Aligning sovereign bond markets with the net zero transition: the role of central banks

Sovereign bonds are central to aligning finance flows with the net zero transition required to meet the Paris Agreement temperature goals. This report aims to understand the system-wide context within which central banks can make a responsible contribution to this alignment. It reviews market innovations and challenges, considers existing practice and sets out robust options for action.

Main messages

• Sovereign bonds play an important role in the economic transition to net zero: they are the main channel through which national governments issue debt to fund public services and investments. The public sector currently accounts for more than half of climate finance worldwide, with about three-quarters of this financed through debt instruments.
• The soundness of sovereign bonds is vital to providing the financial and economic stability needed for a timely transition to net zero. They are a pivotal asset for financial institutions’ risk management because they are generally considered safe and liquid investments.
• Aligning sovereign bonds with net zero requires coordinated action by several stakeholders across the financial system. National governments are first in line to act but central banks have a unique opportunity to make a meaningful contribution.
• There are many practical challenges in aligning sovereign bonds with net zero. For example, it is not straightforward to assess the environmental impact of sovereign bond proceeds and there is no definitive approach to assessing the net zero alignment and climate risks of sovereign portfolios.
• Improved assessment and alignment solutions for investors are emerging, and types of bonds such as thematic green, sustainable and sustainability-linked sovereign bonds offer a way of linking issuance and portfolio holdings with net zero.

Summary recommendations

Central banks can contribute to the net zero alignment of sovereign bond markets in three ways:

• First, as one of the largest owners of sovereign bonds globally, central banks can reallocate part of their domestic and foreign sovereign bond portfolios to better align them with the transition to net zero and manage their climate risk exposure.
• Second, central banks can use their role as standard setters and financial supervisors to contribute to the alignment of sovereign bond markets, such as by supporting the development of assessment and disclosure frameworks for sovereigns and highlighting examples of best practice.
• Finally, central banks can engage publicly on net zero national and international policies and objectives, for example by calling on governments and public agencies to deliver on their net zero pledges and providing them with information and technical assistance on climate-related economic strategies.