JONES DAY TALKS®: European Central Bank’s Climate Center & Investment Plans Focus on Sustainability
The European Central Bank's decision to establish a Climate Change Center and invest in a green bond fund launched by the Bank for International Settlements reflects the growing importance of climate change, and ESG more broadly, in ECB policy. The ECB's focus on climate change and sustainable finance will only grow as the EU's Sustainable Finance Action Plan continues to advance.
Jones Day's Linda Hesse and Dr. Michael Fischer discuss the Bank's aim to reorient capital flows around a more sustainable economy while managing the financial risks brought by climate change.
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Dave Dalton:
The recent announcement by the European Central Bank would seem to affirm the institution's continued interest in climate change issues. The bank has indicated that it will use some of its own portfolio funds to invest in the Euro-denominated green bond investment fund for Central Banks introduced by the Bank for International Settlements or BIS. The move reflects the growing importance of climate change for the ECB's policy, as well as the need for a more structured approach to strategic planning and coordination. It also illustrates how regulators and enforcement agencies continue to view climate change matters as a legitimate risk that must be managed. Jones Day's Linda Hesse and Michael Fisher are here to give us an overview. I'm Dave Dalton, you're listening to JONES DAY TALKS®. Pairs-based Jones Day partner, Linda Hesse advises clients in the areas of capital markets, securities law, public M&A, and corporate governance under both U.S. and French law.
She asks for issuers with respect to their issuances of debt and equity securities listings on EURONEXT, NASDAQ and the NYSE and on regulatory matters involving the SEC and the French Financial Markets Authority. Notably, for purposes of this conversation, her practice includes advising on environmental, social and governance matters, or as we know it ESG. This includes sustainable finance transactions, green frameworks, ESG disclosures, and risk assessments.
And Dr. Michael Fischer is an experienced financial services lawyer supporting clients regulatory needs. Michael's practice covers complex regulatory issues, including M&A transactions involving financial services companies and financial products, and in the areas of anti-money laundering, countering the financing of terrorism, corporate governance, management liability, and recently, COVID-19 regulations. Michael is actively involved in Jones Day's global cross-disciplinary blockchain and LIBOR groups, advising on legal and regulatory issues arising from both. Michael, who's based in our Frankfurt office, is a board member of the German American Lawyers Association and co-head of the associations M&A practice group. Linda, Michael, thanks for being here today.
Linda Hesse:
Thanks Dave.
Dr. Michael Fischer:
Thanks Dave.
Dave Dalton:
A lot to cover today, a lot to unpack. But before we get into the January 25th announcements by the European Central Bank, let's look around Europe, what's going on with respect to ESG. Linda, there's a conventional wisdom or opinion out there that says Europe is ahead of the game in terms of ESG and so forth. Is that right? And if that's right, what does that really mean?
Linda Hesse:
Thanks Dave for that opening question, because I think it's important to really set the stage. One of the things I tell people as an American practicing abroad is that Europeans have been dealing with energy crises and climate change issues, really going back to the beginning of the last millennium, as far back as 1150, they adopted their first laws in France, at least, regarding deforestation and an energy crisis with the lack of wood available, wood being building materials and for energy heating, etc. So I think these are issues that have come up repeatedly in Europe over really a thousand years.
Dave Dalton:
And Linda, pardon me, did you say 1150?
Linda Hesse:
1150, exactly.
Dave Dalton:
A thousand years ago?
Linda Hesse:
Almost a thousand years ago.
Dave Dalton:
Wow, well done.
Linda Hesse:
That just shows that the need to really regulate the availability of energy. Just another funny aside, the French people say one of their expressions is they don't have oil and gas, but they do have ideas. So in a relatively resource constrained area, it's important to make sure that these issues are taken very seriously and dealt with intentionally. So in more recent times, if we look at 2015 and the Paris Accords, that was really the main accelerator event. As everyone knows now, the Paris Accords were adopted in 2015 and they entered into force in 2016. So an international treaty on climate change with very ambitious goals.
And the European Union has really been working very vigorously to meet those goals, set ambitious goals and then meet them. And they've put together all of their key legislation for implementing their target really by the end of 2018. And really one of the most important things that they have done is recognize the need for financing. This change is going to be extremely expensive. It's going to need almost unbelievable amounts of economic resources to get where we need to go. And that's what they're setting out to do.
