Speech
Embargo
14 November 2019, 6.30 pm
Climate risks and central banks: an SNB perspective
Money Market Event
Andréa M. Maechler and Thomas Moser
Member of the Governing Board / Alternate Member of the Governing Board∗
Swiss National Bank
Geneva, 14 November 2019
© Swiss National Bank, Zurich, 2019 (speech given in French)
∗ The speakers would like to thank Fabio Panzera and Nicolas Stoffels for their support in drafting this speech. They also thank Toni Beutler,
Till Ebner, Erich Gmür, Alain Kouo, Mico Loretan, Alexander Perruchoud, Bertrand Rime, Sandro Streit and Jonas Stulz for their valuable
input as well as SNB Language Services.
Ladies and Gentlemen
I wish you a warm welcome to the Swiss National Bank's second Money Market Event in
2019.
The SNB's monetary policy continues to evolve in a particularly dynamic context. The global
growth outlook is clouded by considerable uncertainty - principally of a political, geopolitical
and economic nature. This general environment is reflected in the Economic Policy
Uncertainty Index developed by Baker, Bloom and Davis. As you can see in this
chart 1,
index hit a new high in August 2019. The level of uncertainty captured in the index is
currently almost three times above its historical average. Among other things, this context has
exerted strong downward pressure on long-term interest rates - indeed, this pressure has been
stronger than macroeconomic indicators have suggested in recent months.
Our monetary policy has to navigate these obstacles in order to ensure appropriate monetary
conditions for the Swiss economy. At our September monetary policy assessment, we decided
to leave our expansionary monetary policy stance unchanged. The SNB policy rate is
unchanged at -0.75% and we remain willing to intervene in the foreign exchange market as
necessary.
At our quarterly monetary policy assessment, we also adjusted the method we use to calculate
the negative interest rate we charge on banks' sight deposits at the SNB. This adjustment
takes into account the fact that interest rates could remain low around the world for a long
time to come. We want to limit the burden our negative interest rate represents for banks and
the economy, as long as this is compatible with steering monetary conditions in Switzerland.
Climate change: a major economic challenge
In addition to these economic and political uncertainties, the global environment faces other
longer-term challenges, such as those relating to climate change. This evening, I'd like to
focus on the economic and financial risks that emanate from global warming and associated
climatic events on the one hand, and from measures implemented to support the transition to a
low-carbon economy on the other. I shall also explain how, within the scope of its monetary
policy mandate, the SNB factors these risks into its deliberations and actions.
Economists began to view climate change as a major challenge in the 1970s and this topic has
1
since been the subject of numerous studies. Furthermore, in 2018, the Sveriges Riksbank
Prize in Economic Sciences in Memory of Alfred Nobel, the equivalent of the Nobel Prize in
economics, recognised William Nordhaus for his work on integrating climate change into
long-run macroeconomic analysis.
It may seem obvious, but it is worth reminding ourselves that our planet has undergone
numerous climatic changes throughout history. However, in the past, these changes have
essentially been the result of natural forces. Today, global warming is largely attributable to
human activity - and the rate of warming is faster than it has been in the past.2
Climate change is a negative side-effect of economic activity - what economists call a
'negative externality'. The externality arises because the costs caused by the emission of CO2
and other greenhouse gases are not borne by the emitters. When economic agents emit CO2,
they do not internalise the effect of these emissions on the planet or on future generations.
This is a classic 'tragedy of the commons' scenario:3 the atmosphere - a shared or 'common'
resource that is available to us all but belongs to no one - is being overexploited and
degraded.
The mechanism underlying the 'tragedy of the commons' is well understood and documented
by economic theorists. Yet, in the case of global warming, several factors are in play that
make the phenomenon difficult to grasp and remedy. First, both climate change and its effects
4
on the economy are hard to estimate with any degree of accuracy. Second, the impact of
climatic phenomena is transnational and this complicates efforts to respond appropriately.
Third, the effects of climate change are felt incrementally and over a very long timescale,
which includes future generations. The needs, precise aspirations and technical capabilities of
these future generations are, by definition, unknown and therefore difficult to integrate into
the analysis. And finally, the effects of climate change are potentially irreversible.
