Climate risk in reserves portfolio’s of Latvijas Banka and European Central Bank – legal requirement or risk/return enhancing strategy?

Abstract

Climate change has been a central topic in financial industry amongst both academicians and financial market participants for a while now. Despite the breath and wealth of available information on this subject matter, there is still little systematic knowledge of the financial implications of climate change risks in investment management and particularly reserves management. This thesis firstly deals with sources of the demands for greening of the reserves portfolios and describes interpretation of such demands with focus on financial risk mitigation. Review of regulation around climate change mitigation and its application to European Central Bank and Latvijas Banka is performed. Once groundwork for implementing climate change mitigating strategies is made, different approaches for climate risk mitigationare analyzed for asset classes included within the foreign reserves and own funds’ portfolios with focus on their implications to expected return and risk. Simultaneously rights of central bank to proceed with possibly return deteriorating strategy is viewed in the light of local and EU regulations. The thesis deals with the following research questions: What duties follow from laws and regulation to Latvijas Banka and ECB with regards to greening of reserves portfolios? What are potential consequences of application of climate filters to reserves portfolios’ – does incorporation of climate filters on reserves portfolios endangers preservation of long-term value? This is supplemented by adding some considerations regarding possibility of change in the green course in light of 2022 war in Ukraine – will climate ambitions be put on halt or the opposite – would energy crisis evolving as an aftermath create momentum for green course in Europe.