Dave Dalton:
A couple of things. You talked about the economic resources need and we'll talk more about this in a second, and we're going to swing to Michael, but is there organized opposition to this? There were some things here in the States and there were some people who were nuts about the Paris Accord, but that's been changed. What are people on the ground in France saying, Linda? This isn't something that has radical organized opposition, I wouldn't think. Or do they?
Linda Hesse:
I wouldn't say radical and organized opposition. I do think this is a Europe wide effort. Each of the member states are also marshaling their resources in ways that make sense for their particular needs and also their political climates. But I'd say that as a general matter, there has been a long standing recognition that climate change is something that needs to be faced head-on and organizing principles are necessary to get the full heft of the European Union behind these efforts. And that's why we've seen so many legislative regulatory and administrative actions coming out of the EU and then being deployed at each of the member state levels.
Dave Dalton:
It does seem like the momentum has been more consistent in Europe since I've been paying attention anyway. Whereas sometimes in the States there are fits and starts, that kind of thing. But what do you attribute the sentiment in the European community? It's like, this is something that's important. We're going to keep moving this direction and not always with the speed we'd like. But it does seem like there's been sustained interest there. Why do you think that is?
Linda Hesse:
I'd certainly be interested in Michael's views on this. I guess my view really is that there has been a consensus in the Paris Accords really pulled a lot of these pieces of effort together, but this is something that's been going on for a very long time in Europe. Michael, I don't know if you have points that you think are important for our listeners?
Dr. Michael Fischer:
I would second what you were saying, thank you, Linda, wholeheartedly, as far as the need to fight climate change, there is a very broad consensus where the debate is, is really in how to achieve that goal. And clearly a lot of that has to do with who is going to finance that. And as we said already, part of the consensus, it clearly is significant financing is required to achieve this as far as new funds that will need to be deployed in new ways. And obviously also for existing investments that may have to be redeployed. And we see a broad level of activity across the European Union and its governmental agencies to follow those objectives. Sure.
Dave Dalton:
In fact, that's a nice segue into what I think should be the next part of our discussion. Why don't you talk to Michael about the European Central Bank and how this links, the climate actions and so forth? What's the connection here.
Dr. Michael Fischer:
Sure. I'm happy to do that, Dave. Really the key connection is on this enhancing prong that we discussed and that ties into basically two underlying bigger plans that the European has put out there. One is the European Green Deal, which is a large package of legislative and regulatory measures with the end game inside to cut greenhouse gas emissions. And it includes various investment programs that are being pursued today. And then there is the EU Sustainable Finance Action Plan, which is meant to make sure that the economy really receives the necessary resources to carry out this plan. And this plan has three objectives and those tie directly to what the ECB has as its remit. First, the plan aims to manage financial risks that stem from climate change. Then secondly, it also aims to foster transparency and long-term reasons.
Dr. Michael Fischer:
So really what is intended to be addressed is the challenge that there's way too little information on sustainability related activity out there right now and financial disclosure or disclosure pertaining to non-financial items in the general disclosure is to be beefed up. And then there's the third element and that's encompassing this point and that aims at reorienting capital flows towards a more sustainable economy. And this is what the ECB really primarily intends to target with the actions that are at the center of our discussion here today.
Dave Dalton:
Michael, these three objectives, you mentioned, this is ambitious. You said ambitious. And I second that. There's a lot to work through here.
Dr. Michael Fischer:
I would agree again. And I think any practitioner in this area you ask would agree with that, not only from the perspective of it being a Herculean task and something that affects basically all areas, but also something that, from the perspective of where we are at this juncture in Europe, as far as legislation and regulation is concerned, it has become quite massive.
Dave Dalton:
That's a good overview introduction, big picture stuff. So let's go back to the announcements of January 25th from the ECB. And I'd like to hear from both of you on this, maybe Michael, then Linda. We'll stay with Michael for a second. Talk about the January 25th announcements. What are they about? What are the objectives there?
Dr. Michael Fischer:
Sure. They are both about the E, the environmental part in ESG and in particular, actually climate change. The first one deals with the investments of the European Central Bank's own funds. I.e. the monies that the Central Bank needs to basically finance its operations. And here, what the ECB has announced is that it is investing in a newly created fund for Central Banks, a fund that was introduced by the bank on international settlements. And the second one is on the establishment of what's called a Climate Change Center. So that's a newly created organizational unit within the bank that directly reports to the president to Madame Lagarde. And this body is really tasked with shaping and steering the European Central Bank's climate agenda on a cross-functional basis. I think the ECB really has realized that similar to what we were just saying, this is a big task already within the European Central Bank. And it's the good idea to structure its activities.