How can this problem be solved? When economic agents fail to take sufficient account of the
cost of their actions, economic theory recommends introducing a tax which incentivises them
to adapt their behaviour. In the case of climate risks, a carbon tax can be used to incentivise
5
individuals and organisations to reduce their emissions of CO2, the main greenhouse gas.
The theory may be clear; however, important considerations, such as setting and realising an
overarching objective, require political dialogue. These considerations are not part of the
SNB's mandate.
The SNB contributes to the stability of the economy as a whole, and it is not within its legal
remit to promote or hinder any particular economic or societal development. The SNB can
only credibly and effectively fulfil its mission of maintaining price stability if it concentrates
on the monetary policy tasks assigned to it by law.
But if it is not part of the SNB's remit to intervene in these issues, why are central banks
interested in climate risks?
Why are central banks interested in climate risks?
To fulfil their mandate, central banks must understand how climate change risks influence the
functioning of the economy and the financial system - and hence price stability and financial
stability.
Economists classify climate risks into two categories: physical risks and transition risks.
Physical risks include the direct material effects of climate change on income and production
capacity. For example, severe storms can damage factories and transport infrastructure and
disrupt value chains that are essential to international trade.
In the first instance, physical risks cause supply shocks. These shocks result in a drop in
production in the affected sectors and tend to engender temporary price increases. However,
the overall impact of such events on economic activity is not obvious, as spending on
reconstruction stimulates growth in the short term.
Certain physical risks can also affect the functioning of the economy on a longer-term basis.
In particular, measures taken to mitigate the effects of climate change mobilise resources that
could otherwise be invested more productively. For instance, rising water levels may mean
that dams have to be reinforced and maintained. In Switzerland, milder winters are reducing
snow cover, which in turn is causing perennial problems for winter tourism, especially in
6
lowlying areas. Furthermore, uncertainty about the frequency and intensity of extreme weather
events in the future may affect companies' confidence levels and reduce their willingness to
invest, thereby weighing on longer-term growth prospects. And finally, physical risks
associated with climate change impact the financial system. Insurers are, of course, the first to
be exposed to property damage in the wake of extreme and ever more frequent events such as
floods, landslides and fires. These same events could also hamper the functioning of financial
market infrastructures. In Switzerland, however, the practice of mandatory redundancy (e.g.
multiple data centres with different risk profiles) should ensure business continuity even in
the event of major natural disasters.
With respect to commercial banks, these types of event increase credit risk as they can cause
the value of assets pledged as collateral to decline and cause debtors' earnings to fall (e.g. loss
of rental income following damage to a residential property). Given our country's climate risk
profile and the fact that the bulk of these risks is insured, a climate-related natural disaster is
unlikely to threaten the stability of the entire banking system in Switzerland, even if some
individual institutions could be affected.
Let's now move on to the second category of climate change risks, transition risks. These
include the economic costs and benefits resulting from adjustments to regulations and
government policies aimed at decarbonising the economy. Examples are the scrapping of
polluting production processes, the growth of investment into researching and developing
green technologies, and an unanticipated adoption of new taxes or subsidies. As with any
other tax, the introduction of a carbon tax could change the sectoral composition of domestic
production in a way that is significant but hard to quantify.
That being said, transition risks are above all likely to impact the financial system - through
the revaluation of assets. A sudden shift in climate and energy policy could reduce the value
of assets in the sectors most affected by the new regulations (e.g. commodities, automotive,
heavy industry). For banks, this would erode the creditworthiness of debtors. In the area of
mortgage lending, the adoption of stricter environmental standards could also diminish the
collateral value of non-compliant real estate.7
As you can see, climate risks may be of interest to central banks on a number of fronts.
Each central bank tackles these challenges in its own way, depending on the profile of the
economy in question and the institutional framework within which it operates. Countries are
affected differently by climate risks due to their geographic location and economic structure. I
am thinking in particular of countries that are partially below sea level (e.g. the Netherlands),
those that are highly exposed to extreme weather events (e.g. droughts, storms, floods) and
economies in which carbon-intensive industries (e.g. steel and cement) are strongly
represented.
