Fabio Panetta: Sustainable finance- transforming finance to finance
the transformation
Keynote speech by Mr Fabio Panetta, Member of the Executive Board of the European Central
Bank, at the 50th anniversary of the Associazione Italiana per l'Analisi Finanziaria, virtual, 25
January 2021.
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Introduction
I would like to start by thanking the Italian Association for Financial Analysts (Associazione
Italiana per l'Analisi Finanziaria, AIAF) for inviting me to speak on the occasion of its 50th
anniversary. Promoting high standards in financial analysis is vitally important for guaranteeing
the development and the integrity of markets, to ensure they can serve the real economy. The
work performed by the AIAF over the past 50 years in the fields of research, training and reporting
and its strong ties with financial operators and savers have helped bring Italian standards in line
with international best practice.
The AIAF's ability to keep pace with innovation is clearly reflected in its commitment to
sustainable finance, the subject of my speech today.
In recent years, addressing climate change and the transition to a sustainable development
model more broadly have become increasingly important. Under the responsible financing
approach, companies still aim to create value while taking into account principles such as fair
compensation for employees, respect for ethical and social values and environmental protection.
Sustainable finance - also known as responsible finance - incorporates environmental, social
and governance (ESG) principles into the decision-making processes of financial operators. It
represents an important change designed to ensure the financial system is used for the benefit
of our collective well-being; in doing so, it has become a vital tool for addressing climate-related
risks, which have become increasingly prominent due to the emergence of irreversible damage
to the environment (such as the impact on biodiversity and temperature levels).
In my speech today, I will consider the debate on sustainable development and climate-related
risks in the light of the shock caused by the coronavirus (COVID-19) pandemic. I will then
examine what can be done to strengthen the impact of responsible finance on the economic
system and the ECB's role in tackling climate-related risks.
Sustainable development and climate-related risks in the time of the pandemic
The challenge to find a sustainable development path which meets the needs of present
generations without compromising the well-being of future generations is not new. The German
economist Hans Carl von Carlowitz was already thinking about how resources could be used
sustainably as early as the 18th century.
But it was not until the 1970s and the publication of The Limits to Growth report that the
sustainability of the growth model gained prominence as an item on European and international
policy agendas.
Initial analyses of sustainability focused on the risk of non-renewable natural resources being
depleted. This focus has gradually widened to include the extent to which our natural systems
can cope with the effects of climate change.
The idea that well-being must take into account factors such as equity - within and across
generations - and sustainability was brought to the fore in the 2030 Agenda for Sustainable
Development, launched by the United Nations in 2015. In the same year, the Paris
Agreement recognised the need to speed up the economy's reduction of CO2 emissions and to
protect the environment for the benefit of both current and future generations.
In recent months the pandemic shock has caused global economic, social and environmental
vulnerabilities to resurface, exacerbating them even further and increasing the risk of greater
income inequality and a widening of the wealth gap. The pandemic has also emphasised the
urgent need to address the problems that are affecting people's well-being.
The UN estimates that the number of people living in poverty worldwide will increase by between
40 and 60 million as a result of the pandemic, undoing the progress made in recent years. We
may also see an increase in gender and generational discrimination owing to the severe impact
the pandemic is having on women and young people.
Low-income countries are not the only ones affected by these problems. The pandemic could
also bring about an increase in poverty, social exclusion, inequality and challenges to achieving
universal energy access in advanced economies, many of which were already a long way from
reaching the 2030 Agenda goals before the crisis struck (Chart 1).
Chart 1
Distances of OECD countries from 2030 Agenda goals
Notes: The chart provides the distribution of the distances (expressed in standard units) of
OECD countries from the 17 goals. The blue diamonds show the median distance for OECD
countries. Box boundaries show the first and third quartiles of the distribution of countries'
performances, and the whiskers show the 10th and 90th percentiles. See here for detailed
metadata.
These worrying developments, which undermine the foundations of inclusive growth, are
accompanied by environmental issues, in particular climate change. Natural disasters that
occurred in 2018 caused more than 20,000 deaths worldwide and deprived 29 million people of
livelihoods, resulting in damages estimated at USD 23 billion. Together with 2016, 2020 was the
warmest year on record. Climate scenarios predict that global temperatures will continue to rise
over the course of the 21st century, resulting in more frequent and more intense extreme natural
events, with negative implications for ecosystems and public health.
Economic activity is both a cause and a victim of climate change.
