We are committed to be a carbon-neutral country at the earliest in 2050.” This was the welcome statement by Prime Minister Datuk Seri Ismail Sabri Yaakob during the tabling of the 12th Malaysia Plan, 2021-2025. A month later, in his Budget 2022 speech, the finance minister revealed proposals aimed at developing a sustainable economy, including the launch of the Voluntary Carbon Market (VCM) and the expansion of green technology tax incentives.
These timely proposals, coupled with the goal of achieving carbon neutrality, echo the country’s commitment to the Paris Agreement to reduce up to 45% of its greenhouse gas (GHG) emissions intensity (against gross domestic product) by 2030, based on the level in 2005.
The global trend for decarbonisation may lead to fresh opportunities for early movers. Thus, it is pertinent for businesses and individuals to monitor proposals and identify emerging needs to stay ahead of the curve. Here, we consider different forms of carbon pricing and its critical implications for the country.
Overview of carbon pricing mechanisms
Carbon pricing mechanisms put an economic value on carbon emissions. This carbon price is to be paid by the parties responsible for the emissions, so the burden for environmental harm is shifted back to those who are best placed to reduce it. Key forms of such mechanisms include:
(i) Carbon tax;
(ii) Carbon emissions trading system (ETS); and
(iii) Carbon border adjustment mechanism (CBAM).
A carbon tax is levied on the carbon emissions required to produce goods and services. The two approaches to taxing carbon as identified by the United Nations tax committee are the fuel approach and the direct emissions approach.
The fuel approach imposes a tax on fossil fuels, such as oil, gas, coal and derivative products. Tax rates are determined by volume or weight units based on the average carbon content of each fuel type, which can then be charged anywhere within the carbon supply chain — extraction, importation or consumption. Governments may customise the approach depending on the needs and priorities of the country.
Conversely, the direct emissions approach imposes a carbon tax on GHG emissions at the source. Generally, the taxpayers would be the entities that produce or physically generate the emissions.
Emissions trading system (ETS)
Under an ETS, the interaction between market supply and demand will determine the carbon price. There is a fixed cap on the GHG emissions permitted for each business, and low carbon emitters may sell their excess credits to companies that exceed the cap. Companies may acquire allowances sufficient to cover their emissions through auctions or the allocation of allowances. A perceived advantage of ETS is that it may provide more certainty when planning emission reductions, as governments may achieve reductions over time by reducing the cap.
Notably, in Malaysia, the Ministry of Environment and Water (KASA) announced in September that it is developing a domestic emissions trading scheme (DETS) to execute carbon credit transactions at the domestic level. Further, the Ministry of Finance’s recent proposed launch of the VCM intends to serve as a voluntary platform for trading carbon credit between green asset owners and other entities moving towards low-carbon practices.
Carbon border adjustment mechanism (CBAM)
Also known as a “carbon border tax”, CBAM imposes a border fee on imports from countries without acceptable carbon pricing policies. Producers in countries with stringent emissions policies, which increase domestic costs for producing carbon-intensive goods, may move production of these goods to jurisdictions with lower carbon compliance standards and a cheaper cost base. The CBAM proposal purports to reduce the incentive to move production abroad by equalising the carbon price between domestic and imported goods.
Under the European Union’s CBAM proposal, for example, EU importers from non-EU producers will have to buy carbon certificates corresponding to the carbon price that EU-based producers would have paid if the goods were produced under the EU’s carbon pricing rules. The EU importer can deduct this cost if it can show that the non-EU producer has already paid the price for the carbon used in the production.
Considerations for Malaysia
(i) Equity implications
Since fossil fuel remains the primary source for electricity generation in Malaysia, the imposition of a carbon tax will foreseeably increase electricity production costs resulting in heavier burdens on lower-income groups. Increased compliance costs may competitively disadvantage carbon-intensive producers and this may result in additional costs being passed on to consumers. Mainly, producers who lack the resources to switch to more energy-efficient options or keep up with compliance requirements may face the heftiest impacts from carbon pricing. Also, some businesses with capital constraints may reduce production to avoid carbon tax.
(ii) Compensation policies
Governments should mobilise compensation measures, such as financial assistance or support for innovation, to ensure a sustainable low-carbon economy. Policymakers may also consider incentives to reduce fossil fuel consumption, drive research and development efforts and promote green jobs.
