Green monetary policy: analysing the impact of ECB green policy announcements on the performance of green bonds

This article, a summary of my master's thesis, examines how the European Central Bank's (ECB) green policy announcements impact the performance of green bonds, focusing on five green ECB speeches. Using a Difference-in-Differences approach, the study analyzes how these announcements affect the greenium (the premium on green bonds) compared to conventional bonds. Results show that ECB announcements do not consistently influence green bond performance. The ECB's role is vital, but broader collaboration with institutions like the European Commission is essential for the green transition.

Climate change is one of the most significant challenges of the 21st century. The Paris Agreement aims to limit global temperature rise to well below 2°C, preferably to 1.5°C, by the end of the century. While governments are primarily responsible for driving the transition to a greener economy, central banks, including the European Central Bank (ECB), also play an important role.

The ECB has acknowledged the need to incorporate sustainability into its operations, while maintaining its core objective of price stability. This research investigates how financial markets react to ECB green policy announcements. Specifically, it examines the impact of five green  announcements of the ECBon the performance of green bonds — bonds whose proceeds are used to finance environmentally sustainable projects. The goal is to determine whether these announcements significantly affect the greenium, or the premium investors are willing to pay for green bonds over conventional bonds.

1. Green monetary policy tools

Central banks like the European Central Bank (ECB) have a number of tools they can use to support the transition to a greener economy. These green monetary policy tools aim to influence the flow of money in a way that promotes environmentally sustainable projects. Here are some examples of such tools:

Green Interest Rates: One way the ECB can help green the economy is by adjusting interest rates for banks based on how environmentally friendly their activities are. For example, if a bank lends money to green projects (like renewable energy), the ECB could offer them loans at lower interest rates. This would encourage banks to support more sustainable projects, making it cheaper to fund green initiatives.

Green Bond Purchases: Central banks can also buy green bonds. By buying green bonds, the ECB can increase demand for them, making it easier and cheaper for companies and governments to raise money for green projects.

Green Lending Programs: Another tool is creating special lending programs where banks can borrow money from the ECB at favourable rates if they promise to use the funds for green investments. This encourages banks to support projects that help reduce carbon emissions or improve environmental sustainability.

Greening Collateral Requirements: When banks borrow money from the ECB, they have to provide collateral (something of value like bonds or loans). The ECB could prefer greener collateral, meaning it could give better terms to banks that offer assets linked to environmentally friendly activities. This would push banks to hold more green assets.

Green Guidelines and Communication: Lastly, the ECB can influence markets simply by talking about green policies. By giving clear signals that they are committed to supporting the green transition, the ECB can steer investors and banks toward more sustainable investments. This is called green forward guidance.

By using these tools, central banks can help shift money towards greener projects, making it easier and more attractive for businesses and governments to invest in a sustainable future.

2. Green ECB speeches

In recent years, the European Central Bank (ECB) has made several key speeches addressing climate change and the role of monetary policy in supporting the green transition. These speeches are important because they can influence financial markets by signaling the ECB's commitment to sustainability. Here are short summaries of five major speeches analysed in the study:

January 25, 2021 - Christine Lagarde on Climate and Central Banking
In this speech, ECB President Christine Lagarde emphasized the need for the ECB to integrate climate risks into its operations. She announced the creation of a climate change center within the ECB to coordinate efforts on greening their policies. This was a strong signal that the ECB would take a more active role in addressing climate change.

June 14, 2021 - From Market Neutrality to Market Efficiency
Isabel Schnabel, a member of the ECB’s Executive Board, argued that the ECB should move from a position of market neutrality to market efficiency when it comes to climate issues. This means that the ECB would actively favor greener assets over polluting ones to help combat climate change, rather than treating all assets equally.

July 8, 2021 - Monetary Policy Strategy Review
In this announcement, the ECB presented a roadmap for integrating climate considerations into its corporate bond purchase program. While details were not fully outlined, the strong focus on climate issues marked a turning point in the ECB’s monetary policy, signaling that climate action would be central to future policies.

July 4, 2022 - ECB Climate Agenda
The ECB confirmed that from October 2022, it would start adjusting its corporate bond purchases based on the climate performance of companies. This marked the beginning of a more concrete shift, where companies with better environmental practices would be favored in ECB asset purchases.

September 19, 2022 - Decarbonizing Corporate Bond Holdings
This speech provided further details on how the ECB plans to reduce the carbon footprint of its corporate bond holdings. The ECB announced that it would assess the climate performance of bond issuers and adjust its portfolio accordingly, reinforcing its commitment to supporting the green transition.

3. Data and methodology

The data for this study were obtained from the Refinitiv Green Bond Guide, focusing on green bonds certified by the Climate Bonds Initiative (CBI) to ensure reliability. Each green bond was matched with a similar non-green bond, based on characteristics such as maturity, and credit rating.

The dataset includes 32 matched pairs of bonds, covering different sectors. All the green bonds in the sample are euro-denominated bonds, with French issuers accounting for a significant portion.

A Difference-in-Differences (DiD) approach was used to analyse the impact of ECB green policy announcements on the performance of green bonds, measured by the greenium. The greenium of a green bond is defined as the additional spread a green bond pays when compared with an equivalent non-green bond of matching maturity, seniority and currency.

As can be seen in figure 1, throughout the majority of the period we note a negative greenium, indicating a higher demand for green bonds relative to non-green bonds.

To test the impact of green ECB announcements, the study evaluated three time windows around 5 green ECB announcements: one month, three months, and six months before and after each announcement. Control variables, such as long-term interest rates (measured by the 10-year government bond yield) and systemic financial stress (using the Composite Indicator of Systemic Stress - CISS), were included to account for market volatility and changes in interest rates.

Three hypotheses were tested:

• Hypothesis 1: ECB green policy announcements will increase the greenium.
• Hypothesis 2: Higher long-term interest rates penalize green bonds more than non-green bonds.
• Hypothesis 3: Green bonds are less volatile during market stress, as they are considered part of a buy-and-hold strategy.

4. Results

The results were very mixed. Green ECB announcements led to a significatn decrease in the greenium only for two out of the five events examined. And the events had a notable degree of overlap, since there is only one month between them. So we cannot draw strong conclusions from this.

The study confirmed that green bonds are more sensitive to rising long-term interest rates, which can increase the cost of financing for green projects. However, there was no clear evidence that green bonds are less volatile during periods of market stress.

This research marks only the beginning of understanding how green monetary policy can influence financial markets. While the European Central Bank (ECB) plays an important role in the green transition, it is just one of many actors involved. The broader push for sustainability involves multiple institutions, including the European Commission, national governments, and private sector players. The European Green Deal and regulations like the EU Taxonomy also set the stage for a comprehensive approach to sustainability, showing that coordinated efforts are essential to achieve meaningful progress.