“Institutional investors and asset managers globally have been integrating ESG objectives into investment management since the issuance of the UN Principles for Responsible Investment (UNPRI) in 2006,” said Zainab Kufaishi, Head of Middle East and Africa, Invesco. “From a financial perspective, we have seen that incorporating ESG considerations has the potential to improve risk-adjusted returns by identifying medium-to-long-term exposures that could impact a company’s fortunes.” The One Planet Sovereign Wealth Fund Coalition, of which the Abu Dhabi Investment Authority, Kuwait Investment Authority and Saudi Arabia Public Investment Fund are founding members, has assisted SWFs looking to integrate policy and ESG factors into the investment management process since 2017.
Central banks’ investment activities are gradually following suit. In the Invesco 2020 study of global sovereign asset managers, about a quarter of the central banks surveyed responded that central bank balance sheets should be used to mitigate climate change. The central challenge of climate risk and potential disruption to domestic commerce, international trade, and global financial markets as the result of rising global temperatures has been a factor considered by central bankers and reserve managers. As much as monetary policy is becoming increasingly concerned with the growth and financial stability risks posed by ESG challenges, central bank practices are still evolving.
Central banks have moved more slowly as they face some distinct challenges while seeking to incorporate ESG factors, depending on reserve management objectives, policy framework or asset class composition. Central banks that hold foreign currency reserves to mitigate the impact of economic shocks will have less leeway due to liquidity and capital preservation requirements, whereas other central banks may have more degrees of freedom. “The principles and practice of reserve management are evolving as reserve managers have been working to overlay ESG objectives onto traditional investment objectives of capital preservation, liquidity and return,” said Arnab Das, Global Market Strategist at Invesco EMEA. “Incorporating ESG considerations into investment criteria can play an important part in the prudent protection of a country and economy from potential ravages of climate change, loss of bio-diversity and other natural resources that form the wealth of nations.”
Central bank strategies to incorporate ESG criteria have fallen into three categories – exclusionary screening, investment integration and impact investing. Exclusionary screening is the most widely used because of its simplicity to screen and exclude sectors or companies from the investment universe based on ethical, moral, or scientific beliefs. Investment integration seeks to incorporate ESG considerations to improve risk/adjusted returns as well as societal benefits. Impact investing places policy outcomes alongside financial outcomes.