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Antonio Carrascosa

Article published by the Center for Corporate Governance

1. Introduction

The market economy undoubtedly sidelines or undervalues certain social and environmental activities. Economic theory itself includes the concept of externalities to identify circumstances in which not all the costs or benefits related to the production or consumption of goods or services are reflected in its market price, resulting in excessive production or consumption (negative externalities) or insufficient production or consumption (positive externalities).

Despite evidence that a Pigouvian tax is theoretically the most powerful mechanism for absorbing negative environmental externalities, this article will examine how the authorities are exploring alternative financial policies.

But first, let’s explain what we mean by sustainable finance. This concept embraces the tendencies or movement towards making the financial system (banking, insurance companies, financial markets, asset management, financial mechanisms, etc) sustainable, in the sense of entailing forms of production, consumption and savings that do not jeopardise future growth capacity and are also compatible with good governance and certain societal values. Sustainability considerations are traditionally classified into three categories: the environment, social factors and good governance (ESG).

Banks play a crucial part in the finances of European companies, so they must obviously be key figures in the finance needed for the green transition

Sustainable finance is usually associated with corporate social responsibility, but in fact, the latter is overshadowed by the former because the ESG world will end up penetrating the essential core of financial activity: risk analysis, corporate governance, financial products, business strategy, transparency, etc.

In order to simplify our analysis, this article will focus on green finance although much of the analysis is applicable to social considerations and governance.

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Many countries have set themselves very ambitious targets for the green transition. In the European Union, the commitment to cut emissions by 2030 has been increased to 55%2. Sustainability has even played a prominent part in the extraordinary measures implemented to deal with the pandemic: the recovery and resilience mechanism will channel a significant percentage of these resources (at least 37%) into green (or sustainable) national projects3.

Meeting these targets will require a great deal of private investment. Banks play a crucial part in the finances of European companies, so they must obviously be key figures in the finance needed for the green transition. In addition, banks raise funds by means of suitable mechanisms for fulfilling their sustainability strategies and commitments4. However, it is not all up to the banks: regulators and supervisors have ambitious targets for a clean, green economy, and are studying ways of incorporating sustainable finance into prudential banking regulations.

This article will focus on three aspects of sustainable finance:

  1. firstly, the characteristics of the financial instruments that can be issued to finance sustainable investments;
  2. secondly, the possible contribution of monetary policy to meeting the sustainability targets to which the European authorities have committed;
  3. and thirdly, what is expected from banks, in their capacity as financial intermediaries, in response to the environmental challenge, as regards both the assets and liabilities on their balance sheets.

2. Green financial products

2.1. Characteristics 

The International Finance Corporation (2016) defines a green bond as having the following characteristics. Firstly, it is a fixed-income instrument with the same credit financial characteristics as a regular bond, such as creditor ranking for absorbing losses, pricing, credit rating, etc.

Secondly, it is issued to finance specific environmental sustainability and energy transition projects (e.g. projects related to renewables, public transport, energy efficient buildings and manufacturing, waste management, water management, etc). 

Green bonds are issued to finance specific environmental sustainability and energy transition projects

And thirdly, it is usually backed by the issuer’s entire balance sheet. If the green bonds are part of the issuer’s balance sheet rather than a vehicle outside it, and, in addition, are not backed by specific assets belonging to the issuer, then there is a mismatch between two dimensions: the use or destination of the funds and the credit risk of the issuance, which must be no different from that of other issuances with the same ranking as that of the issuer. Therefore, taking into account the credit risk, investors in these green bonds do not depend on the returns of the assets they intend to invest in, but on the overall performance of the issuer.

2.2. Evolution of issuances

Although certain financial institutions were already considering corporate social responsibility and sustainability strategies more than two decades ago, it was the European Investment Bank that issued the first environmentally-responsible bonds in 2007 with the launch in Luxembourg of the first bond labelled ‘climate awareness’. The World Bank and several multilateral development banks followed the European Investment Bank’s lead, and in 2012 the first green corporate bond came on the scene. But was not until 2014 that issuances of this type began to gain momentum in many sectors worldwide.

