This article comes from the spring 2020 edition of the FORESIGHT Climate & Energy magazine, which was largely written before, or at the beginning of, the Covid-19 pandemic.
Christine Lagarde, the European Central Bank’s leading lady, talked up support for the energy transition in her pitch for the Eurozone’s most powerful economic job. In response to the Covid-19 crisis, the bank has unleashed a massive stimulus programme, buying up assets of all colours, brown and green. How can, and should, central banks support the shift to a low-carbon society and help rebuild the economy
PRINCIPLE AIM
The clean energy transition is a priority of the European Central Bank, but price stability is generally regarded as the main task of the ECB and other central banks
LACK OF INDEPENDENCE
Some central banks in Asia have a broader remit than the ECB, offering preferential loans for investments in the energy transition, but are still not independent and follow where governments lead
KEY QUOTE
Central banks cannot be a substitute for government action on climate change
She said all the right things. At her hearing in the European Parliament’s economic and social affairs committee in September 2019, one-time French finance minister and former head of the International Monetary Fund, Christine Lagarde, won over the parliament’s newly reinforced green wing with her pledge to prioritise climate change and better public communication. She got the committee’s green light for the Eurozone’s top job, president of the European Central Bank (ECB), despite not being an economist and saying very little about her ideas for monetary policy. Eight months into her mandate, we are still waiting to hear more about how the bank could support the energy transition going forward. We will need to wait a little longer. And not just because of Covid-19. On January 23, 2020, Lagarde launched a strategic review of the ECB’s policies whose results will only be unveiled at the end of 2020. An explicit part of the review is to explore how considerations beyond the bank’s primary mandate of price and financial stability can be taken into account, particularly how environmental sustainability should be included. “The primary objective of the ECB is to maintain price stability in the euro area,” says the bank. “As part of our strategy review, we will assess where and how climate change impacts our policies in terms of risk management, financial stability, market operations and banking supervision.”
USEFUL BUT MARGINAL There are plenty of ideas on what the ECB can and should be doing to combat climate change. Some have nearly universal support. Others split the finance community down the middle. Any changes to the bank’s monetary policy would require the support of Eurozone central bankers in the ECB’s governing council. The most progressive thinkers in this group have been the Bank of England, the Banque de France and De Nederlandsche Bank (the Netherlands). The German Bundesbank has typically been the more prudent, conservative schoolmaster, although with the climate debate dominating headlines in Germany until Covid-19 came along, this stance may change. Lagarde has prioritised consultation and dialogue to soothe a warring council, acknowledging her lack of economic expertise and making a clear break with her predecessor’s sometimes iron hand. She has also bought herself some time. But decisions will have to come and expectations managed. “In the end, its role will be useful but marginal,” warns Grégory Claeys, a research fellow at the Brussels-based economic think tank Bruegel. “Central banks cannot be a substitute for government action on climate change.” The trade-off for the ECB’s independence is a narrow mandate to safeguard price and financial stability, says Claeys. That was not always the case. Until about 30 years ago, central banks in Europe did a lot more — and did what governments told them to do. Some central banks in Asia today continue to have a broader remit, such as offering preferential loans for investments in the energy transition, but they are not independent. “They do what the government tells them to do,” says Claeys. Different kinds of intervention are found across emerging and developing countries, including guidance on what to grant credit to. Commercial banks and non-bank financial institutions in Bangladesh are required to allocate 5% of their total loan portfolio to green sectors, says the Bank of International Settlements, effectively a bank for central banks, in a report from January 2020. Other countries such as China and Lebanon have established or are in the process establishing differentiated reserve requirements for local banks in proportion to their lending to green sectors. Yet Europe’s experience with runaway inflation in the 1960s and 1970s suggests that more politically controlled central banks can be devastating for price stability, whatever their other merits. 
CLIMATE COULD BRING DOWN FINANCE The ECB has some margin of manoeuvre to support the energy transition. There is general agreement the bank can and should integrate climate change into its macroeconomic modelling. It is also expected to progressively green its pension funds. The ECB may well push credit ratings agencies to do a better job of measuring the climate-related risks and impacts of the companies they rate. It is set to take climate change into account as a potential risk to financial stability in its role as a supervisor of commercial banks. “Climate-related risks have been identified as being among the key risk drivers affecting the euro area banking system,” said Benoît Cœuré, a member of the ECB’s executive board, at a conference back in November 2018, in Berlin. “[Such risks] fall squarely within the supervisory and financial stability mandates of central banks.” By this reasoning, central banks, to fulfil their financial stability mandates, should steer the financial sector from “brown” to “green” assets. The May 2019 ECB Financial Stability Review included a comprehensive assessment of how climate change can affect financial stability. It showed that climate-related risks could become systemic for the Euro area. The latest November 2019 review highlighted that financial firms disclose less than 30% of the climate risks embedded in their financial assets, even though emissions related to these assets are “very” significant, reported think tank Bruegel. In its January 2020 report, the Bank of International Settlements warns that a climate disaster or “green swan” event could bring down the global financial system. Its warning is notable because this is not an NGO or collective of socially responsible investors, but a group of 60 central banks that includes the ECB and the US Federal Reserve.
