A reminder from the courts for the European Central Bank to take climate change seriously
The recent decision of the German Constitutional Court (GCC) that the Eurosystem’s Public Sector Purchase Programme (PSPP) is invalid has sparked a lot of debate. Some have quickly pointed to the vulnerability of the recently launched Pandemic Emergency Purchase Programme (PEPP) to similar litigation. Others have raised the broader implications of the decision for the EU legal order. Yet the Court’s decision also sheds light on another debated aspect of the Eurosystem’s operations: how the Eurosystem might integrate climate change into its monetary policy.
Brown bias in asset purchasing
For the past three years, the Eurosystem has been under close scrutiny for purchasing assets from corporations whose activities aggravate climate change under its Corporate Sector Purchase Programme (CSPP). This ‘brown bias’ runs counter to the Paris Agreement on climate change, to which the European Central Bank (ECB) is bound.
It also suggests that the Eurosystem may be in breach of its obligation to take into account the EU’s environmental protection objectives when designing and implementing monetary policy, as proclaimed in Article 11 of the Treaty of the Functioning of the European Union, thereby exposing the Eurosystem to litigation risk.
Failure to meet the ‘necessity test’
This is where the recent German Constitutional Court’s decision becomes relevant. The decision is full of arguments that merit closer examination. The one that is relevant for the CSPP is the principle of proportionality. In essence, this principle requires that the relevant policy measure (in the GCC decision, the Public Sector Purchase Programme) be first, suitable to achieve the objective pursued (the ‘suitability test’) and second, necessary to achieve that objective (the ‘necessity test’) – in other words, the competent authority could not have attained the same objective with less onerous measures.
The Court in Germany concluded that the PSPP is invalid because the Eurosystem failed to meet the necessity test: when designing and implementing the PSPP, the Eurosystem did not balance the effects of monetary policy with other policy areas of the EU (in the Court’s decision, economic policy). With this, the Court is not suggesting that the ECB prioritises economic policy. Price stability remains its primary goal. Its independence also remains intact. The Court is not even saying that the PSPP is invalid because the ECB did not take into account the effects of the PSP on economic policy. It is saying that the PSPP is invalid because there is no way of telling whether the ECB took those effects into account or not. The difference is subtle, but it is hugely important.
Without a clear articulation of the reasons for its decisions on monetary policy, the ECB’s decisions could not be subject to judicial review. A clear articulation of the ECB’s reasons for its decisions also supports mechanisms of political accountability. Such an articulation provides evidence of what policymakers took into account when designing their policies. It prevents them from saying “we didn’t know”. This is the very rule of law at stake.
The Court in Germany and the Court of Justice of the European Union (CJEU) share this view. What they disagree on is the extent to which the ECB’s justification was enough to satisfy the test. The CJEU considered references in several documents surrounding the launch of the PSPP to be enough. The German Constitutional Court did not.
What does this mean for the Corporate Sector Purchase Programme and climate action?
The Eurosystem has not taken climate change into account when designing and implementing the CSPP. The ECB’s president Mario Draghi himself confirmed this before the European Parliament in July 2018. Recent evidence obtained by the Finance and Social Justice Project (PDF) confirms that, as of 23 February 2020, this continued to be the case.
Although the Eurosystem has purchased green bonds under the CSPP, these purchases are not the result of a balancing exercise between price stability and climate change, as required under the proportionality principle and article 11 of the Treaty on the Functioning of the European Union: they are a side effect of the ECB’s market neutrality approach. The proportion of green bonds in the CSPP portfolio reflects the proportion of green bonds in the eligible bond universe.
As with the PSPP, an inadequate justification of the design and implementation of the CSPP will expose the Eurosystem to litigation risk. Arguably, given the scarcity of evidence, the CSPP would present an even harder case to defend.
Decision-making around monetary policy and climate change
As part of its ongoing strategy review, the ECB will be rethinking (PDF) how it can take into account the fight against climate change. The German Constitutional Court’s decision gives the ECB a strong incentive to take that exercise seriously.
There are at least two ways in which the ECB could integrate climate change into the design and implementation of monetary policy. First, it could begin to use credit assessment information that reflects climate risks in its credit assessment framework. The ECB relies on this framework to determine the eligibility of bonds under the CSPP. Under these circumstances, a high exposure to climate risks could lead to the downgrade of the issuer’s credit rating and, eventually, to its ineligibility under the Eurosystem monetary policy framework, including the CSPP.
Second, the ECB could set up an internal expert group tasked with evaluating the environmental impact of proposed monetary policy measures whose work could feed in to the discussions at the Governing Council. This expert group could also support the ECB in evaluating how climate risks are incorporated into credit assessment information.
The decisions of the German Constitutional Court and the Court of Justice of the EU are not about what the ECB should prioritise when designing and implementing monetary policy, they are about how the ECB makes decisions. If there is no other way of protecting price stability than by having a considerable effect on economic policy, the ECB must explain why. If there is no other way of protecting price stability than by aggravating climate change, the ECB must explain why. To ignore this is to ignore the rule of law.
Javier Solana is a Lecturer in Commercial Law at the University of Glasgow. The views in this commentary are those of the author and do not necessarily represent those of the Grantham Research Institute.