SPEECH
Closing gaps to bend the trend: embedding the
flow of finance in the transition
Speech by Frank Elderson, Member of the Executive Board of the ECB
and Vice-Chair of the Supervisory Board of the ECB, State of the
Union conference organised by the European University Institute
Florence, 5 May 2023
Many thanks for inviting me to address this conference along with so many esteemed speakers. As the
cradle of the Renaissance, Florence has a long history of attracting people from different disciplines
across Europe. The most gifted individuals in the fields of art, science, politics and finance have long come
to this city to make a difference, together unleashing creative forces of a magnitude greater than the sum
of their already impressive individual contributions. Just as we have come to Palazzo Vecchio today to
unlock the creativity required to address the multidimensional challenges that are affecting the state of the
European Union. My contribution will focus on the most pressing challenge requiring urgent action: the
ongoing climate and environmental crises.
The problem is clear. The state of the EU is not yet on a transition path that is aligned with the goals of the
Paris Agreement - to pursue efforts to limit global warming to 1.5 degrees Celsius above pre-industrial
levels, and in any case well below 2 degrees. Linear trend extrapolation of global warming puts us going
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beyond 1.5 degrees in March 2035.[ Mind you, when country delegates negotiated the Paris Agreement
in December 2015, the trend suggested this level would not be breached until March 2045. In other words,
on top of the seven-plus years that have passed since the Paris Agreement, we have lost another ten.
Using a more sophisticated approach, the Climate Action Tracker - which was developed by a consortium
of climate research organisations - when compiled in November 2022 assessed that the policies and
actions taken by the EU were almost sufficient to be consistent with limiting global warming to 2 degrees
Celsius. The picture improves if the tracker incorporates policy commitments made but not yet
implemented. However, even then it is still not consistent with limiting global warming to 1.5 degrees
Celsius. For some existing commitments, the European Council recently endorsed several measures
proposed by the European Commission. Nonetheless, more specific commitments are clearly required
and all promises need to be kept.
Importantly, under its Fit-for-55 strategy, the EU is committed to lowering carbon emissions by at least
55% by 2030. Moreover, against the backdrop of Russia's horrific ongoing war against Ukraine, the EU
has pledged to become independent from Russian fossil fuels well before 2030 under its REPowerEU
plan.
The European Commission estimates that reaching the Fit-for-55 and REPowerEU objectives requires an
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average annual investment of €1.25 trillion over the years 2021-30.[ That estimate would add around
€500 billion to the level of annual investment in climate and energy security seen in the previous decade.
[ 3 ]
Most of this additional investment will need to come from the private sector as households and firms
adjust to a net-zero economy. However, significant shortcomings in the functioning of the financial system
are presently curtailing the flow of investment in green - and therefore truly sustainable - economic
development.
Gaps in finance
Most prominently, carbon pricing is still not being used to an adequate extent. Progress has been made:
the carbon price in the EU's emission trading system has been rising since 2021, and the European
Council and European Parliament recently agreed on extending the scheme's scope of application and on
4 ]
a mechanism to equalise the price of carbon between domestic products and imports.[ However, overall
emissions continue to be improperly priced, implying that economic activity - including the flow of finance
- remains biased in favour of high-emission activities.
Besides the gap in carbon pricing, a second gap is that capital markets are not playing their potential role
in supporting the green transition. ECB research shows that stock markets can strongly encourage
5 ]
investment in greener technologies.[ However, those markets are still relatively underdeveloped in the
EU and a lack of harmonisation limits cross-border flows. Resolving these issues and advancing a capital
markets union, as proposed by the European Commission, will boost the efficiency and resilience of the
flow of finance in Europe. As ECB President Christine Lagarde has said when speaking about the green
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transition, developing the capital markets union is "too good an opportunity to pass up".[ Today I add: we
must seize this opportunity.
A third gap can be identified in the approach banks are taking to climate-related and environmental risks in
their activities. In recent years, the ECB has conducted several benchmarking exercises among banks
under our supervision to assess their practices against our expectations for a sound management of
climate-related and environmental risks. These exercises showed that while almost all banks acknowledge
the importance of climate-related and environmental risks and while we are seeing progress, banks'
practices to manage these risks are still underdeveloped and insufficiently applied across the board. Given
these shortcomings, at present it is difficult to see how banks can sufficiently help their customers navigate
the transition and become resilient to climate change and environmental degradation in a timely manner.
While most financing for the green transition should come from private resources, the public sector also
has an important role to play, both directly through public investment and indirectly though co-financing,
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private-public partnerships or State guarantees.[ Much of this will be financed at the European level
through the EU Member States' national recovery and resilience plans as part of the Next Generation EU
programme that was set up to support the recovery from the COVID-19 pandemic. How much these
EUfinanced expenditures will contribute to the EU's climate objectives is uncertain and depends on how
successfully and quickly the individual countries implement their recovery and resilience plans. Earlier this
year, the European Commission proposed a Green Deal Industrial Plan intended to support this effort.
Analysis by ECB staff shows that, from a legal and institutional perspective, public investment efforts could
well be supplemented by additional EU-financed resources in the form of a European Climate and Energy
8 ]
Security Fund.[ As in the case of Next Generation EU in response to the pandemic, there are compelling
arguments to suggest that the investment efforts required to support an orderly transition are exceptional,
one-off and temporary. At the same time, concerns have recently emerged about Member States' capacity
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to implement their existing recovery and resilience plans.[ These concerns can largely be traced back to
administrative hurdles at the national and local level and need to be addressed before any additional
resources are considered. Moreover, any additional European funds would need to be accompanied by a
euro area aggregate fiscal stance that is consistent with the ECB's fight against high inflation.
