21 June 2019

Central banks 'to turn to green QE'

Central banks could turn to “green quantitative easing” (QE) as part of their increasingly active response to climate change, a panellist at Environmental Finance’s ESG in Fixed Income 2019 conference argued.

Anna Breman, chief economist at Swedish bank Swedbank, expects central banks will – perhaps in the next economic downturn – “move in that direction”, even if they are not currently openly supportive of the concept.

Green QE is the “most controversial” and “most discussed” tool of central banks to green the financial system, Breman said.

The term Green QE is normally used to describe central banks using their balance sheets to buy green assets, such as investments in energy efficiency or renewables. This could include green bonds.

Given the large balance sheets that central banks have accumulated over the years, “just the potential of green QE is likely to cause repricing in the markets”, she added.

The European Central Bank (ECB), like most other central banks, has not been overtly supportive of green QE, Breman said, but it has at least started discussing the issue.

She argued that the ECB already holds about 24% of eligible public sector green bonds and about 20% of eligible private sector green bonds. “So, in some sense, central banks are already in the green bond space,” she argued.

“[Central banks] will look into the collateral frameworks and the definitions within those frameworks, and I think that’s how you will see these changes coming about,” she continued.

Green QE is controversial, partly because of fears that it could help drive a green bond price bubble.

Breman discussed this theme in a paper in March, called What central banks can do to fight climate change. It cited separate research claiming that the risks of a “carbon bubble” are also significant, and most likely greater than the risks of mispricing green bonds.

“Almost 50% of the corporate bonds [the ECB] holds are carbon intensive. If climate-related risks are not taken into consideration enough in the pricing of those bonds, they risk losing value,” she told the conference.

Breman believes that central banks will eventually take climate-related risks in all their holdings into account, such as in their own pension portfolios.

“I think the green QE issue is here to stay,” Breman concluded. “We might not see them saying they will do green QE, but they will still act.”

Despite increasingly taking action to address climate risks, including through the Network of Central Banks and Supervisors for Greening the Financial System (NGFS), central banks have so far been reluctant to put their own balance sheets to work, with most of the onus being on pushing the financial system to get to grips with carbon risks.

The Bank of England is a good example. While Breman’s paper said the Bank of England is a leader in the field – most recently it has devised climate stress tests – Sarah Breeden, executive director for international bank supervision at the Prudential Regulation Authority (PRA), earlier this year told Environmental Finance that its own balance sheet was not where it could have the biggest “value add”. 

However, there are signs that central banks’ attitudes to applying sustainability concerns to their balance sheets are beginning to change. For example, the Dutch central bank earlier this year became the first central bank to sign the Principles for Responsible Investment and will investigate adopting a target allocation for green bonds.

A recently released report by the NGFS confirms this trend. It writes: “Our conviction is clear: the financial stability and monetary policy mandates of central banks impose the obligation and also give them the tools to respond to the climate imperative.

“Their primary lever is their micro-prudential supervision of financial intermediaries, banks and insurance undertakings, while they also lead by example through their investment policies. But monetary policy is also involved in this collective mobilisation; not so much by directly targeting specific sectors – ‘Green QE’ may be seductive but is too limited – but by thoroughly integrating climate change into the monetary policy framework.”

Central banks are currently focusing on ramping up climate risk disclosure as one of their main tools, the conference heard. They are working to create a level of consistency and harmonisation through international organisations, such as the NGFS, said Lauren Anderson, senior policy advisor for green finance at the Bank of England.

Via the G20’s Financial Stability Board (FSB), central banks have already helped to establish an international disclosure regime – the Task Force on Climate-related Financial Disclosures. And they could promote more disclosures going forward.

“It is incredibly important that we work with market regulators [on disclosure],” said Anderson.  

More corporate climate-risk data is needed to better assess climate-related risks through modelling and scenario analysis, she argued.

While the Bank of England is keen to help promote an orderly transition to a low-carbon economy, it could not forego these climate risk analysis and due diligence processes, she said.

Anderson also highlighted that any material risks— including climate-related — must be disclosed by law.

Whether it is across disclosure, taxonomies or product standards, or whether it is domestically or globally, all multiple stakeholders and parties “need to act in concert,” she said.

Angela Brusas (Nordic Investment Bank) @ ESG in Fixed Income EMEA 2019