Introductory Speech by Prof. Edward Scicluna
Governor of the Central Bank of Malta
The Institute of Financial Services annual's seminar: "The ESG Journey: a Pulse
Check for the Maltese Economy".
St Julian's, Malta
11 November 2022
Ladies and Gentlemen, good morning
I would like to thank the Institute of Financial Services and in particular its
President Kenneth Micallef, for their kind invitation to address this distinguished
audience.
It is becoming increasing apparent that climate change is one of the greatest,
and most immediate, threats faced by mankind.
So I do not need many explanations why today I shall put the emphasis on the
"E" of ESG, namely on the environment and on the fundamental
transformations that lie in front of us.
This is not to underestimate the role of the Social and the Governance
elements: matters of inclusiveness, labour relations, equality and the conduct of
public and private institutions are proof that sustainability extends well beyond
the environmental question.
But Global temperatures are rising - 2010s was the warmest decade on record -
and extreme weather events have doubled compared to forty years ago.
Decades of scientific research have established that greenhouse emissions
associated with human activity are behind climate change.
Only a coordinated international endeavour can deliver the necessary shift
away from fossil fuels. This urgency led 196 parties to sign the 2015 Paris
Agreement to limit the increase in global temperatures. The agreement
committed signatories to keep the increase in the global average temperature
to well below 2 degrees centigrade over pre-industrial levels, and to pursue
efforts to limit this increase to 1.5 degrees centigrade. To meet this target, net
carbon emissions need to fall to zero by around the middle of this century.
Six years after the Paris Agreement came into force, 1.5 degrees centigrade is
the minimum rise in temperatures expected by the scientific community.
However, we are not making progress at the desired speed. News coming from
COP27 this week attest to this.
The Secretary-General of the United Nations, Antonio Guterres said it clearly:
"We are in the fight of our lives. And we are losing."
There is no need to emphasise that Malta as a Mediterranean island would be
deeply affected.
These are facts we have to come to terms with.
While the primary responsibilities for tackling climate change rests on
governments and legislators, central banks are called to play their part.
The questions which many ask is why should Central Banks be involved? Is not
their mandate merely price stability?
Let us just examine the effects that climate change would have on the
economy, with some sectors more directly exposed than others. For example,
agriculture and livestock will have to withstand more severe repercussions than
services or manufacturing. The rising of global temperatures could render vast
regions unsuitable for land cultivation, straining access to food and prompting
mass migration. It will also affect industries like construction, which rely on
outdoor work. Lower income countries are particularly vulnerable to global
warming, while coastal states are vulnerable to rising sea levels. These shocks
to output cannot but have significant implications for prices.
Climate change will impact how the economy operates and will exert a
substantial influence on price dynamics.
Indeed, given the Eurosystem's primary objective is price stability, it is
important for monetary policy makers to be aware of these effects as they set
the policy stance.
Monetary policy is going to be affected by climate change, as well by the
measures taken by governments to address it.
First, climate change will affect the structural parameters of the economy. One
key parameter is the natural rate of interest. The natural rate of interest is
fundamental notion of central banking. When interest rates lie below the
natural rate, monetary policy is accommodative, and vice-versa. In turn, the
monetary policy stance has an impact on the price level.
There is uncertainty over the direction of the impact of climate change on the
natural rate- our r star: climate factors could contribute to the secular decline of
natural rates in line with prevailing structural trends such as demography.
Conversely, higher investment to combat emissions could lead to a rise in
productivity which may push up r-star.
Second, climate change will alter the transmission mechanism of monetary
policy. The value of assets posted as collateral by financial intermediaries could
decline due to the higher frequency of extreme weather events. This could
dent the capital and liquidity positions of banks and other financial
intermediaries, thereby weakening their ability to channel funds to the real
economy.
If the financial system is weakened, the transmission of monetary policy is
impaired, meaning that changes to the monetary policy stance will not be
properly transmitted to the real economy.
The third channel is via climate-related financial risks on the Eurosystem
balance sheet. Rules regarding asset purchase programmes and the collateral
framework will be revised to encourage counterparties to steer away from fossil
fuels, speeding up the transition to net zero.
The Eurosystem, which consists of the ECB and all the national central banks of
the euro area - including the Central Bank of Malta - has taken steps towards
integrating climate change considerations into its policies and operations.
In fact climate features prominently in the review of the ECB's monetary policy
strategy that was finalised in July 2021. The ECB laid out three core objectives:
(i) managing and mitigating the financial risks associated with climate change
and assessing its economic impact,
(ii) promoting sustainable finance to support an orderly transition to a low-
carbon economy, and
(iii) sharing our expertise to foster wider changes in behaviour.
Let me elaborate.
The Eurosystem will adjust its corporate bond holdings towards issuers with
better climate performance. Better climate performance will be measured with
reference to lower greenhouse gas emissions, more ambitious carbon reduction
targets and better climate-related disclosures. Furthermore, a limit will be
enforced on the amount of assets issued by entities with a high carbon
footprint that can be pledged as collateral when borrowing from the
Eurosystem.
The assessment of financial risks for private actors will see an active
involvement of the Eurosystem.
To ensure that the economy remains resilient during the transition to net zero,
the Eurosystem is stress-testing euro area banks for climate-related events.
Banks' level of preparedness will be evaluated and, were deficiencies to
emerge, recommendations will be issued to strengthen banks' climate
frameworks.
The results of the ECB's 2022 Climate Stress Tests (CST) showed that banks have
started to integrate climate risk into their stress-testing frameworks, although
most institutions are still at a very early stage when it comes to factoring
climate risk factors into their credit risk models. (SSM Climate stress test
report).
