PRI study: ESG factors influence countries’ economic development and sovereign debt

Environmental, social and governance (ESG) factors are “material” in the $47 trillion sovereign debt market, according to a new study by the Principles for Responsible Investment (PRI).

The UN-backed initiative’s report, Sovereign Bonds: Spotlight on ESG Risks, aims to make the risks clear to its 1,231 signatories.

Sovereign debt is bonds that are issued by governments in a foreign currency, with the aim of helping the country’s economy grow. The amount of risk involved depends on whether the country issuing the bonds is a developed or developing one, as well as the stability of the government.

The PRI’s study, conducted by its Sovereign Fixed Income Working Group, says ESG analysis helps investors further get to grips with sovereign credit risk.

It adds that investors want credit rating agencies to include ESG factors in their analyses of the asset class.

“While ESG analysis has been applied increasingly to equities, few have put it to the test in fixed income until now”, said James Gifford, the PRI’s executive director who recently announced he would be stepping down from his role in November.

“Stung by market volatility during the euro crisis, institutional investors are now applying ESG analysis to their sovereign bond portfolios and using it in their selection criteria to appoint asset managers. Given the sheer size of the sovereign bond market and compelling evidence that these factors are material to both creditworthiness and investment performance, the challenge is now on others to act.”

The sovereign debt crisis, also known as the eurozone crisis, has been ongoing since 2009. Many countries, including Greece, have been unable to repay their government debt, which has prompted third parties to pitch in.

Florian Sommer, senior strategist at Union Investment and chair of the PRI’s Sovereign Fixed Income Working Group, said, “ESG factors influence the economic development of countries. They also played a role in the current sovereign debt crisis.

“Investment research today still largely fails to make the link between ESG and credit risk, despite growing evidence to the contrary. This working paper seeks to change this by putting the spotlight on sovereign ESG risks.”

Further reading:

Investment reports reveal widespread use of ESG integration

Responsible investment is ‘an inevitable movement in society’

Should bond investors think green?

Poor ESG records scupper private equity deals

The Guide to Sustainable Investment 2013