Network for Greening the Financial SystemTechnical documentA sustainable andresponsible investment guidefor central banks’ portfoliomanagementOctober 2019
NGFSTechnical documentOCTOBER 2019This report has been coordinated by the NGFS Secretariat/Banque de France.For more details, go to www.ngfs.netand to the NGFS Twitter account @NGFS , or contact the NGFS t
Joint foreword by Frank Elderson and Dr. Sabine MaudererCFrank EldersonDr. Sabine MaudererChair of the NGFSChair of the workstream “Scaling up green finance”limate change is having significant effects on our economies, on our communities and on our lives. In 2018, nearly 900 naturaldisasters were recorded, leading to overall losses of around USD 180 billion. Only 45% of these losses were insured.The majority of losses were covered by private households, enterprises or public authorities.1It is quite evident that for all parties climate change is a source of financial risk that is becoming more urgent since the frequencyand severity of catastrophic events shows a growing trend. To address these challenges, international concerted efforts andcollective leadership are required. That’s exactly what we at the Network for Greening the Financial System (NGFS) are tryingto achieve.We believe that the financial community must play a key role in tackling climate change. In April 2019, the NGFS called forcollective action to address climate-related risks in the financial system, publishing a set of recommendations aimed at centralbanks, supervisors, policymakers and financial institutions.One of the recommendations is that NGFS members would lead by example. As a first step, we conducted a comprehensiveportfolio-management survey among our members on how they integrate sustainability factors. The results are presented inthis guide – the first of its kind. They are encouraging: many NGFS members already incorporate sustainability in their portfoliomanagement while others are reviewing their operations.The present guide targets all central banks, NGFS members as well as non-members. It offers valuable insight into Sustainableand Responsible Investment (SRI), presenting potential SRI approaches and ways to implement them. We are confident thatour guide will inspire others to follow suit and integrate SRI into their own operations.But we won’t stop here, as we will continue to do what we can to generate the necessary change towards a low-emissions future.Finally, we would like to thank all NGFS members who contributed to this report as well as the NGFS Secretariat for theirtireless efforts to make this guide possible. We need the support of each and every one of you to tackle this great challenge tohumankind: climate change.1 Cf. Munich Re NatCatSERVICE.NGFS REPORT2
ContentsExecutive summary5Origin of the NGFS61.Introduction72.Central bank portfolios72.1 Policy portfolios72.2 Own portfolios82.3 Pension portfolios82.4 Third-party portfolios8SRI objectives and scope188.8.131.52.3.1 Financial SRI objectives103.2 Extra-financial SRI objectives11Strategies124.1 Negative screening124.2 Best-in-class134.3 ESG integration144.4 Impact investing154.5 Voting and engagement18Monitoring195.1 Monitoring process195.2 Monitoring metrics19Reporting216.1 The case for central banks’ disclosures216.2 TCFD reporting by central banks21NGFS REPORT3
7.Implementation case studies237.1 Responsible investment at Norges Bank237.2 ESG integration at the Banca d’Italia247.3 Impact investing at the Banque de France257.4 Green bond investments at the Magyar Nemzeti Bank267.5 Exercising voting rights at the Swiss National Bank277.6 External manager selection at De Nederlandsche Bank287.7 SRI at the Banco de México29Bibliography31Acknowledgments34Annex 1: Risk-return characteristics of SRI35Annex 2: ESG data considerations36Annex 3: ESG and credit ratings37Annex 4: Examples of climate-related metrics38Glossary39NGFS REPORT4
Executive summaryThe members of the Network for Greening the FinancialSystem (NGFS) acknowledge climate change as a sourceof financial risk. The NGFS encourages central banks andsupervisors across the globe to lead by example and includesustainability considerations in their portfolio management,without prejudice to their primary mandates.This NGFS guide – the first of its kind – outlines ahands‑on approach aimed at central banks wishingto adopt SRI in their portfolio management. It does notoffer a one‑size‑fits‑all solution, but discusses potential SRIapproaches and ways to implement them, allowing centralbanks to accommodate their own specific challenges.The NGFS believes that the adoption of Sustainableand Responsible Investment (SRI)1 practices by centralbanks is important and can help to demonstrate thisapproach to other investors and mitigate material ESGrisks as well as reputational risks. As public institutions,central banks are subject to public scrutiny if they fail toaddress stakeholders’ concerns related to climate change.This is especially true if a central bank calls upon the financialsector to take account of climate‑related risks, but fails toappropriately address these risks in its own operations.There is a growing commitment to SRI strategies amongcentral banks. A unique SRI portfolio managementsurvey among NGFS members shows that 25 out of the27 respondents have already adopted SRI principles intheir investment approaches, or are planning to do so.These principles range from broad environmental, social,and governance (ESG) considerations (60% of the surveyrespondents) to climate‑specific focuses (16%).Central banks manage a large number of assets indifferent portfolios. However, they are not comparable toother institutional investors as their investment practicesare (to a large extent) dictated by the respective policyobjectives. Consequently, central banks face specificchallenges in the pursuit of SRI:1) Sticking to the legal policy mandate. The vast majorityof holdings are dictated by a policy objective. It is up toeach central bank to determine whether an SRI objectivecould be adopted without prejudice to its mandate.2) Investing responsibly while preserving liquidity.Central banks’ balance sheets largely consist ofsupranational and high‑grade sovereign debt with shortduration. The adoption of SRI is less straightforward forthese asset classes.3) Safeguarding independence and preventing conflictsof interest. Since central banks act as independentagents, any conflicts of interest arising from theirinvestment practices should be prevented.4) Striking a balance between transparency andconfidentiality. Transparency is key to any SRI approach.Nevertheless, central banks may not be able to discloseeverything about all of their investment practices as thiscould undermine the primary policy objective.Central banks may choose to adopt SRI to mitigatesustainability risks in their portfolio, or to create apositive impact on the environment and societyalongside financial returns. These objectives can betranslated into different SRI strategies. Among the five SRIstrategies identified in this guide, the most prominent aregreen bond investments and negative screening for equityand corporate bond holdings.This guide concludes with case studies of first‑handexperiences by NGFS members that already incorporateSRI principles in their portfolio management. While workis still needed with regard to critical elements relating tothe availability of data, to transparency, disclosure anda global taxonomy, progress is being made around theworld. These case studies are intended to help build criticalmomentum and lower barriers for other central banks tofollow suit, thereby speeding up the transition to a moresustainable economy.1 SRI comprises a broad range of sustainable investment strategies,including environmental, social and governance (ESG) criteria.NGFS REPORT5
Origin of the NGFS2017established a Networkof Central Banks and Supervisorsfor Greening the Financial System.TSUcentral banksand supervisorsETDECEMBERNONEPLAM M ISince then, the NGFS has grown to46Members9Observersrepresenting 5 continents.The NGFSis a coalitionof the willingIt is a voluntary, consensus-based forumwhose purpose is to share best practices,contribute to the development of climate–and environment– related riskmanagement in the financial sectorand mobilise mainstream financeto support the transition towarda sustainable economy.The NGFS issuesrecommendationswhich are not bindingbut are aimed at inspiringall central banks and supervisorsand relevant stakeholdersto take the necessarymeasures to fostera greener financial system.NGFS REPORT6
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 .
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