A widely promoted statement from the European Central Bank (ECB) provided some nominal comfort around its realignment with climate risks. Going forward, haircuts on collateral posted to the bank will be adjusted for estimated climate risks (ECB to adapt collateral framework to address climate-related transition risks).
Whoop, whoop.
While this may look promising, some attention to the detail might be useful. Notably, the collateral haircuts will only be applied to non-financial corporate bonds (not banks, governments and provinces or other SSAs). Ahem.
The implications of this are twofold:
First, as illustrated in the graph, the corporate book is tiny in the context of the ECB’s overall collateral intake. The left hand side shows total outstanding eligible collateral, where corporate bonds look to be something like 10% of all assets. The right hand side shows actual collateral received by the ECB. This reveals that corporate bonds are little more than pocket lint relative to the total €1.5trn collateral usage. Indeed, the amount is so small the climate effects of this may only be studied by someone with the equivalent of a financial market particle accelerator.
Second, the corporate book requires the issuing entity to be in the Eurozone.
So, whereas a few bonds of Mittelstand Gmbh, an Italian utility transitioning to net zero, or a French automobile maker may be penalised under the ECB’s new collateral framework, beauties like the Province of Alberta’s oil sands subsidy bonds (The ECB and Alberta's oil production tax holiday, The Reformed SSA Trader: High ratings, high risks), will be waved through with no additional haircuts, even though the underlying fossil fuel resources they finance are enough on their own to breach the Paris Agreement’s warming targets.
Similarly, the covered bonds of the reinvigorated thermal coal funder Bank of Montreal would suffer no haircuts under this new rubric (The Montreal-West Virginia-Frankfurt price stability paradox). According to the ECB, they are still hunky dory.
Moreover, size matters. Take another look at the right hand graph. ‘Regional government securities’, such as Alberta bonds, constitute around €40bn of collateral pushed to the ECB, and ‘covered bank bonds’ like BMO’s making up more than €400bn. Our understanding is that non-marketable assets (i.e. bank deposits and bank loans) are not affected by this new policy, totalling €486bn. Corporate bonds - affected by this new announcement - make up €30bn.
To adjust the economics of collateral based on credit climate risk and impact makes sense and is - in our view - necessary. For a central bank to apply it to corporate bonds only is illogical and insufficient. At best, it has only a minimal effect and, at worst and most likely in the ECB case, it could improve the relative cost-of-capital of climate-damaging, non-corporate balance sheets.