Similarly, the institutional framework of each central bank will determine its room for
manoeuvre in discussions on climate change. Some, for example, are responsible for
microprudential supervision and also function as bank resolution authorities. They have to
evaluate the soundness of each bank's balance sheet, and this includes assessing banks'
exposure to climate risks. In Switzerland, this role is assigned to the Financial Market
Supervisory Authority (FINMA). Other central banks advise the government and are expected
to take a position on issues that go beyond pure monetary policy (e.g. fiscal or energy policy).
This is not the case at the SNB.
The SNB's mandate is clearly defined. Its principal mission is to ensure price stability in the
medium term, while contributing to the stability of the Swiss financial system as a whole -
two key conditions for our country's prosperity. After all, can economic agents be expected to
plan their spending, savings and investments sensibly and manage their liabilities if prices
fluctuate widely? If they go up, the value of savings goes down. If they go down, debt
suddenly becomes more costly to service, especially as wage levels tend to move in line with
prices. In short, a financial system that can withstand shocks is essential for a
wellfunctioning economy and the successful implementation of monetary policy.
Measures taken by the SNB
In its assessment of the economic and monetary situation, the SNB endeavours to take into
account all relevant risks, including those linked to the climate. Economic forecasts for both
the international and Swiss economies factor in the effects of climate events that depart from
the norm. More broadly, the SNB regularly updates the tools and methods it uses to analyse
monetary developments and financial stability, in terms of both data sources and the structure
of the models. We continually adapt our models to integrate new economic realities and
structural changes, particularly those induced by climate change.
The monetary policy response to climate change will depend on the nature of the shocks, their
8
intensity and their expected duration. According to our assessment, the overall threat posed
by climate risks that are capable of affecting Switzerland's economic and financial stability
appears to be moderate at present. Nevertheless, these risks and the assessment of associated
exposure could change, which is why the SNB remains vigilant. This is all the more important
as our country is not an island - Switzerland's economy and financial system are closely
interconnected with the rest of the world.
The SNB participates in dialogue at both national and international level. The SNB and
FINMA regularly discuss climate risks of relevance to the Swiss financial sector. In addition
to this, in April 2019, the two institutions joined the Network of Central Banks and
Supervisors for Greening the Financial System (NGFS). This network, which currently has 46
members, was set up to promote the sharing of best practice in handling climate issues and
support the development of climate risk management in the financial sector. It also aims to
enhance the role of the financial system in enabling the transition to a low-carbon economy.
The NGFS's work is carried out in three dedicated workstreams.
• The first, in which FINMA participates, looks into the implications of climate risks for
the microprudential supervision of the financial system, and banks in particular.
•
The second focuses on the effects of climate risks on the economy and the financial
system as a whole. This workstream aims to promote the modelling of and economic
research into specific climate issues and to draw up global stress scenarios that can be
used as a basis for monetary policy and macroprudential supervision. The SNB is a
member of this workstream. It is particularly interested in contributing to this group's
activities as it wishes to explore ways to refine and augment its own analyses and
tools.
•
The third workstream, in which the SNB also participates, examines developments in
sustainable finance and the role of central banks and supervisory authorities in
promoting socially responsible investment within the scope of their mandates. The
SNB is well placed to contribute here by sharing its experience as a global investor, a
subject that we will investigate in more detail in a moment.
As you can see, the SNB is keen to deepen its understanding of the potential implications of
climate risks for its work, and it is actively engaged at the international level to achieve this
goal.
Beyond its prerogatives with respect to monetary policy and financial stability, the SNB
integrates its thinking on environmental sustainability into its operational activities.
Environmental management at the SNB
For many years now, the SNB has been fully meeting its sustainable development
responsibilities in its day-to-day operations. Since 1996, the SNB has applied a systematic
environmental management concept aimed at reducing its energy consumption. We publish
annual reports detailing the environmental impact of our operational activities and the
progress being made on this front.9 Our strategy for reducing CO2 emissions is based on four
pillars: first, avoid; second, reduce; third, replace existing solutions with cleaner energy
sources; and, finally, offset. For the past eight years, the SNB's operational activities have
been carbon neutral. In other words, it offsets all unavoidable CO2 emissions by investing in a
range of climate protection initiatives around the world, including wind farms, geothermal
projects and photovoltaic plants. But the SNB's commitment does not end there: we have also
done pioneering work in introducing the first environmental impact assessment for banknotes.