According to the Green Bond Initiative (2021), the stock of green bonds issued by the end of 2020 had climbed to US$1.17 tr. In 2020, US$ 269 bn were issued, and so far in 2021, US$ 90.1 bn have been issued which suggests, if this trend continues, a substantial increase in 2021 compared to 2020.

2.3. The importance of demand

What do green investors want? Green investors are not only looking to making returns on their investments, but also to actively participating in sustainable projects and handling the possible risks of the green shift better. These new investors are enlarging the traditional investor base to which issuers had access until now. It is a new niche that is still limited today, but has a very positive outlook in the next few years. Inverco (2020), for example, found that 76% of the respondents aged under 26 who were familiar with ESG criteria take them into account when making investments. In the following age group, known as millennials, 56% invest in ESG financial instruments.

Green investors are not only looking to making returns on their investments, but also to actively participating in sustainable projects and handling the possible risks of the green shift better

For an issuer, the preference that some investors show for green bonds should be reflected in some sort of issue premium. This premium for earmarking investments for green projects or “greenium” does indeed have cost benefits for the issuer (lower returns are demanded). In this respect, Alessi, Lucia, E. Ossola & R. Panzica (2019) empirically demonstrated that the green bonds issued by supranational or non-financial authorities do have this premium, but not so those issued by financial entities. This might be because non-financial companies usually issue this type of bond to finance specific green projects.

The importance of this new group of green investors (willing to sacrifice part of their returns in order to meet their investment goals) may explain, for example, why governments issue sovereign green bonds even though specialist issuances of this sort breach the single treasury budget principle, and no bonds are issued to finance very societal expenditure such as education, healthcare and public safety.

2.4. The purpose of issuing green securities

In addition to the criteria laid out by certain associations (e.g. the green bond principles published in 2014 and updated in 2018 by the International Capital Market Association), issuers of this type of security are advised to seek the certification of an internationally known sustainability appraisal or rating agent.

The number of ESG certification agencies increases with every passing day. The growing interest of investors in this sphere has even attracted big credit rating agencies to this business. Unlike traditional ratings, there are different definitions of sustainability, different approaches to measuring compliance with environmental goals and, in general, a lack of data. As a result, the correlation of these ratings is low and the message received by investors is not clear or comparable5.

The European authorities have taken several steps in recent years with a view to disseminating information about sustainability. Examples include the EU directive 2014/95 issued on October 22 2014 by the European Parliament and Council which amended Directive 2013/34 about the disclosure of non-financial information and information about diversity by certain big companies and specific groups; EU regulation 2019/2088 issued by the European Parliament and Council on November 27, 2019 about the disclosure of information related to sustainability in the financial services sector; and EU regulation 2020/852 issued by the European Parliament and Council on June 18, 2020 to create a framework for facilitating sustainable investments, which amended EU regulation 2019/2088.

In general, the intention is to ensure that the disclosed information (precontractual and periodic reports) is trustworthy, understandable and comparable. The disclosure requirements featured in said regulations must enable investors to ascertain the sustainability of a given financial instrument (from an environmental viewpoint) and its underlying degree of sustainability. In other words, the application across the entire European Union of a common concept of environmentally sustainable investment will enable a financial instrument to be defined as green or sustainable and will enable different instruments to be compared.

European Commission headquarters
In 2018, the European Commission set itself the goal of publishing a standardised classification system of sustainable activities to facilitate the work of companies, investors, banks and other agents interested in working towards sustainability (Photo: Berezko)

2.5. EU classification

In 2018, the European Commission set itself the goal of publishing a standardised classification system of sustainable activities to facilitate the work of companies, investors, banks and other agents interested in working towards sustainability. The EU regulation 2020/852 mentioned earlier was a considerable development, with detailed definitions of environmental targets (mitigation of climate change; adaptation to climate change; sustainable use and protection of water and marine resources; the shift towards a circular economy; pollution prevention and management; and protection and recovery of biodiversity and ecosystems).

