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ECB’s new green shift: a ‘distraction’ or just ‘peanuts’?

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What should central banks do about climate change? It’s one of the hottest economic debates of our time. For a while, the drive for policymakers to take a more active approach seemed to be unstoppable, pushed along by initiatives like the Network for Greening the Financial System, formed in Paris in 2017.

But now, with inflation soaring, central banks face criticism that they’ve been getting distracted from their core task of maintaining stable prices. A recent salvo came from former US Treasury secretary Larry Summers.

“I always told my kids that how many extracurricular activities they could do . . . depended upon how they were doing in their core central courses,” Summers told an audience at the London School of Economics. A similar logic could be applied to today’s central banks, he said. “Maybe you don’t get to take on global climate change when you’re having double-digit inflation rates.”

So it’s an interesting moment, as we discuss below, for the European Central Bank to launch a mission to help decarbonise the continent’s bond market. Is it going too far, or not far enough? Let us know your thoughts at (Simon Mundy)

ECB’s new climate push: You can’t please all the people . . . 

On a cloudy Frankfurt morning in March last year, two paragliders drifted on to the roof of the European Central Bank’s glass-fronted headquarters and unfurled a large banner that read: “Stop funding climate killers!”

The Greenpeace stunt was aimed at the ECB’s programme to stimulate the European economy by buying corporate bonds. The scheme has come under heavy fire from green-minded critics who complained that a huge chunk of its investment has gone to bonds issued by some of the continent’s biggest carbon emitters.

Now the ECB is trying to change the narrative. On Monday, it promised to “gradually decarbonise” its corporate bond holdings and “tilt these holdings towards issuers with better climate performance”.

The shift comes as the ECB stops expanding its bond portfolio, part of its effort to tighten monetary policy amid soaring inflation. So the new, greener strategy will apply only to its purchases using the proceeds of the bonds it already holds as they mature. That means about €30bn a year, out of a total portfolio of €386bn.

There’s still plenty of uncertainty around the new policy, which will apply from October. The ECB has given only vague details of how companies’ climate performance will be measured. And the shift on bond purchases is just one part of its new stance. It will soon impose limits on the quantity of corporate bonds issued by highly emitting companies that it will accept as collateral for credit. The bonds of companies with insufficient climate disclosures won’t be accepted at all.

ECB president Christine Lagarde promised there would be more climate-friendly steps to come, sparking speculation that the central bank may eventually start selling down its carbon-intensive holdings, or exclude certain sectors from its bond-buying strategy altogether.

What does this mean for Europe’s bond market — and its climate strategy?

Ulf Erlandsson and Jo Richardson of the Anthropocene Fixed Income Institute have been working on these questions for some time. They characterised this as a “Don’t fight the Fed” moment: the ECB has made clear that it intends to oversee a tightening of the funding environment for high emitters, a signal that only foolhardy investors would take lightly. When the ECB eventually starts shrinking its corporate bond holdings, Richardson predicted, “these are the bonds that will be sold first”.

While the full effects of the ECB’s gradualist approach will take years to be felt, AFII research suggests that some carbon-intensive companies may feel more of a squeeze than others as they look to refinance debt falling due in the next few years. The ECB holds, on average, well over a quarter of each corporate bond issuance that features in its portfolio. These include a €20bn issuance from German power company Eon, with 31 per cent of that maturing in 2024 or earlier. For French oil company Total, those numbers are €16.3bn and 24 per cent.

Erlandsson says the ECB’s bond purchases have meant significant financial support for heavy fossil fuel producers and users. “When the ECB has been buying bonds from Glencore, they’ve been partially funding Glencore’s methane-leaking coal mines in Australia,” he said. “When they’ve been buying Total bonds, they are implicitly supporting Total’s build out of the eastern African oil pipeline.”

The ECB previously pursued a “market-neutral” approach to its corporate bond portfolio, meaning that it tried to make its holding of each asset proportionate to that security’s weighting in the overall bond market. But as an important paper earlier this year pointed out, companies in industries such as mining and energy are far more active issuers in the European bond market than peers in sectors such as technology or professional services. The authors — who include an ECB economist — noted that this means that carbon-intensive industries are hugely over-represented in the ECB’s bond holdings, relative to their share of European economic activity.

