Whilst the European Union is firmly committed to joining the fight against climate change and developing sustainable finance, the significance of the role the European Central Bank can play is being overlooked, write Ludovic Suttor-Sorel and Frank van Lerven.
Ludovic Suttor-Sorel is policy advisor at Positive Money Europe; Frank van Lerven is Economist at New Economics Foundation
In response to the 2015 Paris Agreement, EU institutions have launched several initiatives to mitigate climate change. To achieve its goals, the Commission estimates that Europe will need €180 billion additional yearly investment, notably in clean energy.
To come up with a strong strategy, the European Commission has established a High-level Expert Group (HLEG) on sustainable finance to discuss these topics and draft proposals. Earlier this summer, the HLEG released an interim report, which is currently open for feedback from civil society and stakeholders.
The report includes some very strong recommendations. For example, the necessary addressing of recommendations on climate-related financial disclosure or the idea of a ‘brown-penalising’ factor on banks’ capital requirements. However, by focusing on mobilizing private capital, the report ignores the crucial role of central banks.
Central banks: the missing link
The ECB is in a powerful position to steer the financial sector towards more environmentally friendly policies. Yet it is doing next to nothing to act on climate change, quite the contrary.
Over the past three years, the ECB has injected €2,000 billion into the economy through what is commonly called “quantitative easing” (QE). The ECB expanded the QE programme in June 2016 when it started buying corporate bonds known as the Corporate Sector Purchase Programme. In practice, the ECB is making money even cheaper for large multinationals.
By using money creation to purchase safe assets from companies and financial investors, the ECB is hoping to stimulate the economy and bring inflation closer to the ECB’s target.
It aims to achieve this firstly by making bonds less profitable, thereby pushing investors to look for riskier investments, and secondly, by making lending so cheap that households and companies are driven to borrow more from banks.
Not only is the economic rationale for extending the scope of QE to corporate bonds ambiguous, it also sends a very worrying message over efforts to tackle climate change. From the programme’s inception, it has been heavily skewed towards the high-carbon sector, as highlighted by the Corporate Europe Observatory and QE for people.
A recent study by the Grantham Research Institute on Climate Change and the Environment (LSE) notes: “62.1% of ECB corporate bond purchases take place in the sectors of manufacturing and electricity and gas production, which alone are responsible for 58.5% of eurozone greenhouse gas emissions”
Climate change, described by the climate economist Lord Stern as the potential “greatest market failure”, will have a tremendous impact on financial stability. In the likely event that fossil fuel assets should lose their investment value, the financial community would face massive losses, possibly amounting to a thousand billion.
Furthermore, as developed in the interim report of the HLEG, there is a horizon mismatch between the profit-driven short-term investment strategy of private and institutional investors and the long-term risk embedded in climate related issues.
What the ECB can do to shift investment patterns
The ECB has a large number of potential policy tools that could push investment decisions towards sustainable long-term investment. New Economics Foundation’s recent paper outlines three main ideas, which deserve to be included in the final HLEG report.
The first is that the ECB could implement green macroprudential regulation which could help reduce carbon emissions and maintain financial stability by imposing a type of surcharge on “brown” forms of lending, compensating for the negative environmental externalities and the market failures this misallocation of credit represents.
This could include introducing quantitative ceilings on credit extension to certain carbon-intensive or polluting activities, climate-related stress tests or countercyclical capital buffers.
Secondly, the ECB could also stimulate green investment through the use of “green credit allocation”. Similarly to the TLTRO operations, the ECB would provide Green targeted refinancing lines to which the banks could refinance themselves at a cheaper rate, hence providing an incentive for banks to lend more to the green sector by rewarding them with higher marginal profits.
Finally, the ECB could adopt a Green quantitative easing programme.
In its purest form, a Green QE programme would involve the ECB orienting its public bond purchases towards development banks, or similar public intermediaries such as the European Investment Bank and its national equivalents – which could finance green economic projects including green infrastructure investments, green SME loans and other green initiatives.
As recognized by the ECB, “there are no legal barriers per se to guide purchases towards specific sectors and industries”.
In a more modest and pragmatic option, such policy would simply involve the addition of sustainability criteria into the eligibility list of the ECB’s current QE programmes.
Central banks have rebutted the aforementioned approaches on the basis that the ECB must be guided by the principle of “market neutrality.” However, the purpose of the current discussion on sustainable finance is precisely to seek ways to correct market inefficiencies when it comes to financing the highly needed investments to make the planet habitable for future generations.
Going green is not just a desirable idea for the ECB. There is even a case that the ECB has a duty to do so. Indeed, as with every other EU institution, the ECB is already bound by the Paris Agreement that was ratified by the EU In 2016 and therefore should align its policies to contribute to EU’s climate goals.
It can do so according to EU Treaties, which stipulate that the ECB “shall contribute to the achievement of the objectives of the Union”, which include, as stated in article 3 of the TFEU, “a high level of protection and improvement of the quality of the environment”.
If the EU is serious about building a climate-friendly financial system, all financial institutions must be involved without exception. Central banks are equipped with unique tools that are needed to deal with the actual size of the issue – our planet.