A Sustainable And Responsible Investment Guide For Central .

1.  IntroductionThe urgency to act on climate change is growing. Accordingto the IPCC report 2018, temperatures are likely to increase1.5 C above pre-industrial levels between 2030 and 2052 ifemissions continue at the current rate. In order to be ableto address the risks posed to natural and human systems,associated with a temperature rise of 1.5 C or beyond, arapid and far-reaching transition is required. This transitiondemands significant upscaling of investments in options thathelp to reduce carbon emissions in all sectors (IPCC, 2018).The Network for Greening the Financial System (NGFS)aims to contribute to the development of environment andclimate risk management in the financial sector, as well asto mobilise mainstream finance to support the transitiontowards a sustainable economy (NGFS, 2018). In its firstcomprehensive report A Call for Action, the NGFS provided sixnon-binding recommendations for central banks, supervisors,policymakers and financial institutions to enhance their rolein the greening of the financial system and the managing ofenvironment and climate-related risks. In recommendation2, the NGFS encourages central banks to lead by example intheir own operations: without prejudice to their mandatesand status, this includes integrating sustainability factorsin the management of some of the portfolios at hand (ownfunds, pension funds and reserves to the extent possible).This document serves as a guide for central banks wishing toadopt Sustainable and Responsible Investment (SRI) principlesin one or more of their portfolios.The scope and limitations of SRI objectives and strategies arediscussed throughout this guide. Central banks’ investmentpractices are (to a large extent) dictated by their respectivelegal mandates. As such, this guide does not provide aone‑size‑fits all solution, but rather discusses potential SRIapproaches for central banks. Throughout this document, SRIis used as an umbrella term comprising multiple strategiesand investment practices. These range from specific focuseson sustainability risks to creating a positive impact, and fromclimate‑specific to broader ESG approaches. It is up to eachcentral bank to define the appropriate objectives and scopefor SRI, in line with the mandate of its own specific portfolios.This guide builds on the results of an SRI portfolio managementsurvey – the first of its kind – among NGFS members. Thesurvey shows that most central banks have already adopted(or are considering to adopt) SRI criteria for one or more oftheir portfolios. The increasing prevalence of SRI in centralbanks’ portfolio management mirrors the growing globalcommitments to address climate change and environmentalissues. Case studies of first-hand experiences by NGFSmembers that have already incorporated SRI principles in theirportfolio management can help build critical momentumand lower barriers for other central banks to follow suit.This guide provides an overview of the portfolios typicallymanaged by central banks (chapter 2) and describes the keymotivations for the adoption of SRI principles (chapter 3).Chapter 4 describes five possible SRI strategies, whilechapters 5 and 6 highlight the need for SRI monitoringand reporting. The document concludes with first‑handexperiences by NGFS members in the form of case studiesof seven selected members that have already incorporatedSRI in their portfolio management (chapter 7).2.  Central bankportfoliosCentral banks typically hold different portfolios with variousgoals, depending on their respective mandates. This guidedistinguishes four types: (i) policy portfolios, (ii) ownportfolios, (iii) pension portfolios, and (iv) third‑partyportfolios. This chapter summarises the characteristics ofcentral bank holdings and portfolio characteristics.2.1  Policy portfoliosPolicy portfolios are at the heart of central banks’ mandates,and constitute by far the largest pool of assets on the balancesheet.1 As central banks have distinct legal mandates,the definition of policy portfolios in this guide is broad.It can include portfolios for foreign exchange intervention,the execution of an asset purchase programme or othermonetary policy goals. Notwithstanding the differentfunctions, the holdings within the policy portfolios mustmeet strict policy objectives, which typically requireinvestments to meet high standards in terms of liquidityand credit quality. Consequently, these portfolios mostly1  The survey shows that policy portfolios on average account for over 80% of total assets under management. Note that this number is derived fromportfolios for which SRI is under consideration or already implemented.NGFS REPORT7

