The ECB chooses green: Corporate emissions will be taken into account when buying bonds

Fossil energy companies Shell, Repsol and OMV, Schiphol Airport, the airline Wizz Air, the raw materials and mining giant Glencore. These are companies that cause a lot of climate damage with their activities – but who can count on support from the European Central Bank (ECB).

The bonds they issued are actually on the balance sheet of the ECB, which has bought the loans in recent years. The ECB bought a total of around € 350 billion in corporate debt to reduce its borrowing costs. The economy should boost and – until recently – very low inflation should boost.

On Monday, the ECB issued an important announcement: Monetary policy will turn green. From October this year, the ECB will take climate considerations into account when choosing to buy bonds.

It is true that in addition to the EUR 350 billion, the ECB no longer buys additional corporate loans. Inflation is now too high instead of too low, so the buying program has been interrupted. But bonds that expire will still be replaced by new ones for the time being. Every year, around 30 billion euros are reinvested in business loans according to new, green criteria.

From now on, the ECB will take into account how high corporate emissions are, how ambitious they are in reducing emissions and how open they are about their polluting activities, ECB Governors Isabel Schnabel and Frank Elderson told reporters on Monday. “This will encourage companies and financial institutions to be transparent and gradually reduce emissions,” Schnabel said.

No exclusion

No company is pre-excluded from the ECB buyout – not even a fossil energy giant like Shell – but if an internal scoring system indicates that a company is underperforming, the ECB chooses another bond. Climate criteria will also apply to collateral accepted by the ECB for bank loans.

The ECB’s decision shows how the central banks’ thinking on climate change, an issue they steered around just a few years ago, has changed. The Bank of England and the Swedish Riksbank recently announced similar steps. Investments in fossil fuel companies that do not complete the conversion quickly enough are increasingly considered risky. But it’s not just about risk management. After many years of hesitation, central banks see a role for themselves in achieving the Paris climate goals.

However, that role is limited, says Frank Elderson, a Dutch lawyer at De Nederlandsche Bank, who now works for the ECB. “Governments and parliaments have the main responsibility in this, but we all have a duty to contribute.”

According to the ECB, the legal basis for the green lane is in the EU Treaty. It states that the ECB’s primary task is ‘price stability’ – defined by the ECB itself as 2% inflation. Its secondary task is to contribute to the EU’s general economic policy ‘, including environmental policy. The new ECB policy is based on this second objective. Should these two goals collide in practice (when deciding whether to buy a bond or not), price stability takes precedence over climate policy, Schnabel emphasized. “There’s a hierarchy.”

Read also: ECB: Climate change poses an additional risk to companies and banks in southern Europe

Goodbye market neutrality

Monday’s decision, already set last year, is a victory for the more innovative ECB board members who want climate action. ECB President Christine Lagarde belongs to that group, as do Schnabel and Elderson. One of the most difficult internal discussions in Frankfurt centered on the principle of ‘market neutrality’: the long-dominant idea that the ECB should monitor supply in the bond market so as not to disturb the market. This principle is now overboard. In any case, the bond market, it is now believed, is not a ‘neutral’ reflection of the economy. Large fossil fuel companies issue a relatively large amount of bonds because they need a lot of capital.

Like any financial institution wishing to invest greener, the ECB encounters the forest of criteria that already exist. Elderson said the ECB is tentatively targeting Brussels legislation, including “taxonomy”, the green investment classification system and a new transparency directive for companies. Nevertheless, there is still a risk of manipulating sustainability ambitions (‘greenwash‘), Elderson admitted. “We are well aware of that.”

As a next step, the ECB is considering offering a rebate to banks requesting long-term credit from the ECB if used for sustainable purposes. The Bank of Japan already benefits banks that finance emission reductions.

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