The European Central Bank plans to rejig its corporate bond portfolio to favor issuers that pollute less, marking its most significant shift yet to weave environmental considerations into monetary policy. 

The ECB will reinvest “the sizeable redemptions expected over the coming years” in a way that penalizes companies with a big carbon footprint, according to a statement on Monday. The new plan will affect some 30 billion euros (US$31.3 billion) worth of reinvestments each year, or around 10 per cent of the ECB’s corporate portfolio, Executive Board member Isabel Schnabel said. 

“If you compare it to other central banks, this is a substantial amount, so this makes a difference,” she said.

The ECB is adjusting a cornerstone of its toolbox amid a growing sense of anxiety that time is running out to address the threat posed by global warming. The United Nations Intergovernmental Panel on Climate Change has estimated that the planet might be on track for temperature increases that could be twice the limit set out in the Paris climate accord. 

Meanwhile, the ECB has faced repeated criticism from environmental activists, who point to its holdings of carbon-heavy companies, such as Shell Plc, Eni SpA, and TotalEnergies SE.

We are in the midst of multiple crises, including climate change, that are challenging our society and economy. Within our mandate, we are taking concrete steps to incorporate climate change into our monetary policy operations.
“With these decisions we are turning our commitment to fighting climate change into real action,” ECB President Christine Lagarde said in the statement. “Within our mandate, we are taking further concrete steps to incorporate climate change into our monetary policy operations. And, as part of our evolving climate agenda, there will be more steps to align our activities with the goals of the Paris Agreement.”

 
MONETARY POLICY GOALS

At the same time, there’s a debate around the extent to which it’s appropriate for monetary policy to be redefined in order to join the fight against climate change. In its statement on Monday, the ECB said that the volume of corporate bond purchases will “continue to be determined solely by monetary policy considerations and their role in achieving the ECB’s inflation target.”

And policy makers were eager to show that the planned “tilt” in the ECB’s bond holdings will be a gradual process for the issuers affected.

“We want to give all those companies an incentive to become greener and therefore to make sure that over time they remain part of these portfolios,” Schnabel told reporters. She added that “climate change considerations cannot stand in the way of our monetary policy needs, so there is a clear hierarchy.”

The ECB’s Climate Tilt:

• The measures -- which will initially apply to non-financial corporations -- will take effect from October, with further details to be announced in the interim, the ECB said. Climate-related information on corporate bond holdings will be published regularly as of the first quarter of 2023.
• The ECB updated its collateral framework, pledging to limit the share of assets from issuers with a high carbon footprint. And it will consider climate-change risks when reviewing so-called haircuts -- reductions in the value of collateral that reflect risk -- that are applied to corporate bonds.
• The measure is expected to apply before the end of 2024, if necessary technical preconditions are in place.
• At first, the Eurosystem will apply limits only to marketable debt instruments issued by non-financial companies.
• “There are other assets which are very relevant and therefore we already now plan to extend these measures to unsecured bank bonds and also to credit claims,” Schnabel said
• The Eurosystem will only accept marketable assets and credit claims from companies and debtors that comply with the Corporate Sustainability Reporting Directive (CSRD) as collateral, once the directive is fully implemented
• The Eurosystem will urge rating agencies to be more transparent about how they incorporate climate risks into their ratings.

Daniela Gabor, a professor of economics and macro-finance at UWE Bristol, tweeted that the ECB’s climate plans represent a significant step.

“The new collateral rules are by far the most ambitious in the central banking world: the ECB is now in the business of penalizing carbon financiers,” she wrote.

The efforts mark the result of a year-long process of designing concrete steps for including climate-change considerations in the central bank’s monetary policy. Officials had pledged to start work on a detailed plan last July, when they announced the results of their sweeping strategy review, which also included an adjustment of the ECB’s inflation goal.

Separately, the ECB has also conducted a so-called climate stress test among commercial banks, which is set to reveal that lenders remain poorly equipped to judge how significantly global warming will hit their balance sheets. It’s due to publish results of the test on July 8, though it won’t break out how individual banks fared, Andrea Enria, who leads the ECB’s supervisory board, said last week.