Following the work carried out by the Commission’s classification advisory group6, the first list of activities to be included in said classification was approved on April 21 this year, with decisions about gas and nuclear energy being left for a later date. Thirteen sectors accounting for 80% of all European emissions have been included (renewables, transport, forestry, manufacturing, buildings, insurance, etc). The approved regulations establish a labelling system to identify the economic activities that comply with the Paris Agreement to limit the planet’s global warming. This classification is a live document that will evolve on a par with science and technology.

The classification should create incentives for the least sustainable sectors to invest and collaborate in achieving the international environmental commitments adopted by the EU. There may, at a particular moment, be no zero-emission technologies, but the investments to achieve this target may be regarded as green.

This classification will encourage the creation of green loans and bonds certified by the EU7. What matters is having access to financial entities and investors which, due to regulations or business decisions, have decided to focus on sustainability in their loans or investments.

The classification should create incentives for the least sustainable sectors to invest and collaborate in achieving the international environmental commitments adopted by the EU

The European Banking Federation (2020) highlights the positive response of European banks to the European classification which will offer coherence and transparency but will also have to be adapted to everyday banking activities, particularly when their clients operate in different sectors and jurisdictions (particularly outside the European Union) and have less operating capacity to deal with the relevant information (for example, SMEs).

Fabian, Natham (2021) pointed out developments of the classification, whose first part was approved on April 21, likely in the future. Firstly, if an activity included in a more global classification has obvious environmental benefits, it would be obliged to comply with the classification unless the global activity has a negative environmental impact (for example, fitting energy efficient windows); secondly, some sectors have low emissions (e.g. education and health), therefore their measures to encourage sustainability would have a relatively low impact, but their efforts should, nonetheless, be acknowledged in the classification; and thirdly, consideration is being given to including the environmental efforts of activities with very high levels of emissions (for example, the manufacturing of trucks with high fuel consumption) in the classification.

3. Is a sustainable monetary policy necessary?

3.1. Introduction. Environmental risks 

The main central banks have no doubt that environmental risks must be incorporated into their monetary policy8 (by means, for example, of assets purchased and collateral accepted) and are discussing how to do so9. The European Central Bank (ECB) is no exception. Its analysis10 is based on classifying such risks into physical risks and transition risks.

Physical risks include risks related to climate (extreme meteorological phenomena and chronic climatic patterns) and the environment (water problems, lack of resources, loss of biodiversity, etc), whilst transition risks include those arising from the adaptation of policies and regulations, and from technological developments in response to environmental and climate challenges11.

Euro policy
The main central banks have no doubt that environmental risks must be incorporated into their monetary policy (Photo: Adrian Hancu)

Some sectors are harder hit by climate risk: agriculture, forestry, fishing, health, energy, mining, transport, infrastructure and tourism. Others may be more affected by transition risks (because they are more energy and carbon intensive): energy, transportation, manufacturing, construction and agriculture. These physical and transition risks may lead to systemic risk and jeopardise financial stability if the impact on banks and other financial institutions is highly significant12.

It is not easy to quantify said risks because the impact of certain phenomena, such as climate change, takes place over long periods13. As a result, “the ECB is designing the first climate stress test for the economy as a whole to help authorities and financial institutions assess the impact of climate risks on companies and banks over the next 30 years. The ECB climate stress test examines the resilience of companies and banks in different scenarios. These scenarios are reasonable representations of future climate conditions, but they also take into account the impact that measures, such as carbon taxes designed to limit the scope of climate change, may have on companies. Preliminary results indicate that, if no progress is made on climate policy, the costs of extreme phenomena that companies must bear will increase considerably. They also reveal the obvious benefits of adopting the measures in time: the short-term costs of adapting to green policies are far lower than the possibly much higher costs arising from natural disasters in the medium and long term”.14

3.2. ECB aims and sustainability

The ECB’s main aim is to ensure stable prices. How might environmental risks affect inflation? On the one hand, natural disasters can reduce the production of goods and services and increase their prices, and also affect financial stability. On the other hand, transition risks can also affect inflation directly or indirectly, because the measures taken could increase the production costs of certain goods and services, e.g. electricity and oil.

