Resumo

Environmental physical and transition risks are resulting in a range of financial risks. Environmental Risk Analysis (ERA) is still incipient in the financial investment sphere, especially among Central Banks (CBs). Notwithstanding their regulatory, supervisory and other relevant functions, CBs are among the largest global investors, managing International Reserves totaling trillions of dollars. The theoretical and practical gaps in this subject were reinforced in the first comprehensive report of the newly created group of CBs, the Network for Green Financial System (NGFS).

Through literature review and analysis of specialized reports from praxis, this study addressed how to consider environmental risks in the Strategic Asset Allocation (SAA) of the International Reserves (IRs) managed by Central Banks (CBs). For that, it was also proposed a multicriteria analytical model for the evaluation of the environmental risk exposure of an investment portfolio, compatible with the investor profile of the CBs.

Figure 4- Framework from Theory and Praxis. 1)Scenarios analysis: Caldecott, Tilbury and Carey (2014); CISL (2015); TCFD (2017) and Scott, Huizen and Jung (2017); 2)Environmental risk factors: IPCC (2013 and 2014); Moody´s (2016); Scott, Huizen and Jung (2017) and Bank of England, UNEP and CISL (2017); 3) Environmental risk tools in each impact dimension of the financial portfolio: CISL (2015); GFSG (2016); Dietz, Bowen, Dixon and Grandwell et al (2016); Moody´s (2016); Bank of England, UNEP and CISL (2017) and Benedetti et al (2019). Source: prepared by the authors.

First, the authors analyzed the historical evolution of the environmental sustainability and green finance areas to select the appropriate studies for review. This analysis allowed for the identification of the main global initiatives to be considered, whose reports were studied and included in this research. Additionally, the literature review included the publications of the 22 universities that are members of the Global Research Alliance for Sustainable Finance and Investment. Finally, additional research was conducted in Scopus using specific keywords, as “foreign currency reserves”.

The environmental risks to which the investment portfolios of central banks are exposed (section 2) need to be assessed and quantified to enable their management (section 3). For this purpose, a multicriteria analytical model for the evaluation of these environmental risks was developed. The model, which is compatible with the investor profile of the CBs, is outlined in Figure 8, and its output is an input to the Strategic Asset Allocation Model, outlined in Figure 9, and to the Strategic Green Asset Allocation Model, outlined in figure 10.

The main argument is that ERA should be included in the traditional approach for SAA in CBs. Therefore, each viable portfolio should also be evaluated based on an ERA. This ERA should consider scenarios of environment risks along probabilities and potential impacts. The risk and return relationships of the portfolios in each scenario should be evaluated based on the factors discussed in this paper. In addition to traditional IR objectives, like hedging liabilities and evaluating countercyclicality to market movement, the CBSs should also take environment risk into account.

Andreeva, N, Voysey, A. (2016). ‘Environmental risk analysis by financial institutions: a review of global practice.’ Cambridge, UK: Cambridge Institute for Sustainability Leadership. Bank of England, UNEP Enquiry and CISL- University of Cambridge Institute for Sustainability Leadership (2017) ‘Enhancing environmental risk assessment in financial decision-making.’ Background paper for the G20 Green Finance Study Group. CISL (2015). Unhedgeable Risk: How climate change sentiment impacts investment. Climate Bonds Initiative (2018). Bonds and Climate Change: the state of the Market in 2018.