Sovereign Bonds: Spotlight on ESG Risks

Sovereign bonds issued by developed countries had long been considered a safe haven for institutional investors’ assets. The euro crisis has reminded us that the debt of the highest-rated countries can be volatile. The PRI’s Sovereign Fixed Income Working Group set out to explore the use of environmental, social and governance analysis as a potential risk-reducing, return-enhancing tool when added to the traditional mix of financial and economic data and political risk. The results of this exercise are presented in this study.

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Section 1 looks at what’s at stake: the sheer size of the sovereign bond market and the stabilising role it has played in the portfolios of pension funds and other institutional investors.

Academic and investor research highlighted in Section 2 shows correlations between ESG factors and credit risks, for example, corruption and sovereign bonds performance are clearly correlated.

The research and experience of working group members with regard to materiality, summarised in Section 3, indicates that ESG factors can be material to both creditworthiness and investment performance. Given these compelling results, the challenge to others is to act on the information that is increasingly available.

One of the most commonly debated items on the sovereign bonds agenda is the role of the credit rating agencies. Section 4 highlights what many working group members see as failings in the approach of these companies, and the opportunity to get them to incorporate ESG analysis. In discussions and interviews, the working group and rating agencies have both expressed the need for ESG data presented in a format they can apply. Service providers are rising to the challenge of providing reliable quantitative and qualitative information, as is discussed in Section 5.

You can download the study here.

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