One recent example is the carbon tax on liquid fuels and gas passed in Germany last January, which caused energy prices to rise. The effectiveness of monetary policy could, therefore, be hampered by the impact of climate-related structural changes, or tremors in the finance system (triggered by such changes). The ECB will obviously do everything possible to achieve its basic monetary policy objective.

The ECB is designing the first climate stress test for the economy as a whole to help authorities and financial institutions assess the impact of climate risks on companies and banks over the next 30 years

Environmental risks may also impact banking, which might require decisive action by the ECB, on the one hand, under the single supervisory mechanism (SSM), and on the other, to ensure the smooth running of the transmission channel of its monetary policy via financial intermediaries (as it did to safeguard this function when the pandemic broke out).

Another monetary policy aim is to champion the EU’s general economic policies without jeopardising compliance with the main aim (price stability). One of the EU’s main policies is to facilitate the energy transition. 

Asset buying by the ECB and other asset management operations also pose a direct risk to its own balance sheet. It must not be forgotten that the sectors responsible for the most pollution are, nowadays, very important issuers of financial instruments, therefore, according to the principle of market neutrality, these sectors end up being over-represented in the ECB’s asset portfolio and the most sustainable sectors, under-represented. This is what made Schnabel, Isabel (2021) query the application of this principle recently with a view to increasing the purchase of bonds issued by the most sustainable sectors whose positive externalities are not reflected in the market. What is on the table now is how this risk can be managed with regard to both their direct asset purchasing and collateral acceptance policy15. The assets eligible under this monetary policy can obviously not change overnight.

3.3. Monetary policy priorities

The ECB, like the other central banks, will take environmental risks very much into account when designing its monetary policy, but greater green activism must not make us forget that the ECB’s main aim is price stability. If the ECB was obliged to sell green bonds in order to ensure this stability, it would do so regardless of the economic fallout of such sales. This means that if there were more green bonds on the ECB’s balance sheet (Eurosystem), they would play a more active part in the sale of assets in the event of monetary policy becoming stricter (which does not mean that they should necessarily be sold if the ECB thinks that selling other assets would hurt its balance sheet less).

Environmental risks may also impact banking, which might require decisive action by the ECB

A very aggressive green strategy would obviously help redistribute and re-allocate resources to certain activities and sectors. This might resurrect jurisdictional conflicts like those last year when the German Constitutional Court ruled on the purchases of public-sector assets by the ECB. The German Court considered that proportionality between the ends and means of monetary policy is essential to prevent the ECB overstepping its powers. If the aim is to achieve these objectives come what may, regardless of the economic fallout for economic agents, then according to said court, the principle of proportionality (established in the Treaty on European Union) is not fulfilled. The German Constitutional Court also established in the aforementioned judgement that any monetary measure that enters the realm of economic policy would encroach upon Member States’ own competencies16.

4. Banking and sustainability

4.1. Introduction

Banks also face physical risks (caused by the increasing magnitude and frequency of natural disasters which have an impact on their physical and financial assets) and transition risks (exposure to the sectors affected most by policies designed to facilitate the energy transition). These risks are long-term and indirect (i.e. not caused by the banks’ own decisions).

Environmental risks may be a sort of systemic risk, particularly for banks whose assets are concentrated in certain sectors and regions.

As mentioned earlier,17 the ECB has conducted a preliminary climate stress test whose preliminary findings are:

  • In a scenario with climate policies, the likelihood of default increases at the outset when measures are taken, i.e. the transition risk increases, but physical risks fall considerably in the medium and long term.
  • In a scenario with no climate policies, the likelihood of default due to greater physical risks increases in the medium and long term. Another possible scenario is a messy transition with higher transition costs.

The ECB’s stress test in 2022 will consist of banks assessing their own exposure to these risks and their willingness to take action. The ultimate goal is to incentivise banks to gradually include in their portfolios fewer securities issued by companies with high climate risk18.

4.2. The management of environmental risks by financial entities

Environmental risk management is being fully integrated into the global framework of risk management in banking19. This does not, however, mean it will happen immediately because these risks must be modelled and specific data are needed. 

