Hello from Brussels. By now there seems to be a reasonable degree of confidence here that there will actually be a Joe Biden administration to deal with at the end of January rather than an alt-right paramilitary junta. Attention has turned away from the aftermath of the Capitol Hill insurrection and towards what the forthcoming policymakers are actually saying.
As we noted in Trade Secrets yesterday, the maiden speech of Katherine Tai, the US trade representative-elect, was interesting if not breathtakingly radical. (Not radical is fine, as far as the EU is concerned.) In fact, it echoed a lot of the thinking over here, that enforcement of existing trade rules will be the big thing rather than racking up shiny new agreements. Whether the EU and US can collaborate on said enforcement is the open question.
Today’s main piece looks at an EU initiative that might either be a source of tension or co-operation with the US: its plans for a carbon border tax. Tall Tales continues to mine the rich vein of told-you-sos arising during the implementation of Brexit. Our chart of the day covers the boom in Chinese goods exports.
An incremental way to save the planet
On Monday we looked at the digital services tax, a prominent document in the “Potential trade battles with the US” folder on the EU’s computer desktop. A similar item in the “Potential trade battles with everyone” file is the proposed carbon border adjustment mechanism, or CBAM.
A CBAM, which the EU hopes to introduce in the next couple of years, would mean that the carbon emissions of imports are charged the same cost as their EU equivalents. Such a system would be economically efficient and intuitively fair: it prevents carbon leakage by internalising the cost of carbon emissions to the EU’s trading partners, as well as to its own producers. Unfortunately, its economic and ethical attractiveness is in inverse proportion to the ease of designing a mechanism that could both achieve these desired ends and stay within World Trade Organization rules.
The European Commission’s finest have beavered away since 2019 to produce a proposal by this year. There are two particular reasons why it’s a lot harder than it sounds to come up with an effective CBAM. For one, a blanket tariff on all imports from a particular country erases the difference between relatively carbon-light and carbon-heavy producers. Second, assessing a product arriving at the EU border depending on its last export destination glosses over carbon emitted earlier in the supply chain. Detail matters in the design of a CBAM. Ignoring technicalities is both inefficient and potentially opens the measure to legal challenge at the WTO.
An obvious way to do a carbon border measure, as we’ve described before, is in effect to incorporate foreign producers into the EU’s emissions trading system, its carbon market and also the most important tool Brussels has right now for reducing greenhouse gas emissions. This would require them to buy the permits that European producers must now use to be able to compete with them in the EU market.
Implemented properly, this ought to be OK under WTO law, if necessary by invoking the right to impose tariffs to conserve “exhaustible natural resources”. A paper commissioned by the European Parliament offers a very clear analysis of the WTO legality of carbon border measures. The policymaking connections of its authors, David Kleimann and Joost Pauwelyn, are worth noting. Kleimann is former adviser to the chair of the European Parliament’s trade committee and now a fellow at Georgetown University in Washington: Pauwelyn is Brussels’ nominee to sit on the EU-designed stopgap WTO appeals mechanism, and probably a future appellate body member, if it ever gets revived. He also helped to design border measures in a carbon pricing proposal presented to the US Congress more than a decade ago.
However, using the emissions trading system limits the measure’s scope. The scheme covers only some industries, and to start with the CBAM will similarly be limited to a small range of basic energy-intensive commodities — perhaps cement and steel. For finished goods rather than raw materials, the question remains whether the costs of inputs can be calculated. To assess emissions by product and by producer will require a complex emissions certification, granted by external inspectors working to an EU benchmark.
Finally, there’s the issue about what to do with those EU industries (including steel and cement manufacture) at present given free allocations for emissions under the emissions trading system. It would make sense to abolish those allocations simultaneously with introducing the CBAM. The US already regards 100 per cent-free allocations as trade-distorting subsidies that can be met with anti-subsidy duties. But industries that receive free allocations are resisting.
