Sustainable Finance Watch

SUMMARY

During her public hearing for nomination at the head of the ECB, Christine Lagarde opened the door to Assets Purchasing Programs (APP) embedding climate criteria based upon the EU Taxonomy once the classification will have been completed. She underlined the need to assess during her tenure “whether and how” such Taxonomy-based Green QE could be designed. We are far from a “whatever it takes to combat climate change” mirroring her predecessor “whatever it takes to preserve the euro”, but the dogma of market neutrality is being loosened, for good or ill. However, one should not jump into hurried conclusions. For the time being, the main hurdles are still the insufficient amount of purchasable green assets and the absence of criteria-based classification of sustainable activities. The steady growth of the market and the advance of the EU Taxonomy will progressively erode those hurdles but several years will be needed to achieve the necessary scale. Therefore, it is unrealistic to expect any type of Green QE soon. To overcome Green Bond market size problem, Ms. Lagarde calls on the legislators “to play a role in developing the universe of climate-related bonds”. One wonders whether it was her choice not to refer explicitly to EU Green Bonds (as per EU Green Bond Standard), hereby opening the door to other types of climate-related bonds, namely for example those without earmarked Use-of-Proceeds, i.e. applying EU Taxonomy to a wider range of fixed income products, including pure play issuances. Nevertheless, dealing with climate change arguably falls more naturally within the scope of fiscal or prudential. As Ms. Lagarde puts it, “The most appropriate, first-best policy response and initiatives primarily fall outside the realm of central bank policies”. One could expect more from the new European Commission President, Ms. Ursula von der Leyen and her “Green New Deal proposal”. Still, Ms. Lagarde’s green touch is noticed and promising.  

Climate change was extensively discussed during C. Lagarde’s nomination hearing 

Climate change emerged as an influential topic during the public hearing of Ms. Christine Lagarde by the European Parliament’s Committee on Economic and Monetary Affairs (ECON) on 4 September. This hearing was part of the nomination process at the head of the European Central Bank (ECB). The vivid topic of climate-motivated policy interventions by Central Bankers, Financial Regulators and Supervisors attracted much attention. Several questions in the 48 pages long questionnaire answered by the would-be successor of Mr. Mario Draghi related to financial stability and climate change nexus, putting under spotlight the potential use of unconventional monetary instruments to support greener investments.

A convincing green touch and intervention for a likely favorable vote from Green MPs

Unambiguously, Ms. Lagarde affirmed that the “discussion on whether, and if so how, central banks and banking supervisors can contribute to mitigating climate change is at an early stage but should be seen as a priority”. She seemed to have convinced her audience, especially Green MPs, who became influential in the new European Parliament (the fourth group with 75 seats), to vote in favor of her nomination (plenary vote session from September 16th to 19th). Sven Giegold, a spokesperson, had declared just after the hearingLagarde could make the ECB greener. Lagarde wants to place climate risks at the centre of financial stability. Lagarde has understood that economy and ecology must go hand in hand. With its monetary policy, the ECB can improve the conditions for investment in a green transformation of the economy. We will support Lagarde in making the ECB a lever for climate protection.”

What was so far impossible deserves to be reconsidered thanks to the EU Taxonomy

Asked about the negative impact of the ECB’s policy on climate and adjustments to prevent monetary policy from benefiting carbon-intensive firms, C. Largarde states: “I understand that favouring or penalizing specific assets on the basis of environmental criteria was so far not possible as objective criteria had not been defined. However, initiatives of the European Commission on sustainable finance to create a harmonised definition of green assets, i.e. a so-called taxonomy, which I understand the ECB is actively supporting, will improve transparency and facilitate a more objective identification of what constitutes a green financial instrument. As soon as such a taxonomy is agreed, the ECB will need to assess whether and how it can apply it to its APP.”

Predecessors never as explicitly considered green purpose monetary measures

C. Lagarde’s bold answer, albeit laconic in terms of specific measures, caught our attention. In living memory, no other financial policymaker (not even NGFS Members or Bank of England Governor Carney before) endorse such a possibility as explicitly.  Her answer provides a sort of timeline: “as soon as”, and it is rather prescriptive: “the ECB will need”. She refrained herself to suggest that the deck was stacked (“whether”) and made clear that any intervention would rely on the assessment results and expertise of the ECB (“how”).

