Climate change: the action of the central banks

by Ophélie Mortier,
Responsible Investment Strategist DPAM


In response to the global public outcry against fires in the Amazon rainforest, the last G7 summit decided an emergency aid to help battle the wildfires, and gave rise to the creation of the Alliance for the Amazon, a coalition of countries willing to safeguard rainforest. The Alliance has already received the support of Jamaica and Qatar, and it is reported that Argentina, Chile and the Democratic Republic of Congo would be willing to join too.

The awareness of climate challenges continues to deepen and the current momentum makes more and more likely the adoption of more ambitious and demanding policies. In the absence of any alternatives and in view of the importance of agriculture and biodiversity, we must expect a strengthening of climate-related regulations.

#InevitablePolicyResponse was the hashtag of the world organisation for the Principles of Responsible Investment (PRI) at its annual Paris summit meeting last 11 September.

Is regulatory pressure the same for all institutional investors? What about, for example, the central banks and the financial and monetary authorities at the very core of the financial system.

The Bank of England, a pioneer in the matter

In a speech in 2015, the Governor of the Bank of England, Mark Carney, mentioned the concept of the “Tragedy on the Horizon” and the importance of climate risk. Strongly criticized on the grounds that he had exceeded his competencies and gone beyond his sphere of influence, he continually repeated the significance of climate change in all of his later speeches.

Today, the Bank of England is not alone: under the push of the “One Planet Summit” held in September 2017, a network of several central banks was created on the subject of climate risk. In fact, 8 central banks then decided to establish the Network for Greening the Financial System (NGFS) in order to promote the Paris Agreement. Today, the initiative includes 42 members and 8 observers (central banks and supervisory authorities). They published their first report in October 2019 and in April 2019 signed a statement according to which climate change is a source of financial risks and hence must be clearly a part of their mandate. There are some significant absences from this group and this statement: the American Federal Reserve and the Central Bank of Japan.

The Bank of England remains a leader in the matter by recently announcing the creation of stress tests concerning climate risk for the banking and insurance sectors. Since 2021, the bank will conduct a stress test on the entire English financial system to evaluate its resiliency faced with the financial risks linked to climate change.

The European Central Bank and the European Investment Bank: a zero sum game?

The European Central Bank (ECB), like the majority of central banks, has only lately become involved in this subject, but today recognizes that climate change is one of the main threats to the stability of the euro zone banking system. It is, moreover, a member of the NGFS.

One interesting study, however(1), highlights the lack of consistency between, on the one hand, the requirements of European Commission and its action plan for sustainable finance, and, on the other hand, the ECB quantitative easing program to relaunch the European economy.

In fact, in their intermediate study, the authors Stefano Battiston and Irène Monasterolo of the Universities of Zurich and Vienna demonstrate the extent to which the bond repurchase program of European Central Bank has invested in the sectors that are emitting the most carbon. In fact, most of the investments were made in the sectors with high carbon intensity such as transportation (e.g. VW, Daimler or BMW), fossil energies, public utility goods (Electricité de France and Engie) and high energy-consuming industries.

In March 2015, when Mario Draghi, Chairman of the ECB, launched its quantitative easing program, the intention was to relaunch the real economy and strengthen the effects of the monetary easing policy. Initially targeting sovereign bonds in June 2016, the program was next expanded to include corporate bonds. In this program that ended in January 2019 the ECB purchased bonds issued by 237 companies for a total value of 177 billion euros. It also announced that it would replace maturing bonds by other eligible bonds. One must consider not only the purchases made, but also the future purchases. The conclusion is that the ECB bond purchase program has not contributed to the attainment of the 2030 objectives of the European Commission and will not contribute to that in the future, in particular given the small place granted to green bonds. It should be remembered that the European Commission estimated financing needs of nearly €180 billion annually for renewable energy and clean electricity to reach its 2030 objectives.

In addition, several studies demonstrate that the non-alignment of the investment policies (including the ECB repurchase program) with the energy transition could lead to major losses for investors as well as institutions for financial development or governments whose portfolios are significantly exposed to high carbon emission sectors.

The European Commission and the ECB Chairman, Christie Lagarde, have already signalled that they would work for better consistency between their climate ambitions and their respective investments.

It is in fact surprising that the ECB investments are so little aligned with the climate agenda. At the international conference on the Principles of Responsible Investment last September, Werner Hoyer, Chairman of the European Investment Bank (EIB), recalled the importance of redirecting financing towards sustainable investments and the danger for investors of getting stuck with unsellable assets.

The European Investment Bank or the “Climate Bank”

These are the words used by Ursula von der Layen, future Chair of the European Commission, in a speech to the Parliament, to designate the EIB as the bank called to support the the greenest policy of the Commission.

If the ECB does not appear as an exemplary central bank nor leader on the subject of climate change, the EIB should restore its tarnished image. In fact, as a major provider of funds, in particular of green bonds, to finance various development programs, the bank also announced the possibility of exiting fossil energies from now to the end of 2020. The plan still must be approved by the 28 member states and could mark an important turning point for the central banks and especially the other supranational agencies involved in the question of green finance. The EIB had financed fossil energy projects up to €2.5 billion last year, that were mainly pipeline projects.

Climate change is a financial risk

The major role of the central banks is to determine a suitable monetary policy to confront the shocks impacting the economy. Up to present, most of the climate-related shocks have had a relatively short-lived and limited impact. Climate change, however, is a game changer that makes these risks more extreme and more unpredictable. The central engine of the global financial system, the central banks, the same as any professional investor, foremost, have a fiduciary duty to integrate environmental social and governance factors, in particular climate change, in their strategy and their investment decision-making process. Likewise, it would be legitimate to expect them to have a sense of duty and moral responsibility to finance the defined objectives for environmental ambitions in order to provide full alignment with the practices prescribed by the different governmental authorities.

Beyond the many initiatives launched in recent years, it is now time to take action together.

(1)“How could the ECB’s monetary policy support the sustainable finance transition?” – authors: Stefano Battiston (University of Zurich and Finexus Center) and Irene Monasterolo (Vienna University of Economics and Business), version of March 22, 2019.


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