Antipodean central banks diverge on BIS green-bond fund commitment

The Bank for International Settlements (BIS)’s newly-established green-bond fund aims to help central banks incorporate environmental sustainability objectives in the management of their reserves. Antipodean central banks are increasingly sounding alarm on the risks posed by climate change, but so far only the Reserve Bank of New Zealand (RBNZ) has invested in the fund.

The BIS launched its green-bond fund on 16 September as part of the its wider commitment to supporting sustainability in finance and investing practices, in line with the bank’s participation in the Network for Greening the Financial System (NGFS). The fund, which pools BIS client assets, aims to promote green finance through large-scale climate-friendly investments, strengthen the principles and standards of the green-bond market and safeguard against greenwashing.

The fund is open-ended, denominated in US dollars and restricted to investments in green assets with a rating of A-minus or higher. It is managed inhouse by BIS Asset Management. Investments must align with either International Capital Market Association’s Green Bond Principles or Climate Bonds Initiative’s Climate Bond Standard as minimum criteria.

Peter Zöllner, head of the BIS banking department, said when the fund was launched: “We are confident that, by aggregating the investment power of central banks, we can influence the behaviour of market participants and have some impact on how green investment standards develop.”

Antipodean response

The RBNZ has committed US$100 million to the fund as part of its climate-change strategy. RBNZ governor, Adrian Orr, said in a statement on 27 September: “The green bond investment pool was developed with the objective of promoting investments in green finance, aligning well with the Reserve Bank’s own climate change strategy launched last year.”

The RBNZ’s investment is funded from its foreign-reserves portfolio, which is designed to invest in assets which can be liquidated at short notice to support central-bank functions including monetary policy.

The Reserve Bank of Australia (RBA) has not signalled any intention to invest in the BIS green-bond fund. However, the central bank has been increasingly vocal – along with Australian Prudential Regulation Authority and Australian Securities and Investments Commission – on the risks that climate change poses to the wider economy and financial system.

In the RBA’s October financial stability report, it says: “Financial regulators have a role to play in ensuring that climate risks are effectively managed by financial institutions. This includes setting expectations that financial institutions will identify, manage and disclose their exposure to climate risks.”

KangaNews understands that the RBA’s relatively lean balance sheet precludes it from investment in anything other than very low-risk and high-liquidity assets. As of September 2019, the RBA had A$55.5 billion (US$37.5 billion) equivalent of foreign reserves compared with total assets of A$182.5 billion.

At 31 August 2019, the RBNZ had NZ$22.6 billion (US$14.3 billion) equivalent of foreign-currency assets compared with total assets of NZ$27.6 billion.

Risk management and liquidity

In a podcast accompanying a BIS press release on 26 September, BIS’s asset-management specialist, Omar Zulaica, says in a survey conducted by BIS a majority of central banks indicated there is room to include sustainability as a risk-management objective. Moreover, around 75 per cent of the respondents suggested that investing in green bonds would be the preferred vehicle for introducing sustainability to central-bank risk management.

FX reserve managers face more constraints on their investments than a typical investor, though. Zulaica says: “The primary concern is liquidity as they need to be able to produce currency in a time of need. They also need to maintain value over the lifetime of the portfolio. Balancing these presents a trade-off and introducing sustainability to this brings more trade-offs for liquidity, safety and return.”

According to a study published by BIS, Green Bonds: The Reserve Management Perspective, the safety and return typically provided by green bonds is sufficient for investment from reserve portfolios. However, despite growth in recent years, primary and secondary liquidity still poses constraints. The total amount of green bonds outstanding in US dollars and euros is just 6.5 per cent of global FX reserves, the report states.

The scale of BIS’s green-bond fund should go some way to eliminating liquidity concerns, with central banks able to increase or decrease fund allocations rather than taking smaller direct investments in green bonds.

In the BIS podcast, BIS’s senior relationship manager, Ulrike Elsenhuber, says the BIS green-bond fund offers convenience and a starting point for central banks to access the green-bond market while still addressing the liquidity, safety and return criteria of central-bank investments.