Here in Hong Kong, Category 8 typhoons used to be infrequent. Just as floods in Germany and massive wildfires in California were disasters we might see every decade or so. Sadly, this is no longer the case. In one week alone this October, Hong Kong saw two Category 8 typhoons. Earlier this year, floods devastated parts of central Germany, and California saw five of the largest wildfires in its history in 2020. Hong Kong, Germany, and California are not outliers. Extreme weather conditions have been documented in much of the world.
It is widely recognized that climate change implies more frequent and severe weather events, greatly increasing the physical risks to financial and economic stability. In the absence of urgent action, the impact will be widespread and affect most countries, people’s lives and livelihoods, and many industries. The financial sector will be no exception.
Central banks have an important role to play in responding to this challenge. They are interested in these issues for at least three reasons: (i) preserving financial stability as societies move toward reducing their carbon footprints; (ii) diversifying the investments of central bank reserves to minimize unnecessary risks; and (iii) in keeping with their mandates and expertise, providing support to global efforts to achieve the objectives of the Paris climate accord.
The Asia-Pacific region has the largest need for infrastructure investments, around $1.7 trillion per year for developing Asia alone, according to the Asian Development Bank (ADB). Much of this needs to be green investment. It is also among the most vulnerable regions if actions to combat climate change are not taken urgently. At the same time, Asia has, relatively speaking, an extremely large pool of foreign exchange reserves, at around $5.7 trillion by the end of 2019. So, there is a clear case that we need to find a way to bring these two together and do so creatively and safely. The BIS Asian Green Bond Fund is an attempt in this direction.
The fund is designed to provide central banks with opportunities to invest in high quality bonds issued by sovereigns, supranationals, and corporations that comply with strict international green standards. It has two distinct features. First—compared to the BIS’ previous green bond funds—it has a broader group of eligible issuers. It will invest in corporations, including financial firms, because much of the financing in Asia is through commercial banks rather than directly from capital markets. Second, the BIS has engaged with multiple international financial institutions and development finance institutions—the ADB, the Asian Infrastructure Investment Bank, the World Bank, and the International Finance Corporation—to explore opportunities for collaboration to develop a pipeline of green products in the region to invest in. These institutions also have expertise on the ground to ensure that the highest standards are being followed in forming these green investment opportunities to allay concerns regarding greenwashing.
On the technical side, in line with reserve managers’ appetite for safety, liquidity, and return, all central features of the BIS’s financial products, the Asian Green Bond Fund would be established as a BIS Investment Pool (BISIP), a collective investment scheme structured under Swiss law that is commonly used by the BIS for its fixed income investment products.
While the fund would provide the opportunity for central banks to invest their reserves into greening the economies in the region, the fund is not restricted to investors from Asia. Broad interest to invest in the fund has been expressed by central banks well beyond Asia, reflecting the need of the global central banking community for reserve diversification. Regardless of the domicile of the central bank, central bank investments are generally made with a long-term investment horizon in mind. The fund will thus help channel global central bank reserves to green projects for long-term sustainable growth in the region, which has contributed more than two-thirds of global growth in the past decade.
In light of the fast-changing developments of the green bond market in the Asia-Pacific region, the Asian Green Bond Fund will be an evolving fund, allowing it to be agile and make changes as needed. For example, while the fund will be denominated in U.S. dollars initially, green bonds denominated in Asian local currency will be considered at its first and/or second anniversary. Similarly, while ICMA (International Capital Market Association) and CBI (Climate Bond Initiative) standards will be used at the start, the BIS is open to alternative standards, for example, for bonds funding projects that may not be green at present but are aligned with a transition toward low-carbon activities.
Technologists often say: “Think big, start small and scale fast.” That is how the BIS too plans to approach this endeavor. The Asian Green Bond Fund will represent an important addition to the existing suite of green bond funds at the BIS. As the fund evolves, it will also allow central banks to consider ways of expanding green financial markets, either through diversifying into regional currencies, or by considering the next generation of sustainable bonds adhering to even stricter standards and aligned to the objectives of the Paris accord.