Central banks’  investment challenges: how custodians can help

From transitioning investments towards a low-carbon economy to managing investment portfolios in volatile markets, central banks have new responsibilities.

For central banks’ investment operations, 2022 was a pivotal year. As the global economy entered an inflationary period, challenges arose in two key roles of setting monetary policy and managing foreign exchange reserves.

The pressures that characterised 2022 have intensified in the early months of 2023, adding liquidity risk to continued concerns about high inflation. Central banks such as the European Central Bank (ECB), Federal Reserve and Bank of England continue to counter inflation by raising interest rates and decelerating quantitative easing programmes. In parallel, this higher rate context demands a new focus on portfolio liquidity and asset diversification, especially in foreign exchange reserves.  In addition to their current challenges, increasingly central banks must incorporate sustainability policies and measures throughout their investment operations.

One result is that central banks have new structural needs in asset servicing. More than ever, they require a robust custodian with a deep understanding of their activities.

The right partner needs expertise in three key areas: an extensive global custody network and services; a highly secure service underpinned by the right technology and operating model to support changing investment strategies; and relevant experience with ESG data in understanding climate risks and incorporating sustainability strategies for institutional clients.

Local and global custody support for central banks’ investment portfolios 

Central banks are managing increasingly diverse currency reserves and investment portfolios from a geographical perspective. ECB figures show a 26 per cent increase in its foreign currency reserves between September 2020 and September 2022[1] across European central banks, with higher currency diversification  due to the decreasing proportion of the US dollar.

Optimal security of these assets is critical, but market volatility in 2022 challenged central banks and their custodians in new ways. In this environment, central banks are best served by a large custodian that offers the security of a strong balance sheet, a robust infrastructure with an extensive network of local custodians, and the right operating model to ensure the liquidity of their assets in the local markets at any time.

Clearing, Settlement & Custody

We deliver secure yet flexible services to efficiently manage all securities-related activities

The Securities Services business of BNP Paribas operates a global custody network that covers 90 markets, with a local presence in 27. Having a global custodian with coverage of key emerging markets such as India, China and Brazil means that central banks do not have to rely on additional local intermediaries.

As central banks continue to manage more and more cross-border transactions, global custodians with local resources can help them access the expertise required to navigate local complexities and added-value services when handling central banks’ foreign-exchange mandates in illiquid currencies.

In difficult markets, risk intensifies and the ability to respond swiftly is critical. The largest custodians offer resiliency in their services, such as a back-up network to offer an additional layer of continuity and assurance. BNP Paribas’s Securities Services business has established two live networks, which means clients hosted on a network can be shifted to a second should local market difficulties arise.

Supporting central banks’ changing investment policies

As central banks diversify their investment strategies, with geographical expansion and an ESG focus, they have started to delegate mandates to asset managers to gain external expertise. This is resulting in new – and more complex- investment structures. Increased automation, digitalisation and enhanced data resources can ensure front-office activities are aligned with back-office systems and processes.

Central banks are looking for providers that can offer robust and comprehensive data streams to feed their MAPS platform, which provides the back office for many European central banks. Providers with a consistent engagement with MAPS enable central banks to achieve effective accounting, compliance and risk management while enabling their delegated investment mandates.

That same level of connectivity is also required in other areas where Central banks’ investment strategies are evolving, such as securities lending, collateral management and triparty collateral management. A triparty collateral services agent acts as an agent and custodian managing collateral, both securities and cash, with the aim of protecting trading counterparties from the default risk of one of them. This is a service that is increasingly demanded of custodians.

Finally, a truly global custodian can leverage its bank’s broader offering, bringing investment banking expertise and services to act as a counterparty in certain transactions, such as sovereign debt issuance.

Supporting central banks’ sustainability imperative 

ECB board member Isabel Schnabel encapsulated central banks’ evolving approach to sustainability when she said in a January 2023 speech[2] that the “drastic change in the macroeconomic and financial environment over the past year also requires central banks to review the scale and scope of their own contribution to the green transition”.

ESG issues in two key areas

Central banks are increasing their focus on ESG issues in two key areas. Firstly, in their primary regulatory role, they are advocating the transition to ESG policies for financial institutions, and secondly, by including ESG in their own risk assessments of investment portfolios. This is especially on the second one that custodian can help.

Implementing an ESG strategy

Central banks need to overcome the challenges related to ESG data collection and validation in order to define their own objectives as investors, and introduce sustainability decision-making in their portfolios. They need to access the right technology, ESG data sources and analytical tools to ensure their portfolios are meeting their sustainability goals. Custodians can help support through tools and processes, such as BNP Paribas’ Manaos[3] ESG data platform, as well as the provision of data collection solutions.

Furthermore, in their monetary policy mandates, many central banks are adding more green bonds to re-balance their portfolios. In March 2022, Chile became the first country to use sovereign debt to fund its long-term climate initiatives. The USD2 billion sustainability-linked bond offering (SLB) carried two key performance indicators (KPIs) geared towards reducing emissions and increasing Chile’s use of renewable energy[4].BNP Paribas played here a central role as the joint structuring agent and bookrunner.

Fostering a just transition | BNP Paribas Group

Our role as the European Union’s largest bank is clearly defined in our raison d’être: “We serve our clients and the world we live in.”

As a founder of the Net Zero Banking Alliance and the first issuer of green bonds, BNP Paribas aims for leadership in the sustainability field by not only developing new sustainable financing products, but also by setting ambitious ESG targets for its own activities.[5]

Looking to the future of central banks’ investment strategies

The challenges facing central banks have grown larger and more complex as they face increased market pressure on their investments, more sophisticated asset management needs and the ESG transition.

As they navigate these waters, central banks can work in close and strengthened collaboration with trusted and dependable custodians to gain the support they need in critical areas.

Central Banks face new challenges in their role of investors

Central Banks face new challenges in their role of investors

  • Managing investment portfolios liquidity and stability in multiple volatile markets
  • Embracing sustainability, transitioning towards a low-carbon economy

That’s where custodians step in

Trusted partners with deep post-trade expertise,
they can support Central Banks in processing complex investment strategies and integrating sustainability drivers

Securities Services at BNP Paribas

Access to 90 markets with local services in 27 of them, including Brazil, China, India

Expertise in handling investments in illiquid currencies, securities lending and triparty collateral management

Technology agility to feed MAPS platforms

BNP Paribas’ Manaos platform for key ESG insights
Part of BNP Paribas Group, supporting green bonds issuance

Working together to forge a resilient and sustainable future!

[1] Official foreign currency reserve assets, sourced from ECB, as of September 2022

[2] Monetary policy tightening and the green transition (europa.eu)

[3] Manaos is managed by AELX SAS, a technology subsidiary of BNP Paribas.

[4] https://cib.bnpparibas/chile-sets-a-trend-with-first-sovereign-sustainability-linked-bond/

[5] Fostering a just transition | BNP Paribas Group