This work allows the SNB to assesses the environmental impact of a banknote over its entire
life cycle, and it has inspired other central banks to do likewise.
Balance sheet management
Within the scope of its mandate, the SNB is also committed to sustainable development in the
management of its balance sheet.
The SNB differs from other asset managers in several respects. First, we manage foreign
10
exchange reserves. As these reserves perform a monetary policy function, they must remain
subordinate to monetary policy goals at all times. These considerations determine the
framework of our investment policy. As shows, our foreign exchange reserves
chart 2
(represented by the area in blue) have increased substantially since the 2008 global financial
crisis. This increase is mainly due to the SNB's interventions in the foreign exchange market
to counter excessive appreciation of the franc and stabilise price developments. The expansion
of foreign exchange reserves has also caused an increase - on the liabilities side of the
balance sheet - in the volume of sight deposits that banks hold with the SNB (area in red).
Our reserves could decrease in the future, however. If monetary conditions in Switzerland
called for it, the SNB could sell some of its reserves in order to shorten its balance sheet.
Although we have not yet reached this point, such an eventuality should not be ruled out.11
The SNB must be able to deploy its balance sheet at all times, quickly and without restriction.
These reserves therefore have to meet stringent security and liquidity requirements.
Consequently, as chart 3 shows, we invest a very large proportion of our reserves in
government bonds denominated in the major currencies, such as the euro, the dollar, the yen,
pound sterling and the Canadian dollar. Holding liquid investments that can be mobilised
rapidly allows the SNB to use its balance sheet at any time, should monetary policy require it.
A second aspect that differentiates us from other investors is that we remain as neutral as
possible vis-à-vis the market. In other words, we must be able to move large volumes without
unduly influencing prices. This neutrality ensures that the SNB is able to build up and scale
back its investments quickly and efficiently, while avoiding conflicts of interest with its
mandate. Neutrality also guarantees that the SNB's investment policy remains independent of
all political considerations. In this sense, neutrality is an essential condition for the optimal
fulfilment of our mandate.
Finally, at the operational level, the SNB differs from other investors in that it cannot protect
itself against the greatest risk to these reserves - currency risk. Any attempt on the part of the
SNB to hedge this risk would increase the demand for francs, which would run counter to its
monetary policy objectives. The SNB's risk profile therefore differs significantly from that of
other institutional investors. While the currency risk (orange shading in represents
chart 4)
78% of the total risk exposure of our investments, in the case of a representative Swiss
pension fund, this proportion is only 16%. Due to its particular risk profile, the SNB is
exposed to significant fluctuations in its investment result from one quarter to the next.
Given these fluctuations, we exploit all available room for manoeuvre in order to diversify our
investments. This allows us to optimise our risk/return profile and maintain the value of our
reserves over the long term. To do this, we invest in equities and corporate bonds. Equities are
an attractive asset class for the SNB. Their high degree of liquidity ensures the necessary
flexibility in monetary matters, while their higher return potential helps to improve the
risk/return profile. The SNB differs from other central banks in that it has a relatively high
equity exposure (currently 20%, cf. Our equity portfolio, which is worth more than
chart 3).
CHF 150 billion, is highly diversified. We invest in some 6,700 corporate securities from
more than 40 countries. We hold shares in companies which together account for more than
95% of global market capitalisation. Overall, our investments are denominated in some 30
currencies around the world, including those of emerging economies.
Beyond its need for diversification, the SNB must identify and understand all the risks to
which its balance sheet is exposed and assess their potential impact. Climate risks feature
among the principal risks along with market, liquidity and credit risk. From a financial point
of view, climate risks are not fundamentally different from other risks. They can also amplify
market fluctuations and affect the quality of interest-bearing investments. Ultimately, they
could impact the risk/return profile of our assets and hence the strength of our balance sheet.
How does the SNB handle ESG (environmental, social and governance) risks in its portfolio,
while retaining the room for manoeuvre needed to conduct its monetary policy?
My colleague Thomas Moser will answer this question. The floor is yours, Thomas.
