Climate Change and prudential policy

Central Banks’ objective of maintaining price stability, enables climate protection goals. For example, low inflation rates will allow households and firms to detect price signals from climate policy and adjust thus their behaviour. Putting the right price tag on greenhouse gas emissions is arguably the most powerful weapon  in the fight against climate change.

Central Banks should not slip into the role of a climate policy actor as they have different segregation of responsibilities. Unlike monetary policy, climate policy changes the distribution of resources and income distinctly and permanently. Democratic processes and direct political accountability are important when making such decisions. Central Banks should guarantee independence to safeguard price stability objective.

A clash of objectives could arise as well if, say, the Central Bank attempted to use its monetary policy asset purchase programmes  to pursue environmental policy objectives, as these programmes  need to be scaled back as soon as warranted  to ensure price stability. Ultimately, monetary policy is not a structural policy instrument: it is cyclical in nature, balancing each other out over the long run through  the interplay of monetary policy loosening and tightening.

However, Central Banks can step up their game to protect the climate without running the risk of overstretching their mandate of preserving price stability. As climate change affect firms and lenders, Central Banks need to ensure that climate-related financial risks are appropriately taken into account as part of risk management.

So, from a monetary policy, perspective, Central Banks are within their rights to request better information. The Eurosystem should consider purchasing or accepting as collateral only those securities whose issuers meet certain climate-related reporting requirements. Hence, the importance of the ratings of agencies to adequately and transparently reflect climate-related financial risks.

Other further measure may be to limit the maturities or the volume of securities from certain issuers in the monetary policy portfolio, if required to contain financial risk.

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Spain’ Sovereign Green Bond Issuance in September

The Spanish Sovereign Green Bond Framework is aligned with the four core components of the Green Bond Principles 2021 (GBP) and follows best market practices identified by Vigeo Eiris (VE). The Kingdom of Spain’s Sovereign Sustainability Rating from VE is 78/100, which indicates an ‘advanced’ sustainability performance, the highest level on VE’s four-point scale.

Spain will sell its inaugural green bond in September. The Spanish Treasury’s first such bond will have a 20-year maturity. Spanish government did not specify how much it plans to raise, though the government has identified 13.6 billion euros ($16.1 billion) of projects to finance or refinance projects tied to the country’s environmental objectives, including renewable energy, biodiversity protection, and climate change adaptation.

In addition, Spain will invest around 20 billion euros on other environmental programs through 2023 that will be financed by the European Union’s executive arm. The bloc is also expected to make its green bond debut later this year and ultimately become the world’s biggest seller, channelling those funds to member states as part of its pandemic recovery package.

The EU has also laid out a voluntary green bond framework and Spain plans to align its spending with the bloc’s classification of sustainable investments, or taxonomy. The first green bond is included in the country’s plan to issue 80 billion euros of net debt this year.

Spain’s Sovereign Green Bond Framework: https://bit.ly/3zNr22V

Vigeo Eiris’ Second Party Opinion: https://bit.ly/3rGEP8v

The EU Fit for 55 Package

It is intended to fundamentally revise the EU’s energy policy framework and thus adapt it to the EU updated climate targets. By 2030, the EU’s GHE are to be reduced by 55% compared to the amount emitted in 1990. While the focus in December 2021 will be on decarbonised gas and the buildings sector, ten initiatives was planned last 14 July 2021. Overall, the “Fit for 55 Package” with the initiatives listed below is the central measures package of the European Green Deal:

1.- Revision of the EU Emissions Trading System (ETS), including maritime transport, aviation and CORSIA

2.- Carbon Border Adjustment Mechanism (CBAM)

3.- Revision of the Effort Sharing Regulation (ESR)

4.- Revision of the Energy Tax Directive (ETD)

5.- Amendments to the Renewable Energy Directive (RED) to implement the ambition of the new 2030 climate target

6.- Amendments to the Energy Efficiency Directive (EED) to implement the ambition of the new 2030 climate target

7.- Reduction of methane emissions in the energy sector

8.- Revision of the regulation on the inclusion of greenhouse gas emissions and removals from land use, land use change and forestry (LULUCF)

9.- Revision of the Directive on the Deployment of Alternative Fuels Infrastructure

10.- Revision of the Regulation setting CO2 standards for new passenger cars and for new light commercial vehicles

11.- Revision of the Third Energy Package for gas (Directive 2009/73/EU and Regulation 715/2009/EU) to regulate competitive decarbonised gas markets in Q4 2021

12.- Revision of the energy performance of Buildings Directive (EPBD) in Q4 2021

Vice-President Franz Timmermans presented the plans in Brussels last Wednesday. That was the kick-off for a long process, looking for agreement among the Commission, the Parliament, and the Member States. This will be a challenge, as the new seems to be on achieving the reduction targets, which open to the countries’ challenges of what adjustments are necessary to achieve them. Another key aspect is how to support industries and companies that compete with others abroad EU, maintain international competitiveness. Specially with competitors in countries where the financial burden of environmental protection is lower. Nowadays, these are only draft initiatives, we do not know yet when the implementation will begin in the individual Member States, and what specific content will have agreed on at that time.

