What can central banks do to mitigate the effects of climate change?
While central banks' mandates allow them to play an important role, the primary responsibility for tackling climate change lies with governments. They possess the most effective tools for facilitating the transition by incentivizing green investment, developing systems for pricing greenhouse gas emissions and introducing regulations to restrict those activities with the greatest environmental impact.
For their part, central banks can conduct analyses in support of public policies, to quantify and manage the economic risks associated with climate change and to evaluate the policies needed to fight it. In their capacity as investors, central banks serve as an example for other institutions by making investment decisions that are consistent with the decarbonization targets, and by raising savers' awareness. Under the law, central banks manage investment portfolios that, in many cases, include corporate bonds and shares. It has become clear that, in constructing portfolios, not only are financial risks to be taken into account, but ESG ones as well, including those relating to climate change. By taking this integrated view of risks, central banks can make an important contribution through their investments, since firms that are adapting their business models to nurture the transition towards a low-emissions economy have launched significant investment plans and therefore require considerable resources in the form of both debt and equity instruments. This portfolio reallocation, deriving from the inclusion of climate-related risk, serves as a strong signal to the market, since it has become clear that firms that fail to thoroughly convert their operations will gradually be removed from the investment portfolios.
In addition to investment activity, central banks can contribute in other ways as part of their institutional functions. They can: promote, including by serving as an example, the financial system's participation in the transition towards a sustainable economy; support initiatives asking for laws and regulations that incentivize firms and financial intermediaries to share reliable and comparable sustainability data; encourage the public to take sustainability profiles into account when making choices; and finally, incorporate climate-related risk considerations into all levels of their operational management (real estate, consumables, and so on.). A discussion is under way within the Eurosystem on whether to modify some monetary policy instruments, or their composition, in order to contribute to the achievement of climate-related objectives.
Does being committed to sustainable investment mean sacrificing returns?
The vast literature on the relationship between sustainability profiles and the financial performance of firms indicates that in the majority of cases, the firms most conscious of ESG profiles achieve greater returns and are less exposed to reputational and legal risks. [In other words, most of the empirical analyses and meta-studies refer to the relationship between ESG profiles and market performance; some of these analyses connect this difference in market returns to greater operational profitability]. In general, the integration of sustainability factors into investment policy does not tend to depress returns. Indeed, operating results have improved, thanks to the contribution of process and product innovation. In addition, the lower specific risk estimated for these firms reduces their risk premium [In this case, this refers to the risk premium demanded ex ante by investors, which causes an appreciation relative to these securities and therefore a lower cost of equity and a positive yield spread] and the cost of equity, bringing advantages in terms of financial performance. The Bank's direct experience over the last two years confirms the points raised in the literature: the application of ESG criteria has contributed to achieving risk-adjusted returns exceeding those of the respective benchmark indices that do not incorporate sustainability criteria, more significantly during the phases of strong turbulence recorded in the financial markets in connection with the pandemic.
What does ESG mean?
The acronym 'ESG' stands for environmental, social and governance factors, which most empirical research has found to have an influence on a firm's activity, affecting its risk profile and its profitability. The environmental (E) factors include pollutant emissions, waste production and management, environmental impact and biodiversity, and energy consumption. The social (S) factors refer to gender and inclusion policies, respect for human and labour rights all along the supply chain, fair customer treatment and of civil society in general. The third factor, governance (G), relates to corporate governance practices, including executive compensation, the independence and composition of boards of directors, the procedures for monitoring fair governance, legal compliance and ethics.
How does the Bank decide whether a firm is sustainable from an ESG standpoint?
Measuring a firm's sustainability is a very complex process since it has to take account of a variety of factors, such as the use of natural resources, pollution, workplace safety, human rights, corruption and corporate governance rules. Furthermore, the significant factors to be taken into consideration vary from sector to sector and may also change over time depending on environmental emergencies, developments affecting the company or technological advances. This is why investors, and therefore also the Bank of Italy, turn to experts who analyse a firm's level of sustainability, who offer both data on single aspects of sustainability (for example, CO2 emissions data, water consumption, percentage of staff that is female, and so on.) and its ESG score, i.e. a measurement of its level of sustainability. The Bank uses this information to construct its portfolio, focusing in particular on the quality of the data and methodologies used to calculate the score, because it is aware that the sustainability assessment industry is still gaining credibility and the lack of communication of non-financial information by firms makes it very complicated for the rating agencies to make their assessments.
What is the Bank of Italy doing to cut its own CO2 emissions?
The Bank has been committed to reducing the environmental footprint of its operational activities for over a decade, including by instituting an environmental policy in 2008. Over time, the Bank has carried out a number of initiatives on enhanced energy efficiency, the use of renewable sources, waste management optimization, sustainable mobility and the promotion of a greater environmental awareness. Since 2010, the Bank has published an annual Environmental Report that describes the various initiatives and results as measured by indicators developed based on international guidelines.
