Resumo

Environmental factors are resulting in a range of financial risks, with implications to investments. As well known, risks need to be identified, measured, and managed. The Environmental Risk Management (ERM) is a challenge to investors, including Central Banks (CBs) when acting as managers of the International Reserves (IRs). IRs are investments held by CBs in foreign currencies to execute the monetary and foreign exchange (FX) policies, totaling US$13.978 trillion in 2019. In emerging markets, IRs provide two important and widely accepted functions for CBs: self-insurance and and warning.

In this context and in the search for contributions to this knowledge gap, this is an applied framework study with Latin America (LatAm) CBs towards the ERM of the IRs. The research question was: which are the relevant environmental risk exposures of LatAm IRs, managed by CBs, taking into consideration the risk of sudden stops in capital flows, based on the respective national exports, and the economic objectives of the IRs? Also, how this ERM could be performed through Strategic Asset Allocation (SAA) of the IRs?

Environmental factors include climatic, geologic and ecosystem dimensions. The climatic one implies in physical and transition climate risks. Climate risks lead to financial risks through micro and macroeconomic transmission channels. Those impacts are sources of different types of financial risks, including credit, market, underwriting, operational and liquidity risks (NFDS, 2020). The environmental physical risks and associated transition risks may increase market volatility and sector instability, driving potential financial losses (Roncoronia et al, 2021).

The methodology included literature and desk review, data analysis for ten LatAm CBs, questionnaire and meetings with discussions with selected CBs. The research findings confirmed the economical relevance of commodities for the analyzed countries and the related exposures to environmental risks.

Among the deliverables of this study, the specific LatAm environmental risk exposures are discussed, as well as the alternatives to ERM through strategic asset allocation (SAA) of the IRs. The framework herein discussed includes environmental risk analysis (ERA) in the traditional SAA approach of IRs. In turn, IRs investments can become more resilient to environmental and climate risk exposure.

For IRs management, each viable portfolio should also be evaluated based on an environment risk analysis. A hedge strategy to ERA-related asset price movements is applicable, considering also other traditional SAA relevant data, as IR economic objectives, investment guidelines and investment pillars. An alternative to some CBs of the LatAm sample could be to migrate to assets less correlated with commodities and currencies, as example of relevant scenario to be mitigated.

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