In recent years, the SSM has acknowledged environmental risks to be key drivers in its risk map for banks in the eurozone. The guidelines published recently by the ECB (2020) are not mandatory for banks but are a cornerstone for dialogue between them and the supervisory body because they outline the supervisory expectations about these risks.

To be precise, the SSM expects financial entities to incorporate short-, medium- and long-term environmental risks into many of their considerations including their business strategy; their risk appetite framework and, in general, the management of their financial risks (it is specifically hoped that their loan risk management takes environmental risks into account when granting loans and monitoring them); their cash flow management; their organisational structure, assigning clear-cut responsibilities for environmental risk management; their reporting to the market; their in-house procedures to ensure the sustainability of their business; etc.    

The SSM also expects banks’ boards of directors to take environmental risks into account when defining their business strategy, business aims and risk management framework, and to supervise the evolution of said environmental risks. Each board of directors must base its decisions on the information drawn up periodically by the bank about its exposure to said risks.

The SSM expects banks’ boards of directors to take environmental risks into account when defining their business strategy, business aims and risk management framework

The ECB (2020) recently reviewed the environmental practices and policies of leading European banks. Most of them include environmental risk assessment when identifying their credit risk , which means that some sectors are excluded from bank lending policies. Some banks have started to use quantitative indicators to assess the materiality of these risks. Classifications of environmental risk, however, vary widely from one bank to another and not many banks contemplate these risks in their stress testing and reverse stress testing scenarios. The information that banks release to the market about environmental risk management is also scarce and heterogeneous.

Beyond the regulatory sphere of Europe, the International Settlement Bank (2021) has compiled the main conceptual issues related to the measurement methodologies of financial risks related to climate change, the result being the work of an international group with contributions from different banks.

In September 2020, the European Commission asked the European Banking Authority (EBA) for a series of metrics in order to homogeneously monitor how and the extent to which the activities of European banks can be regarded as sustainable in environmental terms, according to the European classification. In its response20, the EBA underlined the importance of the green asset ratio, and also other performance indicators, for enabling a better understanding of how entities finance sustainable activities and meet the targets of the Paris agreements. It also proposed that these performance indicators should be applied to all relevant assets, including sovereign debt.

These indicators must be implemented prudently because the ultimate aim is to strike a balance between the commitment to climate neutrality and sustainable economic growth, whilst also ensuring a fair transition for all sectors of the economy.

It is not only the authorities that are pressing for progress towards meeting sustainability goals. It was recently announced  that a group of 35 big institutional investors (including Amundi, Nordea Asset Management, M&G Investments, Aviva Investors and Northern Trust Asset Management) managing assets of 11 trillion dollars, are meanwhile putting pressure on the big global banks to stop funding high-emission projects and focus on green lending.

4.3. Prudential management of environmental risks

As part of its action plan for a cleaner, more ecological economy, the European Commission (2018) has proposed that sustainable finance should be incorporated into prudential regulations or, more specifically, “the Commission will examine the feasibility of recalibrating the capital requirements applicable to banks (the green supporting factor as it is known) for sustainable investments, when justified from a risk standpoint, whilst ensuring financial stability”.

The European Commission has proposed that sustainable finance should be incorporated into prudential regulations

This is reflected, for example, in the three mandates received by the European Banking Authority (EBA) under the recent review of the prudential financial regulation framework, Capital Requirements Directive V (CRD V) and Capital Requirements Regulation II (CRR II):

  • the evaluation of the possible incorporation of ESG risks into the supervisory evaluation carried out by the competent authorities, which is necessary to produce a standard definitions of said risks; the processes carried out by the entities to identify, evaluate and manage ESG risks; the tools to assess the impact of these risks on banks’ financial intermediation; etc;
  • the amendment of regulations to include ESG risks in the publication and disclosure requirements applicable to issuances in organised markets (pillar 3);
  • and the evaluation of prudential treatment specifically for exposures to assets with sustainable objectives like components of pillar 1 (which might affect capital requirements).

So far, the EBA has published a sustainable finance action plan for credit institutions featuring useful information for strategy departments, risk management, market information, etc.

