A Consultative Group on Risk Management (CGRM) at the Bank for International Settlements (BIS) published a report that examines incorporation of climate risks into the international reserve management framework.
Aiming to contribute to the ongoing discussion on incorporating sustainability considerations in international reserve management frameworks, CGRM, at its August 2021 meeting, set up a task force on ”incorporating climate-related risks into international reserve frameworks.” The participants of the task force included representatives from the central banks of Brazil, Canada, Chile, Colombia, Mexico, Peru, and the United States as well as from the BIS. The report begins by discussing the findings of a survey on the task force members, some of which are incorporating climate risk considerations in the management of their international reserve portfolios. It then discusses the inclusion of climate risks into international reserve management processes, in line with the central banks’ mandates and with the three pillars of investment—safety, liquidity, and profitability. Next, the report discusses the methodological challenges for climate-related reserve management, along with the data challenges and the climate risk disclosure aspects, before moving on to outline its key findings.
The survey finds that most central bank taskforce members plan to consider climate-related risks affecting their international reserve portfolios and that central banks’ mandates, liquidity concerns, and lack of data are leading reasons for low or no climate-related investment in international reserve portfolios. The survey findings also suggest that the key metrics the central banks use, or plan to use, to monitor climate-related risks in their portfolios are scores from ESG service providers, ratings from credit rating agencies, certain carbon emission metrics, and stress test. The report identifies the below-mentioned key methodological challenges:
- Significant uncertainties in modeling climate factors (physical and transition risks) and mapping these factors to portfolio risk and return characteristics.
- The relative short horizons usually considered for mean-variance optimization approaches pose a challenge to adequately capturing tail risks from extreme climate events (large impact and low frequency).
- Scenario analysis and stress testing may be useful tools for reserve managers, but they are data-intensive, require a wide range of assumptions, and are complex to implement.
The main data challenges include a lack of consistency among distinct environmental, social, and governance (ESG) scores by different providers and challenges in constructing other relevant climate-risk metrics. Data gaps exist across risk factors, regions, and industries. For instance, gaps are observed in Scope 3 emissions data and in the granularity of geographical and issuer-specific data. Moreover, in terms of disclosures, concerns about comparability and standardization coexist with flexible formats of disclosure. By disclosing their climate-related risks, some central banks are already contributing to the development of best practices and the harmonization of approaches. The report notes that incorporation of climate risks into reserve management is still in its early stages. As a next step, the task force recommends continued collaboration between central banks to advance practices for climate-related reserve management. Going forward, central banks will contribute to the global discussions on how to assess and manage climate-related risks, accelerate the development of methodological standards, and improve transparency on climate-related risk management practices.
Keywords: International, Banking, ESG, Climate Change Risk, Disclosures, Credit Ratings, Physical Risk, Transition Risk, Scenario Analysis, Stress Testing, BIS
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