EXPLAINER: How the ECB can print ‘green money’

At the end of 2018, the ECB held around €18 billion in corporate and public green bonds. Could it buy more to support the green transition? [European Central Bank / Flickr]

As the European Commission starts preparing a recovery plan to counter the economic fallout from the coronavirus pandemic, pressure is growing on the European Central Bank to play its role and use the opportunity to accelerate the green transition.

On 18 March, the ECB announced a €750 billion emergency bond-buying programme to help the euro area face the economic shock caused by the COVID-19 coronavirus.

In principle, the ECB’s purchasing criteria proscribes the bank from favouring one sector over another, instead buying whatever public and private bonds are available on the market.

Still, could the ECB use the opportunity to steer investments into the green economy? Read the Q&A below to find out.

Yes, by phasing out fossil fuel assets and preferring green bonds instead.

Christine Lagarde, the European Central Bank’s president, said she backed the idea when she sought parliamentary approval before her nomination last year.

While the amount of carbon assets in the ECB’s portfolio “can’t change overnight,” Lagarde said a “move to a gradual transition to eliminate this type of assets” was “something that needs to be done”.

Climate change is one of the topics of a strategic review that the ECB will carry out in the coming year, along with a reassessment of the inflation target, currently set below, but close to 2%.

More broadly, Lagarde has placed a stronger emphasis on climate protection than her predecessors. “Climate change is actually a threat to financial stability,” she said, after chairing her second rate-setting meeting in January.

Yes, but only indirectly, on the secondary market. And it is already actively doing so, although the amounts are not huge.

At the end of 2018, the ECB held around €18 billion in corporate and public green bonds.

During her confirmation hearing in the European Parliament, in September 2019, Lagarde confirmed that the ECB was allowed to buy green bonds issued by the European Investment Bank (EIB):

“The EIB is already a significant issuer of green bonds. And my understanding is that the ECB, on the secondary market, is also purchasing some of those products,” Lagarde said.

The amount of green bonds held by the ECB are relatively small compared to the €2,600 billion of government and corporate bonds it has bought since 2015 as part of the quantitative easing programme (QE).

But it could grow in the future. Benoit Coeuré, who was the French executive board member of the ECB until January 2020, went into more detail in an exchange with French MPs in May 2019:

“If the political priority is climate change, governments can decide to ask the EIB to do more for the climate. And [the EIB] could do so because interest rates are at zero and because the ECB is buying EIB bonds. So in an indirect way, through monetary policy, we created an environment which is very favourable for long-term investment,” he said. 

The ECB isn’t allowed to buy green bonds on the primary market, directly from the EIB. It has to buy them on the secondary markets, for example from pension funds.

This suits all parties: the ECB purchases pushes up bond prices (because of increased demand) so the pension funds sell their bonds for more than they paid the EIB.

At the same time, higher bond prices drive down yields so the EIB – which still needs to pay the interest rates on the bonds – is paying less.

When the ECB began is quantitative easing (QE) programme in 2015, interest rates on EIB bonds fell from 3% to 1%. This means EIB-financed projects are getting cheaper capital.

The ECB, meanwhile, is fulfilling its goal: purchasing assets in order to stabilise the economy. 

No. The EIB loans to all EU member states, which are its shareholders.

So when the ECB purchases EIB bonds it is also indirectly supporting projects outside the eurozone, like Poland and other eastern EU counties. 

This is significant for Warsaw, which relies heavily on coal for its electricity and faces the biggest challenge in moving towards net-zero emissions.

It’s good for the ECB’s image, especially now that the EIB has committed to phase out fossil fuel financing.

It’s also financially attractive. The ECB can buy 50% of all bonds issued by the EIB, compared to just 33% of government bonds. Moreover, bonds issued by the EU bank are of the highest credit quality. The EIB is rated triple-A by Moody’s, Standard and Poor’s, and Fitch. 

“The threshold to which (the ECB) can subscribe to those green bonds is not the 33% that applies to other bonds issuance, but 50%. So it allows (the ECB) to oversubscribe relative to other subscription of bonds. And I think that’s good,” Christine Lagarde told the European Parliament in September.

Given how much money the ECB is creating – about €55bn per month on average in 2015-2018, €20bn per month currently – a higher threshold looks attractive.

Germany doesn’t like the idea.

“I would find it rather problematic if the ECB were to favour green bonds as part of its bond purchase programmes,” said Isabel Schnabel, who joined the ECB on 1 January as Germany’s board member.

Schnabel also opposed giving green assets preferential treatment when they are accepted as collateral for ECB loans or when setting risk weights for banks, arguing they can destabilise the financial system.

More broadly, Bundesbank chief Jens Weidmann insists it is up to governments, and not the ECB, to fight climate change. “Our mandate is price stability, and the principle of market neutrality must be observed when implementing our monetary policy,” he said during a debate in October

But the Bundesbank’s views may be slowly shifting. In comments made at the beginning of March, Weidmann said central banks should take financial risks related to the climate into account in their risk management. “Climate change and climate policy can have economic effects that are important for maintaining price stability. This must be taken into account in monetary policy,” he said

It’s currently not clear which financial assets are green and which ones aren’t.

However, this could change soon with the introduction of an EU-wide classification scheme for sustainable investments, known as the green finance taxonomy.

By setting clear standards on what is green and what is not, the European Commission intends to widen the market in green bonds and securities and tackle so-called ‘greenwashing’ — companies claiming environmental credentials they don’t deserve.

Lagarde said the ECB could buy more green bonds as part of its monetary stimulus after the taxonomy is introduced.

But plans for a definitive classification scheme may take longer than initially expected.

Although the European Parliament and EU member states reached agreement on the taxonomy in December, they still need to determine what type of industries can qualify as “low-carbon”, “transition” or “enabling” activities.

Governments from the 28-nation bloc want more power to scrutinise what ends up on the list, with some pushing for nuclear and gas to be recognised as green.

The ECB’s quantitative easing policy – buying government debt on the bond market – totalled €2.6 trillion over the 2015-2018 period.

When QE stops, the ECB will continue buying government debt, although at a slower pace dictated by the expiry of the old bonds on its balance sheet.

When doing that, the ECB could choose to prioritise EIB green bond purchases, thus increasing its share of green assets in its total portfolio. 

This way the ECB would create ‘green money’ without fuelling inflation, says Paul de Grauwe, a Professor in European Political Economy at the London School of Economics and Political Science.

Another option is that the ECB could commit to buying a minimum amount of EIB bonds. But the ECB doesn’t comment on the expected duration of its asset purchase programme so this could be trickier.

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