Dave Dalton:
How would someone tap these funds in this new fund you mentioned, green assets? Is there an application process? How does someone apply, if that's the right word? How are these funds made available to interested organizations?
Dr. Michael Fischer:
The only organizations eligible for participation or for investing in these funds are actually Central Banks. It's a Central Bank-only investment vehicle, and what the BIS the bank of international settlements has done, it has already launched a dollar-denominated fund. And now this is the Euro traunch that they're making available for Central Banks. And really what it is intended to do is it helps ease Central Banks like the ECB to incorporate ESG objectives in the management of their reserves and their capital, because they obviously want to make certain that with respect to the monies that they manage, again, for purposes of generating, operating income to fund their operations, they can do that also in climate friendly investments. And this is what this particular fund is all about, which in and of itself invests for the most part in green bonds.
Dave Dalton:
So this is the, please make sure I'm pronouncing this right. EUR BISIP G2.
Dr. Michael Fischer:
That's it.
Dave Dalton:
Okay. And when was this launch? I'd heard vaguely about this. Is this relatively new announcement or was this part of the January 25th announced spin, or when did this come out?
Dr. Michael Fischer:
Absolutely. Concurrently with the announcement that the ECB made, the BIS launched this particular fund. And they had already that time, this dollar fund in place that I mentioned that was launched already in 2019. So this is now following the dollar fund that has been out there. And right now, these two funds together, just to give you a feel for size, will manage entirely somewhere around $2 billion in green bonds for Central Banks.
Dave Dalton:
That's not inconsequential, that's for certain. Linda, let's talk a little bit about the ECBs actions and its effect on the bond markets. Where are the opportunities there?
Linda Hesse:
Well, that really is a very important question because we've discussed in one of our previous podcasts, the kind of burgeoning market for green bond products and sustainability linked bonds. And these actions by the ECB and other Central Banks are really starting to create an incredible market for these bonds. So as companies are raising money to address climate change, they of course need to have buyers for the bonds. And the public buyers are putting themselves in a position to be able to purchase those bonds and in fact, make those a priority. And we've also seen there's a lot of private interest in these bonds. So it's really building demand for the financing and then making sure that as companies have projects that they want to fund, they'll be able to have a market that will be buying their bonds. Part of this building wave and opportunity creation.
Dave Dalton:
And we did talk about this on a previous podcast, I think Lanier Saperstein and I talked about it too. The momentum and the trend in the market for green bonds, the demand is just unbelievable. And I don't think you don't see it slowing down anytime soon, apparently. Right?
Linda Hesse:
No. And in fact, in all of the European regulatory actions are really pushing so that transition accelerates. One of the things we haven't talked a lot about, but we've done previously is point on greenwashing. What the European regulators don't want to see is the market put at risk because there's some doubt about the bonafides of the products that are being offered and sold under these flags. That's one of the other regulatory changes that we'll be seeing how to address. We already are seeing how to address labeling various kinds of products to make sure that people aren't essentially buying something that's not as green as they'd like it to be.
Dr. Michael Fischer:
I think that's also Linda where we can fairly say the flip side to that is that's where we also see a lot of opportunity for the corporate issuers out there. For corporate issuers to really attract the massive investor demand that we see in this space and companies that really do well with their sustainability disclosure. They not only act in their own best interest, but they will also be those that are most attractive to the investment community out.
Linda Hesse:
Exactly.
Dave Dalton:
Well said. Okay, so staying with Michael. So this investment relates to the European Central Banks role as a Central Bank, but what does monetary policy have to do with climate change? Is this in line with ECBs overall mandate?
Dr. Michael Fischer:
Dave, good question. And this in fact is a question that is at the center of a contested, political debate since the primary objective of the ECB really is to ensure price stability. And it would probably find it somewhat of a stretch to include the fight against climate change in that. However, the ECB really takes the position that the objective for price stability can be effected by climate change in many ways. And in that sense, the first one that really stands out is inflation risk because, what the ECB is saying if we are seeing more frequent floods, droughts, or any other kind of catastrophes destroying harvest and resulting possibly in higher food prices, that will ultimately impact inflation. Because climate related policies can impact prices for consumers and that way include electricity or gas or whatnot. And then climate change can also negatively impact the effectiveness of the Central Banks, monetary policies because of losses that are ultimately incurred as a consequence of such catastrophes that we were just discussing.
