As an investor, the Bank of Italy has decided to take sustainability profiles into consideration when making its investment decisions, in line with its long-term investor profile, with an emphasis on social and environmental aspects and with the goal of better managing the financial and reputational risks that stem from sustainability factors. In doing so, central banks can set an example for the other market players by: (a) integrating ESG factors into their portfolio management strategy, as the Bank of Italy has done since 2019; and (b) publishing their own exposures and climate risk management strategies based on the TCFD recommendations, as the Bank has undertaken to do in 2022.
The benefit of taking account of sustainability profiles is backed by a vast body of economic literature that observes how:
- good business practices for firms in favour of sustainability are generally associated with better economic and financial performances;
- focusing on ESG profiles has positive effects on limiting firms' legal and reputational risks, on their operating results (thanks to process and product innovation), and on their perceived firm-specific risk.
- these factors help to reduce the risk premium and the cost of equity, bringing advantages in terms of financial performance.
Some industrial sectors are responsible for a larger volume of greenhouse gas emissions in proportion to their activities and turnover, such as the electricity, fossil fuel extraction, raw materials, automotive and transport sectors. These sectors are the most heavily exposed to shifts in public policies to limit CO2 emissions and, therefore, to transition risk. As a long-term investor with an eye to sustainability and to replicating more broadly diversified market indices, the Bank will continue to invest in these sectors as well, but with a preference for those firms that have begun the process of energy transition. Such an investment strategy, in addition to encouraging the green transformation of the economic sectors, will enable the Bank to reduce its exposure to firms with greater transition risk and, at the same time, to diversify the sectoral composition of its portfolio by including sectors that will nevertheless continue to play an important role in the economic system.
The Bank has adopted a broad vision of sustainability for its investments, which includes environmental, social and corporate governance (ESG) aspects, giving priority to firms that: a) focus on the responsible use of natural resources and their impact on ecosystems; (b) maintain adequate conditions regarding safety, health, justice, equality and inclusion; and (c) generate income and employment in compliance with ethical principles and have the best corporate governance structures.
The Bank's sustainable investment policy is inspired by:
- the principles of the United Nations Global Compact on human rights, labour standards, protecting the environment and fighting corruption;
- the United Nations' Sustainable Development Goals for the 2030 Agenda;
- the Paris Agreement on climate change, which tasks governments with keeping the average global temperature increase well below 2 degrees centigrade compared with pre-industrial levels and continuing to work on limiting the increase to 1.5 degrees centigrade.
The Bank of Italy's Responsible Investment Charter also refers to the recommendations of the Network for Greening the Financial System, in which the Bank has been an active participant since 2019, and to the common stance that has emerged in the Eurosystem for applying sustainable and responsible investment criteria to non-monetary policy portfolios.
An important aspect of the Charter is its indication of the exclusion criteria used by the Bank to determine the universe of eligible investments, from which issuing companies are excluded if they do not respect: a) the eight fundamental conventions of the International Labour Organization (ILO) that require compliance with fundamental rights, including the elimination of forced labour, freedom of association, the abolition of child labour and of discrimination in employment; b) international treaties on chemical, biological and nuclear weapons, anti-personnel mines, cluster munitions, weapons with non-detectable fragments, incendiary weapons and blinding laser weapons. It also excludes tobacco producers.
The Bank has made three commitments in its Charter:
- to promote ESG sustainability, with initiatives to encourage the disclosure of information on sustainability by issuers, banks and other financial system operators;
- to integrate ESG principles into the management of its investments and of financial risks and to promote the spread of sustainable investment and risk management best practices throughout the financial system;
- to publish information and analyses on sustainable finance; to communicate the results achieved in terms of sustainability on a regular basis; and to contribute to spreading the culture of sustainable finance within the financial system and among the public.
Steps taken and results
Since 2019, the Bank has been integrating sustainability criteria into its investment policy with a twofold purpose: 1) to improve the management of the associated financial risks and 2) to highlight its commitment to encouraging sustainable growth, with a focus on social and environmental factors, and, in this way, to promote corporate social responsibility.
The sustainable investment policy was initially applied to the equities portfolio, whose carbon footprint has improved considerably: at the end of 2020, the portfolio's average carbon intensity (i.e. the ratio of greenhouse gas emissions to turnover), decreased by 30 per cent compared with the end of 2018 (the year prior to the introduction of the new investment criteria) and the energy intensity of firms fell by 40 per cent. The equity portfolio at the end of 2020 was basically responsible for:
- a 1.1 million tonne reduction in greenhouse gas emissions (equivalent to the annual emissions of around 210,000 people);
- a drop in electricity consumption of 13.6 million gigajoules, corresponding to the annual consumption of about 158,000 households.
In 2020, the sustainable investment policy was gradually extended to the management of other financial instruments: to equity investment funds in the United States and Japanese markets, replaced with funds that replicate ESG indices; to corporate bond portfolios, denominated in euros and US dollars, also managed so as to mimic indices that integrate sustainability criteria; and, finally, to the purchase of green bonds issued by international institutions. The Bank has also purchased green bonds issued to fund projects with environmental sustainability features, in connection with the management of its foreign exchange reserves.
Disclosures on and transparency of sustainable investments
Environmental sustainability disclosures are crucial for redirecting the resources needed for the transition towards a low-emission economy. For this purpose, in addition to indicators referring to CO2 emissions, absolute and relative, such as those already described, the Bank frequently looks at the ESG score, which is a combined assessment of the environmental, social and corporate governance aspects of firms, States, international organizations and collective investment instruments (mutual funds and ETFs).
These assessments examine the environmental and climate profiles in terms of exposure, the firm's capability in managing such risks and the potential opportunities for investments and innovations for tackling the energy transition. The scores are calculated by specialized companies that have developed their own assessment methodologies and ancillary services.
The importance of ESG scores in making climate-related analyses is due to the fact that they are widely used in the sustainable finance field to choose financial instruments, build investment portfolios, create market indices and for reporting purposes. The limitations of these instruments, specifically the variations in methodologies and the completeness and quality of the data employed, should be borne in mind when using them.