Keynote speech by Luis de Guindos, Vice-President of the ECB, at the Annual Joint Conference of the European Commission and the European Central Bank on European Financial Integration | Brussels, 7 June 2023 |
It is a great pleasure to be participating in this year’s joint conference on financial integration. This event offers an excellent opportunity to reflect on key developments in the financial sector over the past year and to reassess priorities for advancing the integration, development and safety of the financial system.
Recent developments and the euro area banking sector
In recent months, bank failures in the United States and Switzerland have affected financial markets worldwide. This “real-life stress test” has provided valuable insights and lessons for the euro area banking sector and for our regulatory and supervisory framework.
The European banking sector has proven resilient. And the enhanced regulatory and supervisory framework put in place following the great financial crisis has proven its worth. But it is still incomplete – the Basel III agreement still needs to be transposed into EU banking regulation in a full and timely manner. We cannot be complacent.
During the recent bank failures, deposits were withdrawn much faster than during the great financial crisis. Silicon Valley Bank lost more than USD 40 billion – almost 30% of its deposits – in a single day. The extraordinary speed of deposit withdrawals was driven by the widespread use of online banking and the rapid dissemination of news via social media and was compounded by the highly concentrated customer base.[1] In this ever-faster digital world, banks, supervisors, central banks and legislators need to review the tools for safeguarding liquidity conditions and financial stability.
The turbulence seen in financial markets this spring is a timely reminder of the benefits of strong regulation and supervision. While adequate regulatory standards are the first line of defence against bank failures, they must be supported by a second line of defence in the form of steady, powerful and agile supervision.
Harmonised and effective supervision and an enhanced resolution framework
ECB Banking Supervision has successfully developed and promoted harmonised supervisory practices. It started to closely monitor risks related to rising interest rates when the first signs of inflationary pressures emerged, long before the bank failures in the United States. The European Commission[2] and the European Court of Auditors[3] recently confirmed that the ECB has established itself as an effective and mature supervisory authority, and the ECB has already started to implement their recommendations.
The EU has made considerable progress in crisis management by establishing a robust framework for dealing with banks in financial difficulties. While they are not a direct response to the recent turmoil, we strongly welcome the European Commission’s proposed changes to the crisis management and deposit insurance framework. In particular, we support expanding the scope of the resolution framework to ensure that the failure of small and medium-sized banks can be addressed in a more effective and harmonised way. At the same time, ensuring adequate resolution funding is critical to make resolution feasible for smaller banks. This includes using deposit guarantee schemes to help unlock access to the Single Resolution Fund and introducing a single-tier depositor preference. The proposals form a coherent package which must be preserved in its entirety. We call on the co-legislators to adopt it swiftly, preferably during the current institutional cycle.
The events of this spring have demonstrated the need for effective and agile crisis management frameworks for banks of all sizes. To complete the crisis management toolkit for large banks in the EU, we also need to make progress in other areas, such as liquidity in resolution and a backstop to the Single Resolution Fund.
The missing third pillar of banking union
The large gap in our institutional framework is still the missing third pillar: the European deposit insurance scheme. As long as deposit insurance remains at the national level, the sovereign-bank nexus will continue to be a source of fragmentation in the banking union, as the level of confidence in the safety of bank deposits may differ across Member States. In a crisis, we run the risk of deposit outflows towards other Member States and non-banks, thereby exacerbating systemic liquidity stress. An incomplete banking union is a key vulnerability for the EU banking sector and hampers progress towards greater financial system integration.
Furthermore, as firms broaden their funding sources and diversify away from bank loans, there needs to be a greater focus on financing through marketable debt securities and equity instruments. This lies at the heart of the capital markets union (CMU) project.
Implications for the capital markets union
Completing the CMU is essential for three reasons.
First, the CMU strengthens the resilience of the euro area economy through private risk-sharing.
Deep and integrated capital markets provide opportunities for effective risk-sharing. This is essential for financing the real economy and limiting fluctuations in economic activity. However, recent ECB analysis shows that, while euro area capital market integration has improved over the last 20 years, it remains rather modest.[4]
We must also consider the challenges posed by climate change in the coming years. Enhancing the risk-sharing potential of capital markets will help to further improve the ability of the EU financial system to sustain investment flows during climate-related shocks. This will bolster the EU’s overall resilience to increasingly frequent and intense extreme weather events, which typically hit regions asymmetrically.
Second, further developing EU capital markets boosts innovation, supports long-term growth and enables continued financing of the green transition.
This is of paramount importance as the EU navigates rapid technological change and is faced with an increasingly challenging geopolitical environment. The public sector cannot shoulder all the investment required for the green and digital transitions on its own.[5] Capital markets have a key role to play in allocating the private investment required and in complementing the financing provided by banks.
Equity financing – especially venture and growth capital – plays a central role in funding innovative firms. Given equity investors’ greater risk appetite, a larger share of equity financing may be needed to drive green innovation. ECB research suggests that an economy’s carbon footprint shrinks faster when a higher proportion of its funding comes from equity rather than debt financing.[6]
The EU still lags behind its global peers when it comes to developing venture capital markets. Although it has grown in recent years, EU venture capital relative to GDP is still only a fifth of that of the United States. Public investment at the European level can play an important role in crowding in private investment, while coordinated public-private investment can play a crucial role in kick-starting innovation. Furthermore, the EU and its Member States should strengthen their support for initiatives aimed at providing financing to small and medium-sized enterprises or funding EU-based start-ups and scale-ups.
On the plus side, we are already seeing substantial growth in sustainable finance. Although sustainable finance products still only account for a small share of euro area capital markets[7], assets under management of environmental, social and governance funds have tripled since 2015 while the volume of outstanding green bonds has risen tenfold. Promisingly, green bonds are roughly twice as likely as other European bonds to be held cross-border[8], and investments in environmental, social and governance funds appear to be more stable than those in conventional funds.[9] This incipient evidence suggests that, with the right regulatory framework in place, scaling up green finance will be beneficial in supporting both the low-carbon transition and financial integration in the euro area.
Third, the capital markets union and the banking union are intrinsically linked. More integrated capital markets support cross-border banking activities, while more cross-border holdings would allow banks to diversify, making them more resilient. From issuance to underwriting, banks provide essential services for capital markets. Therefore, a more resilient and integrated banking system also supports the smooth functioning and further integration of capital markets.
