Driving ESG accountability in sovereign bonds

Individual and institutional investors across the globe are increasingly looking for attractive returns, whilst helping to create a positive impact on the communities around them. With growing concerns over climate change, geopolitical instability, and uncertainty in financial markets, these concerns have become more pressing. The growing awareness of, and support for, responsible investing has led to increased examination of Environmental, Social and Governance (ESG) issues in many investors’ investment processes.

16 Sep 2019 | 5 min read

Sovereign bonds are an important asset class in the portfolio construction process for macro investors. They make up a large share of assets in many portfolios. Within developed markets, they are considered safe havens, and, in emerging markets, government-issued bonds often offer higher returns at lower levels of credit risk and volatility when compared with their corporate counterparts. Despite the size of the global sovereign bond market, ESG analysis has tended to focus on corporates – whether it is via proxy voting or corporate governance. Corporates have long faced scrutiny over ESG performance, governments have remained largely exempt. There is ample research in the market with regards to companies’ progress on sustainability as well as a market standard of how to assess corporates, but there is no satisfactory equivalent for sovereign bonds.

As stewards of our clients’ capital, we understand that we have a fiduciary responsibility to always act in our clients’ best interests. We have started to integrate ESG into our investment processes within our Multi Asset Solutions team, not only because it is the right thing to do, but because we believe that this will deliver better long-term returns for our investors. From a practical perspective, sustainability factors can – and do - have a material impact on long-term performance and profitability. Our aim is to ensure the companies and countries we invest in are responding to a fast-changing world and looking into the future to address major ESG issues.

At Eastspring Investments, we believe it is important to analyse sovereign bonds with an ESG lens, even if there is less engagement with the sovereign bond issuer versus equity issuers. Countries with higher ESG ratings are less exposed to risks that are not captured in regular credit ratings, and therefore are more likely to be future-proofed. We believe more attention needs to be placed on governments, both because of the important role governments play in environmental, social and governance outcomes, and also because of the huge size and importance of sovereign bonds as an asset class.

When it comes to sustainability, government policy is critical. For example, if a country issued a law stating that all companies must reduce their carbon footprint or ban plastic bags, then all companies would be forced to respond. Therefore, sovereign countries are key in enforcing policies to improve the environmental, social and political landscape. We believe they will likely utilise the Sustainable Development Goals (SDGs) initiative set out by the United Nations as guide rails on the path forward.

While we cannot necessarily influence policy directly, we believe we can do our part by taking a stance when it comes to our investment decisions. There is a lot of information publicly available on ESG, but we found nothing suitable that is collated into a process for sovereign bonds (as there is for corporates). For this reason, we developed our own government scorecard (using publicly available data) that looks at 43 countries in the sovereign bonds’ investable universe. It weights E, S, and G equally and the total score incorporates both the current standing and its improvement over the last three years. This scorecard serves as an integral part of our macro investment process. For example, if we have the same view on Swedish and German interest rates, we will likely favour Swedish government bonds in our portfolio, given their higher ESG score. This scorecard is a tool that best captures how we should view sovereigns from an ESG perspective and how this view can potentially have a positive impact on our clients’ portfolios, whilst working towards financial markets that are focused on sustainable capitalism.

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Macro analysis is crucial to our investment process, but we also need to demonstrate to governments and asset owners that ESG considerations are important. This means that we need to account for where governments are today and look at the progress they have made in terms of sustainability.

Whilst looking to develop our ESG processes, we canvassed thought leaders in investment research about how they approach sovereign bonds, finding that they are not commonly included in ESG assessments. The reasons ranged from it being too controversial to issues concerning assessment, highlighting that there was no standard for evaluating sovereigns’ ESG scores like the one that exists for corporates.

There are a few research houses that have sovereign scorecards; however, we found that they were more subjective than we would prefer for three key reasons. First, other scorecards have some construction biases by not allocating equal weighting to the three pillars. We believe that each pillar is equally important when it comes to sustainability. Currently, there is no absolute basis for deciding which of the three is most important, therefore we weigh each pillar equally to provide a balanced rating which does not overly penalise developing countries where the G (political and legal system), for example, is often still developing. However, we respect that different asset owners might have different ESG priorities.

Second, the other scorecards do not account for momentum in a country’s progress and / or improvement on ESG factors. This is particularly important for developing countries, since they are at different stages in the evolution of their economic, social and legal rights than their developed peers (i.e. services-based vs. manufacturing-based economies). Also, developed countries such as Sweden and Norway have been focusing on ESG for longer than other developing economies. A country’s improvement in ESG factors is important in helping us identify countries with positive momentum in making significant improvements. It is not about punishing bad behaviour but rewarding good behaviour. Behaviour can be measured through the improvement score, as this identifies the actions the country has or hasn’t been taking in the last three years. By looking at the improvement score, governments’ declaration of commitment to SDGs and other claims of ESG behaviours are not merely cosmetic. They become measurable.

Finally, we limit the universe to the investable and liquid sovereign bond universe. Other scorecards rank everything from Afghanistan to Zimbabwe. In our view, this skews the rankings. Our scorecard is not meant to be an academic exercise, but a practical tool for shaping investment processes.

Ultimately, we believe that by considering and evaluating the ESG progress made by sovereigns, our Multi Asset Solutions team at Eastspring can make investments that present less risk and are future-proofed, which is in line with our investment philosophy. Read the MAS Government Bond Scorecard whitepaper You can also hear more from the Multi Asset Solutions team.

1 ibid
2 World Bank. October 2018.
3 Earnings growth estimates from Goldman Sachs as of 21st June 2019. GDP growth estimates from International Monetary Fund (IMF): World Economic Outlook “Growth Slowdown, Precarious Recovery”, April 2019.
4 Infrastructure and Growth: Empirical Evidence. OECD Economics Department Working Papers No. 685
5 World Bank. October 2018.
6 CRISIL Infrastructure Yearbook 2018, October 2018.
7 S&P Global Company, CRISIL. CRISIL Inclusix – India’s Financial Inclusion Index.
8 Statista.
9 India Brand Equity Foundation. May 2019.
10 Market Research Future
11 World Economic Forum. Future of Consumption in Fast Growth Consumer Markets: India. January 2019.
12 Bain PRICE Consumer Survey 2018 (n=5100). Figure shown is representative of the upper-mid income levels.
13 IBEF.
14 10 July 2019.
15 Citi Investment Research. July 2019.

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