ECB member warns of Ponzi risk to green finance as EU sets out low carbon ambitions

Warning of asset price bubble as Commission seeks to “put finance at the service of the climate”

A top official at the European Central Bank, Executive Board Member Yves Mersch, has warned of the Ponzi risk inherent in green finance — saying the undervaluation of risks in new green financial products could lead to price bubbles.

“I call this channel the Ponzi risk of green finance,” he said in a speech entitled Climate change and central banking at an event in Frankfurt.

“We never know exactly where – but the next bitcoin mania is always lurking somewhere around the corner.

In a note on the speech, a Ponzi scheme is described as “an investment scam that promises high returns with low risk for investors. It generates profits for early investors by attracting new ones. However, at some point there won’t be enough money and no new investors, and the bubble bursts.”

Mersch added: “Experience has taught us that you can only properly identify an asset price bubble once it has burst. And certainly a central bank should not try to prick an inflating speculative bubble with the blunt sword of monetary policy – the collateral damage to the economy and inflation could be too severe. By the same token, central banks must not contribute to inflating such a bubble.”

He went on to say that the ECB’s narrow mandate “curtails” its ability to contribute in green finance.

As the ECB is not a regulator, the former head of the Central Bank of Luxembourg said, it is “not free to vary the capital requirements of supervised banks to take into account their climate risks, or to encourage climate finance”. But he did acknowledge that climate risks have been identified in ECB Banking Supervision’s risk assessment for 2019.

Such comments contrast with increasing momentum from central banks around sustainable finance, not least De Nederlandsche Bank’s decision to sign up to the Principles for Responsible Investment and the formation of the Network for Greening the Financial System (NGFS). Bank of England Governor Mark Carney kicked off the Taskforce for Climate-related Financial Disclosures (TCFD).

The EU is making a major strategic push towards sustainable finance and its Action Plan on Sustainable Finance is being likened by EU officials to its blockbuster initiative to create the UCITS investment fund regime back in the 1980s.That was a notable success and UCITS funds now account for just under €10trn in assets.

Just this week EU Capital Markets Union chief Valdis Dombrovskis called on global investors to seize the low carbon opportunity.

Meanwhile, umbrella body Pensions Europe, in a position paper on the sustainable finance legislative package, said regulatory intervention needs to take account of pension funds’ primary role of providing a good retirement income to their members and beneficiaries.

“I call this channel the Ponzi risk of green finance”

The Brussels-based group noted that the revised Pension Fund Directive (IORP II) is still under implementation. The directive contains some hard-won ESG clauses and Pensions Europe said: “From a ‘better regulation’ standpoint, it would be best to assess how the new ESG provisions are transposed and put into practice, before amending them.”

Yesterday RI reported that the European Insurance and Occupational Pensions Authority (EIOPA) plans to assess ESG risks as an integral part of its 2019 stress testing of pension funds. Today Frankfurt-based EIOPA published for consultation its draft technical advice on possible amendments to the delegated acts under Solvency II and the Insurance Distribution Directive (IDD) concerning the integration of sustainability risks and factors. It follows a formal request from the Commission.

All this activity comes against the backdrop of the EU’s new strategic long-term vision for climate-neutral economy by 2050, amongst which it says it aims to put “the financial sector at the service of the climate”.

It said that rapidly scaling up private investment is essential to avoid the ‘lock-in’ of fossil fuels infrastructure and carbon intensive assets: “The additional investment needed is too high for the public sector to provide alone, so the private sector will need to fully play its role.” Key to this will be the EU classification, or taxonomy, which is due shortly.