We'll cover the scope of criminal activities related to the environment, the challenges of uncovering them, and how to monitor which countries are most at risk. We’ll also talk about how we at CountryRisk.io are incorporating information about environmental risks into our country risk ratings.

In November 2021, the Financial Crimes Enforcement Network (FinCEN) released a statement on environmental crimes to every financial institution in the US, encouraging them to provide structured and detailed information on suspicious activities that may be related to such crimes as part of their subject access request (SAR) filings. Likewise, environmental crimes have been a priority area for the Financial Action Task Force (FATF) since 2019. And very recently, the European Commission released a proposal for a new EU Directive to strengthen the protection of the environment through criminal law. 

While there is no standard definition of environmental crime, the term typically captures activities like:

Wildlife trafficking: Illegal trade of protected animals or animal parts.

Illegal logging: Unlawful harvesting, processing, and trading of trees. This includes  protected trees, as well as the logging of trees without the right licenses.

Illegal fishing: Fishing that violates national or international law. 

Illegal mining: Unlawful extraction and trading of commodities. 

Waste trafficking: The illegal dumping or exporting of waste. 

In 2018, INTERPOL and other organisations estimated that such activities generate USD 110 – 281 billion in illegal profits every year, two-thirds of which come from unlawful logging, mining, and waste trafficking. That this estimate range is so wide reflects the data challenge in this area. Environmental crimes are often described as ‘low risk, high reward’ as they are difficult to identify and, even if they are prosecuted, the fines or legal consequences tend to be relatively small in proportion to the potential profits. 

While the estimated illegal profits of environmental crime amount to just 0.3% of global GDP, that figure is likely to be under-reported. And, more importantly, it doesn’t account for the cost of environmental damage, such as the forest system degradation, loss of biodiversity, displacement of people, and contribution to climate change that comes from illegal logging. Since, according to the World Economic Forum, over half of global GDP is moderately or highly dependent on nature and its services, that cost is likely to be significant. Meanwhile, the negative consequences for nature itself are likely far greater than the scale of any illegal profits would suggest. 

Environmental crimes are often related to other criminal activities and perpetrated by organised crime networks. The international nature of such crimes as the illegal exporting of waste from Europe to Africa, or wildlife trafficking from Africa to Asia, means they can only be carried out by sophisticated organisations. Meanwhile, labour-intensive crimes like illegal logging often go hand-in-hand with human trafficking and child labour. Corruption is often another related activity that enables many environmental crimes, such as through the falsification of documents or bribing officials for the purchase of mining rights. 

Co-mingling of legal and illegal goods: Environmental crimes are often difficult to uncover once the goods concerned (e.g. precious stones, wood, or waste) have been moved across borders or up the value chain, as they can be easily co-mingled with legally sourced goods early in the supply chain—trees from faraway Russian forests look the same regardless of their legal status. As such, exposing such co-mingling is only possible through highly transparent supply chains and sophisticated tracking techniques.  

Dual criminality: Often, cross-border cooperation by enforcement agencies, such as the exchange of information, is only possible when the activity is criminalised under the laws of each relevant country. In many cases, a country might not even have laws for such activities because the industry in question simply doesn’t exist there. And in other cases, enforcement or fines related to environmental crimes are so weak that they contribute to  the ‘low risk, high reward’ incentive for criminals.

Cross-border activities: Many of these crimes involve multiple countries. Therefore, prosecution requires international & inter-organisational collaboration and standardised information exchange.     

What are the best sources of country-level data?

At CountryRisk.io, we help organisations identify various country risk factors as part of their due diligence process. We do this by providing data, research, and quantitative models. 

Measuring the country risk associated with environmental crime is challenging. The scoring  of countries based on the prevalence of environmental crime is often hampered by the lack of reliable and consistent data. In addition, measuring the prevalence of environmental crime requires enforcement and quality institutions, which are often lacking in the very countries where such crimes are common. In turn, this can introduce a bias in scoring the environmental crime risks of these countries. To make a solid country risk assessment, then, the prevalence of a predicate offence (i.e. environmental crime) needs to be evaluated against the backdrop of the control environment and quality of enforcement. This calls for a qualitative approach when quantitative data is unavailable. 

