Green initiative: The Netherlands Bank

The Netherlands Bank (DNB) was one of the founders of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS). It has taken part in some important work in addressing the environmental problems that central banks face. Last year, it carried out a detailed examination on one of the hardest: assessing the environmental impact of assets.

DNB has an investment portfolio with a long-term ‘strategic’ size of €8.85 billion ($9.5 billion), not counting gold. About half of DNB’s investment portfolio consists of holdings of equities and corporate fixed-income assets, which are overseen by nine external managers. The other half, consisting largely of sovereign, sub-sovereign and supranational debt instruments, is managed in-house.

Every three years, a team examines the portfolio’s asset allocation and recommends changes to the board. In 2022, DNB decided to use the exercise to further integrate its responsible investing principles into how it manages the portfolio.

The Dutch central bank formed a project team, consisting of some of its own experts, led by DNB portfolio manager and strategic asset allocation coordinator Dan Alexandru, alongside two outside consultants. The team undertook a qualitative environmental analysis of DNB assets. “We’re trying different things,” DNB responsible investment expert, Rianne Luijendijk, says.

It compared how assets performed against traditional equity index benchmarks with how they did so against ‘Paris-aligned benchmarks’. Assets underlying the Paris-aligned benchmarks must be aligned with the Paris Climate Agreement’s long-term target of no more than a 1.5°C rise in global temperature. They must meet certain standards on carbon emission intensity and reduction, while preserving a sector allocation similar to traditional market benchmarks. This rule aims to encourage investment in firms that effectively reduce their carbon emissions, rather than simply excluding highly polluting sectors

The team also modelled how the portfolio would perform in three different climate scenarios, based on work by the Intergovernmental Panel on Climate Change. The first was an orderly transition to net-zero carbon emissions, and the second a disorderly transition. In the third scenario, the transition failed. The team used a deliberately long forecast horizon of about 40 years, rather than the 10 years or so used in many such exercises. It also experimented with using implied temperature rise metrics in its modelling.

Scenarios’ impact

All three climate-change scenarios reduced the overall performance of DNB’s asset portfolio, but in markedly different ways. The orderly transition had the most immediate impact but, after the first few years, the portfolio performed best in this scenario. The disorderly transition had a larger negative impact on DNB assets, and the failure scenario had an even-worse effect. DNB found that replacing standard equity benchmarks with Paris-aligned equivalents reduced the portfolio’s exposure to transition risk. This approach was, however, less successful in reducing exposure to the increased physical risk that associated with climate change.

Different asset classes also showed notably varied performance. There was little impact on equities in the first years of each scenario, particularly for the failed transition. But, later on, the simulation showed a very sharp downturn in the performance of equities if there was no transition to net zero. Fixed income assets’ performance showed much less change. The failed transition scenario assumed governments did not initially change policy. But physical risks grew rapidly in this scenario, leading to two rounds of rapid changes in market pricing, in 2026 and 2035.

The exercise included Implied temperature rise scores in the portfolio optimalisation next to risk and return, giving an estimate of different asset classes’ climate impact. Officials learned they needed to be “a bit humble” about the weight they attached to some analyses, DNB chief investment officer Kommer van Trigt says.

Shift in approach

In September, the team made its recommendations on the portfolio, which the board adopted without any modifications two months later. DNB was able to increase its holding of assets it judged to be ‘green build’ assets. It raised its exposure to equities in developed markets by 15%, and in emerging markets by 33%. It also sold off part of its exposure to high-yield corporate credits. Luijendijk says DNB believes it can “achieve a higher impact via our equity holdings, especially because we intend to align these portfolios to a net-zero trajectory in the near future”.

The central bank also more than doubled its target for the proportion of green bonds held in its internally managed portfolio. It aims to make green bonds 20% of the portfolio, or around €1 billion, up from €400 million.

The research should give the central bank the basis for more sophisticated analysis. “Our ambition is that in three years’ time it can have a much bigger real impact in the strategic asset allocation,” van Trigt says. DNB intends to share what it has learned with other central banks through the NGFS. It is also running several more projects that aim to create more green investment metrics and further improve its portfolio’s environmental footprint.

DNB is working towards a shift in its equities management strategy to a Paris-aligned stance. Via an external manager, DNB will engage with firms and vote at shareholders’ meetings. The central bank will seek to influence firms on key topics, including climate change, an official adds. But DNB will not be an ‘activist shareholder’. Instead, it will play an ‘active’ role in the companies where it owns equities.

Innovative work

The DNB’s team took a highly innovative approach to analysing how asset holdings interact with climate change. Their findings helped the Dutch central bank to make some significant changes in its portfolio and adopt an active management stance. The research methods deployed helped identify some particularly difficult problems and point to some solutions. These methods are likely to be of considerable value to other central banks.

The Central Banking Awards 2023 were written by Christopher Jeffery, Daniel Hinge, Dan Hardie, Joasia Popowicz, Ben Margulies, Riley Steward, Jimmy Choi and Blake Evans-Pritchard.