When it comes to the Maltese economy, the Central Bank of Malta has made a
first attempt at quantifying the exposure of the domestic financial system to
sectors of economic activity that may be affected by transition to clean sources
of energy. In a nutshell, as of June 2021 just over 23% of the domestic banking
sector's lending was directed towards sectors identified to be high carbon
dioxide (CO2) intensive (such as energy, construction and transportation and
storage), while an additional 27.7% was issued towards mid CO2 intensive
sectors (mostly services). As regards, banks' securities portfolios, only 1.6% of
their holdings stems from sectors characterized by high CO2 emissions, with
5.2% invested in mid CO2 intensive sectors.
Insurance companies and investment funds turn out to be more invested in
high and mid CO2 intensive sectors, at about 14% and 10% of their securities
portfolio respectively. (FSR Interim 2021)
Overall, this paints a fairly favourable picture for the Maltese financial system:
the potential impact from climate risks is judged as relatively contained,
although data limitations and early-stage nature of such exercise caution
against an exceedingly benign interpretation.
Addressing climate change will require substantial investment, both in shifting
away from dependence on fossil fuels and in adapting to higher temperatures,
droughts and more extreme weather events.
This investment will need to be financed. A growing segment of financial
markets relates to "green" instruments, which allocate resources to finance
environmentally-friendly investment.
Whichever the starting point, the transition to "green finance" is to be
supported. The green bond market, for example, has been growing strongly in
recent years, reaching a volume of cumulative issuance of about 1.5 trillion USD
in 2021.
While it remains a niche relative to the overall bond market, there is evidence
of investors' interest for instruments aimed at financing environmental projects.
According to the ECB trading in secondary markets bears evidence of a
"greenium", that is a premium that investors are willing to pay to hold green
bonds compared to securities with identical characteristics.
This is a clue that if properly supported by policymakers, for example with the
adoption of a common regulatory standard, the demand for green bonds could
pick up rapidly, fostering the transition towards net zero.
In this respect, Malta is catching up compared to larger European countries.
Although there are currently no green instruments listed at the Malta Stock
Exchange (MSE), despite MSE having laid out advantageous incentives for the
listing of green bonds in 2021, green finance is picking up. Over the summer,
thirteen businesses set up the Malta ESG Alliance with the goal of taking the
lead in the de-carbonisation efforts at a national level. Gradually ESG disclosure
is becoming the norm.
Nevertheless, a report recently published by the Central Bank of Malta has
shown that investors in local markets are still relatively new to green
investments, with over 60% of respondents to an ad hoc survey declaring that
they have never invested in green bonds. Respondents also emphasised the
lack of a unified standard and low market liquidity as constraints to the
adoption of green financial instruments.
Green finance in domestic capital markets thus has great upside potential.
Interest in green finance is widespread among investors and if policies
promoting educational awareness in this regard were made available at a larger
scale, supply could meet demand, triggering a positive cycle that would
jumpstart green finance in Malta. A Bank research paper suggested that a
catalyst for change in this direction could be the issuance of green bonds by the
government. Both the Bank and the government would be studying this
possibility.
The third core objective of Eurosystem relates to sharing expertise and
fostering wider action towards the adoption of clean source of energy. Such
efforts will take several forms. The Eurosystem is working to enhance
transparency by bridging data gaps working in tandem with European and
international partners. Transparency shall apply to the Eurosystem's own
actions as well.
The ECB and the central banks of the euro area will be disclosing climate-related
information about corporate purchases, non-monetary policy portfolios and
environmental footprint.
Lastly, the Eurosystem is also striving to reduce the environmental footprint of
its day-to-day corporate activities.
The Central Bank of Malta is doing its part. In line with the Eurosystem's
common stance for climate change-related Sustainable and Responsible
Investments (SRIs), the Bank is incorporating such principles in the management
of its non-monetary portfolio of assets. The Bank manages part of its assets
externally through mandates, ETFs and mutual funds. In the selection of asset
managers, the Bank verifies that they have subscribed to the United Nations
Principles for Responsible Investments and therefore committed to include ESG
considerations in all their investment decisions.
In accordance with such principles, the Central Bank disinvested from
companies involved in the tobacco industry and/or linked to the production of
nuclear weapons in 2021, while progressively increasing the share of green,
social and sustainable bonds in its internally managed portfolios.
In conclusion
Global warming requires us to rethink thoroughly the way we live, produce and
consume. While the responsibility to engineer a coordinated response rests
primarily on national governments and international organisations, everyone
has a stake in this process.
The Central Bank of Malta, and the Eurosystem more broadly, intends to
contribute to net zero emissions by adjusting its policy framework in favour of
low emitters, by enhancing the resilience of the banking system and by
incorporating climate change into its macroeconomic models to ensure that the
monetary policy stance takes climate into account and that monetary policy
measures are transmitted smoothly to the real economy. These efforts will
safeguard the public good of stable prices while fostering the transition to the
public good of a clean environment.
Private actors too have a role to play.
The more funds are channelled towards environmentally sustainable projects,
the quicker the transition to net zero and the less resources will have to be
deployed to adapt to climate change. In the Maltese capital market, green
finance has a vast untapped potential. It is thus reasonable to expect that in the
coming years green finance will carry a growing weight over traditional
instruments thanks to increasing awareness of the public interest inherent in its
expansion and to the support of policymakers and legislators alike.
Thank you very much for your attention.
Prof. Edward Scicluna, Governor of the Central Bank of Malta
11.11.2022