Towards green balance sheets for central banks
In 2020, the Bank of England (BoE) became the first central bank to disclose climate risks associated with its monetary portfolio. In a report, the UKThe central bank has taken stock of its climate-related financial risks in all of its operations, including how it manages them.
There is now no doubt among central bankers that understanding how specific economic and financial activities relate to climate change is crucial to “greening” the global economy.
Talk to central bank Last year, Sarah Breeden – the executive director of the BoE who heads its climate change activities – said the central bank’s report showed it was meeting the same high standards as the companies it regulates. It was “a necessary step for transparency as a public body that has made climate change a priority,” she said. Unfortunately, the BoE’s disclosures revealed that its portfolio of corporate bond purchases was associated with an estimated average global temperature rise of 3.5 ° Celsius, far from the targets of the Paris Agreement on the climate change to keep the global temperature increase below 2 ° C.
In response to the Covid-19 pandemic, the BoE increased its bond buying program: by November 2020, the program had grown to £ 875 billion ($ 1.2 trillion) in government bonds and an additional £ 20 billion in non-financial investment. quality corporate bonds.
None of UKThe government debt of the is currently rated green, which makes it very difficult for the central bank to green the sovereign bonds in its portfolio. Breeden, appearing before parliament at the end of 2020, said that if the UK the government issued green bonds, the BoE would buy some. The UK The government has since indicated that it will launch a green bond issue.
The lack of a green bond market is just one of the problems central banks face when considering greening their balance sheets, according to a panel of market participants and central bank officials who are expressed during a round table organized within the framework of central bank‘s Summer Meetings, organized jointly with Invesco.
“The world demands investments in assets whose proceeds do not contribute to the deterioration of the planet. As a result, there is currently more demand than supply, which means these assets are effectively trading at a premium, ”one participant explained.
“This prompts treasuries and debt bureaus to issue green bonds, but then it prompts external asset managers to differentiate whether it is greenwashing.”
Not easy to be green
Central banks have two ways to green their balance sheets: through international reserve portfolios or through monetary operations portfolios for those who have embarked on quantitative easing.
But, as many central banks have started pushing lenders to finance green projects, they have become more reluctant to buy the debt themselves, in part because of liquidity issues and unclear guidelines on what makes a green bond.
“Without a definition of what counts as green, there is a risk of greenwashing and lack of additionality,” the Reserve Bank of New Zealand said (RBNZ) said in a report in March 2021. Around the world, many central banks have partnered with public entities to create bespoke national taxonomies in an attempt to rectify this problem.
Thailand’s central bank has partnered with the country’s Securities and Exchange Commission and Ministry of Finance to create an environmental taxonomy of financial assets tailored to the country’s needs.
Similarly, in Singapore and Malaysia, regulators are assessing the potential of a green taxonomy specific to local financial institutions. “We need to find a way to bridge the language and information gaps between scientists, government and financiers,” said Fraziali Ismail, deputy governor of Bank Negara Malaysia. “What the science is saying about climate effects, which climate action the government is prioritizing, what industries are providing and investing are pretty incongruous at this point.”
Jacqueline Loh, Deputy Governor of the Monetary Authority of Singapore (MAS), said the central bank was working with the local financial sector to determine whether a taxonomy would help more effectively channel capital to support Asia’s green transition needs.
Taxonomies developed by policymakers in Europe and China are more widely used in the international financial sector. However, there is evidence that banks apply these taxonomies very differently to their holdings.
A study carried out by the European Banking Authority (TSA) in May 2021 found that banks use a wide variety of methods to estimate the greenness of their assets. The estimates of several banks were much higher than those of TSA, indicating that banks’ own approaches tend to overestimate the greenness of exposure.
Overall, the TSA estimates a “green asset ratio” of 7.9%. This means that, out of all the assets covered by the EU taxonomy, only around 8% comply with the definition of green assets.
Arguably the best example of a collaborative approach has been the joint initiative undertaken by the Climate-Related Financial Disclosures Working Group, which provided a set of guidelines on how to disclose related financial risks and opportunities. to the climate. This, in theory, will allow financial markets to value them correctly.