If and when the EU launches a CBAM, it will start it off narrow in coverage and address as many of the technical and legal complexities as possible while being prepared to adjust it as it goes along. It’s quite likely that there will be WTO litigation: indeed, you might well conclude that if China hasn’t brought a case within a few months, then the scheme wasn’t ambitious enough. Through a process of trial and error, in the same way that the Airbus-Boeing litigation has gradually pointed the way to an enduring aviation subsidies regime, perhaps the EU’s carbon border mechanism will bed down enough that it can at least start to make a measurable difference to relative carbon prices worldwide, which at the moment offer far too little incentive to reduce emissions.
This gradualist approach is no doubt the sensible one, but it does raise the question of whether such an incremental measure is worth the hassle. An independent study commissioned by the Finnish government concluded that a CBAM might well end up being more symbolic than substantive, and indeed counterproductive if it provokes retaliation from the likes of China.
The real prize would be for the mechanism to have an impact on international political economy. If the US enacts its own form of domestic carbon pricing and adopts a similar border measure, the global balance of power could change. It would no longer be Green Europe against the world but that fabled transatlantic alliance we keep hearing about holding China to its promises to cut carbon emissions to net zero by 2060. That’s a project for the medium term, to say the least. But at least a working EU CBAM, even a limited one, might nudge the world gently in the right direction.
Trade tensions? What trade tensions? China’s trade surplus hit its highest ever monthly level in December, as the country’s exports continued to boom during the pandemic, Thomas Hale writes. Exports grew 18.1 per cent in dollar terms last month, while imports rose 6.5 per cent, pushing the trade surplus to a record $78bn. Here’s what has happened to goods exports since the pandemic went global in March last year:
Exporters have benefited from higher demand for medical products and lockdown-related goods at a time when global trade has come under intense pressure and other big economies have struggled to cope. China is the only one of the world’s major economies that is expected to have grown in 2020.
Tall tales of trade
We can see that the implementation of Brexit is going to keep us in Tall Tales, which we might temporarily rename Told You Sos, for months to come.
This week’s involves the comic sight of Dutch customs officials gently relieving a British lorry driver of his ham sandwich at the border under EU food hygiene rules. Cue spluttering from Brexiters that the UK hasn’t diverged from EU regulations in this area, or not yet, so there’s no need to treat them differently. Forgive us while we do a few eye-rolling exercises.
The point, as some of us have explained only about a billion times, is that as soon as you leave the single market and its enforcement mechanisms, including the European Court of Justice, the EU no longer has oversight of your inspection and regulatory processes and so will not take them on trust. It’s not about having the same regs: it’s about having different legal regimes to enforce them.
Bad news for the UK economy, to be sure, but at least the Dutch catering industry can see brighter days ahead, assuming of course there will be any British lorry drivers left to sell sandwiches to.
Michel Barnier has warned that many of the new regulatory frictions hampering cross-Channel trade will be impossible to smooth over, as the inevitable consequences of Brexit begin to manifest themselves for businesses across Europe.
On the topic of frictions, German logistics group DB Schenker on Wednesday became the latest major parcels operator to suspend cross-border delivery services because of new red tape and customs paperwork imposed by Brexit. In a note issued to customers, the company said it was suspending shipments from the EU to the UK blaming the “enormous bureaucratic regulations” created by the post-Brexit trading arrangements that had left recipients in the UK unable to handle shipments in a “legally compliant manner”.
Amsterdam is already showing potential to eat into London’s pre-eminence as a European capital markets centre. Trading in EU shares fled London for EU centres, including the Dutch city on the first day outside the single market at the start of 2021, while Polish ecommerce group InPost picked the city for its stock listing on Wednesday. The announcement by the parcel locker business suggests that initial public offerings may also gravitate towards where trading in European stocks is more lively.
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The US company behind The North Face and Vans will relocate its Asia-Pacific headquarters to Shanghai and Singapore, the latest high-profile corporate exit from Hong Kong.
Even business travel bubbles with 11 neighbouring countries will be closed as Japan restricts entry once again to curb the spread of coronavirus.
Indian government data show imports from China fell 19.5 per cent in the first 10 months of 2020, as a border dispute stoked bilateral tensions and spurred a build-up of domestic industries.
ECB signals rising concern about eurozone bond market sell-off
The European Central Bank has indicated it will increase the pace of its emergency bond purchases to counter the recent sell-off in eurozone sovereign debt markets if borrowing costs for governments, companies and households continue to rise.
