Report - The Nature of Sovereign Bonds as Central Bank Collateral
Integrating Climate Mitigation and Biodiversity Protection Considerations into the Treatment of Sovereign Bonds in the ECB’s Collateral Framework. By Maud Abdelli, Andrew Jackson, Elise Kremer, J. Christopher Proctor, Enrique Serrano Rodríguez and Romain Svartzman
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Executive Summary
This report examines why and how considerations related to climate change mitigation and biodiversity protection (jointly referred to as “nature”) could be integrated into the treatment of sovereign bonds in the European Central Bank (ECB) collateral framework.
The collateral framework is the set of rules determining which assets commercial banks (more precisely, the credit institutions eligible as counterparties to Eurosystem monetary policy operations) can pledge to obtain central bank liquidity, and at what value, i.e. after applying haircuts. Beyond being essential to monetary policy transmission, collateral frameworks matter for the financial system and the real economy: eligibility and haircut decisions signal relative asset risks, shape market prices, and influence issuers’ borrowing costs, including those of governments. As such they affect fiscal space and create de facto interactions between monetary and fiscal policies.
Since June 2026, the ECB has taken a significant step by applying a “climate factor” to assets issued by non-financial corporations eligible as collateral. In practice, the ECB complements its existing risk control measures by applying an additional haircut to the eligible assets, based on their issuers’ exposure to climate-related transition risks and uncertainty.
This report argues that, despite being an important first step, keeping this limited scope (debt issued as non-financial corporate bonds represents less than 2% of pledged collateral) is inconsistent with sound risk management and could distort counterparties’ collateral choices. Ultimately, all assets accepted as collateral should be screened for nature-related transition risks, both to protect the central bank’s balance sheet and to ensure the effectiveness of the monetary policy transmission mechanisms.
Against this backdrop, this report proposes extending and adapting the ECB climate factor to sovereign bonds, a particularly important asset class in the collateral framework, which make up roughly 50% of eligible and 10% of pledged collateral. Doing so is further justified by the fact that financial markets largely do not price the long-term economic benefits of government action to mitigate climate change and protect biodiversity, even though these benefits are central to future price and financial stability.
Moreover, the report expands the scope of the ECB climate factor, which focuses on climate change mitigation, by incorporating considerations related to biodiversity protection. This is fundamental to developing a comprehensive understanding of nature, a term that encompasses both climate and biodiversity, in line with scientific evidence and with central bankers’ own recognition that these topics should be assessed jointly.
We identify three distinct, though sometimes overlapping, justifications for integrating nature-related considerations into the treatment of sovereign bonds in the ECB collateral framework. However, each rationale could imply a different implementation method, with divergent implications for monetary policy, financial valuations and the real economy.
1. A risk-based approach, which is the one explored quantitatively in this report, focuses on protecting the central bank’s own balance sheet from the underpriced climate- and biodiversity-related transition risks borne by each issuer (country), assessed individually. Under this approach, the central bank applies higher haircuts to assets from issuers whose activities or policies are judged to make them susceptible to nature-related transition risks.
2. A resilience-based approach focuses on safeguarding the ECB’s primary mandate of price and financial stability over a medium- to long-term horizon, given the inflationary and destabilizing potential of nature-related risks. Under this approach, the central bank could combine higher haircuts, as in the risk-based approach, with haircut reductions for countries that perform better and therefore contribute more to future price stability.
3. An alignment-based approach focuses on supporting the EU’s environmental objectives under the ECB’s secondary objective, as set out in Article 127(1) TFEU. In practice, this approach would primarily consist of applying lower haircuts, or even bonuses, to countries that adopt policies mitigating climate change and protecting biodiversity.
For the quantitative implementation, we focus on the risk-based approach described above, proceeding in three steps: First, we build on and adapt existing methodologies that assess and rank how governments perform on climate change mitigation and biodiversity protection: the ASCOR methodology for climate mitigation (ASCOR, 2026); and a composite of WWF’s Biodiversity Risk Filter (WWF, 2026), the Yale Environmental Performance Index (Yale University, 2026), and the EU Consumption Footprint dataset (Joint Research Centre, 2026). The resulting scores show significant disparities across countries and a weak correlation between climate and biodiversity scores (Figure A).
Figure A. Sovereign climate change mitigation and biodiversity protection scores
Climate change mitigation score
Biodiversity protection score
Second, we propose two formulas, partially building on the existing ECB climate factor, through which these climate and biodiversity rankings could be translated into haircuts. Finally, we apply these formulas to 2,384 government securities, issued by EU member states, which are eligible as collateral in the ECB framework.
Our results indicate that the aggregate impacts could be significant for several countries. For large EU economies (Italy, France, Germany and Spain), the additional adjustment resulting from the climate and biodiversity factors could increase the total value of the haircut applied by the ECB by a factor of two to five (Figure B). Such adjustments could amount to up to 6% of some countries’ total gross government debt, which may be particularly consequential for countries where a large share of government debt is currently eligible as ECB collateral (Figure C). For example, in the case of Italy this would represent a loss in collateral value of up to €200 billion. However, these results depend heavily on calibration choices, such as the “floor parameter” that determines the highest haircut envisaged by the ECB.
Figures B and C. Adjustments to the collateral value of eligible sovereign bonds after integrating the climate and biodiversity factors, in billions of euros and as a percentage of a country’s general government gross debt
Figure B. Adjustments in billions of euros
Figure C. Adjustments as a percentage of government gross debt
These results suggest that while the risk-based approach, the only one we tested quantitatively, through haircut increases, is the most secure and aligned with the ECB’s practices at first sight, it is also subject to significant challenges: by applying an additional haircut to sovereign bonds issued by countries with relatively poor climate mitigation and biodiversity protection rankings, the ECB could contribute to raising these countries’ borrowing costs, thereby further tightening their fiscal space and their ability to invest in the ecological transition. This would increase their vulnerability to future physical and transition risks, and therefore impair the ECB’s ability to achieve price and financial stability.
To limit these adverse effects, and in line with the resilience- and alignment-based approaches mentioned above, it could be necessary to differentiate via haircut reductions or bonuses for relatively stronger performers rather than by increases for weaker ones. This could help incentivise countries to better mitigate climate change and protect biodiversity, rather than disadvantage them for not doing so. However, such differentiation could create its own trade-off with central bank risk management and monetary policy transmission, for instance if the pool of sovereign assets with high nature-related scores is too small or consists of bonds with higher risks unrelated to climate and biodiversity.
Future work should therefore keep exploring these different approaches, from haircuts to bonuses, and their respective trade-offs, including by quantifying how each could affect monetary policy operations and transmission, debt sustainability, and each country’s ecological transition pathway. Behind the technicalities of collateral haircuts lies a much larger question: how monetary and fiscal authorities will act together, and for whom, at a time when nature-related crises put price, financial and fiscal stability at risk.
IEP Bocconi does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
