FAQ on incorporating climate change considerations into corporate bond purchases
On 4 July 2022 the ECB announced the incorporation of climate change considerations into the Eurosystem’s purchases of corporate-sector securities, encompassing both the corporate sector purchase programme (CSPP) and pandemic emergency purchase programme (PEPP) corporate bond holdings. These responses to frequently asked questions (FAQs) provide further details on the technical aspects of the measures to be implemented for Eurosystem corporate securities purchases from October 2022. For more information about how the Eurosystem conducts its transactions in corporate-sector securities, please refer to the CSPP FAQs on the ECB’s website. For a non-technical explanation of how climate change considerations are incorporated into corporate bond purchases, see our explainer “How are we aiming to decarbonise our corporate bond holdings?”.
Q1 What are the key elements of the incorporation of climate change considerations into Eurosystem corporate bond purchases?
As announced in July 2022, the Eurosystem aims to gradually decarbonise its corporate bond holdings on a path aligned with the goals of the Paris Agreement. To that end, the Eurosystem will tilt its purchases towards issuers with a better climate performance by reinvesting the sizeable redemptions expected over the coming years. The overall volume of corporate bond purchases will, however, continue to be determined solely by monetary policy considerations and the role played by such purchases in achieving the ECB’s inflation target.
To operationalise the tilting of corporate bond purchases towards companies with a better climate performance, a specific climate score is calculated for each individual issuer. Purchases will then be tilted towards bonds from issuers with higher (i.e. better) climate scores. The tilting of the purchases is designed to improve the weighted average climate score of the holdings over time. The improvement in the weighted average score of the portfolio is consistent with a decarbonisation path for the corporate bond holdings that is in line with the goals of the Paris Agreement. The climate score methodology will be reviewed after one year, at the latest, and may be amended if warranted.
In addition, the Eurosystem will use a differentiated bidding approach in the primary market that favours issuers with higher climate scores. It will also give a specific treatment for green bonds, whereby such bonds that comply with a stringent identification process may also be favourably treated by the Eurosystem in the primary market bidding process.
Finally, the Eurosystem will employ other differentiated measures, such as maturity limits for lower-scoring issuers, to further mitigate its climate-related financial risk.
A broad overview of the methodology used for the climate score is set out in the chart below.
Q2 How is an issuer’s climate performance assessed?
The Eurosystem has developed a climate scoring methodology to assess the climate performance of eligible issuers that is based on three sub-scores: (i) backward-looking climate metrics, in the form of (disclosed) past GHG emissions and emission intensities (normalised by revenue); (ii) forward-looking climate metrics, such as whether the issuer has credible and ambitious decarbonisation targets in place; and (iii) the quality of climate disclosures, such as their completeness and their verification by third parties.
These metrics are based on publicly available data as well as other relevant information and methodologies, such as science-based targets, etc. Combining those metrics reflects emerging market practice. Furthermore, the design of the climate scoring methodology is guided by the requirements for the EU Climate Transition Benchmarks and EU Paris-Aligned Benchmarks under Regulation (EU) 2016/1011 as amended by (EU) 2019/2089.
The Eurosystem will review its climate scoring methodology after one year, at the latest, to reflect the increasing availability and quality of climate data and models, any relevant regulatory developments and advances in risk assessment capabilities.
Q3 How is each individual sub-score calculated?
The backward-looking emissions sub-score reflects the past GHG emissions of an issuer. It encompasses Scope 1 and 2 data for the issuer concerned and Scope 3 data at sector level. The sub-score combines a best-in-class with a best-in-universe approach. The best-in-class approach compares companies against their peers within specific industry sectors, while the best-in-universe approach compares companies across the entire corporate universe. If issuers do not have self-reported emissions data, they will be assigned a lower backward-looking emissions sub-score value. This approach incentivises issuers to decrease their carbon emissions using the best data available at issuer level and, at the same time, to adopt a more holistic view of the carbon impact of the sector in which they operate.
