The policy change integrates climate change considerations for the first time into the ECB’s quantitative easing and repo facilities.
On July 4, 2022, the European Central Bank (ECB) announced that it would integrate climate change considerations into Eurosystem monetary policy through changes to its corporate bond asset purchase program and its credit operations, to be implemented from October 2022 (the 2022 Announcement). The initial disclosure regarding this policy shift was tantalizingly brief, but nonetheless the 2022 Announcement has a number of implications for sustainable finance, the European investment grade debt market and, by extension, the entire European debt capital markets.
As of July 1, 2022, the ECB held €345 billion of corporate debt securities. While purchases of securities under the ECB’s Corporate Sector Purchase Programme (CSPP) ceased on June 30, 2022, the ECB has stated that it is committed to reinvesting the principal payments from maturing securities. Reinvestment from CSPP is estimated to be approximately €1.1 billion per month in 2022 (excluding any reinvestment from the €40.3 billion of bonds purchased under the separate Pandemic Emergency Purchase Programme).
The ECB indicated in the 2022 Announcement that it intends to redeploy funds received from maturing CSPP securities towards securities issued by “issuers with better climate performance” to be measured by “lower greenhouse gas (GHG) emissions, more ambitious carbon reduction targets and better climate-related disclosures”.
As a result, the ECB expects that its holdings will reflect a greater share of companies that are more aligned with decarbonization and the energy transition.
The 2022 Announcement signals a shift from the principle of “market neutrality” that had prevailed, by which CSPP purchasing was in proportion to the relative market capitalization of each economic sector of the CSPP eligible bond universe, and therefore securities were selected purely by credit quality and other legal parameters.
However, a number of questions are left unanswered in the 2022 Announcement, which could have significant implications for the investment grade capital markets, namely whether:
- other central banks will adopt similar policies and move away from “market neutrality”;
- green, sustainability, and sustainability-linked bonds (SLBs) will be given greater prominence in the purchases over conventional bonds;
- the assessment will focus solely on the issuer of the security rather than the economic group in which it is a member (i.e., whether the electric car division of an automotive manufacturer or the renewable energies branch of an integrated utility can issue bonds that would be eligible for purchase whereas bonds of the parent would not otherwise be (assuming the relevant data exists at the division/branch level);
- GHG emissions will be assessed on an absolute or net basis (i.e., taking into consideration natural carbon sinks and carbon capture and sequestration) and whether Scope 1, 2, and 3 emissions will be taken into consideration;
- a “more ambitious” carbon reduction target will be judged by consistency with the Paris Agreement or with net zero by 2050 generally or whether it will be judged on a sectoral and/or geographical basis among peers; and
- compliance with the Sustainable Finance Disclosure Regulation (SFDR), the Taxonomy Regulation, and the Corporate Sustainability Reporting Directive (CSRD) (once implemented) is sufficient for the issuer to have “better” climate-related disclosures, or whether the ECB will establish additional quantitative or qualitative guidelines.
In terms of the changes to the collateral framework pursuant to which European credit institutions have access to ECB liquidity facilities in exchange for posting eligible collateral (including investment grade bonds), the 2022 Announcement indicates that, by the end of 2024, the Eurosystem will place a cap on the share of securities issued by high carbon-emitting corporate debt issuers. Currently, no such limits exist as long as the securities constitute eligible marketable assets.
Additionally, the 2022 Announcement indicates that the Eurosystem will, as of 2022, “consider climate change risk when reviewing haircuts applied to corporate bonds used as collateral” (in ECB parlance, a haircut refers to the value assigned to the relevant collateral). This means that not all eligible marketable assets will be treated equally, which will create an incentive for financial institutions to potentially hold fewer such bonds and to favor purchases of bonds from less carbon-emitting corporate issuers.
As of March 31, 2022, the ECB held €74.8 billion of corporate bonds as eligible collateral (after valuation and net of haircuts). The 2022 Announcement does not specify whether the ECB will take a bright-line approach to the haircut or whether each issuer or sector will be judged relative to its peers. Additionally, the 2022 Announcement indicates that the Eurosystem will only accept as collateral marketable assets from companies that comply with the CSRD, once fully implemented in 2026.
These changes have the potential to serve as a fulcrum for greening the European economy, channeling investment grade debt origination towards issuers with “better carbon performance” as the ECB will select for such issuers in its portfolio, and by extension all European credit institutions will be incentivized to do likewise for Eurosystem collateral reasons. Although the volume of ECB purchases will likely be relatively modest compared to its purchasing volumes from 2019 to 2022, Eurosystem eligibility is a key structuring item for investment grade issuers.
Additionally, given the high share of European issuers in terms of the global volume of sustainable finance instruments issued, SLBs focused on GHG emissions are expected to continue to predominate, which in turn will have a knock-on effect with issuers in similar sectors and geographies that are not otherwise Eurosystem eligible, particularly high-yield issuers and US issuers with European peers who have issued SLBs. The 2022 Announcement is also expected to reward certain issuers with lower borrowing costs given the sizeable CSPP redemptions expected in 2023.