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Environmental crime is being funded by legitimate investors

Environmental crime is being funded by legitimate investors

AMSTERDAM This is a criminal enterprise that you might not have expected to be one of the most lucrative in the world. It’s crimes such as illegal fishing, logging, waste trafficking, and trade in wildlife. These attacks on the natural environment upon which we depend are reaping huge rewards for the financial sector.

It is difficult to quantify the environmental crimes that cause damage. These crimes destroy ecosystems, deplete natural assets, and cause livelihoods to be destroyed. They also undermine governing institutions and hinder our ability to address climate change.

Finance for Biodiversity (F4B), in a new report, points out that such crimes can generate as much as $280 billion annually, decreasing tax revenues by around $30 billion each year. Poorer, more environmentally-rich countries are the worst offenders. Financial institutions often support this incentive unwittingly by investing money in companies that profit from such criminal acts. These institutions effectively launder the proceeds from environmental crime through the profits they make.

Anti-money-laundering (AML) rules are supposed to prevent the conversion of proceeds from illegal activities into clean money. Terrorism financing has become more difficult due to tightened regulations and increased enforcement in recent years. However, inadequate information and technology limitations hinder such efforts. Regulators struggle to keep pace with evolving approaches to concealing the origins of funds.

AML rules are not being applied well to environmental crimes. The Financial Action Task Force, an inter-governmental agency that is charged with fighting money laundering and financing terrorism, has been able to raise its profile. However, significant action has been largely limited to the illegal wildlife trading, a criminal enterprise that affects thousands of wildlife species and millions, but is only a part of the problem.

Even if AML rules were extended to environmental crimes, it wouldn’t be enough. The F4B report demonstrates that the returns on investment derived by environmental crimes should also be subject to AML rules.

Pension funds and other financial institutions are not only used to launder profits by environmental criminals, but also invest in nature-dependent areas like food, wood products and infrastructure. Environmental crime can increase the profitability of these sectors. Illegal logging, for example, can increase the land available for agricultural production. This can lower costs, increase output, and improve quality. The result is greater profits for businesses, and higher returns for investors. Although the investments are technically legal, they are derived in part from criminal activity. This is why it is important to regulate them accordingly.

The theory is that financial institutions have an incentive not supporting businesses that benefit from environmental crime. Such firms face the threat to fines or the forced suspension, making them a riskier investment. The risks are too small to deter investors. Environmental laws are often not enforced well and the fines imposed are often small.

Investors should not be discouraged by credit risks. But reputational risk could. Financial institutions will be more susceptible to public backlash against degrading investments as more sophisticated data-driven public campaigns connect the dots between investments, specific environmental crimes, and increasing sophistication of data-driven public campaigning.

It is a good thing that new mandatory environmental due diligence requirements on deforestation, most immediately, will soon be in force in key jurisdictions including the United Kingdom and the European Union. The central bank of Brazil is already incorporating climate, social and environmental factors into financial regulation in Brazil, where there are widespread environmental crimes that have serious global consequences.

As environmental crimes are revealed more, public-interest litigation will also increase. Climate litigation is already seeing some success. It builds on a long history in legal action against companies that complicited in illegal activities within their value chain.

However, this does not negate that governments must take more aggressive action. This should include enforcing AML rules and ensuring they are enforced with greater rigor. There are still significant obstacles to progress, not only in identifying illicit financial flow linked to environmental crimes, but also when they are blended with untainted flows.

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Enforcement also depends on national regulators with widely varying capabilities and resources. Regulators often feel pressured to avoid imposing a financial burden that would make their jurisdictions less attractive for financial institutions or have short term development consequences for livelihoods, communities, and communities.

Although collective action may be able to overcome these obstacles, it is slow and results in conservative outcomes. F4B supports the development of targeted mechanisms and draws lessons from other existing mechanisms that have been established to eradicate supply chains from corruption and slavery. The Kimberley Process is an international, multi-stakeholder initiative which increased transparency in diamond industry has helped to reduce trade.

This approach would be a welcome addition to the financial community. Financial actors could help reduce litigation risk and reputational damage by promoting a multi-stakeholder effort to get rid of investment portfolios linked to environmental crime. It is possible that environmental crimes are not intended. It is the actions that matter when it comes to protecting people or the planet.

Simon Zadek chairs Finance for Biodiversity. Copyright: Project Syndicate 2021.

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