In a widely covered speech, Bank of England (BoE) governor Andrew Bailey had already doubled down on promises to ‘greenify’ the BoE’s policies after Chancellor Rishi Sunak, in March, updated the Monetary Policy Committee’s (MPC) remit to include supporting the transition to a net zero emissions economy.
Now, the BoE has published a Discussion Paper on how the central bank wants to go about greening its Corporate Bond Purchase Scheme (CBPS). The paper sends a clear message: The BoE, as one of the first central banks globally, is ready to rigorously embed climate transition in its work.
It might be tempting to discount the CBPS as a relatively small scheme, but make no mistake its criteria are considered by many of the top UK institutional investors for their own holdings, and, of course, it has a bearing on the liquidity of bonds (i.e. the ability to on-sell to the BoE). Therefore, this green proposal will affect all debt issuers, investors and more: focused on climate disclosures and climate action performance, the BoE’s move will put more pressure on every company to present a credible path towards zero carbon of its operations in order to get funding from the markets.
The BoE paper will also reach past the borders of the UK, with other central banks, the European Central Bank (ECB) in particular, watching closely. We’re all busy, but this is a paper we strongly recommend you carve out some time to read and reflect on the likely implications for your organisation.
You can make your voice heard
The BoE is seeking feedback from debt issuers and investors and all other stakeholders. The deadline is Friday 2 July 2021 and comments should be submitted using the BoE’s response template.
To get you started, we’ve summarized the key components of the proposal.
What is the BoE proposing?
To support an orderly economy-wide transition to net zero, the BoE suggests following three broad principles, which are shaped by the CBPS’s overarching purpose as a monetary policy tool and the Bank’s broader obligations as a public body. This means steps taken to green the CBPS cannot impede the ability of the MPC to achieve its inflation target i.e. must have due regard to protecting public money and must be capable of clear and transparent explanation using robust and proven metrics.
The underlying theme of all three principles is: the BoE will act as a strong net zero advocate, and the bank aims to meaningfully influence corporate behaviour towards a green transition.
To operationalise its principles, the BoE sets out four tools it wants to employ. The underlying theme: climate action performance is equally important as financial performance (and can trump it). And, there’s no hiding for laggards with progressively more stringent measures to be introduced.
Proposed tools for greening the CPBS
Source: Bank of England
Why does it matter?
Key points on why it matters:
The BoE’s move is part of a global effort by central banks to push the financial services industry toward greener finance. Other central banks will be closely watching the implementation of the BoE’s green CBPS (expected to happen in Q4), leading to a spill over effect to other markets and ultimately affecting companies across the globe.
Equally, investors will be watching and learning (the BoE itself points out in its three principles that it’ll proactively engage with investors) to apply a similar approach for their portfolio selection.
Pricing in climate risk and transition costs: Currently, the holdings of the CBPS, which has a volume of some £20bn (6.5% of the sterling corporate bond market) are allocated across sectors of the economy according to the amount of eligible debt that is outstanding in each sector. However, there is increasingly strong evidence that market prices materially under-estimate the risks and the opportunities associated with the transition to net zero. Going forward, the BoE wants these factors priced in to decide which bonds make it into the BoE portfolio. This will fundamentally change the scope of corporate reporting (for all those that haven’t yet introduced such metrics).
BoE acts as certifier: The ability to make it into the BoE’s portfolio will act as a powerful BoE quality trademark that investors can easily recognise, enhancing market access and liquidity for companies with the BoE quality trademark and punishing those that have fallen through.
What does it mean for companies?
While campaigners have long criticized the BoE’s bond buying from ‘big polluters’, and the public debate about the appropriate carbon price to achieve the Paris Agreement goals is ongoing, the BoE is demanding that UK corporates do their green homework. It will set targets for the overall emissions of its corporate bond holdings, invest in ‘green’ corporate bonds as they become available, and it will request bond issuers to publish their emissions as well as price in climate risks and transition costs.
Consequently, issuers with a stronger climate performance will become the preferred targets for the CBPS, and as such will find it easier and cheaper to raise money, while businesses that the BoE regards as ‘inconsistent with achieving net zero’ and hence as not suitable for its portfolio, will most like pay a ‘penalty’ on the financial markets when raising debt and will see their reputation tarnished.
Without any doubt, the BoE move will further increase pressure on companies with high carbon emissions and in particular on those that haven’t yet set out a credible path to reduce emissions: the BoE has stressed that it will focus on the path of a company’s emissions as well as the absolute level.
Moreover, as outlined earlier, the buck doesn’t stop here. On the other side of the channel, the ECB will come under pressure to take similar action, which should come as a natural next step after the EU’s comprehensive package of measures, announced in April. The measures have been designed to further help increase the flow of money towards sustainable activities as well as re-orient investments towards more sustainable technologies and businesses.
So, don’t underestimate the ripple effect of – what some might consider – the CPBS pebble.
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