ECB’s Assets purchasing is mentioned, collateral policies were surprisingly not

Noticeably, she only mentions APP, and not the possibility to tilt collateral requirements to the climate features of the underlying assets hold as collaterals. It would involve amending the rules defining the scope of assets eligible as collateral for monetary policy lending to consider climaterelated risk. Reported backstage discussions among European Officials present haircut on brown assets for collateral policies as a preferable option.  Falling more objectively within their mandate because of their risk profile (provided that no brown taxonomy upon which it would be anchored exists nor is planned to be developed for the moment).

Main takeaway: the instrumental role of the EU Taxonomy is authoritatively confirmed

Above all, Christine Lagarde’s statement is a reminder of how instrumental the EU Taxonomy will be for sustainable economic activities (see our dedicated publication on Natixis GSH’s website). The list of financial and public policies mechanisms meant to rely on the EU Taxonomy as a bedrock is never-ending (see the chart below excerpted from our Taxonomy publication).

Asked about the 2030 Agenda and the Sustainable Developments Goals (SDGs), C. Lagarde appeared more cautious, declaring that “Central banks within the remit of their mandate, however, may only be able to address a limited subset of these goals”. We can imagine that the best candidate among the 17 UN goals, apart from the obvious goal 13 on “climate change”, are the goal 6 on “clean water and sanitation” and the goal 12 on “responsible consumption and production”. They are indeed the most intimately linked to the 6 environmental objectives to be covered by the Taxonomy over the next years.  

From ECB’s incidental purchasing of green bonds to eligibility criteria design?

The ECB “incidentally” purchases green bonds under the corporate sector purchase programme (CSPP) and public sector purchase programme (PSPP). C. Lagarde declared that it “should continue purchasing them given their compliance with the programmes’ eligibility criteria”. The question is “would green features become per se an eligibility criteria”?
It is presently and allegedly impossible for three reasons: one fundamental tenet, the principle of market neutrality, and two practical factors considerations, the limited size of the green bond market and the absence so far of an approved taxonomy of green activities (which is though meant to partially be available by year end).

1/ The principle of market neutrality: it lies in roles repartition among public policies. 
The goal of monetary policy is to safeguard price stability while it is up to macro-prudential policy to assess financial stability risks and increase the resilience of the financial system against shocks. Market neutrality proscribes the ECB from preferring one sector over another and to avoid market distortion by intervening on purpose (i.e. “by design”) in specific market segments. Economic orthodoxy on this matter affirms that it does not fall within the mandate of Central Banks to discriminate between assets (be it favoring or penalizing) based on environmental criteria.       


However, the NGFS April 2019 interim report states that “The NGFS recognises that there is a strong risk that climate-related financial risks are not fully reflected in asset valuations.”.
In the Foreword of the first comprehensive report from the NGFS, its Chair Frank Elderson wrote that “Climate-related risks are a source of financial risk and it therefore falls squarely within the mandates of central banks and supervisors to ensure the financial system is resilient to these risks”. Yet, no consensus exists about the right choice of instruments.

Echoing the message of Benoît Cœuré (“Purchasing green bonds from a number of eligible issuers could be an option, as long as the markets are deep and liquid enough”), C. Lagarde asserts that market neutrality however “does not preclude that the ECB will in the future apply the EU Taxonomy of what constitute green assets”.

For interventionism to become acceptable, other public policies (fiscal, regulatory, prudential) would need to be found in a deadlock and insufficiently effective. Furthermore, the stability risks posed by Climate Change may appear in the eyes of Supervisors and Central Bankers as far exceeding the potential unwanted consequences of “corrective” measures. One fears when “corrective” features embedded into monetary policies turn “distortive” and result in unintended and undesired consequences.

2/ The small size of the Green Bond market: it means that an intervention at the scale of ECB’s APP - during which the Eurosystem has bought €2.5 trillion of securities- could cause severe distortions in the green fixed income market segment (our market data as of 31st July 2019 is available upon request, Green Bond amount issued in euro currency as of 31st July 2019: EUR 236 Bn). Ms. Lagarde highlights that “to provide a wide pool of purchasable securities, the eligibility criteria for the APP are necessarily broad”. For the time being, green financing eligibility criteria such as those set out by Green Bonds Principles and Climate Bonds Initiative focus on fixed-income financial instruments. Ms. Lagarde called for legislators to play a role in developing the universe of climate-related bonds. We do not know if  she on purpose did not explicitly refer to  EU Green Bonds (as per EU Green Bond Standard), hereby opening the door to other types of climate-related bonds, namely for example those without earmarked use of proceeds, i.e. applying EU taxonomy to a wider range of fixed income products, including pure play issuances. Should it be the case, it would considerably enlarge the pool of assets potentially available for intervention.