For central banks, the safest way to invest in green is to buy government-issued bonds. Like the BoE, Peru’s Central Reserve Bank has said it will look to buy green bonds that the country’s government is preparing to issue for the first time.
But problems remain. “There may be a conflict between political goals and climate goals, especially when it comes to monetary policy. How should central banks reconcile these two objectives? thought a panelist from the round table.
Historically, monetary policy has been guided by the principle of market neutrality – central banks buy part of the market portfolio of available corporate and bank bonds in addition to government bonds. However, capital-intensive companies also tend to emit more carbon.
According to a report by weBased on the climate research group Oil Change International, 12 of the world’s major central banks are “insufficiently” aligning their operations with the goals of the Paris Agreement.
The People’s Bank of China continues to direct significant financial flows towards coal, the we The Federal Reserve has “worked to maintain and increase funding for fossil fuels” and the European Central Bank (BCE) continues to support fossil fuel financing “despite some positive rhetoric,” according to the report.
Meanwhile, there is evidence that the Bank of Canada has taken no action to restrict fossil fuel financing, and the Bank of Japan’s monetary policy and financial supervision “strongly support fossil fuel financing.”
About half of the world’s central banks have secondary objectives that typically require them to support the broader economic policies of governments. Climate change is likely to be an integral part of the majority of government programs, and central banks will therefore have a duty to play their part.
In Europe, the BCEThe European Union’s mandate states: “Without prejudice to the objective of price stability, the European System of Central Banks supports the general economic policies of the Union with a view to contributing to the achievement of the objectives of the Union.
Since January 2021, the BCE has accepted certain obligations related to sustainable development as collateral and as part of its asset purchase programs. Likewise, in 2021, the UK the government has explicitly included climate change in its guidelines and referral letters to BoE policy committees.
So far, only a handful of central banks have taken the step towards greening their balance sheets – France and Hungary, for example, have created funds for green investments.
One of the main issues is the size of the current green and sustainable bond markets. “In terms of international reserves, we are limited to only holding fixed income instruments,” a reserve manager from the Americas told a roundtable. Currently, green and sustainable bonds represent only a fraction of the larger fixed income market.
Many green bonds are issued by governments or government agencies, making them more difficult for central banks to buy at a good price. In Finland, the central bank cannot invest in green bonds on the primary market if they are issued by another member of the Eurosystem; instead, the central bank has to wait for the bonds to enter the secondary market, at which point everything is valued.
Green bonds also tend to be issued with too long durations for central banks. The Bank of Finland, for example, generally aims to maintain a term of less than two years. “It is not yet clear whether green bonds are green and the market is still small,” concluded a panelist at the roundtable. “There are probably only $ 500 billion in green bonds, or less, that would even meet the central bank’s criteria, and they tend to have very long durations.”
To get around some of these problems, a central banker in the Americas said his team was studying the possibility of holding green bonds through “special funds offered by multinationals – especially the Bank for International Settlements. [BIS]”.
In September 2019, the BIS launched a USD-a open-ended fund denominated for central bank investments in green bonds in response to growing demand from official institutions for climate-friendly investments. Fund pools BIS client assets to promote green finance through climate-friendly investments.
Eligible bonds have a minimum rating of A- and comply with the Green Bond Principles of the International Capital Market Association and / or the Standard and certification system for climate obligations, published by the Climate Bonds Initiative. In January 2021, the BIS launched a second fund, this time denominated in euros. Together, the two funds will manage $ 2 billion in green bonds for central banks.
Investing in this type of fund “makes our life easier because we don’t have to do the selection or validation on the national side,” said the reserve manager of the Americas.
These types of efforts seem to have the desired effect. A survey conducted by the Network for the Greening of the Financial System (NGFS) in 2019 revealed that almost all of the 27 respondents said they have already adopted principles of sustainable and responsible investment in the management of their portfolios or are planning to do so.