Key legislative initiatives to advance capital markets integration
To move forward on the legislative front, we need to finalise the implementation of the Commission’s capital markets union action plan – without compromising on its ambition. This includes implementing proposals such as the consolidated tape, the targeted harmonisation of insolvency rules and the upcoming initiative on the withholding tax framework.
We welcome the recent statement made by the co-legislators in April, in which they committed to finalising CMU legislative initiatives during the current institutional cycle, and the recent agreement on the European Single Access Point. The ESAP will help to mobilise and allocate capital by making it easier for investors to identify suitable firms and projects to invest in. Likewise, the proposed targeted harmonisation of insolvency regimes should make it easier to reallocate resources from failing firms and provide more transparency for cross-border investors. Finally, a more efficient and harmonised withholding tax framework will reduce the burden and costs for investors and facilitate cross-border investment.
Beyond the current institutional cycle and the CMU action plan, EU legislators should also look at structural issues, such as improving the current architecture to enable more consistent and harmonised supervision of markets.
Conclusion
The euro area financial system recently passed a real-life stress test. At the same time, the events of this spring underlined the importance of making decisive progress on the European banking union and capital markets union projects. The financial market turbulence and contagion from the United States and Switzerland would have been far more muted had we been closer to our goals. Completing the banking and capital markets union projects will increase cross-border bank lending and enhance the dynamism of public and private equity markets. Both are key to enhancing integration and stability in the euro area financial system, and they will also ensure that the funding for the green and digital transitions is available to meet the challenges ahead.
Thank you for your attention.
Compliments of the European Central Bank.
Footnotes:
1. Rose, J. (2023), “Understanding the Speed and Size of Bank Runs in Historical Comparison”, Economic Synopses, No 12.
2. Report from the Commission to the European Parliament and the Council on the Single Supervisory Mechanism established pursuant to Regulation (EU) No 1024/2013 (COM/2023/212 final).
3. European Court of Auditors (2023), “EU supervision of banks’ credit risk – The ECB stepped up its efforts but more is needed to increase assurance that credit risk is properly managed and covered”, Special Report, No 12/2023.
Born, A., Bremus, F., Kastelein, W., Lambert, C. and Martín Fuentes, N. (2022), “A deep dive into risk sharing through the capital channel in the euro area – inter- versus intra-regional risk sharing”, Financial Integration and Structure in the Euro Area, ECB, April.
4. The European Commission estimates that an additional €454 billion per year of investment (in 2021 prices) is needed on average from 2021 to 2030 for EU Member States to reach their climate objectives. See European Commission (2021), “Impact assessment report accompanying the Proposal for a Renewable Energy Directive II”, Staff Working Document, Brussels, July.
5. See De Haas, R. and Popov, A. (2019), “Finance and carbon emissions”, Working Paper Series, No 2318, ECB, September; and Popov, A. (2020), “Does financial structure affect the carbon footprint of the economy?”, Financial Integration and Structure in the Euro Area, ECB, March.
6. Assets under management of environmental, social and governance funds represent around 10% of the euro area investment fund sector, while the amount of outstanding green bonds constitutes around 3% of outstanding bonds.
7. Born, A., Giuzio, M., Lambert, C., Salakhova, D., Schölermann, H. and Tamburrini, F. (2021), “Towards a green capital markets union: developing sustainable, integrated and resilient European capital markets”, ECB Macroprudential Bulletin, Issue 15, October.
8. Capotă, L.-D., Giuzio, M., Kapadia, S. and Salakhova, D. (2022), “Are ethical and green investment funds more resilient?”, Working Paper Series, No 2747, November.The post Banking Union and Capital Markets Union: high time to move on first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Today, the European Commission and the World Health Organization (WHO) have announced the launch of a landmark digital health partnership.
In June 2023, WHO will take up the European Union (EU) system of digital COVID-19 certification to establish a global system that will help facilitate global mobility and protect citizens across the world from on-going and future health threats. This is the first building block of the WHO Global Digital Health Certification Network (GDHCN) that will develop a wide range of digital products to deliver better health for all.
Based on the EU Global Health Strategy and WHO Member States Global Strategy on Digital Health, the initiative follows the 2 December 2022 agreement signed by Commissioner Kyriakides and WHO Director-General Dr Tedros Adhanom Ghebreyesus to enhance strategic cooperation on global health issues. This further bolsters a robust multilateral system with WHO at its core, powered by a strong EU.
This partnership will include close collaboration in the development, management and implementation of the WHO system, benefitting from the European Commission’s ample technical expertise in the field. A first step is to ensure that the current EU digital certificates continue to function effectively.
A global WHO system building on EU legacy
One of the key elements in the European Union’s work against the COVID-19 pandemic has been the digital COVID certificate. To facilitate free movement within its borders, the EU swiftly established interoperable COVID-19 certificates (entitled ‘EU Digital COVID Certificate’ or ‘EU DCC’). Based on open-source technologies and standards it allowed also for the connection of non-EU countries that issue certificates according to EU DCC specifications, becoming the most widely used solution around the world.
From the onset of the pandemic, WHO engaged with all WHO Regions to define overall guidelines for such certificates. To help strengthen global health preparedness in the face of growing health threats, WHO is establishing a global digital health certification network which builds upon the solid foundations of the EU DCC framework, principles and open technologies. With this collaboration, WHO will facilitate this process globally under its own structure with the aim to allow the world to benefit from convergence of digital certificates. This includes standard-setting and validation of digital signatures to prevent fraud. In doing so, WHO will not have access to any underlying personal data, which would continue to be the exclusive domain of governments.
The first building block of the global WHO system becomes operational in June 2023 and aims to be progressively developed in the coming months.
A long-term digital partnership to deliver better health for all
To facilitate the uptake of the EU DCC by WHO and contribute to its operation and further development, the European Commission and WHO have agreed to partner in digital health.
This partnership will work to technically develop the WHO system with a staged approach to cover additional use cases, which may include, for example, the digitisation of the International Certificate of Vaccination or Prophylaxis. Expanding such digital solutions will be essential to deliver better health for citizens across the globe.
This cooperation is based on the shared values and principles of transparency and openness, inclusiveness, accountability, data protection and privacy, security, scalability at a global level, and equity. The European Commission and WHO will work together to encourage maximum global uptake and participation. Particular attention will be paid to equitable opportunities for the participation by those most in need: low and middle-income countries.
Compliments of the European Commission.The post Digital Health: EU Commission and WHO launch landmark digital health initiative to strengthen global health security first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