If used by the ECB, the Taxonomy could unlock new types of financial assets to be targeted by potential future “green” policies (straight bonds from issuers with strong taxonomy footprint, or equity purchase, should it be explored, based upon taxonomy compliance profile of listed companies: share of revenues, R&D and CAPEX meeting the technical screening criteria. NB: the Bank of Japan has been buying domestic equities for years). Green Bonds with the future “EU Green Bond Standard” are not the only tool possible to design green monetary policies, as formerly put by B. Coeuré: “we could potentially expand our investment universe to other asset classes where the ESG-compliant investment space is broader”.

3/ The absence so far of an approved clear taxonomy defining what is “green makes any identification of green assets to buy subjective and imprecise. The crucial issue for the integration of climate considerations into central bankers’ work is the current lack of objective environmental criteria upon which a potential favouring or penalization of assets could be based. The very purpose of the EU Taxonomy is to lay out objective conditions enabling the identification of green financial instruments.

Time horizon for green purpose monetary policies: not overnight if ever  

So, even if those three hurdles are progressively overcome, it is unrealistic to expect any type of Green Assets Purchasing Programs in the near future. The Taxonomy is still a work in progress, open to feedback until September 19, 2019, with a final version to be submitted in late 2019 to the EU Commission. Delegated acts will follow in the first half of 2020. On top of that, a certain period will be required for the appropriation at scale of the technical criteria of the Taxonomy by market participants, alongside upgrading of data collection process, strategy, investments & reporting systems accordingly. 

Does it make sense? The most appropriate response to climate change fall outside the realm of central bank policies

Ms. Lagarde clearly asserted that: “we should also be realistic. The most appropriate, first-best policy response and initiatives primarily fall outside the realm of central bank policies. While the ECB contributes to sustainability objectives within its mandate, it is up to the political authorities to define and decide on the appropriate regulatory and fiscal measures to address these challenges”. We cannot agree more with this stance. Incorporating environmental considerations into prudential regulations is by definition more effective from a risk perspective. Conversely, Green QE would serve to attract more capital by creating a pricing incentive for companies to issue “green” and subsequently grow their pool of eligible projects. However, we are not sure cyclical and discretionary policy instruments such as QE are suitable to drive structural change of the economy such as decarbonization.  

Meanwhile, Climate-related information is probably less headline making, but corporate disclosure aligned with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations will increase the quality and availability of climate-related information accessible by market participants. The 2019 June European Commission’s guidelines on reporting climate-related information fall within this category. The development of stress testing and scenario analysis related to climate change is still in its infancy (NGFS recently published technical details about the latest progress), efforts are needed to strengthen and harmonize scenarios and methodologies for greater comparability.

Climate aligned prudential regulatory policies are another tool. The underlying principle of promoting climate goals via financial regulation exploits the ability of commercial banks to create money by issuing credit. Banks can be incentivized to expand credit creation towards environmentally friendly assets if constraints on the lending process are modified accordingly. In France, a report released on January 30, 2019, from a Committee chaired by Ms. Amélie de Montchalin that was at that time “Whip” of the Finance Committee of the French National Assembly (since then, she became Minister of State for European Affairs), proposed regulatory changes to increase capital requirements for financial institutions who hold or propose “brown” assets undermining the ecological transition (i.e. prudential penalization). This echoes the internal tool that Natixis CIB is currently implementing, the so-called “Green Weighting Factor” whose primary principle is to create an internal supporting and penalizing factor (on our risk-weighted assets) depending on the greenness/brownness of our financings.

