Core Focus: The drivers of ESG integration in reserve management, the distinction between financial risk and societal objectives, the role of sustainability classifications, and the evolving practices of central banks.

In-Depth Notes:
Integrating sustainability has become a new challenge for reserve managers, and the associated trade-offs can be challenging, particularly for reserve managers holding mostly traditional reserve assets. Over the past few years, central banks have increasingly prioritized sustainable development policies, actively seeking ways to promote sustainability through their financial strategies. The greening of central banks and reserves management has accelerated rapidly, driven by a combination of institutional pressures, financial risk considerations, and societal expectations.

The Drivers of ESG Integration:
The drivers of ESG integration in reserve management are multifaceted. From a financial perspective, incorporating ESG considerations can improve risk-adjusted returns by identifying medium- to long-term exposures that could materially impact a company’s fortunes. From a societal perspective, investors seek to positively impact climate change, the environment, and society either by channelling capital to target companies and sectors that “do good” and by restricting capital to companies that “do harm.”

Sustainability Classifications in Reserve Portfolios:
Central banks invest in bonds with different sustainability classifications, as they are part of the market in which they operate. This includes bonds labelled according to the International Capital Market Association’s (ICMA) guidelines for green, social, sustainable and sustainability-linked bonds. However, central banks typically have no specific objective for sustainability-classified bonds—they are included in the asset management because they are part of the market, just like other bonds. These investments are made on the condition that the bonds meet requirements regarding liquidity, return and risk.

The Carbon Footprint of Foreign Exchange Reserves:
Central banks are expanding their reporting of emissions metrics for foreign exchange reserve assets. The Riksbank, for example, reports four emissions metrics: portfolio weighted average carbon intensity, total carbon emissions, carbon footprint, and carbon intensity. The calculation method of the emissions metrics is based on the recommendations for central banks developed by the Network for Greening the Financial System (NGFS), which in turn are based on recommendations from the Task Force on Climate-related Financial Disclosures (TCFD).

The Challenge of Divergent National Policies:
The integration of ESG factors is complicated by divergent national policies, particularly regarding international agreements such as the Paris Agreement. The Riksbank clarifies that the foreign currency reserves shall only consist of bonds issued by countries that have joined the Paris Agreement. However, the reserves need to contain assets in the currencies that may be needed for the Riksbank to fulfil its tasks, for example in a crisis. When the US left the Paris Agreement in January 2025, the Riksbank continued to hold US government bonds because the dollar is necessary for preparedness and to maintain price and financial stability.