Central banks lag other global public investors in integrating ESG into portfolios

ESG

Central banks are lagging other major institutional and public sector investors with their integration of environmental, social, and governance (ESG) criteria, according to a new survey by BNY Mellon and OMFIF.

The survey shows that only 10 per cent of central banks currently incorporate it fully across their portfolios, while half of the 50 central banks surveyed did not implement ESG measures at all.

Other global public investors (GPI) like public pension plans and sovereign wealth funds have been much faster on the uptake. In comparison, 93 per cent of pension funds and half of sovereign funds apply ESG criteria across their whole portfolio.

BNY Mellon and OMFIF note in the report ‘Sustainable Investment’ that the relatively weak uptake of ESG criteria for managing investments among central banks compared with their GPI peers is “in contrast to their activities as supervisors, where several institutions have taken steps or are planning to introduce regulatory measures such as climate stress tests”. 

One central bank respondent from Latin America was quoted in the report as saying: “When investing in an institution, the central bank focuses on the creditworthiness, the credit rating and the yield on investment offered by the institution. ESG is not among those key criteria.” 

This contrasts with the report’s finding that among the public investors that had implemented ESG investing, the main motivation was that they expected superior risk-adjusted returns from sustainable investments. Most agreed that non-sustainable investments are at risk of becoming ‘stranded’ or losing value over time, especially in the case of a climate-related disaster. 

Respondents that had integrated ESG factors were split between those that have seen a positive financial impact from ESG integration and those who claim it is ‘too early to tell’, meanwhile none saw no impact.

Another reason that central banks cited for not applying ESG criteria was the lack of clarity over ESG factors. A central bank from Europe was quoted as saying: “The lack of standard definitions and ESG criteria as well as applied automated algorithms reduce efficiency of external ESG ratings and indices. But we may consider their implementation when the solutions will be further developed and tested.” 

Concerns were also raised over the ability of ratings agencies to adequately capture the actual sustainability performance and risks to a company, after high-profile incidents like the unexpected bankruptcy of California-based utility provider PG&E due to potential negligence from wildfire risks. 

“The shortcomings of uncritical ratings are likely to become even more apparent as systemic risks, such as long-term climate change and pandemic-related shocks, expose hidden company-level risks,” reads the report.

In all, 51 per cent of global public investors cited insufficient data as a barrier to ESG adoption or further integration within their organisation.

“Accessing and analysing complex data from multiple sources continues to be a barrier to investors in further integrating their ESG strategies. Technology is the solution – with technologies being developed that enable investors to measure the non-financial performance of investments and help perform investment manager due diligence and inform conversations with stakeholders,” says Frances Barney, head of Global Risk Solutions at BNY Mellon Asset Services.

Among those that do integrate ESG, one of the most commonly used strategies was negative screening, used by 28 per cent of central banks, 58 per cent of sovereign funds and 81 per cent of pension funds. Tobacco, arms, and coal were the sectors most frequently excluded. 

Among sustainable assets, 76 per cent of global public investors said green bonds were their preferred asset class. 45 per cent anticipate moderate to significant increases in allocation to green bonds over the next 12-24 months.

“Our survey suggests that strong interest from global public investors in green bonds will continue, highlighting the need to solve current bottlenecks in the market. The solution is most likely to come via advanced technology-based ecosystems to deal with information asymmetry and trust issues, thereby helping investors and issuers make informed ‘green’ investment choices, and efficiently raise capital for credible green projects,” adds Barney.