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ECB can't pick and choose, even for the environment

Oil gas fossil fuel hydrocarbon refining 28Aug20 from Adobe 575x375
By Lewis McLellan
27 Oct 2020

An ESG think tank believes that the European Central Bank should drop Alberta’s euro bonds from its list of eligible marketable assets, as a punishment for its support for polluting industries. But while it is a laudable aim, it is not practicable.

There can be no doubt that Alberta’s support for its oil extraction industries are, to say the least, out of step with the prevailing trends in environmental awareness. Earlier in October, it gave oil producers a substantial tax holiday, angering environmentalists and rural municipal authorities, which claim many oil producers owe them back taxes.

Ulf Erlandsson, CIO of Diem Credit and executive chair of the Anthropocene Fixed Income Institute, wrote that including Alberta’s bonds in the ECB’s list of eligible marketable assets, which makes them eligible as collateral for repo operations and therefore more desirable to certain investors, is “effectively a cost of capital subsidy”.

There is no denying that inclusion in the EMA list encourages investors. The Development Bank of Japan joined the list last month, and its deal in early October benefitted from the effect, earning the issuer a lower cost of capital. Calling it a subsidy might be a stretch, in that this implies a cost to the ECB, but this is semantics.

It is right to increase the cost of capital of those funding polluting activities, incentivising issuers to change their ways and transition to a more sustainable model.

However, to use the EMA list in such a political way is not the way to do it. The ECB must, if it is to retain credibility, act impartially. It should not simply exclude issuers it deems unfit but must operate on a clearly replicable system. For one thing, any list of polluting issuers that includes Alberta will certainly include others.

It must surely not simply be a question of including only the greenest issuers and excluding the brownest. A system favouring those with credible transition plans would be preferable — something like the Task Force on Climate-related Financial Disclosures framework.

For the ECB to give its approval to such a system by making it a criterion for inclusion in the EMA list would be a hugely important step — one that must not be taken until the robustness of the framework is deemed acceptable beyond doubt.

The financial markets can be powerful agents for change by rewarding good behaviour with lower funding costs, and central banks may indeed have just an important role to play as they do in markets generally in an age where they dominate so much discussions around pricing of capital and influence them so directly.

But cherry picking polluting issuers is the job of individual investors, not central banks. Divesting is perhaps the most powerful tool for change in the arsenal of financial markets, and investors don't need to wait for the suits in Frankfurt to take the lead.

Erlandsson published his response to this piece here.

By Lewis McLellan
27 Oct 2020