The Bank of England is looking at greening up its £20 billion ($28.2 billion) corporate bond asset purchase program.
The central bank said in a discussion paper published May 21 that its considerations are in line with the U.K.'s commitment to reach net-zero greenhouse gas emissions by 2050, as well as a 78% drop in emissions by 2035. Figures are compared with emissions in 1990.
While government policy and company actions will be "the primary drivers" of a drop in carbon emissions, lenders and investors have a "crucial supporting role to play," the paper said.
The corporate bond purchase program was introduced in August 2016 as part of policy measures to help ease monetary conditions in the U.K. following its exit from the European Union. The bank purchases investment-grade sterling corporate bonds issued by companies deemed to be making a material contribution to U.K. economic activity. The aim is that the program will be wound down once it is no longer needed. "As such, the bank does not expect to be a permanent investor in corporate bonds," the paper said.
The bank's investments are made across sectors of the economy depending on the amount of eligible debt outstanding in each sector, thereby minimizing relative borrowing costs across sectors.
"But there is increasingly persuasive evidence that market prices materially underestimate the risks and the opportunities associated with the transition to net-zero," creating a divergence between today's view of market neutrality and how a portfolio might look if prices were properly reflective of those factors, the paper said.
"Until recently, the bank did not have the mandate to reflect such mispricing," but in March, the chancellor of the exchequer updated the bank's monetary policy committee's remit, in part including an expectation that it will support the transition to a net-zero emissions economy.
Therefore, the bank proposes using the corporate bond program to support an orderly, economywide transition to net zero according to three broad principles: to encourage companies to take decisive action to achieve net-zero emissions, with exclusions and divestments "part of the toolkit, but only where they incentivise that transition"; to lead by example and learn from others — particularly given the relatively small scale of the corporate bond purchase program; and to "ratchet up our requirements over time." For the last principle, the bank said its approach will become "progressively more demanding, setting higher expectations and sharper incentives," as data, metrics and firm-level emissions improve, the paper said.
Along with the principles, the bank proposed exploring four key tools: portfolio targets, setting and disclosing interim targets for certain climate properties of the corporate bond purchase portfolio; asset eligibility, with a role for making eligibility for the program conditional upon climate-related actions by issuers; tilting purchases toward eligible issuers with stronger relative performance when it comes to net zero; and escalation, designing and implementing a strategy for the program with "progressively more stringent requirements, and repercussions for issues who do not meet them."
The bank will evaluate the benefits and risks associated with its proposals over the coming months. It also wants industry feedback on its proposals by July 2.