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July 27, 2022

Surge in sovereign wealth funds and central banks adopting ESG policies

Rob Langston

Invesco’s Global Sovereign Asset Management Study finds a major leap in sovereign wealth funds and central banks adopting ESG policies in the past five years.

There has been a significant rise in the proportion of sovereign wealth funds that have a formal environment, social and governance policy in place, according to Invesco. Three quarters of SWFs now incorporate ESG considerations into their activities, including investment strategy, up from 47 per cent in 2017,  according to Invesco’s latest Global Sovereign Asset Management study.

The adoption of such policies by central banks over the same period has also risen. Though a smaller proportion of central banks, at 47 per cent, now have formal ESG policies, this is a substantial increase from 11 per cent in 2017. This lower figure also reflects that some countries are yet to adopt policies in areas such as climate change.

The uptick in adoption has been driven by increasing stakeholder demands in this area, according to Rod Ringrow, head of official institutions at Invesco. He says ESG has gone from a peripheral issue for SWFs five years ago to one that is “front and centre” thanks to increased awareness among stakeholders.

“Sovereign wealth funds are continuing to work with the asset management community to seek investment opportunities that help them meet their ESG goals,” says Ringrow. “Climate change has been at the forefront for a number of sovereign wealth funds, and obviously a number of funds have got hydrocarbons as a source of revenue, so they [are trying] to work out how to implement an ESG policy that’s compatible with the source of revenue and meeting the requirements of stakeholders.”

The European Central Bank has been one of the leading institutions to engage with the subject. Irene Heemskerk, head of the ECB’s climate change centre, said climate change is a highly important matter for the EU economy and financial system.

“The transition to a greener economy, as well as the physical impact of climate change, can affect our primary objective of maintaining price stability,” she said.

“Besides that, climate change creates financial risks, which matter for both our own risk management and for the risk management of the banks we supervise. Therefore, as part of our ECB-wide climate agenda, we are taking action to reduce the carbon footprint of our balance sheet and we are pushing banks to better manage climate and environmental risks.”

Challenges for SWFs

Victoria Barbary, director of strategy & communications at the International Forum of Sovereign Wealth Funds, said awareness of ESG among SWFs had been building for several years and had increased during the Covid-19 pandemic. However, she said: “Sovereign wealth funds find dedicating resources towards ESG integration challenging, especially those at the beginning of the integration process, because they often have limited internal capacity and expertise to repurpose to ESG. They also struggle with finding reliable data to measure their progress and the financial materiality of ESG risks.”

Barbary added: “Some sovereign wealth funds have impact targets, particularly those with an investment mandate to promote domestic economic development and diversification. The UN Sustainable Development Goals are also becoming a common frame of reference for sovereign wealth funds, suggesting that they are keeping an eye on impact, even if they don’t explicitly have an impact mandate.”

Carine Smith Ihenacho, chief governance and compliance officer at Norges Bank Investment Management, which manages Norway’s SWF Government Pension Fund Global, said the fund aims to be a global leader in responsible investment.

“Responsible investing and ownership activities are integral parts of our management of the fund. They support the return objective of the fund by improving the relationship between long-term return and risk,” she said. “We believe in engagement and voting, rather than divestment, to influence our investee companies and contribute to improved real-world outcomes.”

This was a view echoed by a spokesperson for the Ireland Strategic Investment Fund, who said its long-term returns are dependent on the economy’s overall health, “therefore integrating ESG factors is core to its investment approach”.

The spokesperson added: “ESG consideration benefits ISIF not just through each individual investment, but also at an overall portfolio level, ultimately enhancing both the long-term value of the fund and the reputation of the National Treasury Management Agency in delivering on its mandate.

“As a priority investment theme, climate change in particular is a critical issue for ISIF. The fund focuses on ensuring its whole portfolio, third-party managers and investee companies are considering potential climate risks and opportunities as appropriate, and that it is suitably captured as a part of decision-making and portfolio management in multiple ways.”

Room for improvement

While the proportion of central banks that have an ESG policy has increased significantly, there is still room for improvement, according to Invesco’s Ringrow. However, he said, in previous surveys some central banks had been unable to adopt an ESG policy because of their ties to national governments: “They were unable to publicly commit to any sort of ESG targets because they were so closely tied to government stakeholders and needed their governments to almost instruct them that [ESG] was part of their remit.”

Ringrow added that 83 per cent of central banks had a carbon target, however, which was often aligned with their government’s.

Deputy governor of Norway’s Norges Bank Øystein Børsum said: “Like many other central banks, Norges Bank has increasingly recognised the importance of ESG, with special emphasis on climate change and climate risk. A sound understanding of how climate change and the transition to a low-carbon society affect the economy and the financial system is an important premise for central banks in their conduct of monetary policy and work on financial stability.”

The study, now in its 10th year, collated the views of 139 chief investment officers, heads of asset classes and senior portfolio strategists at 81 SWFs and 58 central banks, collectively managing $23tn in assets.

A service from the Financial Times