European Central Bank (ECB) leaders gather on June 18 for their first in-person meeting since the beginning of the covid-19 crisis. As part of their “strategy review process”, they will discuss how to recalibrate eurozone policy. While it remained a very divisive and controversial issue a year ago, climate will be high on the agenda this time around. ECB council members are likely to adopt measures to “green” their policy, but significant uncertainties remain on what these measures will be. While several options with the potential to reduce the ECB’s support to high carbon companies are on the table, more conservative ECB council members advocate for the use of disclosure requirements and ESG ratings only. These proposals are by no means sufficient to address the climate crisis or to manage the related risks. They could also further delay action.
When talking about climate integration at the ECB, Bundesbank President Jens Weidmann puts forward two measures:
- Linking corporate asset purchases to non-financial reporting, more specifically by requiring TCFD-compliant disclosure to be eligible;
- Using ratings that incorporate climate risks.
These measures seemed to have won some support from more conservative ECB council members. But, as NGOs and activists stress in a letter to President Weidmann, sticking to this low-hanging fruit measures would be a failure for the ECB.
Ignoring EU climate objectives
These disclosure and rating proposals do not have a direct effect on the ECB’s support to polluters. They are grounded in the idea that climate integration at the ECB concerns only the integration of climate-related risks. “Climate action” is deemed to be the domain of states and political leaders only, while the ECB should be “market neutral”.
However, the ECB is already making political decisions and – as Isabel Schnabel recognizes – acting in a non-neutral way. Painting the ECB as a purely independent and neutral institution leads it to ignore the climate objectives set by the EU and member states, despite its mandatory secondary objective to support the general economic policies in the Union. This also, drives it to reproduce or amplify market failures, therefore contributing to climate change and contradicting its primary mandate of price stability.
Furthermore, disclosure and rating could easily be used by ECB members to reject responsibility on market participants. As progress on these fronts have been very slow to materialize, the ECB would refrain from action until financial players are “ready”, of course by then it may be too late to limit global warming to Paris-aligned levels.
Insufficient to manage climate risks
While both proposals are presented as risk management options for central banks, they fall short of the bar they set:
- Disclosure is by no means the equivalent of risk management. Knowing risks is no guarantee of reducing them. For that to happen, action must be taken on disclosed information.
- The overlying assumption behind this proposition is that financial markets will efficiently integrate the new information and reduce their exposure accordingly. This disregards the fact that financial markets are currently already failing to adequately reflect climate risk, even based on the information currently available, and will always remain difficult to precisely evaluate because they are characterized by radical uncertainty.
Mandatory reporting would not allow for the integration of climate risks in asset purchases, and therefore would not fulfill the ECB’s legal obligation to protect its balance sheet. On the contrary it would establish a ‘two track’ system, where “classic” financial risks are considered through credit quality requirements, while climate-related financial risks are somewhat recognized but not accounted for.
Moreover, as Jens Weidmann himself acknowledged during the Green Swan Conference, waiting for potential TCFD compliant disclosure and climate-ready ratings could take time. It could take several years to have enough company using the TCFD and ratings that somehow reflect climate risks.
The Network For Greening the Financial System (NGFS) itself emphasizes that acting now, on the basis of non-financial metrics, could be less costly for central banks than waiting for precise financial information. At the same time, the De Nederlandsche Bank (DNB) stressed it would champion a “precautionary approach” to climate risks at the ECB, that entails mitigating climate change in order to mitigate the related risks.
To conclude, measures that contribute to mitigate climate change are necessary to mitigate the related risks. To fulfill both of its mandates, the ECB is duty-bound to reduce its support to polluting activities and companies. Decarbonizing asset purchases and the collateral framework is a good place to start. Time is of the essence – the ECB should immediately start on this path by excluding fossil fuel companies that do not align with the Paris-Agreement.