Pollutant permits and financing costs


An effective environmental policy should take into account the behavior of the financiers of environmentally harmful companies. In 2013, the EU emissions trading system implemented a reform that resulted in higher compliance costs for manufacturers. This column discusses that, in contrast to possible program intentions, credit spreads have fallen by an average of 25% from 2013 onwards and that this dynamic has partially undermined the expected CO reduction2 Emissions. It identifies a key role for certificate retention in promoting the decline in credit spreads for affected companies.

According to the World Wide Fund for Nature (WWF 2020), the dynamics around climate change are now positive. Polluting companies must be deterred directly from releasing carbon emissions in order for the social costs of carbon to be reflected in prices. A widely used political instrument is cap-and-trade (ICAP 2020). Interestingly, a recent debate calls for higher indirect costs through increased credit or bond spreads from banks and other financial institutions for polluting companies and sectors. Most anecdotal evidence suggests that it has not, at least until recently, as the banking sector continues to fund highly polluting activities (e.g., RAN 2020, Financial Times 2020, Guardian 2019).

The best known fully functional cap-and-trade system is the EU Emissions Trading System (EU ETS) introduced in 2005. In 2013, in addition to the start of Phase III, there were important structural changes in the system. In particular, emission certificates (certificates) were offered with a decreasing quota of 1.74% per year and the participating companies were allocated a lower percentage of certificates free of charge, while the rest with a few exceptions (European Commission 2015). This reform aimed to increase the cost of carbon for polluters in order to reduce their carbon footprint. With the tightening of regulations and the regulatory framework leading to higher costs for polluting companies, we believe that the corresponding financial conditions reflected in credit spreads must have internalized this risk after 2013.

Anecdotal evidence of credit spreads around phase III of the EU ETS paints a different picture, however. Figure 1 shows regression lines for the credit spreads of syndicated loans (DealScan) between the treated group (companies participating in the EU ETS) and the control group (non-participating companies) before and after the start of phase III in 2013. The figure shows parallel trends in the credit spreads between the treated and the pre-program control group. This is in line with the flexibility of the syndicated loan market as the loan terms of a loan facility can be easily adjusted. The upward trend in both sectors up to 2013 is mainly due to the higher financing costs caused by the global crisis and the European debt crisis. From 2013 onwards, credit spreads for the treated companies fell, while for the untreated companies they remained roughly at the 2012 level.

Our most recent study (Antoniou et al. 2020) shows that a company has an incentive to act proactively in order to deal with possibly stricter future regulation. For this purpose, treated firms can hold permits or hold offsets with a similar role to facilitate future regulatory compliance. Then, when treatment comes about, stored permits lower the demand for costly certificates and therefore reduce the cost of compliance. This in turn reduces the risk to which the lender is exposed and results in a narrower credit spread in the second period. In addition, a collective result is obtained when we aggregate individual decisions. The oversupply of permits in the post-treatment period reduces the permit price, which also lowers compliance costs. The risk is lower and the credit spread decreases.

illustration 1 Credit spread for the treatment and control group

We investigate these theoretical theses empirically using a new kind of hand-matched data set that brings together data on syndicated loans to European companies (DealScan), annual company characteristics (Compustat), pollution permits for certain companies (EU ETS) and CO2 emissions, certificates EUA price (EEX market) ). Our identification strategy examines the behavior of credit spreads before and after the implementation of phase III of the EU ETS system in 2013 for treated companies (those participating in the program) and untreated companies (those that do not participate). Phase III of the EU ETS program is the most important for lenders as costly permits have been introduced for most polluters (until then, the lion’s share of permits were freely given to specific companies).

We find that credit spreads have fallen by an average of 25% from 2013 onwards, which is a reduction of 25.4 basis points. To provide a perspective for reducing the total cost of the loan, the 25.4 basis points correspond to a reduction in interest expenses of € 5.56 million for the loan of average size and duration. In particular, we also collect data on the returns on corporate bonds (from SDC Platinum) and show that the bond spreads also fell for the companies covered from 2013 onwards. Hence, the bond markets are also targeting their incentives at the banks, which gives an overall picture of more competitive financing costs for polluting companies after phase III of the EU ETS policy.

Next, we identify the main reasons for the reduction in credit spreads due to the EU ETS policy. We find that the effect is most negative when the EUA price is particularly low, which is the case in 2013-2017 (Figure 2). In addition, the decline in credit spreads for treated companies that are net buyers of permits in the current or in the previous year is much smaller, which shows that these companies do not have enough allowances in stock and are therefore more affected by the implementation of the program. Indeed, anecdotal evidence in Figure 3 suggests that many companies were proactive as net buyers of permits in the period just before Phase III of the EU ETS.

Figure 2 EUA price in the sample period

Figure 3 Number of certificates in the sample period

Our analysis, which puts financing costs at the center of the impact of environmental policy, has real effects on the environmentally harmful activities of companies. By identifying lower financing costs for environmentally harmful companies after the implementation of Phase III of the EU ETS program, we essentially show that any increased costs of this program could have been offset by decreasing financing costs for the treated companies. We document a significantly negative correlation between credit spreads and the verified CO2 emissions of the companies treated, which, together with our key results, suggests that the declining CO2 emissions (e.g. Bayer and Aklin 2020) would actually have been even lower if the Financing costs would not have decreased. Our estimates show that without a reduction in credit spreads, carbon emissions would have decreased by a further 7.9%.

Our results reveal a strategic role for exposure, through retention of permits or equivalent measures, so that future interest rates are skewed downward. Without questioning the proclaimed benefits of storing permits, such as cost smoothing over time, the strategic incentive presented here can be detrimental in terms of pollution. Our results can also provide empirical confirmation for stability reserves on certificate markets, such as Our justification is based on the fact that an excess of allowances, together with the price reduction of the allowances, also reduces the credit spread, which in turn leads to even higher emissions. The withdrawal of permits prevents banks from easing their interest rates. Therefore, the exact level of the limits is critical to the financing of the costs and the related response of companies to emissions or their investments in general.


Antoniou, F, MD Delis, S. Ongena and C. Tsoumas (2020), “Pollution Permits and Financing Costs”, CEPR Discussion Paper 15517.

Bayer, P and M Aklin (2020), “The European Union’s emissions trading system reduced CO2 emissions despite low prices”, Proceedings of the National Academy of Sciences of the United States of America 117: 8804-8812.

European Commission (2015), EU ETS manual.

Financial Times (2020), “European Banks Accused of Helping Coal Polluters,” July 14.

The guard (2019), “Banks warned of Saudi Aramco by environmental groups,” October 17.

ICAP (2020), Emissions trading worldwide: Status report 2020, Berlin: International Carbon Action Partnership.

RAN (2020), Banking on Climate Change – Fossil Fuels Financial Report 2020.

WWF (2020), 2020: a critical year for our future and the planet.


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