A hotly debated move

Still, the ECB’s intention to decarbonise its portfolio, which it’s been talking about since last year, has sparked plenty of pushback. In February, conservative members of the European parliament criticised the plan as a “distraction” from the ECB’s core task of managing inflation, and accused it of trying to expand its mandate “through the back door”.

That chimes with the position of Republican lawmakers who blocked the appointment of Sarah Bloom Raskin to the Federal Reserve board, after the former deputy Treasury secretary said the US central bank should prioritise tackling climate change risks.

One central bank that has already been moving in this area is the Bank of England, whose former governor Mark Carney played a prominent role in driving climate change up the central banking agenda. Last November it announced that companies would need to meet climate-related criteria to be included in its asset purchase scheme, and that its purchases would be “tilted” towards the stronger performers on that front.

But while central banks are right to take climate risks seriously, there are grounds to be nervous about the ECB’s new statement, said Huw van Steenis, a former senior adviser to Carney at the BoE. He voiced concern about the change to the collateral framework, which he said was “there to provide liquidity to the financial system day in, day out, and in particular in emergencies. One tinkers with it only with extreme caution”.

Van Steenis was uneasy, too, with the new bond-buying stance that’s seemingly aimed at raising the cost of capital for some borrowers relative to others. “Actively seeking to skew the cost of capital — that’s not really the central bank’s job,” he said.

The ECB itself said that this move is covered by the second part of its dual mandate, which calls on it to support the European Union’s economic policy — which now has the energy transition at its core.

Others said it should be more aggressive in its climate action. Stanislas Jourdan, head of the pressure group Positive Money Europe, argued that imported fossil fuels are a long-term source of inflationary risks — and that promoting the energy transition should therefore be considered part of the ECB’s primary mandate to manage inflation.

For critics like Jourdan, this is just a small step in the right direction from the ECB. “We’re talking peanuts,” he said, referring to the roughly €30bn of asset purchases that will be affected by the new policy. “What they did here is pretty modest.” (Simon Mundy)

Additional reporting by Hannah Wendland

Japan flips the script on loans for coal financing

The Japanese government said late last month that it will stop providing yen-denominated loans to build two coal-fired power plants in Asia: one in Indonesia and the other in Bangladesh. The policy reversal came in response to the growing global criticism of Japan’s role as a key coal power project exporter.

With the loss of funding, neither project now looks likely to go ahead. Bangladesh will eschew its plans for a coal-based plan in favour of a liquefied natural gas plant for its Matarbari 2 project. Indonesia’s Indramayu project, which had already been placed on hold, may be halted entirely to meet the country’s net zero target.

Japan’s foreign ministry announced the move just ahead of last month’s meeting of G7 nations, which agreed last year to stop international financing support on new coal projects. The world’s third-largest economy originally resisted the agreement and insisted it would exclude ongoing projects, including the Indramayu and Matarbari 2 plants.

Public finance from Japan, China and South Korea accounted for more than 95 per cent of the total foreign financing for coal-fired power plants since 2013, according to the World Resources Institute. Last year, China and South Korea also pledged to stop supporting coal-fired projects overseas.

Japan’s policy shift has been widely welcomed by international ESG investors and local environmental activists. But it also raised a new concern. “This is an important win for global Paris alignment — but only if coal is not replaced one-for-one by LNG [liquefied natural gas] whose climate benefits are consistently overplayed,” said Eric Christian Pedersen, head of responsible investments at Nordea Asset Management. The right alternative is renewables — not LNG — because methane leakage in the supply chain can mean gas power ends up having the same atmospheric warming effect as coal, Pedersen added.

Japan’s decision came as the G7 itself decided to accommodate LNG as a “necessary response” to the current energy crisis caused by the war in Ukraine. Climate activists have since accused the G7 of “backsliding” on its pledge to stop funding overseas fossil fuel projects by the end of this year, our colleague Leslie Hook reported. The final communiqué from the June summit said that “publicly-supported investment in the gas sector can be appropriate as a temporary response” in some exceptional circumstances. (Tamami Shimizuishi, Nikkei)

Smart read

US prison operator CoreCivic faces scrutiny over its alleged profiteering from forced labour by immigrant detainees, writes Lee Fang of The Intercept. But it also features in multiple environmental, social and governance funds run by companies like BlackRock, DWS and State Street.

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