Yannis Dafermos, Daniela Gabor, Maria Nikolaidi, Frank van Lerven – An Environmental Mandate, Now What?

Alternatives for Greening the Bank of England’s Corporate Bond Purchases

Yannis Dafermos is Senior Lecturer in Economics at SOAS University of London

Daniela Gabor is associate professor in economics at the University of the West of England, Bristol

Maria Nikolaidi is an Associate Professor in Economics at the University of Greenwich

Frank van Lerven is leading New Economics Foundation’s work on greening central banks and monetary policy

The following is the Executive Summary of the Paper “An Enviromental Mandate, Now What?”. You can read the complete paper by clicking HERE

In March 2021, the UK Government explicitly included the support for the
transition to a net zero economy in the mandate of the Bank of England. In
response, the Bank announced it would green its Corporate Bond Purchase
Scheme (CBPS) and by November 2021 it provided details about the greening
framework. The Bank plans to use a climate scorecard that evaluates the bond
issuers’ climate performance and tilt purchases towards companies that are
stronger climate performers within their sectors.

The new environmental mandate has created a unique opportunity for the Bank
to play a leading role in the decarbonisation of monetary policy. However, the
approach that the Bank has taken to green the CBPS lacks ambition. The Bank’s
greening strategy has two fundamental limitations. First, it relies on a ‘carrots
first, sticks later’ principle that precludes the introduction of substantial penalties
for poor climate performers, at least at a first stage. Second, the Bank remains
committed to the principle of ‘market neutrality’, despite having recognised
its inherent carbon bias. This restricts the Bank’s ability to reduce subsidies it
extends to carbon-intensive activities in the CBPS.

We explore these limitations through a quantitative analysis that replicates the
tilting of CBPS holdings as proposed in the Bank’s approach, and we show the

ˆThe Bank’s tilting framework cannot reduce the representation of
carbon-intensive activities in the CBPS and can paradoxically lead to some
carbon-intensive companies getting better treatment than environmentally
friendly companies. This is a consequence of the Bank’s continued
adherence to the market neutrality principle, which leads to the tilting of
CBPS holdings within sectors so that the scheme continues to reproduce the
underlying sectoral composition of the bond market.

ˆThe Bank’s tilting approach is not going to substantively reduce the
Weighted Average Carbon Intensity (WACI) of the CBPS portfolio. In our
replication, the WACI would only decline by 7%. Thus, the Bank will find
it challenging to achieve even its own target of 25% reduction in WACI by

To help the Bank of England genuinely lead by example on the decarbonisation
of monetary policy, we propose two alternatives: Strong Tilting and Strong
Tilting+Exclusion. The Strong Tilting option adds activities-based taxonomies
into the tilting strategy and reallocates purchases across different sectors without
being restricted by the market neutrality principle. In the Strong Tilting+Exclusion
option, we additionally exclude from the Bank’s holdings the bonds of fossil fuel
companies and the bonds issued by non-renewable electricity utilities with a poor
climate performance. Our quantitative analysis shows the following:

ˆOur proposals would substantially reduce the subsidies that the Bank
of England extends to companies engaged in carbon-intensive activities.
Under the Strong Tilting option, the proportion of carbon-intensive bonds
in the total CBPS holdings declines from 54% to 48%. In the Strong
Tilting+Exclusion option, this proportion declines even more to 36%.

ˆUnder the Strong Tilting option, the WACI of the CBPS portfolio declines
by 11%, while Strong Tilting+Exclusion leads to a decline of WACI by 39%,
allowing the Bank to achieve its 2025 target right now instead of waiting for
three more years.

Importantly, the Strong Tilting+Exclusion option will likely have the strongest
impact on the decarbonisation of the UK economy. It would directly penalise
those companies that have done nothing or too little to address the climate
crisis. Excluding these companies from CBPS would not just increase their
cost of borrowing through bond markets. It would entail adverse reputational
effects by sending a strong signal to markets that companies which fail to
contribute to the achievement of the Paris targets can suffer financially. Such
reputational consequences can increase the pressure on companies to decarbonise
their activities and fundamentally change their business models. In comparison,
such pressures are minimal under the Bank’s tilting option, whereby some
carbon-intensive companies could even benefit from the incorporation of climate
criteria into the Bank’s monetary framework.

Our proposals remain applicable should the Bank decide to taper its corporate
asset purchases in the coming months. For example, the Bank can implement
tapering by excluding from the eligible universe, or reducing the holdings of,
those bonds that have been issued by poor climate performers. A green tapering
would give a powerful signal to financial markets.

The climate emergency cannot be addressed through economic policies that
simply tinker around the edges. A sharp reduction in emissions requires
bold changes in the design of economic policies and the implementation of
unprecedented measures that will transform the structure of our financial
systems. As a powerful policy institution with a new environmental mandate, the
Bank of England should take up the challenge, lead by example, and contribute
decisively to the fight against climate change.

To continue reading the complete paper click HERE


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