In 2020, the Commission´s nearly €100 billion SURE instrument designed to protect jobs and incomes affected by the COVID-19 pandemic supported about 31.5 million employees and self-employed people and over 2.5 million businesses. SURE effectively encouraged Member States to set up wide-ranging and ambitious short-time work schemes and similar measures at national level, which allowed firms to retain employees and skills, and supported the self-employed.
Today’s final bi-annual report on the implementation and impact of the SURE instrument shows that it was crucial in both mitigating the impact of the pandemic in 2020 and facilitating the swift economic rebound in 2021, which was faster than in previous crises. SURE – the European instrument for temporary Support to mitigate Unemployment Risks in an Emergency – ended on 31 December 2022.
Overall, a total of €98.4 billion of SURE financial assistance was disbursed to 19 Member States (i.e.  Belgium, Bulgaria, Cyprus, Estonia, Greece, Spain, Croatia, Hungary, Ireland, Italy, Lithuania, Latvia, Malta, Poland, Portugal, Romania, Slovenia, Slovakia and Czechia), close to the maximum SURE envelope of €100 billion. This included additional ‘top-up’ financial assistance of €5 billion that was granted to eight Member States in autumn 2022. Careful monitoring continued in the first months of 2023 to ensure the absorption of all SURE financial assistance, which is now confirmed.
To finance the instrument, the Commission issued social bonds on behalf of the EU, becoming the world’s largest social bond issuer.
Ursula von der Leyen, President of the European Commission, said: “SURE is the EU at its best. The programme helped save millions of jobs during the COVID-19 pandemic and, as importantly, it supported EU businesses retain their workforce. SURE set the path for our recovery plan NextGenerationEU, which broke new ground in a successful, unified, economic European response to the crisis.”
The main findings of the report are:
In 2020:

National policy support measures effectively protected around 1.5 million people from unemployment, with new illustrative simulations provided in this report suggesting that SURE-funded schemes accounted for the bulk of this impact.
SURE supported almost one third of total employment (around 31.5 million employees and self-employed people) and over one quarter of firms (over 2.5 million firms) in the 19 beneficiary Member States.

SMEs were the primary beneficiaries of SURE support.
The most supported sectors were contact-intensive services (accommodation and food services, wholesale and retail trade) and manufacturing.

In 2021:

SURE continued to protect employment in particular in the first half of 2021, when the pandemic continued to have a severe negative impact, supporting around 9 million people (15% of total employment) and over 900,000 firms (15% of firms) in the 15 beneficiary Member States that used SURE in 2021.

In 2022:

There was a clear phasing out of national support measures. In the four Member States that extended support measures until early 2022 there was continued support under SURE for 350,000 people and 40,000 firms.

To date:

All public expenditure under SURE has now been spent.
Almost half of total expenditure was allocated to short-time work schemes, and almost one third allocated to similar measures for the self-employed. Wage subsidy schemes and other similar measures accounted for 12%, while the remaining 5% was spent on health-related measures, which included preventive measures against COVID-19, additional labour costs to recruit and support healthcare workers, and the purchase of healthcare equipment and medication, including vaccines.

Member States have saved an estimated €9 billion in interest payments by using SURE, thanks to the EU’s high credit rating. This adds to the positive effects on social and employment outcomes.

