Acting Governor Marja Nykänen, Bank of Finland
Speech at the Finnish Finance Nature Summit in Helsinki,
20 November 2023
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It is a great pleasure for me to be here today to talk about green and sustainable central banking. Even though the main responsibility of tackling climate change does not lie at central banks’ door, it is deeply related to central bank mandates.
We are recognized for our monetary policy work, but as this slide shows, we also do much, much more.
Sustainability is an integral part of our core activities. Many organisations make this same claim of course, so I would like to highlight here, using clear, concrete examples, how sustainability really is visible within the Bank of Finland’s activities. Just imagine, for a moment, a society where:
- prices fluctuate uncontrolled;
- you can’t trust or even access the banking sector or payment systems;
- decision-making systems are not based on facts and robust research; and
- the level of financially literacy is very low.
At the Bank of Finland, we work on a daily basis to make sure these scenarios never occur. Our skilled experts provide facts and data, participate actively in dialogue and in research, promote financial literacy and make sure payment systems are secure and fully functioning − to name just a few areas of our work.
From the range of our activities, I would like to focus on the three which are the most impactful at the moment, one from each of the columns on this slide:
- providing facts and research data, from the middle column headed ‘Influential Information and Cooperation’;
- maintaining price stability, in other words monetary policy work, from the first column headed ‘Sustainable Growth and Wellbeing’; and
- investing responsibly, from the third column headed ‘Management of Climate Risks’.
Providing data, policy analysis and research is one of the core tasks at the Bank of Finland. Robust, up-to-date and trustworthy data and research is needed to support decision-making both at the national and international level. Here, I have added a few examples of articles and blog posts that we have published over the past couple of years specifically on climate change or biodiversity. As you can see, some of these are in Finnish, but many are in English, and we are well aware that there is an increasing demand for this kind of information in English. Another key take-away from this slide, in addition to the wealth of different headlines, is the number of authors mentioned. It is not just one or two people but many experts from different departments across the Bank’s operations that have contributed to our climate work – including many not mentioned here.
I would like to specifically highlight two recently published studies on Finnish banks and transition risks. Both are shown on this slide in English. The first, in the top left corner, is on assessing transition risks in banks’ corporate loan portfolios. This showed that a high proportion of these loans is already being channeled to corporate groups producing energy from renewable energy sources or zero carbon emission sources, i.e. wind, hydroelectric or nuclear power. However, going forward, the net zero transition will need considerable further investment, and so − based on future investment needs − we expect a significant increase in the demand for bank loans and other financing.
The second study, in the top right corner, looked at transition risks using the PACTA tool to assess risk levels. For those who are perhaps not too familiar with PACTA, it is the acronym for Paris Agreement Capital Transition Assessment, a freely available web-based tool to help measure an investment portfolio’s alignment using different climate scenarios which are consistent with the Paris Agreement. At the Bank of Finland, we have used this tool both in research and analysis, but also for scenario analysis on our own investment portfolios.
According to our banking analysis published in July this year, the share of renewable energy financing is relatively high in corporate loans granted by Finnish monetary financial institutions, MFIs. In their loan portfolios, the share of renewable power production is higher than the relative share of these energy sources in the EU.
Using forward-looking scenario analysis we have concluded that the transition risk of Finnish MFIs is limited. Based on data projections to 2025, the share of renewable energy in the corporate loan stock should increase to reach a sustainable level. Finnish banks are relatively close to the targets with regard to energy production financing, so the transition risk appears to be moderate. This finding was based on scenario analysis of Finnish banks’ loan portfolios.
In addition to our own publications, our experts actively participate in international working groups within the Eurosystem but also globally, for example within the Network for Greening the Financial System, the NGFS, a climate network of central banks and financial supervisors.
As this slide shows, our internal research topics vary from assessing banks’ risks related to the green transition, and to floods or other hazards, to identifying climate risks within our own investments using international standards. I would like to highlight here that we also contribute to external working groups on topics such as developing recommendations to central banks on climate change, risk management, disclosure and data development. In addition, our experts are involved in academic research, actively participating in dialogue and providing facts and information. These are all items mentioned in the previous slide. Additionally, we should not forget the collaborative work done on monetary policy development, which is my next point.
In the middle of the last decade, the inflation environment was quite different from what we have seen since last year. At that time, monetary policy rates had practically reached their effective lower bound and the Governing Council of the European Central Bank (ECB) initiated public and private sector asset purchases to address the risks of an overly prolonged period of low inflation. Furthermore, asset purchases also played a crucial role in countering the substantial risks to monetary policy transmission caused by the COVID-19 outbreak.
Asset purchase programmes are now part of the Eurosystem’s set of instruments for steering monetary policy, even though purchase volumes have come down significantly due to changes in the inflation outlook.
Following the ECB’s strategy review in 2021, the Governing Council has expressed a strong commitment to incorporating climate change considerations into the Eurosystem’s monetary policy framework. The first concrete steps towards this in regard to the asset purchase programmes were taken last year when the Eurosystem introduced a specific company-level climate score to tilt corporate bond purchases towards issuers with a better climate performance.
As illustrated in the figure on the right, the climate score is based on three sub-scores, namely the company’s emission metrics, decarbonisation targets and climate disclosures.
The overall volume of corporate bond purchases is determined solely by monetary policy considerations. However, by tilting purchases on the basis of climate considerations, the Eurosystem also aims to gradually decarbonise its corporate bond holdings on a path aligned with the Paris Agreement.
