On March 3rd 2021, Rishi Sunak, the UK Chancellor, announced that the mandate of the Bank of England (BoE) will be changed to explicitly include environmental sustainability and net-zero compatibility. What does this mean? What will the concrete impacts be? And could this help shift the European Central Bank (ECB)?
Bank of England: a new mandate?
Following his announcement, the Chancellor sent two letters to the BoE: one to the Monetary Policy Committee – handling monetary tools – and the other to the Financial Policy Committee – in charge of ensuring the stability and resilience of the UK financial system.
Both letters stress the importance of climate change to the committees’ missions and the Bank of England will have to consider it in its operations: a/ when conducting its monetary policy; b/ when monitoring and managing financial risks and c/ when taking additional measures to further the development of a resilient and sustainable UK financial system.
More precisely, the BoE’s mandate should now reflect “the importance of environmental sustainability and the transition to net-zero”. This does not change the main monetary objective of the BoE, price stability, which requires it to maintain inflation close to 2%. In short, the BoE will have to consider the UK’s climate and environmental objectives and the overall transition of the UK financial system to net zero when fulfilling its price stability objective.
In fact, the main consequence of this announcement is to clarify what the BoE and other major central banks already recognized: that the fight against climate change is part of their mandate. It is worth noting that the Governor of the Dutch central bank – Klaas Knot – recently said that “a stable climate can be seen as an important precondition for central banks to be able to deliver on their mandate”. Furthermore, the very same day that Rishi Sunak made his announcement, Isabel Schnabel delivered a speech that emphasized how and why “greening” the ECB was essential to reach its mandate.
Of course, the mandate change of the BoE is still a big step in the right direction: it makes it impossible for the BoE and its leaders to avoid action and speeds up the implementation of the related measures.
What concrete impact?
We already know the first measure that will be taken by the Bank of England. By the fourth quarter of 2021, it will adjust its Corporate Bond Purchase Scheme (CBPS) to account for the climate impact of the issuers.
This measure was already considered before the mandate change, Governor Andrew Bailey clearly stated that it was on the bank’s agenda. It means that the BoE will no longer buy – and later divest from – bonds issued by big polluters and correct its well-documented carbon bias.
But the effect of this measure will largely depend on the metric used by the bank to define which companies are “polluting”. Two things must be considered when choosing this metric:
- Given that a drastically reducing fossil fuel production is an imperative to limit global warming, companies with fossil fuel expansion plans and/or that lack a phase-out plan must be excluded. They could be reintegrated if they adopt credible 1.5°C alignment plans that entail a complete phase-out of fossil fuel-related activities by 2050, something that none of them has done yet.
- The carbon intensity metric often used in studies and promoted by central bankers is insufficient to enable a transition to net-zero. This transition implies a drop in absolute emissions. If carbon intensity can be used in the short term to significantly lower the CBPS’ carbon footprint, it will need to be supplemented with a trajectory of absolute emission reduction.
Of course, even an ambitious decarbonization of the CBPS will be insufficient to fulfill the BoE’s mandate. The bank should implement several other important measures, notably:
- Decarbonizing its list of collateral, using exclusions of the most polluting companies and adapting haircuts to their climate impact;
- Using its refinancing operations and Term Funding Scheme to contribute to the transition, for example by setting up preferential-rate refinancing operations aimed at financing building renovation;
- Pushing for the inclusion of climate-related risks into the financial regulation – notably by increasing capital requirements to reflect the exposure to high-carbon sectors – and full disclosure of the climate impact of financial institutions.
What could it mean for the European Central Bank (ECB)?
The BoE’s change should be considered by ECB leaders that are currently debating whether and how to integrate climate into the bank’s operations. As said above, many ECB leaders acknowledge that pursuing sustainability and climate objectives is fully compatible with a price stability mandate and even contributes to it. Several ECB leaders already publicly stressed that there is no need for the ECB to change its mandate to align with the EU climate objectives and the Paris Agreement.
What is new is that the BoE goes beyond the talk and actually acts. On the opposite side, even ECB leaders that are deemed to be progressive – like French Governor Villeroy de Galhau – suggest that it could take several years to do the same.
To conclude, if much remains to be done by the BoE, its mandate change sends a positive signal that should push other central banks to speed up their climate agenda. The BoE now has the duty to adopt exemplary measures that will significantly lower its carbon footprint and bring all its operations in line with a net-zero objective. On the other side of the Channel, the ECB can no longer pretend that several years are needed to act and must take immediate action.