Background
SURE has been a crucial element of the EU’s comprehensive strategy to protect jobs and workers in response to the coronavirus pandemic. SURE provided financial support in the form of loans granted on favourable terms from the EU to Member States to finance national short-time work schemes and other similar measures, in particular for the self-employed, as well as health measures.
The Commission proposed the SURE Regulation on 2 April 2020, as part of the EU’s initial response to the pandemic. It was adopted by the Council on 19 May 2020 as a strong sign of European solidarity, and became available after all Member States signed guarantee agreements on 22 September 2020. The first disbursement took place five weeks after SURE became available.
All of the financial assistance granted under SURE has now been disbursed and spent and no further financial assistance can be granted. Today’s fifth bi-annual report on SURE is therefore also the final monitoring report on SURE. The Commission will continue monitoring the repayment of the loans until all outstanding loans have been repaid.
The Commission issued social bonds to finance the SURE instrument and used the proceeds to provide loans to beneficiary Member States. Borrowing under the SURE programme was instrumental for the growth of the EU into the large scale-sovereign style issuer. The report on SURE also provides the relevant reporting under the EU Social Bond Framework. Further information on these bonds, along with a full overview of the funds raised under each issuance and the beneficiary Member States, is available online here.
Compliments of the European Commission.The post Protecting jobs and workers: Final report confirms SURE was crucial in mitigating impact of pandemic and supporting recovery first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Modern Artificial Intelligence (AI) models often work as opaque decision-making engines (black boxes); reaching conclusions without much transparency or explanations on how a given result is obtained. In an era where AI has become an integral part of our lives, where recruiters, healthcare providers, and other fields, rely on this tool to make decisions impacting individuals, understanding the way AI works is essential.
Could Explainable Artificial Intelligence, or XAI, be a way forward, a potential solution? But, what is XAI, how does it work in practice? What are its benefits, but also its risks, its relationship with data protection? What impact may XAI have in the years to come?
These are some of the questions that our distinguished guest speakers and experts tackled during the EDPS’ Internet Privacy Engineering Network (IPEN) hybrid event, which I had the pleasure of chairing on 31st May.
IPEN, established almost 10 years ago by the EDPS, brings together data protection and technology experts, as well as other pertinent actors, to discuss relevant challenges of embedding data protection and privacy requirements into the development of technologies. The forum generates thought-provoking views, fascinating exchanges, which, like for many others, informs and feeds my own reflections about the narrow relationship between privacy and technology.
This IPEN event on XAI was no exception.
Why XAI?
XAI focuses on developing AI systems that can not only provide accurate predictions and decisions, like other AI systems, but can also offer explanations on how a certain decision or conclusion is reached. In other words, XAI should be able to explain what it has done, what will happen next, and what information has been used to make a decision. With this information, individuals using XAI would be able to understand the reasoning behind an automated decision, and to take the appropriate, and informed, course of action. With XAI, the dynamic changes: users would not simply rely on AI systems to make decisions for them, but would play an integral part in making, or verifying, a decision. To this end, XAI – coupled with human cognition – could play an important role in fostering trust in AI systems, as well as increasing transparency and accountability of AI systems.
XAI, accountability, transparency and data protection: how does it all add up?
How does this all work in practice? How can transparency and accountability really be achieved? It won’t be enough if explanations given by an AI system are very technical – only understandable by a handful of experts.
Effective transparency and accountability, and therefore trust in AI systems, can only really be achieved if information about the underlying behaviour of a system can be explained with truthful and sincere simplicity, and in a clear and concise manner, so that this knowledge can be passed on from the provider to the users of AI systems. Obtaining clear information about the behaviour of AI also has an impact on the ability for its users, such as data controllers and processors, to evaluate the risks that this tool may pose to individuals’ rights to data protection and privacy, to protect them and their personal data.
XAI and its risks
Is it easy to explain AI in a simple, clear and concise way? Well, not really. Making AI understandable and meaningful to everyone is challenging to achieve without compromising on the predictive accuracy of AI. Arguably, one of the risks is that explanations could become subjective, convincing rather than informative, or open to interpretation, context-dependent, some participants shared at the IPEN event. Cultural filters can also play a role. There is probably not one single way to explain what an AI system does, but there are certainly many wrong ways to do so.
Risks to individuals’ privacy and personal data should be considered seriously as well. With XAI, results produced by AI systems may reveal personal information about individuals.
Other risks, shared by our panellists, include the possibility that explanations of AI-assisted decisions may reveal commercially sensitive material about how AI models and systems work. Furthermore, AI models may be exploited by individuals if they know too much about the logic behind their decisions.
XAI needs humans
Now that we have examined some of XIA’s possibilities, its possible impact on data protection, and examples of its benefits, but also risks, how may this field progress?
To advance in the field of AI, Human-AI collaboration is important. Moreover, interdisciplinary collaboration is essential. Experts in computer science, cognitive psychology, human-computer interaction, and ethics must work together to develop robust methodologies, standards and safeguards that promotes a fair AI ecosystem, to empower individuals, giving them control over their information and respecting their privacy.
In this sense, XAI is more likely to succeed if researchers, experts and practitioners in relevant fields adopt, put into practice, and improve AI models with their unique and creative knowledge. Above all, evaluation of these models should focus on people more than on technology.
As highlighted by the European Data Protection Supervisor, Wojciech Wiewiórowski, during the Annual Privacy Forum following the IPEN event: when it comes to XAI and Artificial Intelligence in general, enforcement of appropriate rules and existing EU Regulations, such as the General Data Protection Regulation (GDPR), must be upheld. Protecting individuals’ fundamental rights must come first.
When confronted with powerful AI systems, all human beings, even the clever ones, become somehow vulnerable in relation to the power of the machine. Therefore, we must shape AI to our human. As provided in Recital 4 of the GDPR on data processing, AI should also be designed to serve humankind.
Author:

Lenoardo Cerverna Navas, Director, EUROPEAN DATA PROTECTION SUPERVISOR

Compliments of the European Commission, European Data Protection Supervisor.The post EDPS | Explainable Artificial Intelligence needs Human Intelligence first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Can EU companies be both green and globally competitive?
Tradeable allowances for carbon emissions set important price incentives for companies to become greener. Unfortunately, evidence shows that many companies move carbon intensive production to other regions, meaning their emissions leak abroad. This ECB Blog post investigates how the EU can strike a balance between green goals and competitiveness.
One of the EU’s most powerful tools to fight climate change is the Emissions Trading System (ETS). It sets a cap on greenhouse gas emissions for a number of industries and provides tradeable emissions allowances to companies. As the EU progressively reduces this cap over time, this pushes up prices for the allowances and strengthens the incentives to avoid emissions. There is both good news and bad news about the ETS. It has contributed to reducing emissions in the EU. But we also find evidence that this came at the cost of a reduced competitiveness in Europe and higher emissions elsewhere in the world. We look at the benefits and costs of the trading system and discuss how to avoid the export of carbon intensive production – what the experts call “carbon leakage”.
The ETS does curb emissions
The trading system is helping to cut greenhouse gas (GHG) emissions in the EU. Our analysis shows that its contribution totals an emissions reduction of 2-2.5 percentage points per year.[1] The system is effective in two distinct ways. First, stricter emissions regulations to make production greener reduce emissions faster. As we cannot measure this stringency directly, we use a proxy: the ratio of traded allowances to the total amount of emissions allowances used by industry. In other words, we assume that a stricter ETS regulation that forces companies to emit fewer GHGs leads to more active trading. Emissions from regulated industries fell by about 2 percentage points for each 1 percentage point increase in our proxy before 2013, and somewhat more after the ETS was reformed in that year. The price mechanism was also effective as higher stringency and higher allowance prices led to faster reductions of emissions.
Second, the ETS has a powerful steering role for companies: regulated EU industries have reduced their greenhouse gas emissions more than those industries in the EU that are not subject to the ETS (Chart 1).

Chart 1
Changes in greenhouse gas emissions – ETS-regulated industries vs non-regulated industries in the EU and in other regions
Percentages
Sources: Tonnes of CO2 equivalent greenhouse gas emissions are from the WIOD environmental account providing it for 56 industries and 43 countries plus the rest of the world for the period 2000-2016.
Notes: The blue bar is the average decline in emissions since ETS inception across all countries and sectors (-4.6 percentage points). The red bar depicts the difference in GHG emissions in ETS sectors globally relative to the average decline. The yellow bar shows the difference in emissions in ETS sectors within the EU relative to average change in emissions of ETS industries.

However, these achievements came at a cost. Contrary to earlier research showing limited empirical evidence of carbon leakages[2], we have found substantial evidence that companies shift carbon-intensive activities with heavy emissions from inside Europe to outside the EU. This runs counter to the EU’s efforts to also help reduce emissions globally. Although global emissions by all industries in all regions have declined since 2005 (blue bar), the global emissions by regulated industries rose above their level until 2005 (yellow bar), and this despite the fact that emissions in the very same industries fell markedly within the EU.
Obviously, such carbon leakages are detrimental to the fight against climate change. One way to address this problem is a carbon border adjustment mechanism (CBAM) on imports.[3] This tool is designed to find the best possible trade-off between reducing carbon emissions and keeping Europe’s producers competitive. It aims to avoid businesses transferring production from countries with strict climate policies to ones with laxer policies, and to thereby minimise carbon leakage.[4]
The current revisions to the ETS include a CBAM on imports of carbon-intensive products that are heavily traded with non-EU Member States. These include cement, iron, steel, aluminium, fertilisers and electricity. This border regime will be phased in to protect EU producers from foreign competition operating in unregulated regions. It will force importers to buy emissions allowances in proportion to the emissions embedded in their imports, at the ETS market price. This means that products will face the same carbon pricing regardless of where they come from and where the relevant greenhouse gasses were emitted. By treating all companies equally when supplying the EU market, the CBAM mitigates possible competitiveness losses.
The effects of the trading system on competition vary depending on the location (inside or outside the EU) and ownership (domestic or multinational companies).[5] We found that companies in the EU which source carbon intensive inputs from within the EU face a competitive disadvantage. This disadvantage grows as the share of carbon intensive inputs sourced within the EU increases. In contrast, those companies which manage to source these inputs from elsewhere perform better, arguably owing to cheaper inputs. This improvement is proportional to the amount of outsourced emission-intensive inputs. In other words: the more those companies source carbon-intensive inputs abroad, the more they can produce as they gain market share.[6]
EU companies which are subject to the ETS regulations produce less when they source high-carbon inputs from within the EU, but their production increases when they source them from outside the region. For multinational companies, we see a similar correlation, but the impact of the shift to outside the EU increases rapidly as the price of emissions allowances rises and has topped that of EU domestic companies at current ETS prices (Chart 2).