It is a cause for example due to the use of fossil fuels for energy: three-quarters of greenhouse
gas emissions are generated from fossil fuel combustion. Climate change has also had an
impact on human activities: rising average temperatures, with pronounced fluctuations, affect all
sectors, particularly those more susceptible to natural events, such as agriculture. Frequent and
intense heatwaves and hydrogeological phenomena can have significant economic
consequences, while gradually rising sea levels threaten coastal communities throughout the
world.
It is clear that we need to ensure the sustainability of our development model, starting by
gradually moving away from the use of fossil fuels.
In recent months, the steps taken to limit the consequences of the pandemic have temporarily
slowed the rise in emissions. According to NASA, between February and May 2020 atmospheric
CO2 concentrations fell compared to pre-crisis levels to a level consistent with the achievement
of the targets set by the Paris Agreement.
But this will only be a temporary improvement unless climate policy changes course, particularly
if there is not an adequate carbon pricing system that penalises emissions. The challenge facing
us now is how to support general well-being while keeping emissions at levels that comply with
the Paris Agreement.
Monetary and fiscal authorities are responding by introducing decisive policies designed to revive
development. But we cannot just limit our efforts to returning things to how they were before. We
must seize this opportunity to modernise our economy, reduce social and environmental
vulnerabilities and bring about change that makes development sustainable.
The contribution of responsible finance
In the financial world, interest in sustainable growth has long been limited to a small group of
specialist operators. But things have changed in recent years.
The Paris Agreement explicitly recognised the vital role of the financial system in promoting
responsible development.
Since 2015 ESG investment funds have increased the total assets they manage by over 170%.
Between January and October 2020, this category of funds in Europe saw net inflows of more
than €150 billion, nearly 80% more than in the same period the previous year. According to
market operators, this trend is set to continue.
Chart 2
Euro area: assets of global ESG funds by asset class (left) and distribution of holdings across
euro area sectors (right)
USD billions (left); percentage (right)
Notes: The pie chart on the right is based on a sample of 1,076 ESG funds domiciled in the euro
area, comprising 554 equity funds, 262 bond funds and 216 mixed funds. Mixed funds are
classified as equity or bond funds if the respective share of equity or bond investments exceeds
50%. ICPFs: insurance corporations and pension funds; IFs: investment funds.
Sources: Bloomberg Finance L.P. and ECB report (left); Bloomberg Finance L.P., Refinitiv, ECB
securities holdings statistics per sector and ECB calculations (right).
This change of pace primarily reflects the impetus coming from the authorities at global level. I
have already mentioned the UN's 2030 Agenda and the Paris Agreement. But awareness of
social and environmental issues among young people, who are less inclined than the
generations before them to separate consumption and investment decisions from
sustainabilityrelated issues, has also had an impact.
According to the UN, implementing the 2030 Agenda will require total investment of between USD
5 to 7 trillion per year. The European Commission has also estimated that in order for the EU to
meet its 2030 climate target, new investment of up to €260 billion per year will be required over
the next decade.
Whether investment programmes of this scale can be implemented will largely depend on the
cost and availability of financial resources. The lower cost of capital compared with traditional
investments - also referred to as the green premium - could encourage the launch of new
sustainable projects. However, empirical analyses show that this premium would be small at
best. It is therefore unrealistic to imagine that the huge volume of investment needed to ensure
sustainable development can take place without the involvement of the public sector, for example
in order to raise the price of coal by strengthening the emissions trading system or to support
research and development of alternative energy sources.
In order to boost the contribution made by sustainable finance, the financial instruments offered
to investors must be trustworthy and easy to understand. Lenders also need to be able to
assess whether investment projects are consistent with their own financial and non-financial
objectives.
There needs to be detailed information about whether investments meet sustainability criteria. At
the moment, the data available are scarce and of poor quality - for example, the ESG ratings of
individual companies produced by a range of analysts are based on different methods and are
poorly correlated (Chart 3). Here too, public sector involvement, in particular effective regulation,
is necessary.
The European Union is leading the way internationally in terms of regulating sustainable finance.
But further progress would be welcome, also in view of the launch of the European Green
Deal and the European Commission's soon-to-be-published renewed sustainable finance
strategy.
The review of the Non-Financial Reporting Directive could result in significant progress being
made by expanding the range of companies subject to sustainability reporting requirements,
establishing common assessment criteria and ensuring an appropriate degree of data
granularity. Empirical evidence indicates that disclosure makes firms pay closer attention to
sustainability without worsening their performance.
