ESG in sovereign bonds: treading the thin line between engagement and politics

Engagement with sovereigns ensuring bond investments are environmental, social, and governance (ESG)-compliant doesn’t have to be politically sensitive - but you need to be careful.
ESG in sovereign bonds: treading the thin line between engagement and politics

Monitoring environmental, social, and governance (ESG) performance isn't always easy, especially when gauging the "G", or governance, of authoritarian governments where transparency is in short supply.

In places where investigating the ESG benchmarks of a government bond, for instance, can be seen as political interference, investors need to be circumspect.

Asset owners are encouraged to work more closely with fund managers to define clearly what ESG factors they want to see when investing in government debt, and then work on various "non-controversial" ways to improve engagement with the target country.

Jose Garcia-Zarate

“In general terms, one can test the ESG credentials of any issuer by comparing and contrasting rhetoric versus actions," said Jose Garcia-Zarate, associate director of passive strategies at Morningstar. "To do this one can use available data sources on ESG issues plus active ownership activities such as direct engagement."

“For bond investors, engagement becomes crucial as they don’t have the ability to influence an issuer via proxy voting,” he added.

Equity investors have channels such as voting rights or participation in annual general meetings, allowing them to engage directly with issuers and collect information. But not all bond investors have such channels. 

The bulk of metrics currently used to assess ESG credentials of governments are similar to those used in traditional credit rating analysis, and there is no consensus about how to incorporate an ESG analysis into politically sensitive issues such as, for example, a government’s record on human rights.

The consequences of excluding or underweighting in portfolios is also an unknown, Garcia-Zarate noted.

Carmen Nuzzo


“We’re encouraging our signatories both on the equity side and on the bond side to engage with issuers. The challenge with sovereigns is that sometimes this engagement can be perceived as political interference, or lobbying and advocacy,” said Carmen Nuzzo, head of fixed income at Principles for Responsible Investment (PRI).

PRI has over 4,000 signatories across the globe, with 648 (15%) asset owners as of Sunday.

“When it comes to authoritarian governments, it becomes even trickier,” Nuzzo said. “We acknowledge that in some instances it may be difficult because the government is not open to this type of dialogue.”

But things have been improving in recent years. She recalled that many Asian authorities asked PRI what they could do to attract more foreign investment during her last visit to the region two years ago.

According to data released by Bloomberg and Amundi, Asia has accounted for 80% of emerging markets (EM) green bonds issuance in 2021. EM sovereign debts, especially Chinese government bonds, are offering attractive yields above 2%, while yields in developed markets hover around 1%, and at times fall into negative territory.

Source: Amundi, Bloomberg, as of Aug 2, 2021 (Click for full view)

Language can be a barrier for foreign investors. One of the solutions is very simple - to publish more material in English, Nuzzo said. "Things like that are part of an engagement that is aimed at improving disclosure and transparency.”

She said there was a perception that engaging with governments always involved criticising them at some level.

“But that's not necessarily true. Just establishing a relationship and having an ongoing conversation can be quite significant,” Nuzzo stressed. “It's really first and foremost about gathering insights and information and encouraging sovereigns to improve disclosure where data are missing.

"It is [also important] to convey expectations without necessarily having the objective of influencing policy,” Nuzzo said.

For example, on climate change, there are lots of opportunities to engage with the Chinese government, and they, in turn, are quite eager to engage and make progress, she noted.

China, a signatory to the Paris Agreement, has pledged to achieve net-zero by 2060.

“So it's quite legitimate to ask what the targets are, what are the plans to achieve those targets, and how much the costs are relating to these plans in achieving those targets,” Nuzzo said.

“There might be certain issues that are [politically] sensitive, but the engagement doesn't necessarily have to be controversial or negative.”

She said other examples included the Saudi government, which is engaging more frequently with investors than it has in the past as the government begins to diversify its income sources away from oil and investing more in renewable energy.

Asset owners are also encouraged to engage in a noncontroversial way with people and institutions outside the ruling party, Nuzzo said. This includes engagement with various ministries with the opposition parties, local NGOs, credit rating agencies, or with local think tanks.

Other choices also include media, trade unions, or international organizations such as the World Bank, the International Monetary Fund (IMF), or the European Commission, which publish country reports regularly, she added.

Thu Ha Chow


One of Japan’s largest life insurance companies, Dai-ichi Life Insurance, told AsianInvestor in May that quantifying greenhouse gas emissions on government bond investments was complex.

It said it was challenging to clearly define the components of government emissions, or whether it is just the aggregation of corporate emissions. 

A spokesperson of the life insurer declined to comment on whether there had been any progress, saying these concerns were still under consideration.

“It’s the sum of all greenhouse emissions produced by all types of economic and human activity in that country. What a farmer does counts, what we do as private citizens also counts, the infrastructure and energy mix of a country also counts, and so on. So it seems to be much more complex than just adding up emissions of corporations,” Morningstar’s Garcia-Zarate said.

Thu Ha Chow, a portfolio manager and senior credit strategist for the emerging markets debt team at Loomis Sayles, a Natixis affiliate, said she believed it was critical for asset owners to define specifically what their ESG targets are and what kind of impact they want to have on society and nature, and work more closely with fund managers to realize those targets. 

"As an asset manager, you have to be very careful to distinguish between political opinions versus a scientifically based fact," Chow said. 


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