And then there's another item that they feel strongly about, which is really the underlying framework under which the ECB operates. And those are the European treaties, which when they talk about the mandate of the European Central Bank, they require the ECB to support the general European economic policies. So in that sense, you see kind of the political side of the bank's mandate without really diminishing its primary, objective, this other objective to support these policies that includes supporting the sustainable development of the EU. It includes promoting the protection of the environment. So pretty broad in that sense, and also requires it to consider goals relating to protection of the environment.
And then I guess a last item that's out there as well as that the ECB has to consider risks that may occur as a result of climate change, which can then ultimately impact its balance sheet. And all of these elements, the ECB throughout the years has been very clear that it is determined to fulfill the mandate as it interprets it. And in fact, with the recent change at the helm of the organization, this has been underscored even in clearer terms, I'd say.
Dave Dalton:
Sure. I'd like to move on and talk in a second about the potential limits to the authority that the ECB might have to pursue this sort of agenda. But it's interesting. We recorded another podcast with one of your colleagues Lanier Saperstein a couple of weeks ago, and I'd never thought about it before, but he was talking about the risk that climate change bring to a company's balance sheet. Honestly, an insurance company, a bank, the assets you're lending on, and the exposure you have. And he was talking about greater New York City and Jersey and the exposure there, if there were a horrible storm risk, something happened. I never made the connection before in terms of climate risk and potential financial damage to a financial institution. And I don't know why. It's obvious now that somebody points it out to, but that's not the kind of thing you normally think about. You think about they made bad loans. They took on inappropriate risks in terms of the policies they were underwriting, but I'd never made the connection to climate risk before when it comes to a balance sheet for an organization like that.
Dr. Michael Fischer:
And that's clearly something that if you compare that now to what a Central Bank is tasked with doing, you can see that the risk exposure for an entity acting in that top of a capacity is even way greater than that of an individual bank. Right?
Dave Dalton:
Sure. A hundred fold probably, or at least. That's enormous.
Linda Hesse:
Just to jump in on some of the ways that the risk is conceptualized. This kind of goes back to some of the disclosure regulations that were put into place following the dot com financial crisis. There was you have the kind of the Enron scandals that happened around that time if everyone recalls that time. One of the risks that was under appreciated was how the things like market changes could affect companies, balance sheets, their financial stability, their viability. And the SEC at the time put in place a lot of disclosure obligations where companies had to essentially externalize their models and say what would happen to their financial results if there was a move of a certain percentage in interest rates or in other types of derivatives.
And here it's the same thing. The regulators are saying, okay, you now have to give disclosure to the market about, you have to show that you've looked at and considered, and then give disclosure about how these risks, which we've now identified would impact your business if there's a change of this amount or that amount, and then actually run the financial models. And I think that's where kind of the rubber meets the road in a lot of these exercises before it's very abstract. And when you start to say, okay, if there is a one degree change, what does that mean in terms of where our assets are located, what the rain was going to look like and those kinds of things? So in a way we've seen this before, it's just in a different subject area.
Dave Dalton:
I think it's a great comparison. And probably the term stress testing has been around for a long time. But again, I was never that aware of it until after the financial crisis. So in a sense, if I'm using the term correctly, this is a different kind of stress testing we might be moving toward. Correct?
Dr. Michael Fischer:
I would agree with that, Dave. And in fact, when you, again, look at what the ECB is doing here, they have already announced that they want to conduct a climate risk stress test exercise in 2022, which really will tack onto the kind of stress test that we've been discussing here, where the bank in its capacity, as a supervisor of banks within the European Union will go out and consider to what extent the supervised institutions have adequately reflected risk associated with climate change in their banking operations. So this label for purposes of what's happening here is corrected in more than one respect.
Dave Dalton:
Interesting. Well, let's wrap up with this and we try and get very practical, but when we summarize one of these podcasts, what kind of questions are you getting from clients right now after the January 25th announcements? What are clients asking or what are you hearing out there?
