Pollution Permits And Financing Costs – Analysis


Effective environmental policy should consider the behaviour of financiers of polluting firms. In 2013 the EU Emissions Trading System implemented a reform, which translated to higher compliance costs for producers. This column discusses that, in contrast with possible program intentions, loan spreads fell on average by 25% starting in 2013, and this dynamic partly undermined the expected reduction in CO2 emissions. It identifies a key role of permits storage in driving the fall in loan spreads for affected firms.

By Fabio Antoniou, Manthos Delis, Steven Ongena and Christos Tsoumas* 

According to the World Wide Fund for Nature (WWF 2020), the momentum around climate change is now positive. Polluting firms must be disincentivised directly for releasing CO2 emissions, so that social costs of carbon are reflected into prices. A policy instrument widely implemented is cap-and-trade (ICAP 2020). Interestingly, a recent debate calls for higher indirect costs through increased loan or bond spreads by banks and other financial institutions to the polluting firms and sectors. Most of the anecdotal evidence suggests that, at least until recently, this has not been the case, with the banking sector continuing to finance heavily polluting activities (e.g. RAN 2020, Financial Times 2020, Guardian 2019).

The most well-known fully operational cap-and-trade system is the EU Emissions Trading System (EU ETS), launched in 2005. In 2013, along with the initiation of phase III, there have been important structural changes in the scheme. In particular, emission permits (allowances) were offered at a decreasing rate of 1.74% per year and participating firms were granted a lower proportion of allowances for free, while the rest had to be purchased from the market or via auctioning with few exemptions (European Commission 2015). This reform aimed to increase the cost of carbon for the polluters so that they decrease their carbon footprint. Given that the scheme and the regulatory framework became tighter, implying higher costs for the polluting firms, we expect that the corresponding financial terms reflected in the loan spreads must have internalised this risk after 2013.

However, anecdotal evidence of loan spreads around phase III of the EU ETS shows a different picture. Figure 1 plots regression lines for loan spreads of syndicated loans (DealScan) amongst the treated group (firms participating in the EU ETS) and control group (nonparticipating firms), before and after the initiation of phase III in 2013. The figure shows parallel trends in the loan spreads between the treated and control groups before the program. This is consistent with the flexibility of the syndicated loan market, as lending terms of a loan facility can be easily readjusted. The rising trends in both lines up to 2013 are mainly due to the higher financing costs induced by the global crisis and the European debt crisis. From 2013 onward, loan spreads fell for the treated firms, while remaining approximately at their 2012 level for the nontreated firms. 

Our recent study (Antoniou et al. 2020) illustrates that a firm has an incentive to act proactively to deal with potential tighter future regulation. To this end, treated firms may store permits, or hold any offsets with a similar role, to facilitate future regulatory compliance. Then, when the treatment materialises, stored permits lower the demand for costly allowances and therefore reduce the cost of compliance. This, in turn, lowers the risk that the lender faces, inducing a lower loan spread in the second period. In addition, a collective outcome is obtained once we aggregate individual decisions. The oversupply of permits in the post-treatment period reduces the permits price, which also drives down compliance costs. Risk is lower and the loan spread falls.

Figure 1 Loan spread for the treatment and control groups

We empirically examine these theoretical propositions, using a novel hand-matched dataset that brings together data on syndicated loans to European firms (DealScan), firm-year characteristics (Compustat), pollution permits to specific firms (EU ETS), and the Carbon Emission Allowances-EUA price (EEX market). Our identification strategy examines the behaviour of loan spreads before and after the implementation of phase III of the EU ETS scheme in 2013 for treated firms (those participating in the program) and nontreated firms (those that do not participate). Phase III of the EU ETS program is the most important for lenders because it introduced costly permits for most polluters (until then the lion share of permits was freely allocated to specific firms). 

We find that loan spreads fall by 25% on average starting in 2013, which is equivalent to a reduction by 25.4 basis points. To provide a perspective for the reduction in the total loan cost, the 25.4 basis points correspond to a reduction in interest expenditures by €5.56 million for the loan with an average size and maturity. Notably, we also collect data on corporate bond yields (from SDC Platinum) and show that bond spreads also decreased for the treated firms from 2013 onward. Thus, bond markets also align their incentives with banks, yielding an overall picture of more competitive financing costs for polluting firms after phase III of the EU ETS policy. 

We next identify the key reasons for the reduction in loan 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 the period 2013-2017 (Figure 2). Further, the decline in loan spreads is much smaller for treated firms that are net buyers of permits in the current or the previous year, showing that these firms have not stored enough allowances and thus are more exposed to the enactment of the program. Indeed, anecdotal evidence in Figure 3 suggests that many firms were proactive in being net buyers of permits in the period just prior to phase III of EU ETS.

Figure 2 EUA price over the sample period 

Figure 3 Number of allowances over the sample period

Our analysis, placing financing costs at the heart of the effect of environmental policy, has real implications for the polluting activities of firms. By identifying lower financing costs of polluting firms after the implementation of phase III of the EU ETS program, we essentially show that any increased costs from that program might have been compensated by decreasing financing costs for the treated firms. We document a significant negative association between loan spreads and the treated firms’ verified CO2 emissions, which together with our main findings suggests that the declining CO2 emissions (e.g. Bayer and Aklin 2020) would have in fact been even lower if financing costs did not decline. Our estimates show that there would have been a further 7.9% decline in CO2 emissions if there was no decrease in loan spreads.

Our findings uncover a strategic role for commitment, through permits storage or equivalent actions, so that future interest rates are distorted downwards. Without disputing the proclaimed advantages of permits storage, such as cost smoothing over time, the strategic incentive presented here can be detrimental in terms of pollution. Our results can also provide an empirical corroboration for stability reserves in permit markets, such as the EU ETS market stability reserve introduced in 2019 (see ICAP 2020) where the regulator might withdraw permits in case of excessive surplus of allowances. Our rationale relies on the fact that when there is a surplus of allowances, along with the permits price reduction, this also reduces the loan spread which, in turn, leads to even higher emissions. Permits withdrawal deters the banks from relaxing their interest rates. Therefore, the exact level of the boundaries is instrumental for financing costs and firms’ associated response to emissions or their investments in general. 

*About the authors:

  • Fabio Antoniou, Assistant Professor, Economics Department, Athens University of Economics and Business
  • Manthos Delis, Professor of Financial Economics, Montpellier Business School
  • Steven Ongena, Professor in Banking, University of Zurich, the Swiss Finance Institute and KU Leuven; Research Fellow, CEPR
  • Christos Tsoumas, Assistant Professor in Financial Management, Hellenic Open University


Antoniou, F, M D 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 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 Handbook.

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

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

ICAP (2020), Emissions Trading Worldwide: Status Report 2020, Berlin: International Carbon Action Partnership.

RAN (2020), Banking on Climate Change – Fossil Fuel Finance Report 2020

WWF (2020),2020: A Critical Year for our Future and the Planet.


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