Here are some examples of data sources that can be useful: 

United Nations Office on Drugs and Crime: One of the key sources of data on various crimes is the United Nations Office on Drugs and Crime, which we used for a blog post on wildlife trafficking. However, in our view, the data quality—especially in terms of country coverage and timeliness—isn’t good enough to enable the purely quantitative scoring of countries.  

Wildlife Trafficking Report by the US Department of State: A welcome source for country assessments is the report to Congress on the ‘Eliminate, Neutralize, and Disrupt Wildlife Trafficking Act of 2016’, which lists Focus Countries and Countries of Concern. As part of its annual reporting, the State Department pools knowledge from various US agencies to identify those countries where wildlife trafficking is an issue. The latest report highlights the following countries: Bangladesh, Brazil, Burma, Cambodia*, Cameroon*, Democratic Republic of the Congo*, Gabon, Hong Kong, India, Indonesia, Kenya, Laos*, Madagascar*, Malaysia, Mexico, Mozambique, Nigeria*, People’s Republic of China, Philippines, Republic of the Congo, South Africa, Tanzania, Thailand, Togo, Uganda, United Arab Emirates, Vietnam, and Zimbabwe (* indicates countries of concern). The inclusion of Hong Kong and the UAE also underscores the importance of trading hubs. 

Organized Crime Index: Another great resource is the Organized Crime Index 2021 (OCI), which provides information on 190 countries in respect to flora, fauna, and non-renewable resource crimes alongside other predicate offences, such as human trafficking and drug trade. Based on the OCI, the highest risk countries are: Democratic Republic of the Congo, Colombia, Myanmar, Mexico, Nigeria, Iran, Afghanistan, Iraq, Central African Republic, Honduras. 

INTERPOL and EUROPOL: For individual country reports, we also recommend INTERPOL and EUROPOL. Their reports are especially useful for learning more about individual criminal activities. 

Global Environmental Tracker: The Environmental Investigation Agency’s Global Environmental Tracker is also a useful resource.  

World Bank and International Monetary Fund (IMF): Finally, we also recommend publications by the World Bank or IMF for a detailed understanding of money laundering risks, environmental crimes, and the quality of regulation and enforcement. 

Relevance for ESG investing and AML compliance

The relevance of environmental crimes for anti-money laundering (AML) is clear, as the profits from such activities are often laundered through the international financial system. As a result, financial institutions need to assess the source of funds and report suspicious activities, as the recent guidance from the Financial Crimes Enforcement Network (FinCEN) highlights. Information about the source country its environmental crime prevalence can help when combined with data on the individual or corporation linked to the funds. 

In turn, heightened awareness of the risks associated with environmental crimes can also reduce reputational risks, and is increasingly seen as a competitive advantage for multinational companies.  

When it comes to environmental, social, and governance (ESG) investing in corporate bonds or equities, the goal is the same as with AML compliance: do not invest in companies that engage in environmental crimes. While the AML compliance office is often close to the individual financial transaction, the portfolio manager is far removed from the operational activities of the company. As such, even more than on the compliance officer, the portfolio manager must rely on available certifications and corporate transparency reports. 

At a country level, investors can incentivise countries to address environmental crime by excluding from their investable universe those where such crimes are rampant. Theoretically, exclusion by a significant enough proportion of investors should lead to higher financing costs for these countries. An even better approach would be to engage with sovereigns by actively working with governments to address environmental crime through increased funding for enforcement agencies, legal changes (e.g. higher fines, easier information exchange with other countries), or the ratification of international treaties. 

How we incorporate environmental crime data at CountryRisk.io

We plan to integrate some of the available environmental crime data and visualisations into our platform to help AML country analysts better understand where dirty money might be coming from. Similarly, we are considering adding an indicator to the ESG sovereign risk rating model regarding a country’s strength of enforcement of international environmental conventions.

In this third part of our series on the intersection of ESG investing and AML compliance, we explore the important issue of environmental, or ‘green’, crimes.

