ECB mulls active reshuffle of bond portfolio away from climate laggards

Reduced reinvestment means bank will not meet decarbonisation targets under current approach, active reshuffling suggested by board member Schnabel.

The European Central Bank (ECB) is considering changes to the climate tilting of its corporate and sovereign bond portfolios, including a “reshuffling” of its portfolio towards greener issuers.

In a speech at the Swedish Riksbank on Tuesday, ECB executive board member Isabel Schnabel noted that the bank’s existing approach, where it will tilt reinvestments towards issuers with better climate performance, “lost part of its punch” when it decided to stop net asset purchases.

In July last year, the ECB announced plans to introduce a climate tilt to the roughly €30 billion annual reinvestment from its corporate sector purchase programme (CSPP), based on issuers’ backward-looking emissions, forward-looking targets and climate disclosures, with the possibility of halting purchases from the worst performers.

At its December meeting however, the bank said it would continue full reinvestment of maturing securities under its Asset Purchase Programme, which includes the CSPP and equivalent programmes for public sector and covered bonds, and asset backed securities, until February 2023. After this date, reinvestment will be cut by an average of €15 billion a month until the end of Q2.

The reduction in scale of reinvestments will reduce the ability of the current approach to decarbonise corporate bond portfolios in line with climate ambitions, Schnabel said. She also noted that decarbonisation will depend on portfolio companies decarbonising in the real economy.

If companies stopped taking any action on climate, and the bank reinvested all maturing bonds, ECB analysis suggests it would achieve only half the required decarbonisation by 2030. By ending reinvestments, portfolio decarbonisation would slow down substantially and be “largely out of our control”, according to Schnabel.

The tilting approach “is thus insufficient to achieve our goal”, she said. “The Paris Agreement requires a stable decarbonisation trajectory in our portfolio irrespective of our monetary policy stance or companies’ individual actions.”

With this in mind, Schnabel said the ECB needs to move “from a flow-based to a stock-based tilting approach”, and that “actively reshuffling the portfolio towards greener issuers would need to be considered”.

She warned, however, that the bank should not initially divest completely from high emitters, but instead foster incentives to reduce emissions further. This approach should also be extended to ABS and covered bond portfolios, although this would require a framework for assessing their climate impact.

A note published by the Anthropocene Fixed Income Institute after the speech noted that the implications of this policy for the valuation of carbon-intensive versus less carbon-intensive bonds “could be significant”. The note suggested that the mention of incentives for higher emitters “could also be interpreted as a willingness to actively engage with fossil fuel intensive companies”.

Schnabel also discussed the alignment of the ECB’s public sector bonds, which account for roughly half its balance sheet.

A climate tilt in this portfolio is constrained by other monetary policy requirements, the lack of a reliable measurement framework and limited availability of green bonds, she said. In order to green the public bond portfolio, Schnabel said the ECB could either tilt towards supranationals and agencies, which issue a higher proportion of green bonds, or reshuffle the portfolio towards government green bonds as supply expands.

Also in the speech, Schnabel called for governments to use fiscal policy to accelerate the green transition, warning that they had “failed to use the past years of low interest rates to accelerate investments in greener and more sustainable energy”.

She hit back at suggestions that higher borrowing costs complicate the transition by making investment more expensive. “It would be misleading to use tighter financing conditions as a scapegoat for further delays in the green transition,” she said. “By bringing inflation down in a timely manner, monetary policy restores the conditions that are necessary for the green transition to thrive.”