Focus on SNB's investment policy
As part of its monetary policy mandate, the SNB has put in place a professional and modern
portfolio management system. The SNB has often played a pioneering role among central
banks. For example, it was one of the first central banks to establish its own in-house portfolio
management set-up (in 1984) and to invest a proportion of its reserves in equities and
corporate bonds (in 2004).12 The vast majority of our investments are managed internally.
External asset managers are used to benchmark internal portfolio management and obtain
more efficient access to certain asset classes.
The SNB was also among the first central banks to adopt a structured approach to managing
non-financial aspects, such as ESG risks. How does the SNB factor ESG risks into its balance
sheet management?
I would like to start with our bond portfolio, which accounts for 80% of our foreign exchange
reserves. Most of this portfolio is made up of government bonds. Other bonds, such as
corporate bonds, represent 12% of our reserves. Our bond portfolio is actively managed in
terms of country selection and weighting. In other words, while we use a combination of
broad bond indices, we deviate from these - within pre-set limits - in order to generate a
higher return. Our portfolio managers use all the information at their disposal to guide their
investment decisions. This comprehensive assessment essentially includes all types of
financial risk that may arise in one form or another. Factoring climate risks into risk
assessment is therefore an integral part of good portfolio management. In this context, it is
worth mentioning that, for some years now, the SNB's bond portfolio has included green
bonds. As their name suggests, these are bonds whose proceeds are used to finance
environmental projects.
What about our equity portfolio? In our equity investments, we pursue a passive and neutral
approach (index-linked management). This means that we replicate a combination of
representative market indices to determine the size of each holding of securities in our
portfolio. Index-linked management ensures that the SNB acts as neutrally as possible in the
markets without engaging in 'stock picking'. It also prevents some sectors and companies
from being over or under-represented. Besides these advantages, the choice of the passive
management approach is based on political considerations. A more active management of our
equity investments would be tantamount to indirectly pursuing a structural policy. The SNB
could quickly acquire significant stakes in select companies - and these could be construed as
strategic participations. Clearly, it is not part of the SNB's mandate to promote or
disadvantage certain companies or sectors. The aim is to avoid such conflicts of interest at all
costs, not least in order to preserve the SNB's independence and credibility.
The SNB only departs from the principle of neutrality in certain, very specific cases. This is
illustrated in On the one hand, the SNB refrains from investing in shares of
chart 5.
systemically important banks and medium and large-cap banks in the advanced economies in
order to avoid any real or perceived conflict of interest. For the same reason, it does not hold
shares in Swiss companies.
On the other hand, the SNB employs ESG criteria in the management of its equity portfolio
via a selective exclusion policy. Since 2013, it has refrained from acquiring shares in
companies whose products or production methods seriously violate ethical principles -
notably, firms that produce internationally condemned weapons, seriously violate
fundamental human rights or systematically cause severe environmental damage. Such
exclusions, which also apply to our corporate bond portfolio, enable the SNB to align its asset
management with the fundamental values and norms of our country.
How does the SNB go about identifying the companies to be excluded? It follows a clear and
structured process, in which it draws on the knowledge of external experts. With respect to the
environment and human rights, we regularly evaluate our investments in a two-step process.
First, an expert consultancy collects all publicly available information and then draws up a
warning list containing high-risk companies (i.e. companies that most likely meet our
exclusion criteria). In a second step, another specialist firm evaluates these allegations in
detail and prepares a full report for each high-risk company, accompanied by a
recommendation. The final decision on whether or not to exclude a company is taken by the
SNB.
In addition, the SNB exercises its voting rights for a portion of the shares in its portfolio. It
focuses on aspects relating to good governance. Good governance contributes to the positive
development of a company, which ultimately improves the return on our investments.
Ladies and gentlemen, we are convinced that our approach to managing our foreign exchange
reserves is appropriate given the requirements of our mandate. More active management in
the environmental field would severely limit our investment options. It could further
accentuate the fluctuations in our results - fluctuations that are already significant as our
balance sheet has to absorb exchange rate movements without recourse to hedging. Besides, it
is not clear that an investment strategy based on ESG criteria would generate superior risk-
adjusted returns. In addition to this, given the particular profile and size of our portfolio, a
more targeted selection of our investments would increase concentration risk, which would
compromise our neutrality in the markets and hinder the implementation of monetary policy.