This stablishes the EU positioning of climate policy in everyday Europeans’ life, impacting firms and the way Europe makes business. It is key to ensure no one must be left behind in the process, to guarantee a social and society fair transition.

More on: https://bit.ly/2VJlB6i

Overhaul of the EU Emissions Trading System (ETS), the Energy Taxation Directive (ETD), and the introduction of a Carbon Border Adjustment (CBAM)

The European Commission has adopted a package of measures intended to put the EU firmly on the road to climate neutrality by 2050 with the intermediate step of a minimum 55% reduction in net greenhouse gas emissions by 2030. An overhaul of the EU Emissions Trading System (ETS) and of the Energy Taxation Directive (ETD), and the introduction of a Carbon Border Adjustment (CBAM) form part of the package:

A.- ETS overhaul: it would bring maritime transport within the scope of the ETS and accelerate the reduction of the number of emissions allowances that can be issued each year. A separate proposed directive would lead to the gradual reduction of free emissions allowances available to the airline industry. It also envisages the establishment of a separate emissions trading system for road transport and heating fuels which would apply from 2026 at the fuel supplier level. Its introduction would be accompanied by the establishment of a Social Climate Fund.
B.- ETD overhaul: the ETD does not reflect the current mix of energy products and criticized that it does not link the minimum tax rates to energy content and CO2 emissions.
Minimum tax rates would be based on the real energy content and environmental performance of each product, with most polluting fuels taxed at the highest level. The tax base would also be expanded – including through the removal of existing exemptions. An eye-catching change in this respect is that fuels for the aviation and maritime industries would lose existing exemptions.
The burden of higher minimum levels of energy taxation may be felt disproportionately by consumers and poorer households. The mitigation of this risk does, however, appear to be left mostly to each Member State’s tax system and the commission encourages Member States to consider using energy tax revenues to support vulnerable households.
C. CBAM introduction: the overarching aim is to prevent carbon leakage. The CBAM has been designed as a system of certificates to complement the ETS rather than, for instance, an import tax. Importers will be required to purchase certificates at a price to be set by the Commission on a weekly basis to mirror average ETS prices (which are established on a daily basis) in respect of relevant goods (being, at least initially, only iron and steel, cement, fertiliser, aluminium and electricity generation as per Annex I to the proposed CBAM regulation) imported into the EU customs territory from third countries. Imports from countries that participate in the ETS or have an emissions trading system linked to it are exempt from CBAM.

More on: https://bit.ly/3yYDk8a

EU social taxonomy and taxonomy extension linked to environment reports

The draft proposal for a social taxonomy will argue that in the face of a pandemic, unanswered social questions around a sustainable transition, continuing human rights abuses and continuously rising costs for housing, the time is right to identify economic activities that contribute to advancing social objectives. Just as the EU environmental taxonomy defines activities that substantially contribute to environmental objectives, a social taxonomy would do the same for social objectives.

Built on the foundation of international norms and principles like the sustainable development goals (SDG) and the UN guiding principles for businesses and human rights, a social taxonomy would help investors to contribute to finance solutions around ensuring decent work, enabling inclusive and sustainable communities and affordable healthcare and housing. A social taxonomy would be a tool to help investors identify opportunities to contribute to these objectives.

The Public Consultation Report on Taxonomy extension options linked to environmental objectives will be focussed on support for the environmental transition needed in the whole economy – it proposes further clarity on both: activities that are significantly harmful to environmental sustainability, and those that have no significant impact on it. The aim is to support transitions in areas currently of “significant harm”. They should transition to a level that at least does not cause significant harm, even if they do not actually reach substantial contribution (green). The report will set out options to build on the existing taxonomy and its use.

The Platform on Sustainable Finance will welcome stakeholder feedback on both drafts through two calls for feedback, which will run from 12 July to 27 August 2021. Platform’s advice on this will feed into Commission’s report on potential extension of taxonomy framework to be adopted by the end of 2021.

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New EU measures for transitioning to a Sustainable Economy

The EU Strategy for Financing the Transition to a Sustainable Economy, and the rulebook for green bonds will be unveiled next week. They center around the Green Deal to reach net-zero emissions by 2050.