Higher capital requirements are advisable when the likelihood of default on loans increases due to specific environmental risks that may arise during the term of the financial operation provided by the bank. Likewise, capital requirements should be lower when this likelihood falls.

For example, will the probability of default be lower because the housing being bought with a mortgage is more sustainable? It is not certain that borrowers’ ability to pay is closely linked to their preference for sustainable housing. Therefore, in this instance, capital requirements should not be reduced. The conclusion would be different, however, if the collateral for the loans, i.e. the sustainable housing, was worth more because this type of housing was expected to command higher prices in the long run.

Higher capital requirements are advisable when the likelihood of default on loans increases due to specific environmental risks that may arise during the term of the financial operation provided by the bank

Although it is very positive for all economic agents, including banks, to contribute to meeting environmental goals, it must not be forgotten, for example, when granting a loan and determining its conditions, that financial risks, particularly credit risks (i.e. those related to default by the borrower) are fundamental (and a priority). Before considering whether a loan meets certain environmental goals, the bank should weigh up the financial risk of the operation.

On the other hand, if exposures involving environmental goals without any financial justification (based on a thorough evaluation of the financial risks of such operations) received more favourable prudential treatment, this would lead to certain implicit transfers between borrowers (green and otherwise) and, in all likelihood, the borrowers most able to choose, for example, a sustainable home would be those with more purchasing power. All these effects must, therefore, be weighed up when discussing new regulations in this field.

For the time being, the supervisors have taken a prudential path: firstly, pillar 3 (transparency), asking banks to explain their risks and policies so that the market can decide; secondly, pillar 2, banks will assess themselves and the supervisor will decide whether to apply surcharges to pillar 2 based on the risk guide issued by the ECB; and thirdly, possible changes to pillar 1 requirements, after the work being carried out by supervisors and regulators.

4.4. Green bonds issued by banks22

The green bonds now being issued by banks usually finance green projects but have the financial backing of the issuer and its entire balance sheet, without having any guarantee or special entitlement to part of the bank’s assets. Banks began by issuing senior bonds, and senior, non-preference stock is already being issued and even other types of capital such as those known as AT1 and T2.

The green bonds now being issued by banks usually finance green projects but have the financial backing of the issuer and its entire balance sheet

Banks usually have global sustainability frameworks that state the intended purpose of the finance raised by these issues (in line, for example, with the principles of ICMA green bonds, 2018). They are also usually described in greater detail in prospectuses. Banks’ balance sheets usually feature a portfolio which, according to their own criteria (linked to international standards and good practices), they regard as a sustainable portfolio, whilst awaiting the implementation of the recently approved green business classification which will become mandatory under the European green bond standard being drafted by the EU.

Hence the funds raised by these issues are intended to finance assets that meet certain sustainability criteria. Similarly, issuance prospectuses and global frameworks usually caution that if certain assets cease to be eligible for green consideration, the bank will not use the respective funds to finance other types of assets and will hold them in its treasury until a green destination is found. Some banks even promise to replace the assets if they lose their green credentials in a specific period.

4.5. Commitments or legally binding obligations?

As mentioned earlier, banks usually have global frameworks for sustainable bonds that reflect their commitments to sustainability, but according to the global frameworks and brochures, are these commitments legally binding?

Prospectuses usually state that the issuer will honour such commitments whenever possible and usually also point out possible discrepancies between the issuer’s sustainable criteria and international or regulatory standards, since the latter are in constant flux. This merely underlines the rather vague definition of the green bond concept.

Prospectuses also usually state that the issuer may not be able to invest in green assets for different reasons, and that the auditor (of these investments) might have an unfavourable opinion. Neither of these instances would constitute an event of default that could, for example, trigger the early repayment of the bond. Default (and the ensuing fallout) would only be linked to the bond’s financial aspects – not its green credentials. This means that the commitment to investing in green assets is a matter of good faith rather than legally binding.

The commitment to investing in green assets is a matter of good faith rather than legally binding

Some prospectuses are less specific about the obligation to keep funds in the treasury if they are not invested in green assets. If the economic viability of the bank is at stake, bondholders will obviously have no objections to their being made freely available if this means they can recover their investment.

