Verisk Maplecroft & BlueBay: ESG factors are impactful in sovereign bonds

May 24, 2019

Global risk analytics company Verisk Maplecroft and fixed income specialist BlueBay Asset Management (“BlueBay”) have released a joint research report that uses a new way of measuring country environmental, social and governance (ESG) factors to reveal the extent to which they genuinely matter in sovereign debt investing.

The findings of the research highlighted a number of important results:

• Once all economic differences are factored out, the research shows spreads of the best overall ESG performers are approximately 70% lower than those of the worst.
• Governance performance is considered particularly important, with a 1-unit overall improvement being associated with nearly a 13% reduction in spreads. However, under certain circumstances investors are warier of the political risks associated with democracies than they are of those associated with authoritarian states.
• Markets do not appear to be pricing in environmental or climate risks and either ignore or penalise better environmental performance.
• While investors do partly price in physical climate change exposure, the data also shows that the most climate change-exposed countries are, in general, also the most biodiverse – and that markets reward countries for having substantial natural resources still available to use.
• Investors also still appear to prefer countries with ineffective environmental regulations and which are not making efforts to decarbonise.
• Collectively, these patterns suggest that the strategic focus of institutional investors on environmental and climate risks has yet to translate into meaningful changes in trading behaviour in sovereign debt markets.

Aimed at supporting the development of sovereign ESG investing, ‘The role of ESG factors in sovereign debt investing,’ introduces an innovative way of measuring sovereign ESG across 198 countries, using over 80 risk factors assessed by Verisk Maplecroft, that arguably differentiates and identifies investment-material momentum more effectively than traditional methods.

The work also comprehensively quantifies the relationship between ESG and sovereign bond pricing in 97 developed, emerging and frontier markets between January 2013 and May 2018.

Speaking about the findings of the research, James Lockhart Smith, Head of Financial Sector Risk at Verisk Maplecroft, said, “Our work strengthens the case for sovereign debt investors to factor in ESG, which has so far proved difficult to achieve, and helps address the challenges of non-linearity and complexity in country ESG. The evidence shows that environmental or climate risk is still being underestimated as a risk factor by investors and indicates the potential for market repricing once perceptions change.”

Jana Velebova, Senior Portfolio Manager, BlueBay Asset Management, said, “The extensive analysis has quantified some assumptions we have made about ESG investing in sovereign debt, and has provided valuable insight into potential areas of mispricing, or where risks are not yet being appropriately priced. From an investor and portfolio performance perspective, the research highlights the case in favour of systematically including ESG as an element of sovereign risk analysis, and points to the usefulness of engaging with sovereigns on ESG."

Verisk Maplecroft and BlueBay plan to continue their research to analyse further connections and correlations between ESG and sovereign bonds.