Philip Lane, chief economist of the ECB, said on Thursday that the central bank was “closely monitoring the evolution of longer-term nominal bond yields” and its asset purchases “will be conducted to preserve favourable financing conditions over the pandemic period”.
The ECB has pledged to ensure financial conditions encourage investment and spending, helping the eurozone economy to make a swift recovery and lifting inflation towards the central bank objective of just below 2 per cent.
To achieve this, Lane signalled that it would rely on its pandemic emergency purchase programme, under which it plans to spend up to €1.85tn on buying bonds by March 2022. There is just under €1tn of that amount left to spend.
“We will purchase flexibly according to market conditions and with a view to preventing a tightening of financing conditions that is inconsistent with countering the downward impact of the pandemic on the projected path of inflation,” he said.
Eurozone government bonds fell to their lowest levels for almost six months this week, and while Lane’s comments caused a brief rally on Thursday afternoon, prices then resumed their downward path.
Bond yields move inversely to prices, so the sell-off is pushing up the cost of borrowing for governments, which must sell vast amounts of extra debt this year to cover the cost of the coronavirus pandemic and its consequences.
Germany’s 10-year bond yield has risen to its highest level since last March, while the French equivalent returned to a positive yield for the first time since June and Italian sovereign yields hit their highest level since November.
ECB president Christine Lagarde said in a speech on Monday that policymakers were “closely monitoring” the rises.
Isabel Schnabel, another ECB executive board member, said in an interview with Latvian news agency Leta published on Thursday: “A too-abrupt increase in real interest rates on the back of improving global growth prospects could jeopardise the economic recovery.”
Lane gave more detail of how the ECB defines “favourable” financing conditions, saying it would track the availability and cost of bank lending and market-based funding — in particular, the risk-free overnight index swap curve and the GDP-weighted eurozone sovereign bond yield curve, which have both risen in recent days.
He warned of the need to avoid “a mutually-reinforcing adverse loop” in which banks interpret lower borrowing demand as a negative signal about the economy and companies interpret a tightening of bank lending conditions as a worrying sign about the outlook.
Eurozone bank lending to the private sector grew by just under €12bn in January, down 75 per cent from the average monthly loan growth last year according to data published on Thursday.
Much of the slowdown was because of a sharp fall in net lending to insurers and pension funds. Lending to non-financial companies also retreated slightly, while lending to households still grew but at its slowest rate since last April.
Krishna Guha, vice-president at Evercore ISI, said “ECB jawboning” was “having little effect” and “the next step — in our view presaged by Lane — is for the ECB to dial up the pace of its [bond] purchases”.
Last week the ECB spent a net €17.3bn on its emergency bond purchase programme, up slightly from the previous week but still well below the levels of last April, during the previous sell-off in government bond markets.
Frederik Ducrozet, strategist at Pictet Wealth Management, said the ECB was likely to wait until it was clear the bond market sell-off was a lasting shift before increasing its emergency bond buying above €20bn per week. But he said that “will bring the risk of disappointment [for investors] — because you have to walk the walk as well as talk the talk as a central bank”.
Armenia’s prime minister claims military is plotting a coup
Armenia’s prime minister has claimed the country’s military is plotting a “coup,” and taken to the streets with his supporters after senior army figures in the former Soviet republic called on him to resign.
Nikol Pashinyan has faced months of protests demanding he step down after the defeat of Armenian forces in a six-week war with neighbouring Azerbaijan that ended in November.
The army weighed in on Thursday, calling on the prime minister to quit after he fired the first deputy chief of staff for criticising him.
A letter to the prime minister signed by 40 senior officers warned Pashinyan not to use force against demonstrators, but did not say whether the army would act to remove him from power.
“The current government’s ineffective management and serious mistakes in foreign policy have put the country on the brink of collapse,” the officers wrote on Facebook.
Pashinyan later fired the chief of the general staff, Onik Gasparyan, ordered police to secure government buildings in Yerevan and told his supporters in the capital’s Republic Square to avoid violent clashes.
Describing the situation as “manageable” the prime minister denied he was planning to flee the country and said the army’s statement was an “emotional reaction” to a dispute over the defeat in the Nagorno-Karabakh conflict.
