Why a Recent Judgment by the German Bundesverfassungsgericht Might Introduce Climate Change Considerations into Monetary Policy

The recent judgement by the German Federal Constitutional Court (‘FCC’) has been widely criticised both for its legal reasoning and for its impact on the EU legal order. Nevertheless, it yields valuable lessons for the ECB. Even though the ECB is an EU institution and the Court of Justice of the European Union (‘CJEU’) had already confirmed that it acted within its mandate, the FCC emphasises that the EU Treaties impose certain procedural guarantees that must not be overstepped in order to keep EU institutions like the ECB accountable. For this reason, it urges the ECB to demonstrate greater transparency in conducting monetary policy.

The ECB should take the FCC’s concerns seriously when balancing price stability objectives against the effects on other policy areas—such as environmental protection and climate breakdown mitigation. As Ms Lagarde has recently pointed out, the time has come to make climate change 'mission-critical'. Therefore, the ECB should start to undertake climate impact assessments of its monetary policy programmes and thereby prove its active engagement with climate breakdown in order to avoid imminent litigation risks.

For the FCC, efficient judicial control is key for the ECB’s accountability

The gist of the FCC’s landmark judgement is that the CJEU should ensure that EU institutions act within the competences conferred upon them and not beyond. According to the FCC, the CJEU must do so through a rigorous application of the proportionality principle. As regards the validity of the ECB’s Public Sector Purchase Programme (PSPP) decisions, the FCC has ruled that both the ECB, in adopting and implementing a monetary policy programme without sufficiently assessing its proportionality, and the CJEU, for its incomprehensible judgement, ‘Weiss and Others’, in applying insufficient reasoning in its proportionality assessment, have acted beyond their competences.

Which standard of the proportionality test should be applied?

The proportionality principle is applied in many forms and cannot be pinned down to the form the FCC demanded of the CJEU (when reviewing ECB actions) and the ECB (when taking its decisions). The CJEU’s test comprises up to three steps, in which the court scrutinises whether (1) the measures are suitable to attain the envisaged objective (the suitability test), (2) whether there are no other means available that have less onerous effects on other policy areas (the necessity test), and, in some cases, (3) whether the benefit obtained is proportionate to the cost incurred (proportionality stricto sensu).

Nevertheless, the degree of judicial review varies because such an assessment is inherently fact-specific. The CJEU, furthermore, takes into account whether institutions, such as the ECB in the case at hand, are required to make 'choices of a technical nature and to undertake complex forecasts and assessments' (Weiss, para 73)

In its decision in Weiss, the CJEU acknowledged the validity of the PSPP after assessing whether (1) there was a 'manifest error of assessment' on the part of the ECB (cf CJEU, Weiss, para 56, 78, 91), (2) the programme 'manifestly' went beyond what was necessary to achieve its objective (cf Weiss, para 79, 81, 92), and (3) its disadvantages were 'manifestly' disproportionate to the objectives pursued (cf Weiss, para 93 et seq). In its assessment, the Court relied on the ECB’s 'broad discretion' (cf Weiss, para 73).

In its recent decision, the FCC found that the CJEU’s standard of review was too lenient, as it failed to undertake an 'overall assessment and appraisal' of the ECB’s decision (cf FCC, para 123). Because the CJEU’s proportionality assessment would allow 'the ECB to expand—gradually and in a manner that is not necessarily noticeable from the outset—its competences on its own authority', it would undermine the possibilities to keep the ECB legally accountable (cf FCC, para 156).

However, because neither the CJEU nor national courts apply the proportionality principle in a unique form, the FCC’s standard of review is controversial in itself.

Transparency ensures accountability

Beyond the debated question on the appropriate level of judicial review of ECB actions, the judgement’s general thrust is that the FCC emphasised the need for the ECB to make its decisions as well as the reasons behind them them clearer and more transparent (cf FCC, para 176-177, and also 139, 173). Failure to do so limits accountability and hampers judicial review of its acts.

With respect to the PSPP, the FCC could not determine whether the ECB had conducted any kind of proportionality assessment. This lack of sufficient proportionality considerations in the ECB’s decisions on the PSPP made it impossible for the FCC to check whether the ECB had overstepped its monetary policy mandate (cf FCC, para 164).

Put simply, compliance with the proportionality principle requires the ECB to sufficiently justify its decisions. Following the FCC’s line of argument, whenever the ECB’s programmes have significant side effects on other policy areas, the question of their compatibility with its mandate would hinge on a properly documented proportionality assessment. Whereas the CJEU has accepted a whole set of documents, such as press releases or the ECB’s Economic Bulletin, as evidence of the proportionality of the PSPP (cf Weiss para 34-40), the FCC disagrees on the extent to which the ECB must give account of such assessment in the key monetary policy documents. The FCC found that '[i]t is not ascertainable that any such balancing was conducted, neither when the programme was first launched nor at any point during its implementation' and that 'neither the ECB’s press releases nor other public statements by ECB officials hint at any such balancing having taken place' (FCC, para 176). Keeping in mind that public statements indeed prove that the ECB considered the PSPP’s side effects, as well as how to mitigate them, and that the FCC itself requires that the ECB Governing Council adopt 'a new decision that demonstrates in a comprehensible and substantiated manner' that the PSPP is proportionate (FCC, para 235), one may conclude that more extensive proportionality considerations are desired in the key monetary policy documents, i.e. the decisions on the programmes.