Conclusion: a sound momentum for Green & Sustainable Finance in Europe

Overall, we can be optimistic about ECB’s Sustainable finance Agenda under Ms. Lagarde should her nomination be confirmed. She voices an active support for European Commission’s roadmap (released in March 2018 as The EU “Action Plan: Financing Sustainable Growth) and called for the ECB “to contribute substantively to the Network for Greening the Financial System (NGFS)” and to devote accordingly significant resources. She confessed to hoping that the “Green Deal for Europe” announced by the Commission President- elect before the European Parliament can be a game-changer in upgrading the EU’s role in funding sustainable projects and redirect public investment towards low-carbon solutions. Ursula von der Leyen, President of the European Commission, has promised to put forward a Green Deal for Europe in her first 100 days in office. She highlighted that “increase of ambition [ objective to reduce CO2 emissions by 2030 by 50, if not 55% ] will need investment on a major scale. Public money will not be enough.” So, she is expected to propose a “Sustainable Europe Investment Plan” and “to turn parts of the European Investment Bank into a Climate Bank”. It will allegedly unlock €1 trillion of investment over the next decade. Among other measures, the new Commission President mentioned a Carbon Border Tax to avoid carbon leakage and “a Just Transition Fund” to support regions most affected by low-carbon transition. 

APPENDICES

Table 1: Range of measures for Central Bankers & Supervisors

Intervention

Concept

Current Application

Discussions in France & Europe

Likelihood

Prospective timing

Assessment of climate-related financial risks (stress-testing)

Develop & apply methodologies to identify and measure climate-related risks to financial institutions

DNB, Bank of England (FCA)

Climate related stress-test: Banque de France & ACPR

+++

Under development/testing

Disclosure of climate-related financial risks

Enforce or encourage disclosure of climate-related financial risks by firms and investors

FSB Task Force on Climate-related Financial Disclosures, French Energy Transition Law

BdF & ACPR : 2°C alignment metrics

EU Accounting Directive

+++

2020

Green Quantitative Easing

Purchase green assets as part of quantitative easing programs

Assets purchased only if they meet the central bank’s eligibility criteria, such as EIB bonds

Lobbied by observers

Statement from C. Lagarde

+

Medium or long-term (after 2022)

Environmentally aligned prudential regulatory policy

Incorporate environmental considerations into prudential regulations

Banque du Liban, Banco Central do Brasil, PBoC

Statement from former EC Vice-President Valdis Dombrovskis

Commission des finances de Assemblée nationale : “brown penalizing factor”

+

Upcoming decade

Support to development of green finance

Enhance knowledge & cooperation, diffusion of good practices

Listing requirements, subsidies, public guarantees, etc

G20, Sustainable Insurance Forum, NGFS, Stock exchanges,

Guidelines & Recommendations published, NGFS’s technical supplement

+++

In progress already

ESG integration in Central banks’ investment policies

Integrating ESG criteria in the evaluation of the overall risk of an asset purchased

Only for own purchases, for example, DNB, Norges Bank, Banque de France

First Article 173 report from Banque de France

BoE to follow in its next reporting

++

In progress already

Source: Natixis GSH (authors) and research from Campiglio, E., Dafermos, Y., Monnin, P., Ryan-Collins, J., Schotten, G. and Tanaka, M. (2018). Climate change challenges for central banks and financial regulators. Nature Climate Change, 8(6), pp.462-468

 

 

Table 2: More futuristic proposals under review

Intervention

Concept

Current Application

Discussions in France & Europe

Likelihood

Prospective timing ?

Green central banking financing

Provide additional / subsidized liquidity to banks that lend to environment-friendly activities and/or haircut on brown assets collateral eligibility

Bangladesh Bank, Bank of Japan

Banque de France

Bundesbank

NGFS

+

Under exploration

Lending quotas

Impose a minimum proportion of bank lending to flow to environment-friendly sectors

Reserve Bank of India, Bangladesh Bank

Lobbied by observers

Unlikely

Futuristic

 Source: Natixis GSH (authors) and research from Campiglio, E., Dafermos, Y., Monnin, P., Ryan-Collins, J., Schotten, G. and Tanaka, M. (2018). Climate change challenges for central banks and financial regulators. Nature Climate Change, 8(6), pp.462-468

 

 

 

RESSOURCES

 

NATIXIS GREEN & SUSTAINABLE HUB

 

  • EU Sustainable Finance Action Plan Page on GSH’s Website:

https://gsh.cib.natixis.com/our-center-of-expertise/categories/eu-sustainable-finance-action-plan
 

 

EXTERNAL RESSOURCES

 

 

 


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