areas in which trade-related measures can reinforce climate action. These include three core objectives: removal of tariffs on environmental goods and new binding commitments for environmental services, introducing disciplines to eliminate harmful fossil fuel subsidies, and developing guidelines on voluntary eco-labelling programmes.’31 The negotiation of the ACCTS is ongoing, and the only information in the public domain is a periodic high-level summary of progress, but New Zealand has also undertaken related innovations through recent FTAs with the UK and the EU, examined below.

The UK-New Zealand and EU-New Zealand FTA

New Zealand’s FTAs with the UK and the EU reveal its approach to climate cooperation through more traditional FTAs. The UK-New Zealand FTA contains a few climate-related firsts. These include the most comprehensive list of environmental goods being liberalised of any FTA to date32 (a less notable achievement given that the FTA eliminates all tariffs between the parties, though some on a slower timescale).33

Also, like the UK-EU TCA, the FTA is also one of the first to reference Parties’ net-zero by 2050 ambition, and sets out that they will pursue efforts to limit warming to 1.5 degrees C above pre-industrial levels.34 Unlike the TCA, this is a high-level commitment not tied to dispute settlement.

The EU-New Zealand FTA, signed less than a year later, also contains commitments on fossil fuel subsidy reform, but the language is weaker: rather than eliminating, it commits both Parties to ‘progressively reducing fossil fuel subsidies.’ They also ‘reaffirm their commitment to work to meet this objective in accordance with national circumstances, while taking fully into account the specific needs of populations affected.’ The EU-New Zealand FTA also affirms the Parties’ commitments to the Paris Agreement, which is included as an essential element of the FTA, but does not reiterate their ambition to net-zero emissions by 2050.36

Analysis: The scope and force of FTA obligations on fossil fuel subsidies

As part of the Cairns Group of agricultural exporters, New Zealand has long been an advocate of the elimination of trade-distorting domestic agricultural subsidies, and more recently has become an international leader advocating reduction of fossil fuel subsidies, as discussed further in the conclusion.37 The novel nature of these FTA obligations on fossil fuel subsidies, and the differences in phrasing between the EU-New Zealand FTA and UK-New Zealand FTA, prompt further reflection on their interpretation and legal weight.

As set out above, key differences include that, in the former, Parties agree to ‘progressively reducing’ them, the latter, ‘eliminating’ them, the former describes them as ‘inefficient’ fossil fuel subsidies, the latter, ‘harmful’, and both commitments are qualified, but in different ways: in the UK-New Zealand FTA there are ‘limited exceptions in support of legitimate public policy objectives’, while in the EU-New Zealand FTA, there is a broader carve out responding to national circumstances and taking into account the needs of local populations.

On first glance, the UK and New Zealand have made much stronger commitments: elimination versus reduction, with narrower exceptions. However, this conclusion is complicated by the different ways that countries measure fossil fuel subsidies. The UK adopts the methodology of the International Energy Agency, based on a ‘price-gap’ approach, which examines the difference between a benchmark price and the price offered to consumers. As a result, the UK Government asserts that it does not provide any fossil fuel subsidies.38 In contrast, the EU and the OECD adopt an inventory approach, that includes direct government support and tax expenditures.39 The implications are significant: the OECD considers the UK fossil fuel tax regime to include subsidies, and a Commission report in 2016, just before the UK left the EU, concluded that it was the largest provider of fossil fuel support in the EU.40 In contrast, while New Zealand has faced controversy about its climate commitments, particularly its high agricultural emissions,41 its international leadership on fossil fuel subsidies reflects its lack of defensive interest in this area, and its domestic commitment to subsidy phase-out.

The FTA commitment does not establish any particular criteria for defining fossil fuel subsidies, leaving that to the discretion of Parties. Thus it does not require the UK to change any of its current practices. This underscores the strategic importance of a common definition for fossil fuel subsidies, and the influence that a stricter definition would have in increasing the legal weight of the commitment.

Similarly, the UK and New Zealand have already agreed to phase out export finance for fossil fuel development, so while it is ground-breaking to include this in an FTA, it does not bind them to undertake anything beyond what it has already agreed domestically.

There are additional sources of interpretative ambiguity that would seem to weaken the legal weight of the commitment. First, in order to be relevant, fossil fuel subsidies must be ‘inefficient’ (EU FTA) or ‘harmful’ (UK FTA). The term inefficient has been used more broadly in fossil fuel subsidy commitments, as detailed below. Commitments to phase out environmentally harmful subsidies have been discussed in multilateral fora, such as the WTO in the context of fisheries subsidies, so the use of the term ‘harmful’ may be intended to create continuity with these discussions.42 In either case, not all fossil fuel subsidies are covered, but only some, and the criteria for their identification remain discretionary. Further, both commitments contain an implicit proportionality element: countries are able to provide subsidies if they meet unspecified public policy and public interest objectives. When viewed together, all these factors make it appear unlikely that either side could successfully demonstrate that the other had failed to meet its obligation. Despite these limitations to the transformative value of the commitment, it is still a significant advance in integration of trade and climate objectives, with wider ramifications examined below.

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Emily Lydgate

Research Theme Lead for 'Negotiating a Turbulent World'

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