ECB's avenues to intensify climate action in quest “of punch”

Monetary policy tightening, responding to 2022’s inflationary spike, could hinder the green transition. Interest rates and raw material price increase create new barriers to low-carbon investments. ECB’s own goal to align with the Paris agreement adds up to the complexity to maintain price stability without hampering efforts to transition to a low carbon economy.

The ECB must navigate through a double constraint, maintaining price stability, which is crucial for the transition to occur at an appropriate pace and in an orderly manner - all the while intensifying its own decarbonization[1].

In a recent speech, Isabel Schnabel, an influential member of the ECB's Executive Board who is vocal on climate change, argued that the current ECB climate actions are insufficient to ensure carbon neutrality in its operations by 2050. The ECB has pledged to align with the Paris agreement as part of its climate change-related Roadmap[2].

Indeed, in October 2022, the ECB started tilting its corporate debt portfolio and collateral framework towards issuers with better climate performance through the reinvestment of redemptions[3]. But the change from half a decade of quantitative easing to a quantitative tightening put a halt to reinvestment perspectives and made that tilting approach inadequate. Schnabel stressed that “the tilting parameter lost part of its punch when we decided to stop net asset purchases”.

In order to intensify efforts to decarbonize itself, she suggests for the ECB to move from a flow-based (tilting ECB’s reinvestments toward better climate performers) to a stock-based (actively tilting ECB’s portfolio through capital reallocation) approach.

In her speech, Isabel Schnabel evoked other avenues to explore in the near future for the ECB to comply with its climate objectives:

• Enlarging the tilting approach to the public sector (sovereigns, supranationals and agencies);
• Greening its lending operations by limiting the share of highly carbonated assets that can be pledged as collateral when borrowing from the Eurosystem.

As of today, ECB’s climate ambition strongly relies on its portfolio’s assets own transition, half of which come from the public sector and the other part depending significantly on the actions of a few high-emitting companies (Figure 3).

On February 2nd, 2023, the ECB decided to intensify its flow-based approach and further tilt redemptions’ reinvestment in its CSPP towards best climate performers both on primary and secondary markets[4] - contrarily to covered bonds where it will now only buy in secondary.

Unarguably, the ECB’s board member Isabel Schnabel is willing to strengthen the ECB’s climate engagement, however, consensus within the institution, timing and details are highly uncertain. Therefore, her proposals must not be considered as reflecting what the ECB will do, but only could do.   

The current economic environment rendered the flow-based tilting approach inadequate. Ms Schnabel highlighted that “the forthcoming reduction in reinvestments will further significantly constrain the ability of a flow-based approach to decarbonise our corporate bond portfolio at a pace that is consistent with our climate ambitions”. Indeed, the asset purchase program is planned to decline to €15bn per month on average until June 2023 by not reinvesting full principal payments from maturing bonds.[5]. The decrease in net asset purchases hampers the capacity of the bank to progressively tilt its portfolio (figure 1).

The ECB raises the point of German government twin bonds’ greenium (Figure 5) reaching record levels in absolute terms in January 2023 (-15 bps). An ECB green tilting towards green bonds might strengthen this trend for Germany and more broadly.

If the greenium effect is confirmed and if the ECB extends its tilting to the public sector, sovereigns could benefit from cheaper financing for green purposes and be further incentivized to invest in the transition.