Our approach is therefore the result of a careful weighing-up of interests. The benefits of
more active management in terms of superior returns, risk management and climate risk
impact are still highly uncertain. On the other hand, the costs of such an approach are very
considerable indeed, particularly with regard to market neutrality, concentration, and - above
all - the politicisation of our portfolio management.
Let me illustrate this last point with an example. As I mentioned earlier, we invest a portion of
our reserves in environmentally-friendly investments. Now imagine if our portfolio were
overweight in this segment and the SNB had to shrink its balance sheet. To accomplish this, it
would have to sell a significant proportion of its socially responsible investments. Such a sale
could prove to be doubly problematic. Due to the limited size and relatively low liquidity of
the market, the SNB would scarcely be in a position to shorten its balance sheet quickly and
efficiently without influencing prices. Its market neutrality would no longer be guaranteed.
Moreover, such a sale could well expose the SNB to substantial political pressure.
Conclusion
Ladies and gentlemen, to conclude:
Climate risks are an important issue for our country's population and economy. However, the
objectives and solutions associated with transitioning to a low-carbon economy must be the
fruit of a political dialogue and agenda. These questions are not part of the SNB's remit.
Let's not forget that the SNB has a clear mandate: to ensure price stability. By fulfilling this
mandate, it is making a crucial contribution to balanced economic development and a stable
financial system - and it is doing so against an international backdrop freighted with
uncertainty. Broadening this mandate to pursue other objectives, such as promoting a green
economy, would pave the way for conflicts of interest and politicise monetary policy. This
would affect the very essence of the SNB's independence and thus its ability to make
decisions that are occasionally difficult but absolutely necessary in order to fulfil its mandate
and support Switzerland's economy.
The SNB takes environmental issues that fall within its mandate very seriously. It is
constantly developing its skills to understand and assess the impact of relevant risks -
including those linked to climate change - on the economy and the stability of the financial
system. It also integrates these considerations into its balance sheet risk management in order
to guarantee the value of its reserves over the long term. Here, the SNB applies ESG criteria
to its asset portfolio, while respecting the requirements of monetary policy. Given the rapid
pace of developments in environmental economics, the SNB is closely monitoring
developments at both national and international level.
Ladies and gentlemen, it is now my pleasure to invite you to a round table. This will give us a
chance to broaden the debate beyond central banking and to hear what other players have to
say about the impact of climate risks on the economy and the financial system.
Climate risks and central banks: an SNB
perspective
Andréa M. Maechler, Member of the Governing Board
Thomas Moser, Alternate Member of the Governing Board
Swiss National Bank
Money Market Event
Geneva, 14 November 2019
Economic policy uncertainty hit a record high in August 2019
Davis.
and
Bloom
Baker,
SNB,
Sources:
1 14.11.2019 Climate risks and central banks: an SNB perspective | Andréa M. Maechler and Thomas Moser | © Swiss National Bank
The SNB's balance sheet mainly comprises foreign exchange reserves
- a key tool of our monetary policy
SNB.
Source:
2 14.11.2019 Climate risks and central banks: an SNB perspective | Andréa M. Maechler and Thomas Moser | © Swiss National Bank
Our foreign exchange reserves are broadly diversified and meet stringent
security and liquidity requirements
GBP
EUR
6%
CAD
3%
39%
JPY
9%
USD
35%
flaticon.com.
SNB,
Sources:
3 14.11.2019 Climate risks and central banks: an SNB perspective | Andréa M. Maechler and Thomas Moser | © Swiss National Bank
The SNB's risk profile is very different from that of a Swiss pension fund
- a reflection of the primacy of monetary policy
78%
16%
SNB.
Source:
4
14.11.2019 Climate risks and central banks: an SNB perspective | Andréa M. Maechler and Thomas Moser | © Swiss National Bank
The SNB applies a clear and structured exclusion policy - its balance
sheet reflects the fundamental values and norms of Switzerland
Ethical
Conflicts of
reasons
interest
• Internationally
• Medium and large-cap banks and condemned weapons
other quasi-bank institutions
• Violation of fundamental human
rights
• No investment in Swiss companies
• Severe environmental damage