consist of supranational and high‑grade sovereign debt,and may be subject to overriding principles such as marketneutrality. Still, some central banks manage their policyportfolios in a different manner, which could provide someroom for SRI principles. The extent to which SRI is applicablein the end depends on its compatibility with the respectivepolicy objective of the portfolio. Box 1 shows the currentstate of SRI adoption for the four portfolio types.2.2  Own portfoliosMany central banks manage own portfolios. These portfoliostypically have the objective of generating returns within acertain risk tolerance level. The asset mix of these portfoliosis more diverse compared to the policy portfolios, withholdings often including equities, corporate bonds andsometimes private debt.2 Some central banks invest theseholdings in a market‑neutral manner to limit the impact onthe constitution of the broader market. Adoption of SRI isrelatively straightforward for central banks’ own portfolios,as long as it does not interfere with the primary objective.2.3  Pension portfoliosPension portfolios serve as a long‑term savings account forretirement and have a longer investment horizon. While theasset allocation is largely determined by the nature of theunderlying pension liabilities, central banks’ pension funds aregenerally invested in more diverse asset classes and geographiclocations compared to the own portfolios and policy portfolios.The holdings are also subject to a fiduciary duty. As such, theremay be room to adopt SRI as long as this is in line with thefiduciary duty (this is further discussed in chapter 3).2.4  Third‑party portfoliosMany central banks manage portfolios on behalf of a third party.Examples include the local government’s foreign reserves, orthe ECB’s foreign reserves which are managed by nationalcentral banks within the Eurosystem. The objectives and assetallocation of these portfolios vary, as they are determinedby the third party. The extent to which SRI can be adoptedin these portfolios thus depends on the client’s demands.Box 1SRI in central banks’ portfoliosThe NGFS survey covers 27 central banks. In total 25 manageone or more portfolios for which SRI is already included orunder consideration. Of these 25, all have adopted, or areconsidering adopting, SRI principles in their own portfolios.For the policy portfolios, pension portfolios and third‑partyportfolios, the survey results are more balanced, as roughlyhalf of the respondents indicate that they have adopted, orare considering adopting, SRI principles in these portfolios.These relatively high shares reflect the broad definition of“the incorporation of SRI principles”, which covers varyingstrategies and may be applied only to specific parts (assetclasses) of central banks’ portfolios (see chapter 4). Moreover,as outlined in paragraph 2.1, policy portfolios can servedifferent functions across central banks. Most centralbanks that apply a form of SRI to their policy portfolio,indicate this refers to their foreign exchange portfolio.C1  SRI in central banks’ s5072030604050Under consideration60708090100NoSource: NGFS SRI portfolio management survey 2019.Note: 27 respondents. In total, the surveyed central banks manage68 portfolios: 24 policy portfolios, 12 pension portfolios, 15 third‑partyportfolios, and 17 own portfolios. Note that there are 17 own portfoliosmanaged by 15 central banks (two respondents have 2 separate ownportfolios). The survey only included pension portfolios that are part ofcentral banks’ balance sheets. This means central banks’ pension portfoliosmanaged by an independent entity are not represented.2  Over the last few years, central banks have broadened their assets under management, holding around USD 800 billion in equities (6% of total) andUSD 1 trillion in return‑enhancing bonds (9% of total) (OMFIF, 2019).NGFS REPORT8

T1  Characteristics of typical central bank portfoliosPolicy portfoliosOwn portfoliosDictatedbyPolicy goal – determinedby central bank mandate.MainTo support, implementobjective and maintain confidencein monetary policy andcurrency management.Character Assets meet high standardsin terms of liquidity andcredit quality in order tobe able to absorb shocksin times of crisis or whenaccess to borrowing iscurtailed. Can be subject tomarket neutrality.AssetLimited. Mostly (sub-)classessovereigns, supranationalsand agency (SSA) and somecorporate/covered bondsand equity.Duration From short to mediumterm. From 3-6 years formajority. Less than 2 yearsfor one-thirdof respondents.Financial return goal – e.g.to help cover operatingexpenses.To generate returns withinset risk tolerance levels.Secondary objectivecan be to gather marketintelligence.Subject to risk-returnconsiderations. Morefreedom in investmentdecisions, but interferencewith monetary policy orcurrency managementshould be prevented.Pension portfoliosFiduciary duty – managedon behalf of beneficiaries.To provide for theretirement pensionobligations of the centralbank’s employees.Long term investmenthorizon in line withthe pension liabilities.Short-term volatility is lessof a concern.Third-party portfoliosThird-party mandate –managed on behalf of anexternal party.Set by a third party. Varies,e.g. financial return,short-term liquidityprovision or foreignexchange intervention.Depends on main objectiveof funds. Cases wherecentral bank managesforeign exchangereserves on behalf of thegovernment.Diverse. Mix between SSA,corporate/covered bondsand equity, and potentiallyprivate debt.Diverse. Mix between SSA,corporate/covered bonds,equity, and private debt.Diverse. Mainly SSA,followed by corporate/covered bonds, and equity.Short term. Less than 2years for majority.Longer term. More than 6years for two-thirds of therespondents.Balanced. Varies fromshort term (0-2 years),medium term (3-6 years)and longer term ( 6 years).ConclusionPolicy portfolios constitute the largest pool of assets managedby central banks and mainly consist of supranational andhigh‑grade sovereign debt. These holdings are subject toa policy mandate. Some central banks also manage ownportfolios, which typically provide room to adopt an SRIobjective alongside the objective to generate financialreturns. The remainder of central bank holdings is in pensionportfolios or third‑party portfolios, which are driven bybeneficiaries’ and clients’ demands. The characteristicsof the different portfolio types are summarised inTable 1.3 In general, the specific portfolio objectives andcharacteristics determ

Central bank portfolios 7 2.1 Policy poroliostf 7 2.2 Own poroliostf 8 2.3 Pension poroliostf 8 2.4 Third-pary t poroliostf 8 3. SRI objectives and scope 9 3.1 Financial SRI objectives 10 3.2 Extra-financial SRI objectives 11 4. Strategies 12 4.1 Negative screening 12 4.2 Best-in-class 13 4.3 ESG inegt ationr 14 4.4 mpacI t investing 15 4.5 Voting and engagement 18 5. Monitoring 19 5.1 .