The European Central Bank (ECB) finally announced a clear shift away from its sacrosanct “market neutrality” principle, as it will introduce green criteria in its rules for corporate bond purchases and refinancing operations. While this is a significant improvement, the introduction of these measures remains slow and applies to only 5.87% of the ECB’s balance sheet.
On 4th July, we finally got the long-awaited news on the concrete measures that the ECB will take to incorporate climate change into its monetary policy operations. One year ago, the ECB announced an action plan on climate change as part of its strategy review, but the plan still lacked details at the time. So what exactly will change?
Ending market neutrality in corporate bonds purchase
First, the ECB announced that the purchases under its corporate sector bond holding programme (CSPP) will be “tilted” towards issuers with good climate performance. In practice, this means that the ECB will abandon the “market neutrality” principle when purchasing corporate bonds. Under market neutrality, the ECB used to simply mirror the distribution of assets in the market when purchasing corporate bonds, thereby benefiting the most carbon-intensive companies, as we already argued three years ago. Instead, under the new rules, the ECB will increase the share of bond purchases of companies that have positive climate performance, while reducing its purchases from the most polluting ones. To do so, the ECB will create an internal scoring system for the 300 companies that are eligible for the CSPP, based on three factors: greenhouse gas emissions, carbon reduction targets, and climate-related disclosures. It’s positive that the ECB included straightforward carbon emission criteria, as this signals that it is willing to go beyond a pure risk-based approach.
As Positive Money Europe has repeatedly argued, “market neutrality” was always a myth, as there is nothing neutral in purchasing or accepting as collateral high-polluting assets. Nevertheless, such a myth has been recurrently used by central bankers as an excuse to avoid facing responsibility for the consequences of their policymaking. With this important step, the ECB is finally acknowledging the harmfulness of this approach and is turning its operations into socially desirable goals.
Green collateral rules for accessing ECB’s liquidity
A second important announcement relates to the so-called “collateral framework”, which is the ECB’s rulebook for banks to access liquidity from the central bank. Under the new regime, the ECB will limit the number of dirty assets that banks can use as collateral to get cheap loans from it. Furthermore, the ECB will better reflect climate-related risks by incorporating them into the “haircut” criteria. Haircuts are the difference between the value of the asset posted as collateral and the amount of money received from it (for example, if a bank uses a corporate bond valued at 100€, and gets 90€ from it, the haircut is 10%). This means that the higher the climate risk of an asset, the fewer money banks will be getting from it.
On top of that, an asset will only be eligible as collateral if the issuer of the asset discloses its sustainability performance, in line with the upcoming requirements under the Corporate Sustainability Reporting Directive (CSRD) of the EU. However, the adoption of CSRD was delayed and therefore this measure is expected to become effective only in 2026.
Despite the steps forward, the ECB has not gone all the way yet. It is true that it will limit the number of dirty assets to be eligible as collateral, but the ECB clarified that it does not intend to exclude them altogether. Furthermore, the Central Bank will only start to apply this decision “before the end of 2024”, and it will only apply it to marketable assets issued by non-financial corporations (corporate bonds). In the graph below we can see that, in the first quarter of 2022, 74.8 billion euros of corporate bonds were used as collateral, which represents about 2.66% of the total collateral used by banks. Given this marginal volume, we do not understand what prevented the ECB from purely excluding the dirtiest assets from the collateral framework, as it is clear that banks will still have a very big pool of collateral to be used for their refinancing operations.
Use of Collateral and Outstanding Credit
Source: ECB
For this measure to have a greater impact, the ECB should accelerate its implementation and extend its applicability to other types of assets, as covered bonds and asset-backed securities.
Toothless pressure on credit ratings
Third, the ECB said it will “urge rating agencies to be more transparent about how they incorporate climate risks into their ratings and to be more ambitious in their disclosure requirements on climate risks“, which is a rather disappointingly weak and toothless promise. In our latest report, we propose to further develop the role of the central banks’ own internal credit assessment systems (ICAS) to integrate climate and environmental risks, instead of relying on external credit rating agencies, whose progress in this regard has not been satisfactory.
However, the ECB announcements fall short of any commitment to increase its in-house credit risk assessment capacity. The ECB merely announced it will implement common and minimum standards in the in-house credit assessment system. Why are the minimum and common standards desirable for the in-house credit assessment system and not for external credit rating agencies?
Overall conclusion
The ECB has finally adopted some of the measures Positive Money Europe has been campaigning for since 2019. This is welcomed, however, when analysing the announcements more carefully, it appears evident that both speed and scale of implementation are lacking.
Taken altogether, the measures will apply at most to about 5.87% of the ECB’s balance sheet dedicated to monetary policy operations. Given this rather small size, the ECB could perfectly exclude (instead of limiting) the dirtiest assets without running the risk of depriving banks of having enough collateral for the appropriate transmission of monetary policy.
Last but not least, the current fossil fuel-driven inflation context requires even bolder measures than were envisaged in the ECB’s roadmap one year ago. It is now clear that scaling up investments in renewables and energy efficiency will directly contribute to the ECB’s price stability mandate, which justifies considering more proactive instruments such as a green discount rate on refinancing operations such as TLTROs. However, the ECB still did not seriously consider the option of green TLTROs, although Member of the ECB’s Board Frank Elderson insisted that it was not completely off the table.
The journey towards a green ECB is continuing. Given the ECB’s commitment to review this set of measures at least every year, Positive Money Europe will continue to pressure the ECB in the coming months to ensure that it adopts more ambitious measures to accelerate the financing of the green transition.
It has been 7 years since Mark Carney, then governor of the Bank of England, said that we had to break with the tragedy of the horizon. We were lacking time to act against climate change then, and time is even more precious today.