ESG Investing and AML Compliance: Environmental Crimes

In this webinar, Markus Wimmer will guide you through a holistic climate risk assessment, which is highly relevant for all leaders regarding country risk analyses, investment decisions, and strategic goal setting.

The climate crisis is one of the biggest challenges facing humanity this century, as evidenced by global warming measurements and the frequency of extreme weather events. It affects macroeconomic outcomes, financial markets, and institutions primarily through two channels: physical risk & transition risk. Projected economic losses resulting from physical climate-related risks for individual countries vary widely across studies and time horizons.

To make the webinar as interesting as possible, Mr. Wimmer will “bridge the gap” between climate science and financial regulation, show how climate risk stress tests can be used and provide some connections to other global risks which are relevant regarding country risk assessments.

World leaders are congregating at COP26 in Glasgow this fortnight in yet another attempt to flesh out a credible plan for keeping climate change under control. And with hopes for a global breakthrough remaining modest, there’s even more reason to gauge the risks that further warming of the planet would pose for the creditworthiness of sovereigns. 

New research provides insights into the havoc that climate change could wreak on the sovereign ratings of rich and poor countries alike. That said, it also provides reassurance that stabilising the planet’s temperature in line with the Paris agreement will benefit sovereign ratings[i]. 

In the film Casablanca, Humphrey Bogart uttered the famous line that titles this article as his character reminisced about halcyon days gone by. That is not what we’re doing. Indeed, it is exactly what we cannot afford to do in the context of climate change which, in the words of Nicholas Stern, is the biggest market failure in history. As estimates of the economic consequences of climate change continue to grow, financial markets and business leaders are facing growing pressure to factor climate risks into their decision-making. Fortunately, what we will always have is the Paris of the eponymous Agreement, which makes it clear that we can be the master of our climatic destiny if we can only muster the will to take control. As such, we should view the latest research not as a harbinger of doom, but as a call to arms for swift and comprehensive mitigation action.

Still, a fundamental challenge remains: decision-makers lack the risk information they need. It is not enough to know that climate change might somehow be harmful to your portfolio. Markets need credible, digestible information on how climate change translates into material risks. However, an explosion of environmental, social and governance (ESG) ratings and voluntary, ad hoc, unregulated corporate climate disclosures has created a confusing hotchpotch of unfamiliar, incomparable, conflicting metrics. 

As we have shown elsewhere, ESG indicators allow for an excessively wide variance of outcomes for corporate and sovereign issuers alike. Depending on which indicators you choose, the same sovereign can end up at the both the top and the bottom of the ESG scale. It’s a choose-your-own-adventure story that has failed to give investors and other stakeholders reliable risk guidance.

Understanding the shortcoming of current approaches is what motivated a group of environmental and financial economists at the University of Cambridge’s Bennett Institute for Public Policy to have a stab at the world’s first “climate-smart” sovereign credit ratings[i]. The report provides a clear warning: climate change will affect the ratings of rich and poor countries alike. And the downgrades could begin this decade. 

By linking climate science with economic models and real-world best practice in sovereign ratings, the authors avoid subjective ESG go-betweens. Instead, their methods directly simulate the effect of climate change on economic outcomes and sovereign credit ratings for 108 countries under three different warming scenarios.

To that end, the authors developed a random forest machine learning model to predict sovereign credit ratings, which they trainedon ratings issued by S&P between 2015 and 2020. Then, they combined climate economic models with S&P’s own natural disaster risk assessments to develop a set of climate-adjusted economic indicators that describe the various warming scenarios. Finally, the authors fed this climate-adjusted macroeconomic data into the ratings prediction model to simulate the effect of climate change on sovereign ratings. 

Unlike much of the climate economics literature, this research found that the material impacts of climate change could be felt early as 2030. Under Representative Concentration Pathway (RCP) 8.5—a high-emissions climate scenario that closely traces recent historical emissions, leading to global warming of about 5 °C by the end of the century compared to the preindustrial average—63 sovereigns (58%) will suffer climate-induced sovereign downgrades of approximately one notch by 2030. This wave of downgrades will broaden and deepen to encompass 80 sovereigns (74%) that will face an average downgrade of 2.5 notches by 2100.