Besides gaps that curtail the transition, there are also gaps in the financial system that are threatening its
resilience to increased climate-related and environmental damages. A recent discussion paper by the ECB
and the European Insurance and Occupational Pensions Authority shows that only around 25% of all
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climate-related catastrophe losses in the European Union are currently insured.[ In some countries,
including Italy, the figure is below 5%. As natural disasters become both more frequent and more severe,
insurance costs are expected to rise. Some insurers may reduce risk coverage or stop providing certain
types of catastrophe insurance altogether, which would widen the insurance gap further.
11 ]
The lack of climate catastrophe insurance can affect the economy and financial stability.[ If losses are
not covered by insurance, households and firms will take more time to resume their activities, slowing
economic recovery. Banks' exposure to credit risk may therefore increase. The fiscal position of
governments may be also weakened if they need to provide relief to cover uninsured losses.
All this confirms that, when preparing for the future, we must acknowledge that the world - and therefore
the economy - will change. Regardless of whether the gaps that I have described are closed or not, the
economy will face profound changes and increasing shocks. Moreover, analyses consistently show that if
we fail to deliver on a timely and orderly transition, the macro-financial damage will be more severe than if
we act in time. We are in a race against the clock, and so far the clock is winning.
Implications for the ECB
The ECB takes the consequences of the ongoing climate and environmental crises into account in the
pursuit of its mandate. We are mindful that if we ignore these consequences we cannot deliver on our
objectives of maintaining price stability and preserving the safety and soundness of the banking system. In
fact, we are committed to aligning ourselves with a Paris-compatible transition path across all our tasks
and responsibilities because this is a precondition for sustainably fulfilling all our tasks and responsibilities.
Let me give two specific examples of actions we are taking within our mandate that show our focus on
some of the gaps that I have mentioned.
On the monetary policy side, in an effort to correct for the bias that exists in financial markets in favour of
high-emission activities, since October 2022 we have been tilting our corporate bond purchases towards
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those issuers with a better climate performance.[ Similarly, we will incorporate climate-related
considerations when assessing the collateral that banks can pledge when borrowing from us.
In banking supervision, we have been persistently pushing the banks we supervise to close the gap
between their practices and our expectations on the sound management of climate-related and
environmental risks. Banks' practices must be fully aligned with our expectations by the end of 2024 at the
latest and we have set interim deadlines for banks to satisfy specific requirements even earlier. If
necessary, we will enforce these deadlines, standing ready to use all the supervisory instruments at our
disposal. Let me be clear: as Vice-Chair of the ECB's Supervisory Board, it is not for me to determine
whom banks should lend to. Instead, what I and other banking supervisors around the world have
consistently been emphasising is that a failure to adequately manage climate-related and environmental
risks is no longer compatible with sound risk management. To manage their own risks, banks need to
engage with their customers to gain a deep understanding of how they are being affected by the climate
and environmental crises and how they will mitigate and adapt to the consequences.
Conclusion
Let me conclude.
Leonardo da Vinci - a resident of Florence when finance first thrived back in the early days of the
Renaissance - is believed to have said that "nature never breaks her own laws". Indeed, nature's laws are
a constraint on human activities that we cannot set aside. After all, we are an integral part of nature. We
have been pushing the boundaries of this constraint for far too long and the devastating consequences are
now increasingly upon us.
Yet we do have the power to bend this trend we ourselves set in motion. This requires us to be mindful of
the gaps that perpetuate the destructive trend and to work relentlessly towards closing them. Only then
can we change nature's current course and ensure a Paris-aligned transition path. Each and every one of
us must act in our areas of competence and responsibility. Respecting nature's laws. Conscious of her
precariousness, preserving her preciousness.
Thank you for your attention.
1.
Copernicus (2023), " Global temperature trend monitor ".
2.
See Figure 1 in Abraham, L., O'Connell, M. and Arruga Oleaga, I. (2023), " The legal and institutional
feasibility of an EU Climate and Energy Security Fund ", Occasional Paper Series, No 313, ECB, Frankfurt
am Main, March.
3.
The exact amounts are subject to uncertainty and depend, among other things, on which other policy
measures are taken and which specific objectives are targeted.
4.
This mechanism is called the Carbon Border Adjustment Mechanism.
5.
De Haas, R. and Popov, A. (2019), " Finance and carbon emissions ", Working Paper Series, No 2318,
ECB, Frankfurt am Main, September.
6.
Lagarde, C. (2021), " Towards a green capital markets union for Europe ", speech at the European
Commission's high-level conference on the proposal for a Corporate Sustainability Reporting Directive, 6
May.
7.
Avgousti, A. et al. (2023), " The climate change challenge and fiscal instruments and policies in the EU ",
Occasional Paper Series, No 315, ECB, Frankfurt am Main, April.
8.
Abraham, L., O'Connell, M. and Arruga Oleaga, I. (2023), op. cit..
9.
Dorucci, E. and Freier, M. (2023), " The opportunity Europe should not waste ", The ECB Blog, 15 February.
10.
ECB and EIOPA (2023), " Policy options to reduce the climate insurance protection gap ", Discussion
Paper, April.
11.
In the joint discussion paper, the ECB and EIOPA put forward several policy options to improve climate
catastrophe insurance on which the institutions will collect feedback and discuss in a workshop with
regulators, policymakers, insurers and academics on 22 May 2023.
12.
In March 2023 we decided to increase the tilt towards bonds with a better climate performance as we
moved from full reinvestment of maturing corporate bonds towards partial reinvestment of maturing
corporate bonds to maintain a decarbonisation path for our corporate asset holdings that is compatible
with the Paris Agreement.
Copyright 2023, European Central Bank