More elaborate reasons would improve the possibility for a court to review what the ECB took into account in its decision-making and also enhance the ECB’s political accountability.

This also applies to policy areas other than economic policy, such as environmental protection.

The ECB has an obligation to take environmental considerations into account

Article 11 TFEU imposes on the ECB an obligation to consider environmental protection in the design and the execution of its measures. As a consequence, the ECB must balance a measure’s beneficial effects on price stability against the envisaged potential adverse impact on climate breakdown.

However, the Corporate Sector Purchase Programme (‘CSPP’) may be an example that the ECB is falling short of that obligation because there is little to no evidence that the ECB conducted the required proportionality assessment.

Several studies revealed that a large share of the bonds that Eurosystem purchased during the execution of the programme were issued by corporations that prominently aggravate climate breakdown. Mr Draghi acknowledged in 2018 that the ECB had not undertaken any climate impact analysis of the CSPP at that time. The German Bundesbank’s response to a recent request for information by the  Finance and Social Justice Project confirms that this continues to be the case. Although the ECB has published a breakdown of the green-bond holdings under the CSPP (two years after the programme was launched), this may not suffice to discharge its obligation under Article 11 TFEU. On the contrary, it merely shows that the ECB has implemented the CSPP according to the 'market neutrality' principle in order to avoid undue market distortions. The national central banks participating in the programme have neither included nor discriminated against specific assets from the purchases on the basis of issuers’ economic activities. Therefore, the reason why green bonds are bought because they fall within the universe of eligible assets and represent a certain proportion of eligible assets—not because of their potential contribution to mitigating climate breakdown.

Overall, the ECB’s persisting reluctance to provide a clear climate impact assessment of the CSPP and its missing explanation why this effect is proportionate to the expected benefits may be in breach of Article 11 TFEU. This can open up the ECB to the risk of litigation.

Consequences for future policy-making

The FCC decision urges the ECB to become more transparent regarding its decision-making processes. Whenever it must balance maintaining price stability against effects on other policy areas—eg positive or negative impacts on climate breakdown by virtue of Article 11 TFEU—it must clearly explain how it reached its decision and why the measure is proportionate. This has implications for the CSPP as well as for all current and future monetary policy programmes. With respect to environmental protection, they are twofold:

If the ECB disregards the climate impact of its monetary policy decisions, their validity can be challenged for breach of Article 11 TFEU.

However, even if it considers their environmental effects but fails to explain how the benefits for price stability (the ECB’s main objective) are proportionate to the (positive or negative) impact on the environment, it may be accused of venturing outside its mandate. If the ECB decides to promote climate breakdown mitigation alongside maintaining price stability (by virtue of Article 11 TFEU and Articles 127 (1) TFEU, 3(3) TEU), it must determine why this is proportionate to and compatible with its primary mandate, in order to prevent a challenge against the measures for them allegedly being ultra vires.

After the recent success of the German plaintiffs, the risk of further litigation is now more pressing than ever. Ultimately, only a clear articulation of reasons for its decisions will prove the ECB’s measures to be proportionate and will demonstrate compliance with Article 11 TFEU.

If the FCC and the CJEU decisions can be taken as a rough scale of what is required of current and future proportionality assessments, for the ECB, this could translate into three steps:

1. The ECB should constantly conduct and update climate impact assessments of current and future monetary policy programmes and, thereby, balance monetary policy objectives against effects on environmental policy.
2. The ECB should document that this balancing exercise has taken place in the key monetary policy documents and, thereby, make it ascertainable for a court that the ECB did in fact consider its effects and consequences.
3. Every time the ECB decides to extend a monetary policy measure it should give appropriate reasons for why prolonging potentially negative effects on environmental policy is warranted.

The implementation of these steps would allow the ECB to minimise its exposure to the risk of future litigation and to actively engage with climate change as required by Article 11 TFEU.

These changes will be crucial if the ECB intends to promote the fight against climate change alongside maintaining price stability, as envisaged by Ms Lagarde.

Conclusion: An opportunity for the ECB

The ECB should take the PSPP judgment as an incentive to engage in greater transparency. Taking the FCC’s concerns on proportionality as an opportunity for the ECB to provide more elaborate reasons for its actions and to further improve the communication of its monetary policy decisions will increase accountability. This includes the ECB’s obligation to take climate breakdown into account under Article 11 TFEU.

The time has come to make climate change 'mission critical'. Considering the growing importance and awareness of both climate breakdown mitigation and climate-related financial risks, the public scrutiny of the steps taken towards environmental protection is likely to increase. The ECB must start to justify why environmental protection can be promoted alongside price stability—or, with respect to the CSPP, to justify why it cannot. The ECB should take this chance rather sooner than later in order to minimise the risk of future litigation and to actively engage with climate breakdown.

Federica Agostini is a Graduate Teaching Assistant in corporate and financial law and PhD candidate at the University of Glasgow.

Elia Cerrato is a PhD candidate at the Universidad Carlos III de Madrid and adjunct professor at CUNEF.

Nicolas Jaberg holds an LL.M. degree from the University of Glasgow and is currently preparing for the German state examination at the Johannes Gutenberg-Universität Mainz.

The authors have worked together in the University of Glasgow’s Finance and Social Justice Project.

This post first appeared on the European Law Blog here.