The Montreal-West Virginia-Frankfurt price stability paradox

10 minute read

The Bank of Montreal (BMO) recently reversed its anti-coal financing policy to avoid being blacklisted by the US state of West Virginia, which bars alleged fossil fuel boycotters from doing business with state entities. However, this change is at odds with the climate policies of the European Central Bank (ECB). As a result, BMO’s EUR9bn of outstanding covered bonds, we argue, should be excluded from the ECB’s collateral framework. This could in turn affect prices of all BMO’s outstanding covered bonds.

The ECB has been vocal about the threat climate change poses to its mandate, and made efforts to align its monetary policy with a low-carbon transition. ECB President Christine Lagarde is even on record saying “climate change actually has an impact on price stability.”

By continuing to finance coal, BMO is out-of-line with the ECB’s own climate objectives. The central bank therefore has grounds for excluding BMO’s covered bonds from its collateral framework. If it does not, other bond issuers may believe financing coal has the ECB’s de facto stamp of approval.

The collateral framework imparts tangible benefits to issuers. Eligible bonds have tighter spreads than ineligible bonds, and the former also benefit from enhanced liquidity. It is arguably improper that a non-climate-aligned issuer such as BMO should reap these benefits alongside issuers that are meaningfully transitioning to a low-carbon future.

If the ECB takes action on BMO, the price of its covered bonds could be adversely affected. In addition, because evidence shows access to the collateral framework benefits an issuer’s entire capital stack, the rest of the bank’s outstanding bonds could be impacted, too.

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