The EU strategy will propose tightening reporting requirements for financial entities, by incorporating climate-related risks into credit ratings and bank capital requirements. It will also enable supervisors to address greenwashing.

The European Commission (EC) will invite the ESMA to assess how ESG factors are incorporated by credit rating agencies and will consider proposing an initiative to make sure those risks are captured by the assessments. The EC will also ask the ECB to conduct regular climate change stress tests.

The strategy paves the way for financing activities such as natural gas during the transition, after Germany and Poland pushed for including it in the taxonomy, despite the resistance of the others member states. Thus, BAU is falling under the agenda of sustainable finance.

Supervision of ESG risks for credit institutions and investment firms

The European Banking Authority (EBA) published yesterday a report which provides recommendations for institutions to incorporate ESG risks-related considerations in strategies and objectives, governance structures, and to manage these risks as drivers of financial risks in their risk appetite and internal capital allocation process. The EBA also recommends developing methodologies and approaches to test the long-term resilience of institutions against ESG factors and risks including the use of scenario analysis.

EBA sees a need applying at least a 10 years horizon to capture ESG related risks, proposing a phase-in approach. This Report should be considered in conjunction with the EBA and ESAs disclosure publications under the Capital Requirements Regulation (CRR), the Taxonomy Regulation and the Sustainable Finance Disclosure Regulation (SFDR). The EBA will publish Pillar 3 disclosure requirements on ESG risks, transition risks and physical risks, as defined in this Report, later this year.

The report will be taken into consideration in the context of the Renewed Sustainable Finance Strategy, the review of CRR/CRD, and an update of the SREP Guidelines to include ESG risks in the supervision of credit institutions.

More on https://bit.ly/35LC5wH

Network for Greening the Financial System (NGFS) update of their economic scenarios

Reaching net zero by 2050 could lift growth and employment but would require an inflation-boosting $160 per tonne carbon price — or equivalent “shadow price” — by the end of the decade. This will push up inflation and also raise unemployment in some countries with energy-intensive industries.

Only a relatively quick and orderly transition to a low carbon economy would add to growth while a delayed transition or no action would cut deep into the economy.If these changes occur in an orderly fashion, the scenarios suggest that it could lead to some increase in global GDP, and lower unemployment relative to prior trends.If the transition fails, the scenarios suggest that up to 13% of global GDP would be at risk by the end of the century, even before accounting for the potential consequences of severe weather events.

Currently about a fifth of the world’s greenhouse gas emissions are covered by a carbon price.

More on: https://bit.ly/3ziT7j6

EU-wide pilot exercise on banks’ climate risk by EU Banking Authority

The EU aggregated GAR stands at 7.9%, which identifies the institutions’ assets financing activities that are environmentally sustainable according to the EU taxonomy.

More disclosure on transition strategies and GHG emissions would be needed to allow banks and supervisors to assess climate risk more accurately. It is important banks to expand their data infrastructure to include clients’ information at activity level.

Regarding the EU taxonomy classification, banks are currently in different development phases to assess the greenness of their exposures. The two estimation techniques, banks’ bottom-up estimates and a top-down tool, are considered in the exercise and the report highlights the differences in outcomes.

The scenario analysis shows that the impact of climate-related risks across banks has different magnitudes and is concentrated in some particular sectors. The findings should be considered as starting point estimates for future work on climate risk.

More on: https://bit.ly/3ufO53o

Innovation is key for the Net‐Zero Emissions Scenario 2050 (NZE)

The @IEA just released the world’s first comprehensive roadmap for the global energy sector to reach net-zero emissions by 2050. They say almost 50% of the emissions reductions needed in 2050 in the NZE depend on technologies that are at the prototype or demonstration stage. This share is even higher in sectors such as heavy industry and long‐distance transport.
This is clearly ambitious, as most clean energy technologies that have not been demonstrated at scale today should reach markets by 2030 at the latest. Technologies at the demonstration stage, such as CCUS in cement production or low‐emissions ammonia‐fuelled ships, are brought into the market in the next three to four years. Hydrogen‐based steel production, direct air capture (DAC) and other technologies at the large prototype stage reach the market in about six years, while most technologies at small prototype stage – such as solid state refrigerant‐free cooling or solid state batteries – do so within the coming nine years.
In the NZE, electrification, CCUS, hydrogen and sustainable bioenergy account for nearly half of the cumulative emissions reductions to 2050. Just three technologies are critical in enabling around 15% of the cumulative emissions reductions in the NZE between 2030 and 2050: advanced high‐energy density batteries, hydrogen electrolysers and DAC.

You can read the report “Net Zero by 2050: A Roadmap for the Global Energy Sector” here