After all, a green bank is still a bank. It is obvious that if a bank deploys the funds and is still unable to survive, then no green commitments could be fulfilled. In a settlement after a bank becomes unworkable, both sustainable and other types of bonds would be paid for and converted according to the same criteria if they have the same priority ranking. It is obvious that in the event of a crisis, financial stability must prevail over commitments to sustainability.

It is clear that, for the time being, the ramifications of failing to fulfil green commitments are reputational rather than legal – but this does not mean that this risk need not be managed, because if it is not, future green issuances and their investor base will suffer.

5. Conclusions

Green bond prospectuses usually caution that the issuer will fulfil said commitments whenever possible. Default (which could, for example, trigger the early repayment of these green bonds) is linked solely to the bond’s financial dimension, not its green credentials. This means that the commitment to invest in green assets is a matter of good faith.

This article has outlined the need to have a sustainable classification that clearly identifies green and sustainable activities. It is advisable for the new classification to create incentives for less sustainable sectors to invest and collaborate in achieving the international environmental commitments taken on by the European Union

If a bank finds itself in a crisis scenario and is obliged to pay off and convert debt, today’s legislation makes no distinction between green bonds and other types of bonds. Whether they are sustainable or not, bonds would be paid off and converted in exactly the same way if they have the same priority ranking. There is no doubt that in a crisis, financial stability must prevail over commitments to sustainability.

The ECB, like other central banks, will pay great attention to environmental risks when designing its monetary policy, but we must not lose sight of the fact that the ECB’s main aim is price stability.

The contribution of financial authorities and credit entities must not replace other public action in this sphere. Because the design of incentives has a key role to play in encouraging the transition towards a climate-friendly economy, certain taxation measures will penalise the activities that generate the most pollution and will incentivise technological innovation in order to improve the fulfilment of environmental goals (and thus correct the negative externalities arising from certain activities). The ultimate aim is to strike a balance between climate neutrality and sustainable economic growth, whilst ensuring a fair transition for all sectors of the economy.

Notes

  1. The author is most grateful to Andrés Alonso, Mario Delgado, Enrique Ezquerra and Pepe Simarro for their invaluable comments.
  2. European Commission (2020A).
  3. For other EU environmental commitments, see Viñes, Helena and José Luis Blasco (2021).
  4. Alonso, Andrés and Clara Isabel González (2021).
  5. For a detailed explanation of rating differences, see Peñarrubia, Susana and Teresa Royo (2021).
  6. Viñes, Helena and José Luis Blasco (2021).
  7.   European Commision (2020B).
  8. Financial Times (2021).
  9. Network for Greening the Financial System (2021). In this report, the NGFS appraised the impact of adapting climate strategy to each monetary policy operation, and found no specifically negative impact. It therefore concluded that each central bank would decide how to incorporate climate change considerations depending on their mandate.
  10. De Guindos, Luis (2021).
  11. For a detailed description of said risks, see the Financial Stability Board (2017).
  12. European Systemic Risk Board (2020).
  13. Financial risk analyses usually have horizons of three to five years. Hence the “tragedy of the horizon” described by Mark Carney (2015), i.e. the materialisation of climate risk will affect a future generation that has no control over the mitigating actions that should be implemented today.
  14. De Guindos, Luis (2021).
  15. Oustry, Antoine, Bünyamin Erkan, Romain Svartzman & Pierre-François Weber (2020). This study conducted in the Banque de France found that green assets account for an insignificant percentage of the total assets used as collateral.
  16. For some points of the discussion triggered by this judgment, see Carrascosa, Antonio (2020).
  17. De Guindos, Luis (2021).
  18. Alonso, Andrés and Clara Isabel González (2021).
  19. Alonso, Andrés and José Miguel Marqués (2021).
  20. European Banking Authority (2021).
  21. Mooney, Attracta & Stephen Morris (2021).
  22. This chapter and the next are a summary of several parts of: Carrascosa, Antonio and José Luis Simarro (2021).

References

All written content is licensed under a Creative Commons Attribution 4.0 International license.