The forward-looking target sub-score reflects the issuer’s expected future changes in GHG emissions. Issuers that are on an ambitious decarbonisation path towards Paris Agreement targets are given a higher score, particularly if the target is science based and has been validated by a third party. If issuers have no self-reported emissions data, such that emissions reduction targets cannot be verified, they will be assigned the lowest sub-score in this dimension. Similarly, if issuers do not have concrete short-term decarbonisation targets, they will be assigned the lowest value for this forward-looking sub-score. This approach incentivises all eligible issuers to plan and set up their forward-looking decarbonisation targets.
The climate disclosure sub-score reflects the quality of the emissions data provided by issuers. The sub-score considers the current challenges in terms of data availability and accuracy, and rewards issuers with high-quality disclosures, thus creating incentives to improve data quality. For example, the Eurosystem will look at whether issuers disclose their greenhouse gas (GHG) emissions and whether these are verified by a reliable third party. The Eurosystem does not rely on estimated or modelled data on issuers’ emissions. If issuers have no self-reported emissions data, they will be given the lowest sub-score value, reflecting the fact that it is not possible to assess the transition risk that these issuers are subject to. The aim of this approach is to provide the Eurosystem with better insight into issuers’ climate-related financial risks and to incentivise all issuers to calculate and disclose their carbon footprint.
The three sub-scores are combined into a single climate score for each issuer.
Q4 Why do you use Scope 3 data at sector level and not at issuer level for the backward-looking emissions sub-score?
Scope 3 data provide the most comprehensive picture of the total emissions of companies, but are also more complicated to calculate at this stage. Issuer-specific Scope 3 data quality is currently not deemed sufficient for the data-dependent decision-making process that will be used for tilting. Sectoral Scope 3 data were, however, assessed as being sufficiently reliable and were therefore included in the methodology. Using these data ensures that the tilting methodology more accurately reflects the issuer’s overall carbon footprint. The inclusion of sectoral data also makes it possible to incorporate Scope 3 data progressively, thereby minimising any cliff effects that might occur if issuer-specific Scope 3 data were to be introduced at a later stage.
Q5 How are issuers’ individual climate scores used to tilt purchases?
The Eurosystem will tilt corporate bond purchases towards issuers with higher climate scores. While the asset allocation for the corporate bond purchases has so far been based mainly on issuers’ market capitalisation – meaning that the Eurosystem bought more bonds from issuers that issued more bonds – it will now also take into account information that is relevant to assess the climate-related risks of companies.
First, the benchmark guiding Eurosystem purchases will be tilted by increasing the benchmark weighting given to higher scorers and decreasing the weighting of issuers with lower scores. The higher the climate score, the bigger the weight increase. Second, the tilted benchmark will be incorporated into issuer group limits to ensure that purchases are guided by the tilted benchmark. This means that the issuer limits will be raised for higher scoring issuers, resulting in greater purchases from issuers with a better climate performance.
In general, the purchase volumes for a specific issuer will not only depend on its climate performance (which in turn will determine its benchmark allocation), but also on any potential risk management considerations and on the current Eurosystem holdings of that issuer.
Q6 Will the Eurosystem publish the climate scores of individual issuers?
No, the climate scores of individual issuers will not be published. Publishing such information might undermine monetary policy objectives and the effectiveness of the Eurosystem’s corporate bond purchases.
Q7 Will the Eurosystem apply any maturity limits to the securities it purchases from issuers with lower climate scores?
The Eurosystem will impose maturity limits on corporate-sector securities issued by companies with lower climate scores. This will help to mitigate the longer-term exposure of the Eurosystem to transition risks.
Q8 Will the Eurosystem adopt favourable treatment for green bonds?
Tilting is intended to mitigate climate-related financial risks on the Eurosystem balance sheet. It is the risk profile of the bond issuer that poses financial risks for the Eurosystem. Consequently, the Eurosystem will look at the key drivers of climate-related financial risks when tilting its corporate bond purchases based on issuer profile.