Malaysia’s experience with green incentives can and should be drawn upon when considering carbon pricing incentives. The country has experience with compensation policies in the context of green tax incentives such as the Green Investment Tax Allowance (GITA) and Green Income Tax Exemption (GITE), which are periodically reviewed. Policymakers have proposed in Budget 2022 that the scope of GITA and GITE be expanded to include rainwater harvesting system projects in support of the UN’s Sustainable Development Goals 2030. Further, fossil fuel-reliant industries may contract due to carbon pricing; thus, employers should adequately equip workers dependent on such industries for changes, for example, through worker training programmes.
With the imposition of carbon pricing mechanisms, it will also be crucial to consider measures to ease Malaysia away from its reliance on petroleum-related revenue, which is expected to make up about 16% of total federal government revenue in 2021. Policymakers must balance between diverting away from such revenue and ensuring the financial sustainability of these measures in the long run.
(iii) Carbon tax rate
The imposition of appropriate tax rates is vital in ensuring an effective carbon tax regime. It is hoped that the government will view a carbon tax as a means to achieve carbon neutrality and spur decarbonisation efforts instead of as a revenue generating instrument.
Although carbon tax should be sufficiently significant to drive emitters to invest in greener technology and reduce their carbon footprint, it should not form an intolerable burden to hinder business operations. Disproportionately high tax rates will lead to a drop in revenue for manufacturers and ultimately lower GDP, whereas low tax rates may be brushed off as a simple burden that businesses may attempt to pass on to consumers without investing in necessary changes.
Notwithstanding this, implementing carbon pricing mechanisms, even with an initial sub-optimal rate, may be more important than delaying implementation in hopes of getting the “right” rate.
(iv) Data monitoring and accountability
The successful implementation of carbon pricing instruments depends on the sufficiency and accuracy of data on carbon emissions and, as such, credible data on emissions must be analysed to ensure that emitters remain accountable. The Malaysian government has yet to announce a framework for monitoring GHG emissions under future carbon pricing mechanisms, but we hope a uniform carbon monitoring and reporting framework will ensure consistent measurement and accountability.
(v) Legislative framework and enforcement
KASA has announced that a Climate Change Act may be drafted shortly to manage climate change risk. It remains unclear if this legislation will cover the introduction of carbon pricing mechanisms or if parliament will enact separate legislation. Looking abroad, the UK Climate Change Act commits the UK government to bring its GHG emissions to net zero by 2050 and establishes a framework to ensure that the government can meet this legally binding target. In drafting our new legislation, the legislature would benefit from a comparative law analysis of jurisdictions with established carbon pricing frameworks.
(vi) Business disclosures
Climate risk reporting for businesses in Malaysia is still at a nascent stage, and it is unclear if policymakers will mandate the disclosure of businesses’ climate change plans. One advantage of making data available to stakeholders is that lenders can make informed decisions on greener investment and lending.
(vii) Business competitiveness
If Malaysia’s carbon pricing policy increases local costs, businesses may shift production to jurisdictions with a more relaxed approach. However, moving production offshore is a short-term strategy that may lead to other risks. If CBAM is implemented, Malaysian exporters may lose competitiveness regardless of where they base their production. Before designing systems, businesses should consider the future landscape of carbon pricing so as not to waste resources implementing short-term measures.
Businesses with sufficient foresight will benefit from the implementation of carbon pricing mechanisms if they adapt ahead of competitors, for example, by developing new strategies and introducing energy-efficient technologies. Consumers and investors are increasingly interested in a company’s climate strategy, thus, those prepared to innovate early may reap the benefits of their climate-friendly actions.
The future of carbon pricing in Malaysia
We can only tackle the planetary climate change crisis through concerted efforts across all nations. Malaysia’s refreshing and ambitious climate action goals come with the hefty challenge of decarbonising a fossil fuel-reliant economy. Although it is too early to predict precisely how Malaysian policymakers will implement carbon pricing, the time is ripe for businesses and individuals alike to assess their exposure to climate change-related risks, plan, and be ready to embrace this push for a carbon-neutral economy.
Adeline Wong and Jason Liang are partners at Wong and Partners. Kellie Allison Yap is senior associate, Jeff Sum is associate and Ashley Sern is chambering at the law firm.