The ECB wakes up from its trip to Fantasia | Opinion of Cristina Triana
If one of them was a child or a young book lover like Bastián, the human protagonist of ‘The Neverending Story’ by Michael Ende, it is likely that one night he was hung up on an exciting reading, which has had him so absorbed that at look out the window one day and see the face of a flying dragon willing to offer a taxi service. If it happened to him, and despite the drunkenness of lack of sleep, surely the alarm clock acted as a reality shower, putting an end to his adventure in Fantasia and leaving him for a whole day with a body touched by fatigue and some regret.
2022 was that alarm clock for the world of ESG and the number of those who are realizing that the road is steeper than it seemed is increasing. The last one that has recognized it is the ECB. This week, Isabel Schnabel, a member of her Executive Committee, advanced that the central bank’s balance sheet was far from the objectives of the Paris Agreement and that she would have to retouch the strategy on the fly in a speech.
“Although our actions related to climate change are ambitious, they are far from the goals of the Paris Agreement because they are not enough to ensure that our decarbonization strategy leads us to be carbon neutral by 2050,” he acknowledged for some time, having advanced many of the steps that the ECB will take in climate matters.
The central bank is not the only one that, after the ‘post-COP 26 rush’ landing, has already confessed that it is more difficult than is thought than the 2021 climate promises to which a large part of the financial industry and many joined companies and institutions, are consolidated without turns, modifications and slips of different magnitude.
Vanguard, the second largest asset management giant in the world, announced a few weeks ago that it had abandoned Net Zero Asset Managers. The American has chosen to assume the reputational consequences of defecting from the group of investors who have pledged to be ‘net zero’ by 2050.
Specialized in the creation of index investment products, Vanguard would have to decarbonise all the underlyings of its products – including third-party indices – to turn its balance sheet around, which requires an almost complete transformation of the business. It is true that it could change its entire range, but the risk of losing customers is probably too high (governing states).
And the problem facing the ECB is not dissimilar to the Wall Street giant. The central bank has the power to put all the limits it wants on its investments in corporate bonds (and there is no doubt that it will do so), but its hands are very tied when it comes to public debt, which it accounts for about half of its balance, valued at some 8 trillion euros after its multibillion-dollar QE programs.
Regardless of possible future security programs, the ECB is limited by the “capital rule”, as Schnabel recalled on Tuesday, something that prevents it from tilting its portfolio towards more ‘green’ issuers as it seems willing to do in the case of corporate debt, because it must take into account the relative weight of each member country within the institution.
As alternatives to ‘solve’ this handicap in the short term, the ECB proposes the purchase of supranational issues (the Eurobonds that cost so much to issue) or green placements. However, for its activity to be intense in these latest issues, the offer must increase; something easy immediately, not only due to the rise in interest rates, but also the placement process of this debt because it is very laborious, since the funds are assigned to specific projects, which prevents it from covering the general financing needs. Spain, for example, barely has 8,000 million issued sovereign green debt and it is estimated that the ECB controls more than 400,000 million in Spanish debt. At that volume, if the ECB were to go into buying domestic green bonds it would likely distort the market, significantly altering prices.
Although Schnabel does not cite it, another big problem is political, something that institutional investors already face. Although the ECB is protected by the “capital rule” that forces it to be neutral, the big problem with ESG debt managers is that their efforts to influence different governments to implement climate measures can be very frowned upon. .
Can you imagine BlackRock sending messages to certain governments for their poor climate ‘performance’? And the answers to these? What would happen if the ECB announced that it would buy debt based on how much a country is cutting emissions? BlackRock’s investment portfolio, at some $10 trillion, is not far from the mountain of debt that hides the balance of the Eurozone central bank.
Companies are aware that the pressure will come for them both from the market and from financial institutions, but demanding something similar from governments is something that is still very difficult to propose – managers recognize that their ability to force states energetically is limited and that raised pressure strategies such as the sale of debt can give rise to very misinterpretations. One solution could be for the membership of the ‘Paris Agreement’ to be voluntary, but entail obligations of permanence and commitments (such as NATO), which would already provide a framework of ‘pressure’ acceptable to investors and other institutions, such as the ECB.
Without this, or a similar commitment, and with heavily indebted public finances (it is estimated that there are more than 70 trillion dollars of government debt in the world and 300 million including the rest), decarbonizing the world economy in 2050 thanks to the goodwill seems like a dream of the Childish Empress of Fantasia.