Dr. Michael Fischer:
One of the questions that we're getting clearly from clients is to what extent are they going to be impacted by what's happening here, the level of the European Central Bank. Our response to that, I'd be curious to hear whether Linda will second that, has clearly been that there is a tremendously strong commitment by the European Central Bank to pursue the fight on climate change. In fact, Lagarde is cited to have adding declared a war on climate change. And this is something that will not merely address what we have been talking about so far, which is their investment policy and their actions as a Central Bank, but also their work as a banking supervisor. And remember the ECB kind of wears two hats It's also responsible for supervising banks within the Eurozone. And as we discussed just a minute ago on the stress test point, it wants to make certain that banks really adequately manage their climate related environmental risk.
And it has in fact already put down in a guide that it shares with its supervisory staff, the expectations that supervision has for the banks, how they deal with this type of risk management, which actually goes so far to be very explicit in their expectation with respect to these bangs, how they include risk referring to climate change in their risk appetite framework, which really means does that risk report for that particular bank in cents and dollars, or that cents here, cents and euros, reflect the exposure to climate-related risk. So a lot of the questions that we get and that we expect to continue to get are in that direction.
Dave Dalton:
How does a bank get this right? It seems like they need someone to be the point person on this in a very high level, like reporting directly to the CEO or something, or the bank president. It seems like this is not something to be taken lightly. Clearly the momentum is there and it's the right thing to do. And there are probably incentives at some point, but to effectively handle this, does this require an organizational shift for a responsible bank?
Dr. Michael Fischer:
I think most financial institutions that we work with have been at this for quite some time. So while I wouldn't say that there is a shift required, I think continuing awareness clearly is required. It is a rapidly evolving body of legislation and regulation that supervised institutions are dealing with in this sector. And the way they have been addressing this is by cross-functional teams, I.e. teams that are basically composed of all sectors within a respect to financial institutions, because it is such a multifaceted challenge and really requires all hands on deck.
Dave Dalton:
Absolutely.
Linda Hesse:
Well, this is exactly what the ECB announced with respect to its Climate Change Center. Modeling a structure that ensures that climate change and related risks and opportunities are being handled at the highest levels of the bank and reporting directly to Madame Lagarde. They cut across all groups of the banks and make sure that the complex issues are given the right urgency and determination to make sure that the ECB is addressing them as they unfold.
Dr. Michael Fischer:
In international comparison, we quite frankly don't know of any other institution where a group of in this case, 10 individuals are doing nothing else, but working on ESG. And in this case, particularly climate change related issues directly reporting to the top of the organization.
Dave Dalton:
Well, that's a clear message right there then isn't it unbelievable. So, well this all great information. Thank you very much. Michael, you and I are going to do another podcast, I believe in a few weeks and Linda, we hope you join us too, but whatever happens short-term here, I'd like us to get back together, maybe towards the end of 2021 and talk about progress, see how things have developed with ECB in the meantime. And it's an exciting time, I think a challenging time for people in your roles in terms of the stakes are big and the clients are sophisticated and need answers and need help. But this has been very informative. So thank you both so much today. This was a great program.
Dr. Michael Fischer:
Thanks Dave.
Linda Hesse:
My pleasure.
Dave Dalton:
Thanks Michael. Thanks Linda. Talk soon. This was the second in a series on climate change related podcasts with JONES DAY TALKS®.
We're talking to lawyers in the U.S. And Europe and likely Asia later to get a global perspective on what's happening in this space. So look for another podcast on the subject matter in the next several weeks. In terms of what we did today, for contact information and complete biographies for Michael Fisher and Linda Hesse go to JonesDay.com. While you're on our website, visit our insights page. There you'll find other content, including more podcasts, newsletters, white papers, videos, blogs, and on that insight section at JonesDay.com, make sure you spend some time on our ESG page. You'll find content on climate change, sustainability, human rights and shareholder activism, and how these issues from a legal and regulatory perspective affect the global marketplace, corporations, investors, and other relevant parties. You can also get there from a search engine just by typing in Jones Day ESG. Subscribe to JONES DAY TALKS® at Apple podcasts and wherever else you can find quality podcasts. As always, we thank you for listening. I'm Dave Dalton. We'll talk to you next time.
Thank you for listening to JONES DAY TALKS®. Comments heard on JONES DAY TALKS® should not be construed as legal advice regarding any specific facts or circumstances. The opinions expressed on JONES DAY TALKS® are those of lawyers appearing on the program and do not necessarily reflect those of the firm. For more information, please visit JonesDay.com.