Chart 2
The effect of shifting purchases of high-emissions inputs from inside to outside the EU
Percentage points
Sources: OECD-AMNE and authors’ estimates.
Notes: The chart depicts the effect on companies’ production of a one percentage point shift of high carbon footprint inputs, across sourcing regions, from inside to outside the EU. For a 10 percentage point shift across regions of high carbon footprint inputs, EU companies expand production by 1 percentage point, compared to a no-shift strategy. This is based on regression analysis (for details see “Benefits and costs of the ETS in the EU, a lesson learned for the CBAM design”). The log value of sectoral production is regressed on country-sector-ownership fixed effects, emission intensity (emissions per euro worth of production), log value of inputs and the four shares of high carbon footprint inputs sourced from Domestic and MNE companies. The coefficients on these four regressors capture the elasticity of sectoral production to emission-intensive inputs depending on the regions in which they originated, e.g. from inside or outside the EU, as well as company ownership. The specification also includes the interaction of these shares with the price paid on allowances in t-1, to capture nonlinearity of the price for allowances. Finally, the specification encompasses deterministic country and industry trends and control for unobserved time heterogeneity. Matching the AMNE and WIOD databases eventually yields 34 sectors and 44 countries (including RoW) spanning the period 2000-16. Regulated (ETS) industries are Coke and refined petroleum products (C19), Basic metals (C24), Other non-metallic mineral products (C23), Electricity, gas, water, waste and remediation (DTE), and Transport and storage (H).

The effectiveness of the ETS in curbing EU greenhouse gas emissions is undeniable. But it comes at the significant cost of making EU companies less competitive, especially those that are domestically owned, as well as triggering carbon leakages. The degree to which EU production is affected depends on a company’s ownership and where it sources emission-intensive inputs. This suggests that some business models with multinational production chains may have more leeway in reorganising and sourcing “dirtier” inputs from outside the EU. The details of the CBAM must be carefully considered to make sure that the new EU environmental legislation prevents this. Based on our analysis we advise that the CBAM be extended to all regulated productions. Our evidence is a call for regulators to carefully establish the terms for the tariff equivalent charged on emissions embedded in imports and for the CBAM industry’s coverage.
Authors:

