Lagarde Seeks to Assert the ECB’s Dominance – and it could affect the sustainable/credit rating market

Today’s post reacts to comments recently from Christine Lagarde, relating specifically to the role and neutrality of the European Central Bank and its position with regards to advancing European policies. We have discussed, on a number of occasions recently, the perilous position of the sustainable rating environment and, as I suggest, the potential importance of European sustainable-related developments to the health of that particular industry. In that regard, the recent comments on the role of the ECB in potentially enforcing the EU’s climate-related policies not only marks a controversial turn in sentiment, but potentially impacts the development of the sustainable rating marketplace.

 

Lagarde spoke recently and in emphasising her unhappiness with the development of sustainability in the marketplace, declared that ‘climate risks are not adequately priced’. The article in Bloomberg’s Quint offering suggests that she may lead the ECB in a new direction, with the decisions on which companies and industries to lend support to would be tied to compliance to EU policies on the issue of tackling climate change. The suggestion is that Lagarde could take the ECB down one of two paths; the soft path being to urge companies to better disclose climate risks that they face, and the more extreme path of judging who should benefit from the ECB’s mammoth bond-buying programme in relation to their compliance with EU regulations on non-financial informational disclosure, and the wider Action Plan that will contribute to the eventual goal contained within the European Green Deal. There are a number of arguments against this more extreme approach, mostly consisting of the lack of authority for the ECB to do this. Furthermore, the EU is seeking to become a ‘less is more’ style institution, which goes against the concept of the ECB becoming the enforcement vehicle for the Action Plan. However, analysts from Hermes have been cited as saying ‘the ECB has been very vocal about its intentions to continue to fight the climate crisis… its ambitions are very serious’. For Lagarde, she has rightly bemoaned the understanding that information that is currently being declared is ‘at best inconsistent, largely incomparable, and at times unreliable’. Whilst the ECB does have the mandate to support the EU’s economic policies, it rarely does so in such an explicit manner. Options that have been suggested range from introducing adjusted ‘haircuts’ that could be applied to securities after their climate risk has been assessed, to outright exclusion from purchasing programmes. If the ECB does decide to take a more direct approach, the credit/sustainable rating environment could be impacted.

 

This is because the disclosure of non-financial information is of, arguably, crucial importance for the development of the two interconnected industries. The mainstreaming of ESG and its variants are bringing the two industries together more and more. We can see this when it comes to the M&A activity that has seen a number of ESG data providers/raters be absorbed into the leading credit rating agencies. This pressure from the ECB is leading towards an endpoint that I have been speaking about recently in that one of the key issues for ESG providers is that they do not have the necessary information to provide truly valuable ratings etc. If the ECB is successful in forcing better rates of disclosure, and encouraging better compliance with the new sustainability finance disclosure regulations, then that issue will, potentially, be resolved. The question then becomes whether the ESG providers can then provide that quality, which I argue misses the point. I argue that it is not necessarily the value of the ratings that are the issue, but that the ability to compare ratings against each other, and also the ease at which the ratings can be assimilated into informational processes, are the issue for the marketplace. Furthermore, the more that the sustainable finance field becomes prevalent, the more important it will be for the largest investors to signal to their dispersed investor base the quality of what they are investing in and considering – would a dispersed investor recognise CDP over S&P? The signalling potential of a credit rating agency that has absorbed the ESG rating service is, potentially, one of the strongest factors in the bourgeoning marketplace for sustainable finance and, in truth, we are almost there when we look at the M&A activity – there are not many stand-alone ESG providers left who have not been exposed to this campaign in some way, shape, or form. The ECB’s radical change from its neutral standpoint, if implemented, will be just another component in bringing about the eventuality I have described here.

Keywords – ECB, central bank, credit ratings, ESG, @finregmatters