Figure 1 shows the magnitude and geographical distribution of sovereign ratings changes predicted by our model by 2100 under RCP 8.5. The most affected nations include Canada, Chile, China, India, Malaysia, Mexico, Peru and Slovakia, all of which are set receive downgrades exceeding five notches. More importantly, the results show that virtually all countries—rich or poor, hot or cold—will suffer downgrades should carbon emissions continue on their current trajectory[i].

Second, the simulations strongly suggest that stringent climate policies consistent with the Paris Agreement will result in minimal climate impacts on ratings, with an average downgrade of just 0.65 notches by 2100 (Figure 2). Considering the multiple-decade time frame, this would be a mere blip. 

There are, however, some caveats. Due to a lack of scientifically credible quantitative estimates of how climate change will impact society and politics, these variables are excluded from the model. For example, Honduras continues to feel the effects of the deterioration of its social fabric and domestic security that followed the devastation caused by Hurricane Mitch in 1998. This ongoing situation has contributed to the stunting of business confidence and growth prospects, while adding to the fiscal burden required maintain a modicum of law and order in the country. Similarly, climate change could lead to further corrosion of societal order, resulting in climate refugees and mass migration across the globe. And since none of these effects are captured by the ratings model used to calculate the ratings impact of climate change, the report’s findings are likely to be conservative estimates. As such, the results should be interpreted as scenario-based simulations rather than predictions. 

High-emissions scenarios like RCP 8.5 closely track recently observed trajectories and remain useful over near- to mid-term timescales. However, the pace of renewables deployment and climate policies, like the banning of new petrol and diesel vehicle sales, offer hope that future trajectories may fall closer to low-emissions scenarios, such as the Paris-compatible RCP 2.6 scenario. 

COP26, then, is a pivotal opportunity to steer the globe towards the Paris goals. Should a breakthrough be achieved, safeguarding sovereign creditworthiness would be a significant positive side-effect. But should our leaders fail, rising sea levels could overwhelm the flood defences of the River Clyde, immersing the very convention centre in which the climate summit is being held.

The bottom line is that it’s possible to ‘do climate finance’ without compromising on scientific credibility, economic rigour or decision-readiness. Existing climate science and economics can support credible, decision-ready green finance indicators. As such, this research is of interest to investors, sovereigns and credit ratings agencies alike. And with governments issuing ever-longer dated bonds that life insurance companies and pension funds eager to match their own long-term liabilities are eating up,the long-term creditworthiness of sovereign issuers is a vital consideration for investors.

With a reliable yardstick for assessing sovereign creditworthiness beyond the current decade yet to materialise, this research has the potential fill the gap. Data on adaptation and resilience is only going to become more crucial. And by using the recently adopted UN System of Environmental Economic Accounts – Ecosystem Accounts (SEEA-EA) as a framework for tracing environmental investments and expenditure, national statistics offices could also play a decisive role. 

[1] You can watch a replay of a CountryRisk.io webinar on the research discussed in this article here.

[1] The author is member of that research group.

[1]Some sovereigns are shaded green and would, therefore, experience upgrades. But this is not to suggest they will be climate change winners. Instead, this is more likely a reflection of the fact that they’re currently very low-rated relative to the outcome calculated by the AI ratings model. For example, Argentina’s economic fundamentals would suggest it should be rated higher than it is. The reason it isn’t is that the AI model doesn’t account for rating factors such as the default history of serial defaulters or socioeconomic and ethnic strife, as in the example of Iraq.

We’ll always have Paris: Climate change and sovereign creditworthiness

Webinar: Climate risk stress testing

Jenny Asuncion
Dec 07, 2021

ESG Investing and AML Compliance: Environmental Crimes

We’ll always have Paris: Climate change and sovereign creditworthiness

Written by:
Jenny Asuncion

Webinar: Climate risk stress testing

Jenny AsuncionDec 07, 2021

ESG Investing and AML Compliance: Environmental Crimes

We’ll always have Paris: Climate change and sovereign creditworthiness

Written by: Jenny Asuncion

Jenny Asuncion
Dec 07, 2021

Written by:
Jenny Asuncion