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ESG Data Spotlight Shines on Sovereign Debt and its Challenges

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The ESG lens is being focused on sovereign bonds, considered by many observers as the next frontier for sustainability data.

The Assessing Sovereign Climate-Related Opportunities and Risks (Ascor) project has launched a framework for assessing government debt that it hopes will develop into a standalone tool. The organisation, which comprises asset owners and managers that control around US$5 trillion in assets, said the tool would fill an “analysis dearth” in the sovereign space.

“The framework sets out a common basis to assess individual country climate change approaches and will reinforce public disclosures to aid investors to understand sovereign action and progress,” Ascor said. “It builds on existing data but will also further enable issuers to detail material information, so that investors can more effectively support country transition plans.”

Growing demand for broader integration of ESG factors in sovereign bond portfolios have largely prompted louder calls for data on the governments that issue bonds on public markets. Slow progress by some countries to implement their carbon-reduction pledges under the Paris climate agreement have intensified scrutiny of government activities.

Recent sudden shifts in the geopolitical landscape have also accelerated calls for more comprehensive data sets. For instance, countries including the UK and Germany have been criticised for appearing to soften their opposition to coal-generated power in the wake of the Ukraine invasion. And across the rest of the ESG spectrum, allegations of human rights abuses by national governments and poor governance in some capitals have led to unease over investment in some sovereign issuers.

ESG Integration

Ascor presented its proposals in a consultation paper released last week. It said the framework would be built on data about issuing countries’ sustainability plans and their net-zero transition programmes – and progress towards their carbon-reduction targets.

Financial institutions have often been unable to integrate ESG into sovereign debt portfolios because the data is lacking and the framework for assessment is complicated.

On the data gaps, asset manager Franklin Templeton, an Ascor signatory, said the absence of “a universally coherent way to assess sovereign debt from a climate change perspective” was at the heart of the problem.

“Investors do not have consistent data for their financial analysis; their ability to have informed engagement with and to support national climate action is constrained; and, subsequently, the climate-related investment case is unclear,” it wrote in a response to the Ascor consultation report.

Nations have begun selling green bonds, nevertheless. Chile, Germany and Poland are among recent issuers and the UK is preparing to sell its latest, a £2 billion 1.5%, 30-year green gilt, at the end of this month. UK green gilts’ proceeds are used to “fund finance expenditures in clean transportation, energy efficiency, renewable energy, pollution prevention and control, living and natural resources, and climate change adaption”, the government says.

Insufficient Detail

Britain’s lack of specific use-of-proceeds details illustrates the second problem associated with assessing sovereign bonds: it’s not easy to do so.

At last year’s A-Team ESG Data and Tech Summit in London, Citi head of sustainable finance Jason Channell said sovereign bonds would be the “next big thing” in ESG but added due diligence research would be “complicated”, even with enough data.

Unlike corporate bonds and green bonds, whose sustainability can be judged by the stated uses of the debt sale’s proceeds – often single projects with an ESG goal – sovereign debt usually isn’t issued with a sole project in mind.

Channell told the summit, a “very broad range of policies” would need to be assessed when deciding whether to invest in sovereign bonds. When an issuer provides few specifics on the purpose of its green bonds, investors would have to be sure they can trust the governance of a nation to lend to it, he said.

The Ascor consultation paper comes as experts predict growth in sovereign green bond issuance. The Organisation for Economic Cooperation and Development forecasts that the green bond market will be worth about $5 trillion by 2035.

Issuance jumped 103 per cent following the COP27 in Glasgow, Scotland, in 2021, according to the Climate Bonds website. Cumulative sales had climbed to US$193 billion by the end of that year compared with $95bn the previous year.

Among issuers, were 40 emerging market nations, the World Bank said. It noted late last year that the number was expected to grow this year as the world’s poorest nations seek to gird themselves against climate risks.

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