Justus Böning, PhD Candidate, KU Leuven

Virginia Di Nino, Principal Economist, Economics, Business Cycle Analysis, ECB

Till Folger, Consulatant, TWS Partners

Compliments of the European Central Bank.
Footnotes:
1. See Boning J., Di Nino v., Folger T., 2023, “Benefits and costs of the ETS in the EU, a lesson learned for the CBAM design”, ECB Working Paper No 2764.
2. See Chan, H. S. R., S. Li, and F. Zhang (2013): “Firm competitiveness and the European Union emissions trading scheme”, Energy Policy, 63, 1056-1064; Jaraite, J. and C. Di Maria (2016): “Did the EU ETS Make a Difference? An Empirical Assessment Using Lithuanian Firm-Level Data”, The Energy Journal, 37, 1-23; Koch, N. and H. Basse Mama (2016): “European climate policy and industrial relocation: Evidence from German multinational firms”; Dechezleprétre, A., Gennaioli, R. Martin, M. Muûls, and T. Stoerk (2019):”Searching for Carbon Leaks in Multinational Companies,” CGR Working Paper Series; aus dem Moore, N., P. Grosskurth, and M. Themann (2019): “Multinational corporations and the EU Emissions Trading System: The specter of asset erosion and creeping deindustrialization”, Journal of Environmental Economics and Management, 94, 1-26.
3. See the relevant press release.
4. For a definition of carbon leakage see Climate EU trading emissions “Carbon leakage refers to the situation that may occur if, for reasons of costs related to climate policies, businesses were to transfer production to other countries with laxer emission constraints. This could lead to an increase in their total emissions. The risk of carbon leakage may be higher in certain energy-intensive industries”.
5. Data on gross output by country and sector, the share of emission-intensive inputs and imports in total were obtained from the OECD AMNE database, which categorises companies according to domestic and foreign ownership (see Cadestin, De Backer, Desnoyers-James, Miroudot, Rigo and Ye (2018)).
6. See Boning J., Di Nino v., Folger T., 2023.The post ECB | Stop carbon leakage at the border first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Tighter financial conditions test resilience of households, firms, governments and property markets
Financial markets are vulnerable to disorderly adjustments, given investment fund vulnerabilities, stretched valuations, high volatility and low liquidity
Euro area banks robust to recent stress outside the euro area, but higher funding costs and lower asset quality may weigh on profitability

According to the May 2023 Financial Stability Review published today by the European Central Bank (ECB), the outlook for euro area financial stability remains fragile, in the context of recent banking stress outside the currency union.
While economic conditions have improved slightly, uncertain growth prospects paired with persistent inflation and tightening financing conditions continue to weigh on the balance sheets of firms, households and governments. Furthermore, an unexpected deterioration in economic conditions or financial tightening could lead to disorderly price adjustments in either or both financial and real estate markets.
“Price stability is crucial for durable financial stability,” said ECB Vice-President Luis de Guindos. “But as we tighten monetary policy to reduce high inflation, this can reveal vulnerabilities in the financial system. It is critical that we monitor such vulnerabilities and fully implement the banking union to keep them in check.”
Looking more closely at vulnerabilities, euro area firms face tighter financing conditions and uncertain business prospects. This could be particularly challenging for those firms that came out of the pandemic with greater debt and weaker earnings. At the same time, high inflation is hitting households – particularly those on lower incomes – by reducing their purchasing power and compromising their ability to repay loans. Demand for new loans, especially mortgages, declined sharply in the first quarter of 2023 in response to rising interest rates. While falling energy prices in recent months have reduced pressures on governments to fund additional fiscal support, public authorities nevertheless face rising funding costs.
Euro area real estate markets are undergoing a correction. In residential markets, house price increases have cooled considerably over the last few months, reducing overvaluation in the sector. While price adjustments have been orderly so far, they could turn disorderly if higher mortgage rates increasingly reduced demand. Commercial real estate markets remain in a downturn, facing tighter financing conditions and an uncertain economic outlook, as well as weaker demand following the pandemic. The ongoing correction could test the resilience of investment funds with interests in the commercial real estate sector.
Financial markets and investment funds remain vulnerable to asset price adjustments. Stretched valuations, tighter financing conditions and lower market liquidity might increase the risk of any adjustment becoming disorderly, particularly in the event of renewed recession fears. So far, investment funds have been largely unaffected by recent tensions in the US and Swiss banking sectors. This could change, however, if funds suddenly required liquidity, forcing them to sell assets quickly.
Euro area banks have also proved resilient to stresses in US and Swiss banks on account of their limited exposures. This resilience was supported by strong capital and liquidity positions resulting from regulators’ and supervisors’ efforts over recent years. It will be essential to preserve this resilience amid some concerns about banks’ ability to build up capital. For example, higher interest rates reduce lending volumes and increase banks’ funding costs, which may impair their profitability. Furthermore, there are already signs of deteriorating asset quality in loan portfolios exposed to commercial real estate, smaller firms and consumer loans. Banks may therefore need to set aside more funds to cover losses and manage their credit risks.
In this context, it is essential to complete the banking union and, in particular, to establish a common European deposit insurance scheme. Additionally, vulnerabilities in the non-bank financial sector require a comprehensive and decisive policy response in order to further increase trust in the financial system and its ability to withstand risks.
Contact:

Daniel Weber | Daniel.Weber1@ecb.europa.eu

Compliments of the European Central Bank.The post Financial stability outlook remains fragile, ECB review finds first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.