POLLUTERS GET AN EASY RIDE Most controversial is how far central banks can — and should — integrate climate change into monetary policy. “Green monetary policies can complement government action [on climate change] by providing a powerful short-term signalling effect to financial markets,” argues green finance activist Stanislas Jourdan, who leads the Brussels-based NGO Positive Money Europe. Many believe the ECB and other central banks should bring climate considerations into the rulebook governing what they support and how. The bank could change its “collateral framework” or the rules that define what kind of assets it invests in. These can be assets purchased under a quantitative easing (large-scale asset buying) programme to inject liquidity into the economy, or assets pledged as collateral in commercial bank refinancing operations. The ECB could also provide greater support to the European Investment Bank (EIB), which is supposed to double its share of climate finance to 50% by 2025. Some suggest the EIB could launch a green bonds programme for the ECB to buy. This initiative would be a source of fresh funds for the European Green Deal, which aims to turn Europe into the world’s first climate-neutral continent by 2050. The ECB owns about a quarter of public sector green bonds and a fifth of corporate green bonds worldwide. It already buys bonds from the EIB, which has helped reduce yields on EIB bonds drastically since the beginning of quantitative easing in 2014. The poster child of the campaign for a more climate conscious ECB is the call for a greening of its corporate sector purchase programme — part of its asset purchase activity or quantitative easing. The bank has spent €2.7 trillion in this way since 2014 to keep inflation on target. Most of that investment has gone to public bonds. But €600 million has been spent on privately issued bonds and the majority of that went to economic sectors that are the worst greenhouse gas emitters, says a study by Positive Money Europe, such as fossil fuel extraction and distribution, and car manufacturing. In other words, polluters are getting a break on the cost of capital, with no strings attached. GREEN TAXONOMY: A NEW RULEBOOK “The question is whether the ECB should only apply climate risk factors or strip out dirty assets,” says Jourdan. So far the bank has upheld the principle of “market neutrality”, treating all assets equally, green or brown, with the logic that this allows it maximum market impact. It is presumably this logic that explains why there are no “green” criteria included in its €750-billion pandemic emergency purchase programme (PEPP). Whether and to what extent the bank moves away from such neutrality is part of the current strategic review. Claeys argues that quantitative easing should not be the primary target for ECB climate action. Initiatives such as the asset purchase programme are temporary measures to keep inflation on target, he says, not the permanent source of investment that the energy transition needs. That said, he agrees that when implemented, measures like the corporate sector purchase programme could be greener. Any shift away from market neutrality is made easier by parallel EU-level legislative work on a green taxonomy that defines exactly what constitutes a green investment. At her hearing in September 2019, Lagarde said this new taxonomy would be integrated into the ECB’s work. “I think that is something that needs to be done if we are convinced of the absolute need to unite our strengths to fight against climate change in all our institutions.” A global Network of Central Banks and Supervisors for Greening the Financial System recommended greater clarity on which economic activities are “green” and which are “brown” as one of six priorities in a first call for action in April 2019. The network was launched by eight central banks and supervisors at the Paris One Climate Summit on December 12, 2017 and has since expanded to 54 members and 12 observers across five continents. Its founding members were from Mexico, the UK, France, the Netherlands, Germany, Sweden, Singapore and China. China has already established a definition for green loans and EU lawmakers reached political agreement on their new taxonomy at the end of 2019. It was the last of a trio of legislative files that made up a first EU sustainable finance package in May 2018. The agreement will be followed up by secondary legislation in 2020. The European Commission hopes to finalise the climate criteria for the taxonomy by the end of 2020, neatly in time for the end of the ECB review. Rules around biodiversity, pollution, water and the circular economy will follow next year so the taxonomy is fully enforceable from 2022.
POLITICAL MOMENTUM The European Commission should produce a “renewed” sustainable finance package in autumn 2020 and political support is building for ECB action on climate change. In February 2020, the European Parliament passed a resolution that united those on the left and right of the political spectrum in an unprecedented call for the bank to look into climate change. MEPs reminded Lagarde of her endorsement during her hearing of “a gradual transition to eliminate carbon assets” from the ECB’s portfolio and a commitment to a greener financial system. They suggested closer cooperation with the EIB, underlining that 62% of the ECB’s corporate bond purchases have taken place in sectors responsible for 59% of the Euro area’s greenhouse gas emissions. These questions become all the more urgent with the new PEPP. Back in September 2019, Lagarde said all the right things. Just over a year later, everyone will be watching to see what she manages to deliver, especially in the wake of the Covid-19 crisis. Given just how much of the world’s assets the ECB has under its wing, any decisions it makes are likely to influence the whole world economy.
TEXT Sonja van Renssen PHOTO Lemrich/European Central Bank