European central banks pushed to adopt climate-friendly policies

EU member states' central banks and the European Central Bank (ECB), which controls the bloc's monetary policy, have been asked to cut back on investments that clash with the Paris Agreement, amid the EU's push to make more financing climate-neutral.

The call for greener finance came from the governor of the Bank of France, which is secretariat of the Network for Greening the Financial System, a central bank coalition, in a speech at the "Climate Change and Sustainable Finance" event on 11 February.

Governor François Villeroy de Galhau warned climate change threatens central banks, with impacts including reducing national GDP by 2-6% in 2050, lower labor productivity, and price shocks. For example, higher energy prices through carbon taxes would be "difficult to manage."

Villeroy de Galhau asked the ECB to decarbonize its balance sheet, including corporate assets like bonds and collateral, but excluding sovereign debt, based on climate performance data and compatibility with the Paris Agreement. He suggested doing this by adjusting the valuation of all corporate assets according to their climate-related risk.

Central banks should set an example for private banks in their handling of climate risk, he said, adding that climate risk reporting guidelines for issuers should be harmonized across Europe. A second step would be to apply the decarbonization rules to financial institutions.

Reporting on climate risk takes place today under voluntary frameworks such as the Task Force on Climate-Related Financial Disclosures (TCFD), launched in 2015. The UK government is an early mover on national mandatory TCFD-aligned climate risk reporting for large companies and financial institutions, launching rules set to come into full effect by 2025.

Central banks, supervisors, and practitioners are all seeking to act on climate risk, so there is some support for governments making climate risk disclosure mandatory, according to a paper published by the Bank of France and Bank for International Settlements last year.

But Villeroy de Galhau regretted that no bank in Europe had developed a way "to compare - and therefore to correctly assess - the heterogeneous data published by financial institutions and companies" on decarbonization, part of which is envisioned in the EC's planned revision of the 2014 Non-Financial Reporting Directive (NFRD).

The speech comes three months after the ECB pushed central banks like the Bank of France to review their climate-related practices in guidance. It said that the financial institutions central banks watch over are lagging behind on making climate-related and environmental risk disclosures, with about half disclosing risks and 8% calling them immaterial.

The ECB has asked the central banks to self-assess under the guidance and draw up related action plans in 2021. The ECB will challenge the banks' self-assessments and plans then take "concrete follow-up measures where needed" in 2022.

Already, the ECB and 19 European central banks have pledged to make green and socially responsible investment decisions with certain funds they manage themselves, such as certain investment portfolios and staff pension funds, according to an ECB statement on 4 February.

Limits to bank power

Bankers are divided over whether central banks should act on the transition to a low-carbon economy through monetary policy, and specifically whether the current ECB mandate should be changed to allow central banks to address climate change. The debate is becoming more heated as the ECB governing council expects to announce a revision of its strategy in September. This was originally slated for late last year, but was postponed due to the need for central banks to address the COVID-19 pandemic.

Lively debate is hinted at in a blog posted by new ECB board member and Dutch central bank governor Frank Elderson. He wrote that the ECB's climate action powers were limited by its founding treaties, and while it had a duty to prevent inflation related to climate change, it must not take over states' roles as green policymakers.

In addition, he argued, the ECB has stepped far enough into the issue. "We are already taking action where there is overlap between climate change and our areas of competence relating to financial stability, we have clarified our supervisory expectations of how banks should manage climate risks, we are conducting a climate stress test, and are one of 83 members of the Network for Greening the Financial System," he wrote.

Pushing for more action, however, the Bank of France's Villeroy de Galhau said: "The consideration of climate change by the Eurosystem is neither an abuse of mission, nor a simple activist conviction or a fad; it's an imperative that we must continue in the name of our current mandate and to ensure the proper implementation of monetary policy."

In January, the Bank of France announced it would exit coal financing and limit exposure to natural gas and oil by the end of 2024 in a pledge to the Finance Committee of the French National Assembly.

EU green finance rules

While action on cleaning up banks' balance sheets is still in the early stages, the offering of green bonds might be in its heyday. Billions in EU-issued green bonds are already planned, thanks to the EU's pandemic recovery fund, Green Deal proposals, and emissions reduction pledge.

Currently, the EU has issued about €50 billion ($60 billion) in bonds, but soon it could become one of Europe's largest such bond issuers, with billions more set to be committed for green finance. The European Commission's (EC) proposal is to ensure green bonds make up 30% of the €800 billion ($967 billion) in bonds being used to finance the EU's Recovery and Resilience Facility for member states, wrote attorneys at Mason Hayes & Curran.

On 10 February, the EU Parliament approved the Recovery and Resilience Facility funds, and the European Council must approve it before it enters into effect.

But the ECB's large offering is still small relative to demand by investors. "Overall, the bond market has plenty more fire power than even the mighty ECB, with $30 trillion and rising of capital out there looking for sustainable assets to finance the energy transition and the equality transition in the 2020s [...] It would be another important signal for the ECB to start applying negative screening or carbon factoring to its balance sheet; this is the other side of the coin," White & Case partner Chris McGarry told IHS Markit.

The EU's executive body, the EC, also wants to bake-in climate data reporting as part of a revision of the NFRD. Villeroy de Galhau called the EU's revision of the NFRD "the battle to be fought in 2021" (the emphasis is his).

The NFRD also will bolster EU financial greening regulation still under wraps. The NFRD already requires some sustainability data reporting by companies in Europe, and making it stronger will align it with other ESG-related EU regulations, according to law firm Dechert. "Forthcoming EU legislation, such as the Disclosure Regulation and the Taxonomy Regulation, can only achieve their objectives if more and better non-financial information is available from investee companies," Dechert attorneys wrote.

The European Fund and Asset Management Association and finance and environmental groups also issued a statement in support of the revised NFRD in July, recommending mandatory reporting for more companies, so long as it didn't duplicate other regulations.

Posted 18 February 2021 by Cristina Brooks, Senior Journalist, Climate & Sustainability, IHS Markit