Chart 3
Correlation of environmental scoring performance by Bloomberg and Refinitiv
Notes: The Bloomberg and Refinitiv environmental scores give values between 0 and 100,
whereby a higher value indicates a better performance in terms of environmental variables.
Sources: Bloomberg, Refinitiv EIKON and ECB own reports.
There is a need for the definitive launch of the classification system (or taxonomy) of sustainable
activities, planned for 2022. The use of this tool by analysts, banks and companies will require
further steps, such as approving delegated acts and establishing guidelines.
The new regulatory framework will need to offset investors' information requirements against the
need to avoid overly complex and burdensome transparency obligations for issuers, particularly
small and medium-sized ones.
Lastly, the development of sustainable finance requires global cooperation, also considering that
around 90% of the global emissions are produced outside Europe. Coordination is necessary in
order to adopt a common set of rules and practices for taxonomies and non-financial reporting
criteria, and to establish procedures to prevent opportunistic behaviour and regulatory arbitrage.
This year's G20 presidency provides Italy with a unique opportunity to put these issues at the top
of the international agenda.
What is the ECB's role?
In recent months the ECB has launched a reflection process to identify policies through which it
can contribute to the climate transition in full accordance with its mandate under EU law.
Article 127 of the Treaty on the Functioning of the EU states that the primary objective of the ECB
is to maintain price stability. The Treaty also states that, as a secondary aim, the ECB shall
support the achievement of the EU's objectives. And Article 3 of the Treaty includes sustainable
development among these objectives.
The monetary policy stance has at best only a negligible impact on environmental risks. This is
due to both its very different time horizon compared with climate change and the fact that it
cannot target individual sectors. However, the economic and monetary analysis that underpins
the monetary policy stance should also take into account the shocks caused by climate change
to both conjunctural and structural developments.
The ECB can contribute to environmental policies in the implementation of monetary policy -
what we refer to as the operational framework. We have already taken steps in this direction, for
example by including sustainable finance instruments - the sustainability-linked bonds - among
the collateral that can be used in refinancing operations. In addition, to ensure that it remains
financially sound, the ECB has to protect its balance sheet from the financial risks caused by
climate change that are not correctly priced by the markets. By performing its own analysis of
these risks on the basis of rigorous methodologies, the ECB can contribute to the accurate
valuation of these climate-related risks and promote awareness among investors, thereby
helping to combat climate change. These issues are currently being considered as part of our
monetary policy strategy review.
But it is not just monetary policy that is affected. Climate change has an impact on the overall
stability of the financial system. The most vulnerable intermediaries are those that operate with
long time horizons and are exposed to the consequences of extreme events, such as insurance
companies. We are currently defining models that could be used to measure the systemic risks
caused by climate change, including through specific stress analyses.
ECB Banking Supervision - the ECB's supervisory arm - has also recently published its
expectations on how banks should manage climate and environmental risks in their balance
sheets. Looking ahead, this could then influence banks' capital and public disclosure, increasing
awareness among intermediaries and investors of these risks.
Lastly, the ECB is actively involved in European and international initiatives aimed at improving
information on the environmental impact of companies and intermediaries.
Conclusion
Advanced economies have long been characterised by a high level of savings and insufficient
investment. Productivity growth is subdued, while interest rates and inflation are at historically
low levels.
The pandemic shock has squeezed the spending capacity of households and businesses and
caused widespread uncertainty, accentuating these trends. Exiting the crisis will require
prolonged support from economic policies - both monetary and fiscal - and a significant
increase in productive investment.
Sustainable investment projects can play a crucial role in helping to reabsorb excess savings
and raise growth potential, while also setting out a growth path that reduces social vulnerabilities
and counteracts climate and other environmental risks.
The recovery and resilience plans that European countries are being asked to prepare so that
they can access the Next Generation EU funds are an opportunity to relaunch growth, steering it
to a sustainable path.
If used wisely - to increase human capital, to invest in technology and to protect the environment
- these funds can help us transition from a crisis with dramatic implications to an opportunity for
progress. We need to be bold and forward-looking in seizing this opportunity and do so in a
timely manner.
Responsible finance can play an important role in reconciling development with environmental,
ethical and social values. The next European strategy on sustainable finance provides an
opportunity to align financial flows with these values.
The ECB has started to reflect on how it can contribute to responsible development. A central
bank that is responsive to the needs of citizens - both now and in the future - has a duty to be
mindful of the demands of sustainable development in order to ensure stability in all its forms:
first and foremost monetary stability, but financial, environmental and social stability too.