In addition to this, climate risks are also being taken into account in the monetary policy collateral framework, for example by limiting the share of high carbon footprint assets that can be pledged as collateral by banks when borrowing from the Eurosystem.
All in all, without prejudice to the primary objective of maintaining price stability, the Eurosystem is committed to incorporating climate change into monetary policy implementation as broadly as possible.
Let’s move on to the third impact activity, our own investments.
The Bank of Finland has approximately €13 billion in assets as part of our reserve management and own long-term investments. There are many reasons why these investments have been made, and these include crisis management, the pension fund and the need for assets to cover liabilities (such as banknotes). The investments are divided between gold, fixed income and equity investments, and a small amount of real estate, too. The fixed income investments are very heavily skewed towards government debt instruments and those of government related entities. This also poses a challenge when it comes to our own climate target setting. We are one of the first central banks, and possibly even the first, to have set a broad long-term net zero climate target for its overall investment portfolio, excluding gold. Gold is excluded as there are no international carbon accounting standards yet for this asset class.
Our aim is to reach carbon neutrality by 2050 at the latest. We are confident that in equities and corporate bonds, and in real estate asset classes, we will be able to reach net zero before 2050, but the real issue is the sovereign part of our portfolio, as the vast majority of countries have made pledges to 2050 and not earlier.
We have been publishing our Responsible Investment Principles for a couple of years now and have maintained an annual update cycle. In addition to our net zero commitment and intermediate asset class specific targets, which include strict thresholds on fossil fuel companies for example, the Responsible Investment Principles define what we mean by responsible investment and set out our chosen responsible investment approaches, how we are organized and what commitments we have made.
We are one of the first central banks to have signed the UN- supported Principles for Responsible Investment, the PRI. Through this public commitment we are showcasing that we mean what we say and we say what we mean. We are committed to integrating environment, social and governance considerations, ESG, into our investment decisions, and we report on our activities and also on our outcomes in a transparent fashion. Please visit our website to look at our report on climate related risks. This is also in English, so there’s no need to learn Finnish just for this.
This next slide visualizes the most important responsible investment approaches we have selected for our own investment activities. As I mentioned a moment ago, ESG integration is one of the most important approaches. We firmly believe that portfolio managers have the best knowledge on individual issuers, and as material ESG factors have financial relevance, it is important that portfolio managers integrate this data throughout the entire investment process. Secondly, we make green, social and sustainable investments taking into account market conditions, acceptable greenium, or green premium, levels and limitations on what we are able to purchase. Finally, our minimum requirement for our direct holdings is that issuers adhere to international norms and our climate targets. Issuers unable to do so are excluded from our investment universe and benchmark indices. However, as the green transition is so vital and financing is needed to enable this transition, we have allowed ourselves an exception to our climate target rules. If an issuer that we would normally exclude based on their climate performance is looking for funding through a green bond or an equivalent investment product and we are confident that the bond’s ‘use-of-proceeds’ will be directed to the green transition, we are able to invest in it. This exemption does not apply to issuers who, in addition to breaching the climate targets, also breach human rights requirements or other norm-based screening requirements.
In my next slide I would like to introduce our intermediate climate targets. These are set by asset class, as different asset classes have different characteristics. The aim of these targets is to show our commitment to the long-term target. We are not just sitting on our laurels doing nothing and waiting for 2049 to come, and then completely overhauling our portfolio to show that we reached the net zero target by outsourcing emissions and everything else too. These intermediate targets function as a series of waypoints, as the road map reaching the long-term target. We are currently approximately half way to our first set of intermediate targets, as these take us up to the end of 2025.
For the government and government-related entities sections of our portfolio we have qualitative targets for the time being. We have, for example, started holding issuer meetings to encourage government-related entities to set climate targets for their own investment portfolios. We noticed as we were drafting our first Responsible Investment Annual Report that despite this specific portfolio being aligned with a 1.5˚C degree temperature rise scenario, these scenarios only account for scope 1 and 2 emissions and leave out value chain emissions, including emissions from investment portfolios. This metric thus shows only part of the story. Looking at it from another perspective, from climate target setting perspective, these issuers have set only small climate targets or none at all. The opposite is true for our equity portfolio, where the majority have set ambitious or other science-based targets. But again, when looking at it from another perspective, we can see, that the emissions released imply a significant temperature rise, a rise well above a 2 ˚C degree scenario. For the equity portfolio, we have, for example, a quantitative target of reducing our weighted average carbon intensity by 50% from the Q1 2021 baseline. In the Bank of Finland’s 2022 annual report, we reported that the reduction was already 29%.
In our direct corporate holdings, we put our fossil fuel thresholds into effect during 2022, meaning that we no longer directly invest in companies that breach these thresholds on coal, oil and gas production, including unconventional methods such as Arctic and deepwater drilling.
We require our external fund managers to either set an ambitious climate target at the fund management company level or that the product to be invested in needs to have a clear and measurable positive climate impact, such as an investment in a green bond fund.
We are not the principal actors, however. That responsibility lies with governments, elected officials and legislators. But in addition to our primary mandate of maintaining price stability, we can and must support an orderly green transition, because climate change affects price stability and our own investments.
Many central banks – including the Bank of Finland − have (significant) research departments that are able to provide good quality data to support decision-making at various levels in society.
Central banks are not organisations detached from the rest of the society but have their own distinctive yet impactful role to play.
Thank you for your attention.