Viewpoint: ECB offers climate factors solace, without the quantum

The non-obfuscated meaning of the phrase ‘quantum of solace’ is ‘a small bit of comfort’. And, as a Bond movie title from 2008, it applies well to the European Central Bank’s (ECB) recent announcement that it would start applying climate transition factors to its collateral portfolio.

The ECB’s fixed income collateral pool is one of the world’s largest, amounting to roughly €1.5trn today. While this is down from a peak of €2.8trn in the aftermath of the Covid-19 crisis, it is still very big.

Therefore, the fact that the ECB is starting to use climate factors to adjust collateral haircuts is an important one. Well, nominally at least.

According to its announcement, the ECB will start applying higher haircuts to collateral securities that have a perceived higher climate transition risk. When discounts increase on ‘brown’ assets relative to ‘green’ ones, it follows that supply and demand will shift. Bonds eligible for inclusion in the collateral pool with low haircuts are close to cash-like. Those with high haircuts are more expensive to turn into euros, making them less valuable from a liquidity perspective. All else being equal, this dynamic should move prices and increase the cost of capital for those activities underlying ‘brown’ assets.

But while the wildfires tearing through southern Europe are catastrophic, the ECB’s implementation of climate factors is microscopic. The solace is there; the quantum is not.

“An analogy would be the Great Financial Crisis: some money was lost on homebuilders and other corporates in the real estate segment, but the real damage was done by financial institutions.”

Ulf Erlandsson, founder of the Anthropocene Fixed Income Institute

It may be hard to glean from the ECB’s press release, but it turns out its climate factors affect only 2% of currently used collateral. The central bank’s programme only covers corporate bonds issued by entities in the Eurozone. These instruments already attract steep haircuts and are not particularly attractive to post as collateral, hence their low prevalence in the system.

Moreover, bank bonds, including covered bonds, are out of scope. Such bonds constitute roughly 32% of collateral used in the Eurosystem. Applying the factors to this pool would have a much larger effect and potentially drive cost-of-capital in a greener direction. It would also arguably lower the ECB’s risk exposure. An analogy would be the Great Financial Crisis: some money was lost on homebuilders and other corporates in the real estate segment, but the real damage was done by financial institutions.

As a result of its policy choices, the ECB has ended up allowing the issuers least aligned with its climate transition preferences to dodge all penalties.

As a recent report from the AFII shows, there’s a sizable cluster of non-Eurozone banks that have taken advantage of the ECB monetary policy toolbox while exhibiting behaviours that do not show a commitment to the climate transition. These banks make much more money doing fossil fuel deals than green deals, and even ejected themselves from the Net Zero Banking Alliance as soon as they were given cover by larger, more influential institutions. They are also operating under a regulatory system that is aligned with a +3°C temperature rise trajectory. Non-conventional hydrocarbon extraction is a centrepiece of these banks’ energy strategies, whereas most Eurozone banks have extensive exclusion rules for such activities.

It is only logical to link these institutions’ commercial activities to increased greenhouse gas emissions, and hence to increased climate risks – and price stability risks in the Eurozone.

The bottom line is this: if the ECB were to follow its primary mandate, it would fashion its monetary policy tools so as to minimise price volatility. Subsidising the cost-of-capital, through collateral operations, of non-Eurozone institutions that actively push for more carbon emissions leads to higher price volatility and is in direct conflict with the primary mandate.

Put another way, indiscriminately allowing bonds and assets as collateral that are linked to greater climate pollution simply contradicts the ECB’s primary mandate. Indeed, the bank has already acknowledged this in its recent announcement. To call the 2% of in-scope assets (starting in the second half of 2026, no less) an ambitious start would be very generous.

Large swathes of Europe are under existential risk from climate change. Those affected could be forgiven for thinking that the ECB supporting tar sand capital structure funding and greenfield thermal coal funding through its monetary policy toolbox is not only morally deplorable but also technically inept.