“We have no enemies in Armenia. I am calling for calm,” Pashinyan said, according to Russian news agency Interfax. “Of course, the situation is tense, but we need dialogue, not confrontation.”
He later took to the streets with several thousand supporters and a megaphone — an echo of the 2018 “velvet revolution” that swept him to power following a march across the country that galvanised popular support. A few thousand opposition supporters gathered at a different square and cheered as a fighter jet flew overhead.
Pashinyan has fought off calls for his resignation since signing a Moscow-brokered peace deal in November that cemented territorial gains for Azerbaijan in Nagorno-Karabakh. The mountainous enclave in the South Caucasus is internationally recognised as part of Azerbaijan, but is populated by ethnic Armenians who seized control after a war that broke out in the dying days of the Soviet Union.
Azerbaijan, a mostly Muslim country and a close ally of Turkey, launched an offensive in September with the aim of retaking the entire enclave. Armenia’s army was ill prepared for oil-rich Azerbaijan’s modern drone fleet and significant backing from Ankara.
More than 3,300 Armenian soldiers died in the conflict, with a further 9,000 wounded. Thousands of civilians were displaced, including some who set their own homes on fire as they fled land now under control of Azerbaijan.
Russia, the traditional regional power broker and Armenia’s most important ally, remained neutral even as several previous ceasefires failed and has deployed 2,000 peacekeepers to secure the region.
Pashinyan admitted the terms were “unbelievably painful for me and my people” but argued the concessions were necessary to prevent further losses.
The devastating defeat sparked fury among Armenians who stormed the country’s parliament and attacked its speaker, demanding the prime minister’s resignation.
Pashinyan backtracked on a pledge to step down after snap elections earlier this month and remained in office in the face of opposition from Armenia’s ceremonial president, three parliamentary opposition parties, and key church leaders.
The Kremlin said on Thursday it was “following events in Armenia with caution” but considered them “exclusively Armenia’s internal matter”.
Dmitry Peskov, President Vladimir Putin’s spokesman, told reporters Russia was “calling on everyone to be calm” and said “the situation should remain within constitutional limits,” according to Interfax.
German accounting watchdog chief to step down in wake of Wirecard
The head of Germany’s accounting watchdog is to step down following mounting political pressure over corporate governance shortcomings exposed by the Wirecard fraud.
Edgar Ernst, the president of the Financial Reporting Enforcement Panel (FREP), said on Wednesday he would depart by the end of this year. He is the third head of a regulatory body to lose his job in the wake of one of Germany’s biggest postwar accounting scandals.
The collapse of Wirecard, which last summer filed for insolvency after uncovering a €1.9bn cash hole, triggered an earthquake in Germany’s financial and political establishment.
Felix Hufeld, president of BaFin, the financial regulatory authority, and his deputy Elisabeth Roegele were pushed out by the German government in January for failing to act on early red flags suggesting misconduct at Wirecard. Ralf Bose, the head of Germany’s auditors supervisor Apas, was fired after disclosing he traded Wirecard shares while this authority was investigating the company’s auditor, EY. The German government is also working to revamp the country’s accounting supervision and financial oversight.
Meanwhile, criminal prosecutors in Frankfurt are evaluating a potential criminal investigation into BaFin’s inner workings and on Wednesday asked the market authority to hand over comprehensive documents, the prosecutors office told the FT, confirming an earlier report by Handelsblatt. The potential scope of any investigation as well as the individuals who might be targeted is still unclear. BaFin declined to comment.
Ernst came under pressure as the parliamentary inquiry commission uncovered that he joined the supervisory board of German wholesaler Metro AG in an apparent violation of internal governance rules, which from 2016 banned FREP staff from taking on new supervisory board roles.
Last week, the former chief financial officer of Deutsche Post filed a legal opinion to parliament defending his move. He argued that his employment contract was older than the 2016 ban on board seats and hence trumped the tightened governance regulations.
The German government had subsequently threatened to ditch the private-sector body which currently has quasi-official powers.
In a statement published on Wednesday evening, FREP said that Ernst wants to open the door for a “fresh start” that would be untainted by the discussions around his supervisory board mandates. “FREP is losing a well-versed expert in capital markets,” the body said.
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