The Eurosystem acknowledges, however, the importance of green bonds in funding climate transition. It may therefore give preferential treatment to green bonds in its primary market bidding behaviour, subject to certain conditions. However, aggregate purchases of each issuer will continue to follow the tilted benchmark.
Currently there is no uniform green bond standard within the EU. Consequently, in order to further mitigate greenwashing risks, the Eurosystem will adopt a stringent identification process for the green bonds that are given preferential treatment. The criteria will include, as a starting point: (1) alignment of the green bond framework with a leading market standard, such as the International Capital Markets Association Green Bond Principles or Climate Bonds Initiative; (2) a second-party opinion indicating that adherence to that standard has been reviewed and is confirmed; and (3) a pledge in the bond prospectus to the effect that regular third-party assurance on the use of proceeds is foreseen (e.g. annual verification by an external auditor) until the funds concerned have been fully deployed.
The Eurosystem supports the development of the European Union’s Green Bond Standard (EUGBS). The EUGBS is expected to become a leading standard for green bonds, enabling companies and public bodies to raise large-scale financing more easily for climate and environmentally friendly investments, while protecting investors from greenwashing.
Q9 Have the CSPP eligibility criteria changed? Have the purchasing modalities changed?
CSPP eligibility criteria remain unchanged. Moreover, corporate bond purchases will continue to be conducted by the six purchasing national central banks on behalf of the Eurosystem. Please refer to the CSPP FAQs on the ECB’s website for more information.
Q10 Will the Eurosystem sell holdings because their issuer has a low climate score? Will the Eurosystem exclude specific issuers or industry sectors from its purchases?
It is not currently foreseen that a low climate score will trigger sales. Rather, further purchases of low-scoring issuers will be constrained, or even halted, until their climate score improves. Specific issuers and industry sectors will not be excluded from the tilted benchmark. Their climate performance will instead affect their benchmark share, which in turn will affect the volume of future purchases from those issuers and industry sectors. This approach is expected to incentivise a wide range of issuers and sectors to improve their climate risk profile and performance.
More generally, the corporate bond portfolio will remain a monetary policy portfolio, and the overall purchase volumes will continue to be determined solely by monetary policy considerations and the role in delivering on the ECB’s price stability objective.
Q11 How will the Eurosystem publish climate-related information on its corporate bond holdings?
As communicated in the ECB press release of 4 July 2022, the Eurosystem will start publishing climate-related information on corporate bond holdings regularly. The first report is scheduled for the first quarter of 2023. Thereafter, the reports will be released at an annual frequency.
Q12 Will the Eurosystem publish the changes to the Eurosystem holdings of bonds from individual issuers resulting from the application of these measures?
The Eurosystem will not publish a detailed breakdown of its corporate bond holdings by issuer, given that this could undermine the monetary policy objectives of the purchases. However, the Eurosystem remains committed to being as transparent as possible. It will therefore continue to publish breakdowns by country, rating and industry sector every six months.
Regulation (EU) 2019/2089 of the European Parliament and of the Council of 27 November 2019 amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks (OJ L 317, 9.12.2019, p. 17).
Scope 1 emissions encompass an entity’s direct emissions, and thus its exposure to rising costs from higher carbon taxes. Scope 2 measures indirect emissions from electricity, heat and steam consumption, and therefore reflects an entity’s exposure to rising input prices. Scope 3 is defined in the GHG Protocol as all the indirect emissions of an entity and its products, excluding those falling into Scope 2, i.e. it includes emissions across the entire value chain.
The framework in which the issuer sets out how the proceeds raised by a green bond issuance will be used in undertaking eligible green projects.
See the Opinion of the European Central Bank of 5 November 2021 on a proposal for a regulation on European green bonds (CON/2021/30) (OJ C 27, 19.1.2022, p. 4).
Nationale Bank van België/Banque Nationale de Belgique, Deutsche Bundesbank, Banco de España, Suomen Pankki/Finlands Bank, Banque de France and Banca d’Italia.